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Signet Jewelers Limited (NYSE:SIG)

Q2 2012 Earnings Call

August 25, 2011 8:30 am ET

Executives

Michael Barnes – Chief Executive Officer

Ronald Ristau – Chief Financial Officer

Tim Jackson – Director, Investor Relations

Analysts

Rick Patel – Bank of America Merrill Lynch

Bob Drbul – Barclays Capital

Jennifer Davis – Lazard Capital Markets

David Wu – Telsey Advisory Group

Anthony Lebiedzinski – Sidoti & Co.

Ike Boruchow – JP Morgan

Bill Armstrong – C.L. King & Associates

Rod Whitehead – Deutsche Bank

John Baillie – Société Générale

David Berman – Berman Capital Management

Michael Lopiano – Fidelity International

Michael Friedman - Cumberland

Operator

Good day and welcome to the Signet Jewelers Second Quarter Results conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to your host today, Mr. Tim Jackson. Please go ahead.

Tim Jackson

Thank you, Operator. Good morning and welcome to the conference call for Signet’s second quarter fiscal 2012 results. I am Tim Jackson, Investor Relations Director. With me are Mike Barnes, CEO, and Ron Ristau, CFO. The presentation deck we will be talking to is available from the Webcast section of the Company’s website, www.signetjewelers.com.

Before I hand over to Mike, I will give the Safe Harbor statement. During today’s presentation, we will in places discuss Signet’s business outlook and make certain forward-looking statements. Any statements that are not historical fact are subject to a number of risks and uncertainties, and actual results may differ materially. We urge you to read the risk factors, cautionary language and other disclosures in the annual report on Form 10-K that was filed with the SEC on March 30, 2011. We also draw your attention to this slide.

Michael Barnes

Thanks, Tim. We’re very pleased with the record results in our second quarter which reflect the ongoing success of our business, driven by our competitive advantages. For the quarter, total Signet same store sales were up 9.9%, led by the U.S., with a 12.2% comp store sales increase and followed by the U.K. which comped positive 1.4%. Some other key highlights include operating margin was 12.8%, an increase of 430 basis point; income before taxes was $99.8 million, up $45.1 million or 82.4%; diluted earnings per share were $0.76, up $0.31 or 68.9%; and the free cash flow was $61.4 million.

Reflecting the strength of our business model and its cash flow, the Board has declared a quarterly dividend of $0.10 a share. We feel this is an excellent way to return value to our shareholders while still maintaining financial flexibility to invest in future business initiatives.

Now looking at the results in a little bit more detail and starting with the U.S. division performance – total U.S. sales were $643 million, up $65.3 million, an increase of 11.3%. Kay had another outstanding quarter and increased same store sales by 13.5%, up from the 2.7% growth achieved in the same second quarter of fiscal 2011. Jared again performed extremely well with comps of 12.6% following a 14.1% increase last year – outstanding two-year comps. Overall, U.S. same store sales increased by 12.2% compared to an increase of 6% last year.

Average selling price, excluding the charm bracelet category, was up 12% for Kay and 8.6% for Jared, 13.3% for the regional brands. This reflects not only price increases but also importantly our consumers trading up our pricing architecture, including to new higher price point merchandise in the bridal category. Operating income was $104.4 million, up $43.7 million which was a 72% increase. The U.S. division’s operating margin increased by 570 basis points to 16.2%.

In jewelry retailing, a superior in-store customer experience is central to our success. It’s that final two feet of supply chain right over the display case that’s crucial. It’s here where the relationship with the customer is created, where there is an opportunity to up-sell, to sell add-ons, and where the sales is completed, allowing the opportunity to create a customer for life. Before joining Signet, I didn’t fully appreciate the emphasis Signet placed on the customer experience, the sophistication of the systems underlying the in-store execution, the resources put into associate training and development, and how central it is to the culture of our company.

Our results call – I can’t do it justice, but I would urge you to go into any of our stores and experience it for yourself, and we hope that you have the chance to attend our investor relations day and store visits on October 4, held in New York when we’ll have the opportunity to meet some of our store team members. A great in-store customer experience takes many years of dedication to achieve, and it’s far from easy to replicate.

