Like most jewelers, Sterling Jewelers’ financial results are under stress in the current weak environment. Profits were down in the first quarter ended April 2008, while total sales were flat in the U.S., while same-store sales slipped by 4.7 percent.

 

In a conference call with Wall Street analysts, management outlined four major factors that had an impact on the company’s financial results:

 

• The retail environment remains very difficult.
• New store growth has slowed, and more stores will be closed this year.
• Retail prices have been raised.
• Bad debt levels are rising significantly.

The following table summarizes financial results for the three-month period ended April 2008.

 

 

Highlights of Sterling Jewelers’ first quarter financials are as follows. These results are for U.S. stores only.

 

• Despite the weak retail environment, the company’s gross margin in the U.S. rose by 50 basis point over last year’s first quarter. Further, the average transaction was up by 7 percent in the mall brand stores (Kay and regionals), and it up by 6 percent at the superstores (Jared). However, management cautioned that these financial trends are less relevant than usual, in part because the company was adjusting prices and promotional activities.

• Management’s goal this year is to maintain its gross margin at last year’s levels. Despite the strength of the first quarter, we won’t know if this goal can be achieved until the conclusion of the all-important fourth quarter. Further, the merchandise sales mix, the level of price-based promotional activity and the cost of precious metals and gemstones will also have an impact on overall gross margins for the company.

• The company’s operating profit margin in the quarter was 7.2 percent, down 230 basis points from last year’s 9.5 percent. However, this is better than some jewelers who are reporting losses at the operating level.

• The most important financial change related to bad debt levels. The company’s net bad debt charge increased by 70 basis points versus the same period in 2007. Further, it is outside of the tight range that the company has maintained over the past ten years. However, additional interest and fee income from the credit portfolio helped offset somewhat the overall increase in bad debt levels.

• Sterling is experiencing more customers requesting credit to finance their purchases; unfortunately, credit approval rates are lower. Still, the credit/cash customer ratio increased by 170 basis points in the first quarter of this year. Historically, just under half of all of Sterling’s customers have utilized credit to purchase jewelry.

• Virtually all classes of consumers who use credit are taking longer to pay down their balances, and more are delinquent than historic trends.

• When an account has not made a payment for three months, Sterling expenses the balance due as a provision for bad debt. At about seven months, the asset is totally written off, though this has no impact on financials, since the bad debt expense is taken at the end of 90 days when there is no payment activity on the account. This is an accounting nuance; however, it is important to understand how Sterling handles its bad debt “provision” versus writing off the asset totally. When the account is still in the “provision for bad debt” category (roughly three months after no payment activity), the receivable is still shown in “customer accounts receivable.” When the asset is written off (roughly seven months after any payment activity), it disappears from accounts receivable and from the “provision.”

• This year, net new store openings will add 4-5 percent new space to Sterling’s store portfolio; for the past several years, the company has added new space at a rate of 8-10 percent annually. Existing store closings have been raised by about a dozen to just over 40 units this year from a normal rate of 15-20 stores annually. The company plans to open just under 20 Jared units and about 50 new stores in its Kay and regional brand divisions. Management clarified that there is no notable incremental expense related to the increased number of store closures, since many of them will be at the end of their lease period.

• When queried about the impact of Zale’s heavy discounting to move discontinued merchandise, management said they had felt a modest impact on sales – “a couple of percent” – but they felt that Zale’s promotional strategy is not sustainable due to its negative impact on the company’s overall financial strength.

• When queried about its pricing strategy, management said its primary price increases covered the impact of higher gold costs. Further, management also said that it had increased its promotional cadence in response to the general environment. But company officials quickly added that it did not put prices up to mark them down again. The net effect, though, is that this year’s gross margins should be about in line with last year, despite rising costs of materials and merchandise.