Signet Jewelers Ltd Earnings Call Nuggets: Ultra Gross Margin and Third Quarter Guidance

Signet Jewelers Ltd (NYSE:SIG) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Ultra Gross Margin

Rick Patel – Stephens: Can you help us think about what happened to Ultra’s gross margin on a sequential basis just comparing the first quarter to the second? On the surface, it looks like things got a little worse, but we’re just trying understand if that has to do with product, pricing or if it’s just the traditional thing that you’re going through right now?

Ron Ristau – CFO: Rick, you mean the operating margin at Ultra?

Rick Patel – Stephens: Gross margin.

Ron Ristau – CFO: The operating margin at Ultra was affected in the second quarter by one-time exit costs. So, therefore, the loss was about $0.06 in the quarter as we had previously indicated. And as we said, the entire loss in Ultra, about $0.09 in the first half of the year, a lot of that is related to transitional or one-time costs. So, as we move forward, we don’t, of course, next year believe that $0.09 expense will continue.

Rick Patel – Stephens: And do you have confidence that the gross margin part of Ultra or at least the impact of that to the total gross margin line is going to improve as you through the year?

Ron Ristau – CFO: I believe that the gross margin in Ultra will do a little better, yes.

Rick Patel – Stephens: And then can you talk to us about how we should we be thinking about SG&A for the remainder of the year. I’m curious if you can achieve leverage in the back half and how we should be thinking about the fourth quarter, specifically given last year’s 53rd week and the acquisition of Ultra.

Ron Ristau – CFO: Well, we don’t give specific guidance on that. I think our SG&A spending, as I indicated, was well controlled. If you look at our SG&A spending, excluding Ultra, we actually leveraged it and we believe that our excellent controls in SG&A will continue as we go through the year. That’s probably the best I could say about that. We will experience some deleveraging as it relates to Ultra, but we expect that the base business will continue to perform well…

Michael W. Barnes – CEO: I’d just add to that pretty much what Ron said and as he talked about in his remarks earlier and that is, we have had a successful transition of Ultra now. We had a dilution of $0.09 in the first half of the year. It’s going to be very minimal Q3 and then it’s going to become accretive. So, as we continue to ramp up these new Kay stores we have converted, things should look better over time.

Rick Patel – Stephens: And then just the last question around made for outlet products, just curious what you have learned from Ultra so far and how we should be thinking about that going forward.

Michael W. Barnes – CEO: That’s a great question, Rick. We’ve learned a lot and prior to the acquisition we were a much smaller in the outlet market and we were operating the stores primarily as normal Kay stores within the outlet realm. And there’s a lot of specialized marketing, not just merchandise, but specialized marketing that we’ve learned from them that we are going to put into place going forward that we think is going to be a real win for us, but also doing (made for product) allows us to kind of engineer the product so that we can gear it for the bargain hunting consumers that want to shop at the outlet malls. So, we’re going to have a much more desirable product mix out there for those consumers that like to shop at the outlet malls. So, we think that with the learnings that we got both from Ultra and now that we have a really solid team of people moving forward with a pure outlet strategy that we’re just going to see more and more improvement over time. And like I mentioned, this is a channel of distribution that’s actually growing in the U.S. They are building new developments. I think they are slated to have another 51 outlet malls open over the next three to five years. I’m not sure what the timeline was on that, but I heard that number the other day and we want to be a part of it. We want to be the leader in the outlet industry. We’re going to have 120 outlet stores for Kay by the end of this year compared to only having about 30 last year. so, we think it’s a big win for us and we’re looking forward to driving that part of the business.

Third Quarter Guidance

Jennifer Davis – Lazard Capital Markets: First, Ron, could you help us understand third quarter guidance. I guess I was a little bit surprised to see you guide you a decline in earnings, and I think maybe part of it is the fact that Ultra is a lower margin business still. And then a follow-up to that would be, how long do you think it will take for the outlets to reach the productivity levels of the Kay outlets?