The in-store experience is particularly important in the bridal category, which was again one of our cornerstones of our performance. Neil Lane Bridal is largely a non-comp business in the second quarter, and the range is now available in all Kay and Jared stores with the rollout to all regional stores planned for the third quarter. There was further store expansion for the Tolkowsky Diamond as well, which is now available in 600 doors. Neil Lane Bridal and Tolkowsky Diamond have price points that are higher than the average bridal purchase for our mall stores and have been important contributors to the growth in average selling price and store productivity as well. Our unbranded bridal selection, which still accounts for the majority of the bridal sales, continues to offer great value to the customer.

Our non-bridal exclusive and differentiated brands outperformed with the charm category remaining strong. In particular, we benefited from the success of Charmed Memories, which was largely a non-comp business in the second quarter, and the Pandora range continued to show strong growth. Another differentiated brand that performed well was Le Vian, which is also helping drive higher average selling prices. As a group, the exclusive and differentiated brand ranges for both bridal and non-bridal categories continues to gain momentum.

One reason for our continued strength is the effectiveness of our advertising execution. We again significantly increased investment in marketing and we continue to test advertising support for the bridal category and have achieved further encouraging results. We see this as a very important opportunity.

Another important element that drives not only advertising but also direct commerce is our web presence. We saw sales grow on our websites by 50% over the comparable quarter last year. We’re upgrading both the Kay and the Jared websites in the third quarter ahead of the holiday season. They’ll be easier to use, have richer and more engaging content, and will include a number of important new features. This is being done with our usual thoroughness and we’ll be testing the upgraded sites before launch.

Turning to the U.K., we continued to operate well in a challenging economy and again outperform non-food retail sales in the quarter. Total sales were $154.6 million, up $12.6 million, an increase of 8.8% with same store sales up 1.4%. At constant exchange rates, there was a 0.1% increase in sales, so we saw some sequential improvement from Q1. Both watches and the bridal category, including gold rings, continued to perform well, as did the charm category. E-commerce sales also continued to outperform in the U.K. with a 14% increase over prior year quarter two. Average selling prices, excluding the charm bracelet category, were up by 5.3%. The U.K. consumer is shopping more to a budget rather than higher retail prices driving sales. It’s therefore very important to be continually looking at the merchandise and making sure that appropriate opening price points are maintained. While we continue to keep a tight control on costs, the operating margin was down by 150 basis points with the U.K. division’s operating income being $2.8 million, down by $1.9 million for the quarter. In the comparable quarter last year, the results benefited from a $900,000 surplus on a real estate sale.

Notwithstanding the fact that we did outperform the broad discretionary retail market in the U.K., we fully recognize it’s our responsibility to drive initiatives that will deliver the expected results. Our team members through all levels of the Company know that we must drive this process, so as in the U.S., we remain focused on providing the superior in-store customer experience with an emphasis on customer service and staff training. In addition, we have a number of initiatives underway in the U.K. For example, there’s an increased emphasis on branded, differentiated merchandise and new products in general. Some of these are specific to the U.K. market, such as the Amanda/Wakeley collection, while others such as Love’s Embrace, Tolkowsky, and Le Vian draw from our U.S. experience. In H. Samuel, we’re having success with fashion jewelry lines, including DKNY and Guess. Additional investment has been made in marketing with television advertising for H. Samuel ahead of Mother’s Day being successful. This was done in conjunction with Chamilia. We’ve also increased customer relationship marketing for both H. Samuel and Ernest Jones. I’m encouraged by the performance of the U.K. business in this challenging marketplace and I’m pleased with the number of initiatives that we do have underway because in difficult times, it’s those that have the perseverance and the financial strength to continue proper investment in their business and who innovate to create new and exciting product ranges to come out ahead. It’s through these processes that the foundations for long-term success are built.

I’ll now hand the call over to Ron to go through the financials in a little bit more detail.

