Most jewelers attempted to offset lower gross margins by cutting expenses. In general, they were successful.

 

However, far too many jewelers reported that they had cut back on sales associates’ hours in the store. In the long term, that is a killer strategy: it will kill a retailer. While sales salaries are one of the easiest expense categories to reduce, sales associates are the foot soldiers of the army. Without adequate soldiers fighting for market share, jewelers will lose the war to other merchants who maintain or increase sales people, when the going gets tough.

 

Pretax Margins Deteriorate

Gross margins were down, but the decline was somewhat offset by reduced expenses. Interest expense was slightly higher, and other expenses were generally flat. Thus, most jewelers reported only a small deterioration in their pretax margin.

 

We estimate that jewelers’ pretax margins fell by about six-tenths of one percentage point in the first quarter of 2007 versus the same period last year.

 
The graph below summarizes pretax margins (in some cases, segment operating margins) for the major publicly held jewelers.

 

Jewelers' First Quarter 2007 Pretax Margins Flat to Down Source: Company Reports

 

GUILD JEWELERS

Despite generally strong sales leverage, publicly held guild jewelers reported mixed results related to their expense ratios: some were lower and some were higher, as a percentage of sales.

 

Tiffany & Co. – Tiffany’s operating expense ratio fell in the quarter to 41.4 percent of sales from 42.1 percent last year. The following factors had an impact on its operating expenses.

 

• Strong sales helped leverage relatively fixed expense components in the company’s operating costs.
• Store costs and marketing expense rose.
• Most other expenses rose in line with sales or the number of stores in operation.
• Tiffany’s reported pretax margin declined to 12.6 percent of sales from last year’s 13.0 percent. This was due to gross margin erosion, offset partially by an improvement in the operating cost ratio.
• In the U.S., Tiffany’s operating margin fell to 14.6 percent from last year’s 16.2 percent. This was largely due to a decline in this division’s gross margin.

Harry Winston – Harry Winston’s operating cost ratio rose sharply to 49.7 percent from 45.0 percent last year. Several factors had a negative impact on the operating cost ratio.

 

• Expansion costs were significant in the quarter.
• Salaries and benefits rose.
• Rent and building expense increased.
• Amortization costs were higher.
• Professional fees and other costs also rose in the quarter. Last year, for example, audit fees rose by 96 percent.
• The company’s goal is to reduce Harry Winston’s operating cost ratio to 44 percent of sales, and further reduce it by 1 percentage point per year.
• For the quarter, Harry Winston lost money versus earning a profit last year. This year’s loss was about $3.4 million, a $4.4 million reversal from last year’s $1.0 million profit. The company’s retail segment operating margin was a loss of 5.8 percent this year versus a 2.0 percent profit margin last year.
• The mining segment of Aber Diamond’s business generated sales of nearly $83 million and profits of about $21 million. This strong performance helped offset profit weakness at Harry Winston.

Birks & Mayors – The company’s operating expense ratio declined modestly to 47.6 percent of sales versus 47.9 percent last year. The following factors had an impact on operating costs.

 

• Cost controls in the Mayors division had the most impact on operating expense levels in the quarter.
• In the fourth quarter, the company had a negative tax rate. Its accountants have agreed that the NOLs (net operating loss carryforwards) from its Canadian division will likely be recognized by taxing authorities. The U.S. division still has NOLs amounting to about $70 million that are not on the books; these could possibly be used in the future to abate taxes.
• Overall, the March quarter operating loss was reduced to $2.4 million from last year’s $3.6 million. The net after-tax loss this year was $1.9 million versus a loss of $5.8 million last year.

Movado Boutiques – Movado does not report the operating cost ratio for its retail division as a separate line item. However, the operating loss in the Movado retail division (both Boutiques and Outlet stores) rose significantly in the quarter to $1.66 million from last year’s loss of $1.25 million.

 

• The retail segment’s operating margin was a loss of 9.1 percent this year versus a loss of 7.5 percent this year.
• The company cited three reasons for higher operating costs for all of its operating divisions.
• Retail expansion
• Increased customer support
• Higher levels of equity compensation
• Weak sales in the Boutique division de-leveraged fixed costs and drove up the operating cost ratio.
• Movado also reported that its operating margin in the wholesale watch division declined to 5.3 percent of sales from last year’s 5.8 percent of sales.

MASS MARKET FASHION JEWELERS

Like guild jewelers, mass market fashion jewelers reported mixed results for their operating cost ratio.

