When Birks & Mayors reported that total corporate sales for the three months ended December were up 6.4 percent, but same-store sales were down 6 percent, the disparity between those two numbers caught our eye.

 

We’ve seen this kind of dramatic spread between total sales and same-store sales in high growth companies where there are a large number of new stores that are contributing to sales, but sales from those new stores aren’t included in the same-store sales base (sales from new stores are typically included in the same-store sales base 12 or 13 months after opening). Despite the hard work that Birks & Mayors’ President Tom Andruskevich and his team have done to turn Mayors Jewelers around and build Birks, we can’t categorize Birks & Mayors as a “high growth company.”

 

For the three-month period ended December 2007, Birks & Mayors’ total sales were about $122.6 million versus a revised $115.3 million in last year’s December quarter, a gain of 6.4 percent year-over-year. Corporate same-store sales were down 6 percent, with same-store sales down 4 percent in Canada (40 stores, of which 38 are in the same-store sales base) and down 7 percent in the U.S. market ( 31 stores, 29 of which are in the same-store sales base).

The following table summarizes financial results for Birks & Mayors’ December 2007 quarter.

Sales Gain Driven by Three Key Factors

The company cited three factors that drove the strong total sales: 1) two new Mayors Jewelers stores in Florida; 2) two acquired Brinkhaus stores; and 3) a currency translation adjustment.

 

In an effort to help explain the disparity between total sales gains and the same-store sales decline (roughly 1,200 basis points), we investigated each component of its total sales gain. Here are our conclusions.

 

• Currency translation of $8.2 million – The company disclosed that the strengthening Canadian dollar added about $8.2 million to revenues, which are reported in U.S. dollars. If the currency translation is eliminated, sales in constant dollars in the December 2007 quarter would have been $114.4 million, down just under 1 percent, instead of the $122.6 million which was reported.
  
  Currency translation is more than just an accounting entry. When currency values swing, they can affect dollars flowing through the cash register till. For example, in the fourth quarter of 2006, each Canadian dollar-denominated sale that Birks booked added about $0.85 to the company’s revenues in U.S. dollars. In the fourth quarter of 2007, that same Canadian dollar of sales added about $0.98 of sales to corporate revenues in U.S. dollars. In short, if unit sales had been flat in the fourth quarter of both years, “booked” revenues from Canadian dollar-denominated sales would have been about 15 percent higher in 2007 versus the prior year.

• Brinkhaus added an estimated $3.8 million to total sales – Annual sales at the two acquired Brinkhaus stores (one in Calgary and one in Vancouver) are about $15 million (Canadian). Management disclosed that the Brinkhaus stores contributed $3.8 million of sales in the November-December period; this represented an estimated 3 percent of sales in the December quarter. Thus, if revenues from Brinkhaus are removed from the quarter, sales would have been about $110.6 million, a decline of about 4 percent from the prior year (after eliminating currency translation).
  
  We believe that Brinkhaus did not meet its sales budget for the holiday selling season. Assuming that the seasonality of Brinkhaus’ sales is similar to most specialty jewelers, it would have normally generated about one-third of its annual sales in November and December, the two months that Birks & Mayors owned the chain. Under this scenario, Brinkhaus should have contributed about $5 million in sales. Sometimes high-end jewelers experience less seasonality, but we believe that the reported $3.8 million was below plan, especially since demand in the company’s Canadian markets was so weak in December.

• Two new Mayors stores added an estimated under $2 million to sales – Calculating this number is a bit more problematic. The typical Mayors store generates sales of about $4.4 million annually. The two new stores are immature, so they generate significantly less than the corporate average – first-year revenues are probably about 60 percent of a mature store. “Back of the envelope” math suggests that each of these two new stores contributed perhaps $800,000 each of revenues in the December quarter, adjusting for the reported soft demand in the Florida market.
  
  So, adjusted corporate revenues for the fourth quarter, excluding currency translation, revenues from the acquired Brinkhaus stores, and revenues from the two new stores would have been about $109 million, or down about 6 percent, about in line with the reported same-store sales decline.

Reported sales were also affected by deflationary retail pricing in the company’s Canadian market. In an effort to offset price differentials between the same goods sold in the U.S. and Canadian stores (and to stop Canadians from traveling across the border into the U.S., armed with very strong Canadian dollars, to buy those same goods at a lower equivalent price), Birks’ stores reduced prices on selected merchandise in the December quarter.

 

This was not an across-the-board price reduction; rather only certain merchandise was affected. It is not possible to reliably calculate the impact of this deflationary pricing on reported revenues for Birks & Mayors. Management said that the price reductions helped boost sales in its Canadian stores.

 

Further, like most merchants, Birks & Mayors reported that customer traffic declined in its stores, worsening in December. For the October and November period, Canadian same-store sales were up, but declined sharply in December. In the U.S. market, same-store sales were down in all three months, with the largest decline in December.

 

Brands Drove Sales

In the fourth quarter, the strongest product categories for Birks & Mayors were as follows:

• High-end branded timepieces
  • Most prestigious brands
  • Most complicated watches
  • Most expensive watches
• Van Cleef boutique goods (in five stores)
• Birks’ galleries in Mayors stores
• Branded jewelry
• Mayors’ “crown jewelry” sales priced $20,000 and higher
• Collections

The weakest category was diamond jewelry, particularly bridal jewelry. Company management said that consumers either traded down or put off jewelry purchases.

 

Other Financial Results Mixed

Despite disappointing sales, Birks & Mayors’ same-store inventory levels declined by 1 percent due to new inventory management policies which the company has implemented. This is in contrast to most jewelers who reported a sharp increase in same-store inventories.

 

However, the decline in corporate same-store sales had a negative impact on operating margins. The company’s gross margin declined to 48.5 percent from last year’s 50.0 percent due to two key factors: 1) a higher sales mix of timepieces which carry an inherently lower margin; and 2) reduced retail prices in the Birks Canadian stores. Further, its operating cost ratio rose to 30.4 percent of sales in the December quarter from 29.4 percent last year due to three key factors: 1) currency translation; 2) higher marketing costs; and 3) expenses associated with two new stores and two acquired stores. There was somewhat offset by lower compensation expense, probably related to lower commissions and bonuses as a result of reduced sales levels.

 

Management’s outlook calls for a total sales gain in the mid-single digit range for the fiscal year ending March 2008, but earnings are expected to be substantially below last year’s levels.