Two very important themes emerged from Signet Group’s second quarter financial report: The U.S. stores had an increase in the number of transactions and gross merchandise margin continued to rise.

 

• The number of jewelry transactions in Sterling’s mall stores (primary branded Kay, but including some regional brands) rose by 5 percent-to-6 percent in the second quarter. Despite a decline in traffic in U.S. malls, Sterling was able to increase the number of sales it made during the quarter. Management did not say whether these sales were to new or existing customers, but the question is moot. The point is simple: some jewelers are reaching out and increasing their customer transactions; this will position them to do much more business at much higher average tickets when the economy recovers.

• Sterling’s gross merchandise margin in the U.S. continues to rise, despite pressure from higher gold prices and competition. Management noted that there seems to be less frantic price-cutting by independent jewelers than earlier this year. Our surveys confirm this: jewelers who were barely hanging on earlier this year are now buying gold at very low prices and re-selling it near market prices; this is generating enough gross profit for them to stay in business without running new cut-throat price-based promotions.

While other jewelers struggle, Signet’s U.S. division is outperforming its competition handily. Terry Burman and his team run a tight operation; they rely heavily on research; they have state-of-the-art systems. So, it is no real surprise that they are posting better results than most of their mass market competition.

 

In the U.K., Signet’s sales are weak, though same-store sales on a constant-currency basis are not down quite as much as same-store sales in the U.S.

 

Despite weak sales, Signet posted an operating profit in both its U.S. and U.K. divisions. In the U.S., operating income was up marginally year-over-year, while it declined by more than half in the U.K. division.

 

The table below summarizes Signet’s key financial trends for both the U.S. and the U.K. division.

 

Second Fiscal Quarter Highlights

The following are highlights from Signet Group’s second quarter financial performance in its U.S. division:

 

• Total sales in the U.S. were down 4 percent in the three-month period ended July 2009. Same-store sales declined by 5.5 percent. However, same-store sales in its mall stores were broadly flat. The average selling price in Sterling’s mall stores fell by 5.7 percent; this was offset by a roughly equal increase in transactions, which yielded the reported “flattish” same store sales levels. In the higher end Jared division, same-store sales were down by 11.6 percent. This is no surprise, since upper-end jewelers are suffering worse than mass market jewelers in the current recessionary environment. In part, people are “shopping down”; in part, wealthier people have been harder hit, with the double-whammy of a stock market decline and diminished real estate values.
  
  Management noted that two key factors helped maintain sales levels in its stores: 1) differentiated merchandise such as the Leo Diamond and 2) new collections and merchandise. Further, it has developed new campaigns such as the Loves Embrace program which it tested during Mother’s Day. It is expanding its Jane Seymour line. Sterling clearly understands the concept that a merchant must offer a reason for customers to come into their stores: new, differentiated merchandise resonates with consumers, even in a recessionary environment.

• In the U.K., total sales on a constant-currency basis were down just 0.4 percent, while same-store sales declined by 4.3 percent. However, GAAP accounting requires companies to report sales after a currency exchange translation. Since the Pound Sterling weakened against the U.S. Dollar in the quarter, reported total sales in the U.K. were down 18.1 percent. We emphasize that the 18.1 percent is strictly an accounting measure; it does not reflect store-by-store performance which was nearly flat.

• Signet reported that its gross merchandise margin in the U.S. climbed by another 10 basis points in the second quarter; for the year-to-date, it is up roughly 60 basis points. Its gross merchandise margin increase has been fueled by a more favorable mix of merchandise (primarily more lower-priced goods which carry a higher gross margin) and lower polished diamond prices, but offset by higher gold prices. Signet’s gross margin trends in the U.K. market are also favorable.

• Its net bad debt in the U.S. rose by 110 basis points versus the same quarter a year ago to around 5 percent of total sales. Assuming that credit sales are about half of total sales, this means that bad debt represents about 10 percent of credit sales. In a period of rising unemployment and slow wage growth, bad debt typically rises. Sterling’s U.S. credit operation is in-house. Management noted that the approval rate is up 130 basis points year-to-date, but that credit participation (percent of sales made on the in-house credit program) is up about 20 basis points compared to last year’s levels.

• Management says the company is on track to cut roughly $100 million of expenses this year. Some areas have been almost completely eliminated: with few new stores planned, most store planning and opening personnel have been eliminated. Other areas have seen their budgets reduced, as well.

• Management noted that it will be closing about 75 stores this year in the U.S., mostly regional brands in malls with a Kay store, in order to “de-risk” the business. Net store square footage is expected to decline by about 2 percent this year, and by about another 1-2 percent in 2010 (fiscal year ending January 2011). The following table summarizes store openings and closings (due to rounding, changes in square footage, and other factors, totals and percentage calculations might not appear correct):

Source: Company reports

• Advertising is important to Sterling, and it plans to continue spending about 6.5-7.0 percent of sales on advertising. Advertising helps maintain and promote brand awareness, business intent, purchase intent and creates a more robust sales base that will be a springboard for sales, when the economy strengthens. As a result, Sterling says its “promotional cadence” (but not spending) will remain higher than normal, especially in the upcoming holiday selling season. It plans to redeploy spending from radio and print to national television. While Kay impressions will be down mid-single digit levels from last year, Jared impressions will be up modestly. Advertising and marketing is also allowing Sterling to take market share, especially with a higher number of jewelers going out of business.