Ronald Ristau

Thank you, Mike. Total sales for Signet increased 10.8% to $797.6 million compared to $719.7 million in the second quarter last year. The total Company comp store sales increased 9.9% versus an increase of 4.6% in the comparable quarter last year. In the United States, sales increased to $643 million, primarily reflecting comp store sales up 12.2% versus 6% of an increase last year. The space impact was adverse by 0.9%.

In the U.K., sales rose to $154.6 million, reflecting a comp store sales increase of 1.4% compared to a decline of 0.5% last year. As reported, U.K. sales were favorably impacted by currency fluctuations which more than balanced the 1.3% adverse impact of reduced space.

Now looking at the reconciliation of the $45.1 million increase in income before taxes from $54.7 million up to $99.8 million. Gross margin was $294.8 million, an improvement of $57.6 million. The gross margin rate was 37%, up by 400 basis points. The drivers of the improvement were gross merchandise margin, which improved by 90 basis points with the U.S. up 100 basis points and the U.K. down 40 as we continue to successfully manage fluctuations in commodity costs as we have done for many years. Net bad debt to total U.S. sales ratio was at 4.4%, which was 80 basis points better than last year, and we realized leverage on our occupancy expenses.

The SG&A expense was $224.5 million, up $20.8 million or 10.2% from last year. As a percentage of sales, they were down—I’m sorry, they were 28.2%, down 10 basis points from last year, and I will cover this more on the next slide. Other operating income was $32 million, up $4.8 million on last year primarily reflecting interest income on higher accounts receivable which have a 20 basis point favorable impact on the operating income margin.

The second quarter’s operating income was $102.3 million, an improvement of $41.6 million or 68.5%. The operating margin was 12.8%, up from 8.5% last year in the second quarter, an increase of 430 basis points. Net interest expense was $2.5 million, a decrease of $3.5 million, a fall of 60 basis points as a percentage of sales. This primarily reflected the benefit of prepaying the private placement notes last year. Income before income tax was $99.8 million, an increase of $45.1 million or 82.4%. As a percentage of sales, that was 12.5%, an improvement of 490 basis points based upon excellent execution in all aspects of our business. The quarterly tax rate was 33.6%, reflecting the geographic mix of profits and favorable tax settlements in the comparable period.

Now looking at SG&A in more detail and focusing on the second quarter – the major contributing reasons for the increase of $20.8 million in the second quarter were as follows: we increased our net advertising investment by $4 million; $3.5 million of the increase was attributable to currency fluctuations; $1.5 million was attributable to higher 401K contributions primarily in the U.S., $7.6 million of the remaining increase was a result of increased store staff costs which flex with our increased sales; and the balance primarily reflected increased investment in IT and credit infrastructure and other expenses. On the year-to-date, the information is also included on a slide for your reference. We believe our SG&A remains extremely well controlled.

Our graph on receivables shows the second quarter net bad debt to sales ratio and the collection rate for the last 10 years. We note that for the period, we received results broadly in line with the historic range. This improved by 80 basis points from 5.2% to 4.4%, reflecting both higher sales and an improvement in the underlying performance of the receivables portfolio. We would point out that this is the seventh consecutive quarter that we have seen improvement in our bad debt ratios. In-house consumer finance participation rate was 57.7% versus 56.3% last year, the increase driven by growth in our bridal business.

Turning briefly to the year-to-date results, for the year-to-date total Signet same store sales were up 10.1%, led by the U.S. with a 12.4% same store sales increase, the U.K. up 0.8%. Operating margin was 13.1%, an increase of 370 basis points. Income before taxes was $217.6 million, up $88.8 million or 68.9%. Diluted earnings per share were $1.63, up $0.60 or 58.3%, and our free cash flow year-to-date was $153.8 million.

Free cash flow remains strong. As compared to a year ago, free cash flow this year supports an increase in inventory which reflects higher costs and supports our sales growth. Inventory in total rose 6.8% as compared to Q2 last year and below our increase in sales. We remain pleased with the quality and level of our inventory.