Ron Ristau – CFO: Sure. Well, the third quarter is – Ultra is of course a fact in that, and you could see in our statements that we think Ultra will be – it won’t really contribute or it may contribute negatively by a couple of pennies. We do believe it will become accretive in the fourth quarter of the year and so we can’t predict how rapidly the productivity should increase. Although, we are seeing some good results out of the stores that we have converted to Kay and some nice sales increases there. So we’re hopeful that next year we will be significantly better than this year’s results in Ultra. And more importantly, as Mike indicated, the Ultra is only a part of our outlet strategy. We’ve opened and we’ll have, just exclusive of Ultra, 53 total stores that were just Kay to begin with, because we’ve opened up quite a number of them this year. So by the end of the year, we’ll be operating a 120 total combined Kay outlets stores and about 39, I believe it was, Ultra stores. So as it goes forward, the outlet strategy should become a much greater contribution, but it’s not just from the Ultra stores, it’s the Ultra stores as well as these new Kay outlet stores that we are opening up. When we think about the guidance in the third quarter, number one, we’ve given hopefully a prudent view of what we believe comps will be. We do expect that we will see some impact in our margins as it relates to the issue that we’re having in bad debt, which we believe will be primarily offset by their operating income. We have projected for now because we will be doing a lot of test work in the third quarter in our U.K. business that the U.K. business will continue to lose money in the third quarter, as it always does, but we have been a little conservative with our U.K. business, because our idea is to allow them great latitude for testing and new products and to try some different things to get ready for the all-important fourth quarter to make sure that we are 100% positioned there. So, third quarter is our lowest quarter of the year as you know and very small movements can cause some changes in the level of operating EPS for the quarter. For the full year, we think we are in very good shape, and we just have to get through this third quarter.

Michael W. Barnes – CEO: This is Mike, I’d just add onto that, reiterate Ron’s point. This is our smallest quarter of the year. Having said that though as I mentioned, we started off positive in both the U.S. and the U.K., and three weeks does not a quarter make obviously, but we just wanted to give you an update on the trend as we start the quarter as we usually do, at least the directional trend. But we are trying to prudent with our guidance. Again, there is a lot of noise out there and gosh only knows what’s going to happen in the geopolitical climate with all that stuff going on. So, we think that we are well positioned to outrun the competition whether we are in good times, bad times or in different times. And that’s really the key here. We need to outpace the competition in whatever environment is given to us and that’s what we always try to do. And frankly, in tougher times, generally, it’s a little bit, in my opinion, it’s easier to gain market share in tough times than it is in good times because people start running for the hills. While we still have our strength, our financial flexibility, we are able to invest, and we are continuing to invest in so many great strategic initiatives and we’re going to talk a lot about those at the Investor Day on October 8. So, this is a situation where we feel great about the back half of the year. We feel well-prepared. We think the team is well prepared and we’re just being prudent. We like to be good forecasters of our business…

Ron Ristau – CFO: And there’s one other point I’d like to make, Jennifer to your excellent question. In the third quarter this year we have increased our advertising a little bit because of some new exciting programs that we are going to be running in the September/October timeframe and we’ve taken a prudent view on the sales impact on that, but we have included in our guidance the additional advertising spending. So, that’s also having some impact on our guidance and we’ll see how it all turns out.

Michael W. Barnes – CEO: In that third quarter TV advertising was not part of our program last year.

Jennifer Davis – Lazard Capital Markets: I completely understand in the fourth quarters when you generate about 50% of your earnings. So, obviously, the fourth quarter is a quarter that matters. So, Ron, can you quantify maybe how much you are planning on losing in the U.K. in the third quarter?

Ron Ristau – CFO: Well, we wouldn’t be that specific, although I would say that the level would be a little greater than that experienced last year, unless the business surprises us and gets a little better. We’re planning it conservatively I would say.

Jennifer Davis – Lazard Capital Markets: And then finally with your online merchandise, do you think you have an opportunity to expand that and begin to carry online exclusive merchandise and if so, when do you think we should start seeing that?

Michael W. Barnes – CEO: Well, I think that what we have the ability to do is have an expanded range online, which I guess you could call that exclusive, because it’s not in the stores. We have physical limitations within the stores and then online, there are no physical limitations. The other thing that we are doing is – and this is a really exciting program as we are really ramping up our custom jewelry manufacturing. And this goes beyond personalizing a ring. We’ve had built a ring for a while where you can pick a he ring, you can pick the mettle, silver, 14 carat gold et cetera. You can pick diamonds, emeralds, rubies, whatever. You can kind of build the ring. But we’ve got a custom program in place that we’re really putting a lot into, where people can actually design custom jewelry themselves. They can walk in with sketch and our guys have the ability to put it into 3D CAD renderings and design it out and get it custom-made and delivered, and what’s the delivery time on that, Ron, do you remember?

Ron Ristau – CFO: Like, less than two weeks.

Michael W. Barnes – CEO: It’s like two weeks or less delivery. I mean, this is custom-made jewelry to their specifications. So, it’s pretty exciting program and it’s in early stages right now, but it’s something that we believe has a lot of legs to it for the future, so a lot of the personalization that we can do. But yeah, I think that what we can do with our online business is we can have a much broader product offering, and then it’s going to continue to drive great performance for us. The U.S. was up 36%. I mean, the growth that we have seen recently online has just been spectacular, and we’re looking forward to continue driving that business at full speed.

Jennifer Davis – Lazard Capital Markets: Congratulations, Mike and Ron, you guys have done a great since you started, I mean, with the Ultra acquisition and expansion of outlets and online, and all of the strategic initiatives, so best of luck.