 

Finlay Enterprises – Finlay’s operating cost ratio fell to 47.5 percent versus last year’s 49.6 percent. The following factors had an impact on its operating costs in the quarter.

 

• The company controlled store level payrolls closely.
• There was significant same-store sales leverage, especially from the specialty stores.
• For the quarter, Finlay reported a pretax loss of $10.8 million, or 6.5 percent of sales, versus a loss of $10.5 million, or 7.0 percent of sales, last year. Our records go back ten years; the company has never posted a profit in the first quarter during that period.

Sterling Jewelers – Signet does not report expense levels by operating division. However, it does report operating profit by operating division.

 

• U.S. expenses were up due to marketing costs, mostly related to the timing of promotions for Mother’s Day.
• Bad debt levels have not risen, and are tightly in line with historical levels.
• U.S. operating profit was $59.9 million, down modest from last year’s $62.7 million. The operating margin was 9.5 percent, down from last year’s 11.2 percent. About half of the decrease in the operating margin was due to timing differences in marketing expense.

Zale Corporation – Zale’s operating expense ratio rose sharply to 47.7 percent of sales from last year’s 45.8 percent. The following factors had an impact on its operating expense ratio.

• A major portion of the operating expense increase is related to the lack of sales leverage. With a decline of 3.4 percent in same-store sales, Zale’s relatively fixed overhead costs were de-leveraged.
• Management cited several factors that hurt operating expenses, including higher occupancy costs (largely fixed to a point), higher labor costs, greater promotional costs (de-leveraging at work here), and costs related to the settlement of a lawsuit.
• Management noted that it is spending more on training. Mystery shoppers have often cited sales associates as a weakness at Zale.
• Unfortunately, the year-over-year comparison is not “clean.” If the $8.7 million of deferred revenue had been included this year, the operating cost ratio would have been 47.2 percent (still well above last year’s levels).
• Excluding $5.0 million in severance and store closing costs last year, the operating cost ratio would have been 44.9 percent, rather than 45.8 percent.
• The bottom line is that Zale’s operating cost ratio rose sharply, and was the major cause behind the company’s loss this year versus a profit last year in the quarter ended April.  
• Zale posted a small gain in the first quarter from the use of derivatives.
• The following table summarizes sales and operating earnings for Zale by division. As is clear, Zale’s operating profits have plummeted in its operating divisions, and they are down in its insurance (and reinsurance) division. Further, unallocated profits (and losses) are significant; we are surprised that the “unallocated” numbers are so large. In the quarter ended April 2007, unallocated loses were $5.9 million versus a pretax loss of about $5.0 million. That’s a lot of loss that cannot be tracked back to an operating division, in our opinion.
  

 

ONLINE JEWELERS

Online jewelers also reported mixed results for their operating cost ratio. However, like virtually all of the other jewelers, a combination of a lower gross margin and some erosion in their operating cost ratio yielded a lower pretax margin.

 

Blue Nile – Blue Nile’s expense ratio declined in the quarter to 14.1 percent of sales from the same quarter a year ago when the expense ratio was 15.1 percent of sales. The following factors had an impact on the company’s expense ratio.

 

• Strong sales leveraged relatively fixed operating expenses.
• An increase in stock-based compensation offset some of the positive impact of the sales leverage.
• Blue Nile’s after-tax margin was 4.7 percent in the quarter, up from last year’s 4.6 percent.
• Its pretax profits were up over 33 percent, and its after-tax profits were up over 34 percent.

Abazias – Abazias.com reported that its operating expense ratio rose in the first quarter.

 

• On a comparable “apples-to-apples” basis, Abazias’ operating cost ratio increased to 17.5 percent of sales from last year’s 13.2 percent of sales. We believe this is related to increased expenses associated with its sales growth.
• On a reported basis, Abazias’ operating cost ratio was 85.2 percent of sales, but this included non-cash stock-based compensation.
• On a roughly comparable basis, the company lost about $200,000 (on sales of $1.6 million) this year versus a loss of about $50,000 last year (on sales of $1.1 million).

Bidz.com – The operating cost ratio rose to 10.8 percent of sales from last year’s 9.7 percent.

 

• Increases in payroll, outsourcing and administrative expenses drove up costs.
• Sales and marketing expenses were 5.8 percent of sales, down from 6.9 percent a year ago.
• The average cost to acquire a new buyer was $45, up 18 percent from a year ago.
• The company’s pretax margin fell to 7.9 percent of sales from the prior year’s 9.7 percent.