Receivables moved in line with U.S. sales and net cash used in investing activities was $38.3 million, up from $14.4 million last year and reflecting our planned increase in capital expenditures. We ended the quarter with cash of $440.2 million, down from $485.4 million a year ago. This reflects the prepayment of $280 million of private placement notes, offsetting the cash generated last year.

In the year-to-date, we believe we have made excellent progress against all of our financial objectives for fiscal 2012. In particular, the improvement in gross margin has been very marked. Reflecting our performance on year-to-date, we have increased our free cash flow guidance to $175 million to $225 million from our original target of 150 to $200 million.

I’ll now turn it back to Mike.

Michael Barnes

Thanks, Ron. So far, we’ve concentrated on the second quarter, but since it ended there has been considerable volatility in the financial markets and increased concerns about the economic outlook. This is clearly something that we’re monitoring closely. Given the great execution that our team members have demonstrated, we believe we’re well positioned for the rest of the year and into the future to gain profitable market share. Unlike many retailers, we have limited inventory risk. We also have a strong balance sheet and great cash flow. However, we must all recognize that the global economy is fragile at best, and we must always be prepared for whatever the unknown future holds. If – and I emphasize if – we do face a challenging economic environment, it’s just at such time the competitive strengths become even more important and the strong take the opportunity to build the base for future market share gains. We currently feel great about the rest of the year and are well prepared for the holiday season.

I’ll now open the call up for questions.

Question and Answer Session

Operator

Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please press the star or asterisk key followed by the digit one on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star, two. Again, please press star, one to ask a question. We will pause for just a moment to allow everyone to signal.

Our first question today comes from Rick Patel from Bank of America. Please go ahead.

Rick Patel – Bank of America Merrill Lynch

Thank you. Good morning. Just two quick questions – first, can you just help us understand how much prices increased on like-for-like products in the second quarter? And then second, can you just talk a little bit more specifically about what’s driving the trade-up within the bridal category? Is it just Neil Lane and Tolkowsky being introduced to more stores, or is there something else going on there?

Ronald Ristau

Your first question, I would say we don’t really go into the percentage price increases, nor would we disclose that for competitive reasons. Obviously, our price increasing has been very successful. We’re very careful and prudent with it, and it is something we have to do on an ongoing basis, given the pressure on commodity costs; but we’ve been very able to successfully more than offset the commodity price increases. So I’m sorry, Rick, I wouldn’t go into the specifics of how much we’ve increased prices on an item-for-item basis.

Michael Barnes

Yeah, good morning, Rick. On the bridal, I think that you hit it pretty well there. Obviously, our branded offerings are helping drive that business even higher for us, and it’s been a—a big initiative for us this year has been to really focus on bridal anyway. You know, the Neil Lane product is being very well received and we have been rolling it out to all the Kay and Jared stores, and are rolling it out to the regionals as we mentioned on the call. Tolkowsky has been successful as well. We have opened a lot more doors with that. We still feel like our branded differentiated bridal products will continue to drive that category for us in the future, and we’re very pleased with the results that we’ve seen there.

Rick Patel – Bank of America Merrill Lynch

Great. Thank you very much.

Operator

Thank you. Our next question comes from Bob Drbul from Barclays Capital.

Bob Drbul – Barclays Capital

Hi, good morning. The first question I have is can you talk a little bit about the sales trends throughout the quarters, you know, the monthly progression of sales and anything that you’ve seen since the quarter ended in terms of the comps?

Michael Barnes

Well, I think that in the second quarter, it was a pretty consistent sales trend that we saw, so there was nothing remarkable about any one month in there. Since the second quarter has ended and now we’ve gone a full three weeks into the third quarter—you know, through three weeks of August, we’re very pleased to say that the strength continues to hold. We’ve seen our sales remain pretty much in line with what we saw in the second quarter. Obviously, we don’t know what the economic future is going to hold for us, any of us; but we’re cautiously optimistic that we’re going to continue to execute at full throttle and our business will continue to be strong. We think we’re well prepared to gain market share and well prepared for the holiday season.

Bob Drbul – Barclays Capital

Okay, great. And then when you look at the price increases—I know you’re not willing to sort of give the price increases, but when you look at your ability to continue to raise price, do you think that you’re nearing a level, or is there any price sensitivity that you’re leery of heading into the back half of the year?

Ronald Ristau

We’re always cautious with price increases, but we are also always providing a full range of pricing for customers so that as we take price increases, we are cognizant of opening price points and a range of prices so that consumers can choose according to their pocketbook. We have successfully over a long period of time dealt with these rising commodity prices. We do not at this point in time see any major change in consumer behavior, and we’ll continue to execute our price increases the way we have in the past, and we’ve been very successful with it. So no, there’s no changes that we would call out.

Bob Drbul – Barclays Capital

Okay, great. My last question is on the exclusive differentiated brands, could you give us a level of the penetration rate, the percentage of sales in terms of what you view as the exclusive or differentiated percentage in second quarter?

Michael Barnes

Yeah, we have seen them continue to gain momentum, as we mentioned. You know, last year, as we have stated in the past, they were up to about 22% of our mix within our stores, and that was up 300 basis points from the prior year. I don’t know—Ron, I don’t think that we have an interim percentage that we disclosed on that, do we?

Ronald Ristau

No, we don’t disclose an interim, but it has continued to improve; and we don’t really set a target on it. It just continues to be driven by consumer and how the consumer reacts to these products.

Michael Barnes

So it has improved from the year-end of 22% of our mix, but we don’t have a number for you on that right now.

Bob Drbul – Barclays Capital

Okay, thank you very much.

Michael Barnes

You’re welcome. Thank you.

Operator

Our next question comes from Jennifer Davis from Lazard Capital Markets.

Jennifer Davis – Lazard Capital Markets

Hey guys. Congratulations on yet another great quarter. And Ron, thanks for that SG&A detail. That was really helpful.

Ronald Ristau

Oh, good. I hoped it would avoid some of the questions we had on our last call.

Jennifer Davis – Lazard Capital Markets

I know, right?

Ronald Ristau

I’m glad you find it helpful or useful.

Jennifer Davis – Lazard Capital Markets

I have a couple of questions. Mike, first on the supply chain, could you talk a little bit about what you’re seeing there and if you’re thinking about—you know, back in 2006, you began testing the rough diamond initiative. Could you kind of give your thoughts on that? And also, I was wondering what you’re seeing in the competitive landscape with the mom and pops and the higher commodity prices, what you’re seeing in terms of store closing or pressure there. Thanks.

Michael Barnes

Okay, thanks Jennifer. As far as the supply chain, obviously that’s something that we’re extremely focused on. We’ve got some pretty big initiatives that we’re working on there. We’re looking at ways that we can strategically get closer to our suppliers and find ways to really strengthen the supply chain. We think that we have a great advantage competitively in the fact that we have the size and scale to really be able to work with people in a very large way, so we are looking at a number of initiatives. I wouldn’t detail those out one by one for competitive reasons, but we think it’s a competitive advantage that we have, our ability to work closer with the supply chain, with our suppliers, and we’ve got some initiatives that we’re pretty excited about there that we think are going to help us secure the long-term supply of products that we need for our company.

On the competitive landscape out there, especially vis-à-vis what’s going on with the commodities, we think that we also have a competitive advantage in how we manage commodities because we do have a pretty substantial hedging program in place on commodities, and so I think the way that the commodities, especially as they—you know, in a volatile way tend to go up and down very quickly, I think it has less effect on us. We have a long lead time and an ability to really forecast out what the effect is going to be and adjust for it accordingly. I think that’s something that probably is not as easy for, as you mentioned, a lot of the mom and pops out there that pretty much just have to deal with what the day-to-day pricing and how it drives their business. So I think it’s a competitive advantage for us. I think that long term, we will see it continue to help us increase our market share.

And I think that we’ll continue to see some consolidation in the industry. It obviously slowed as the economy got better. Who knows where the economy is going right now based on all the volatility we’ve seen out there. Our business, as I mentioned, has continued to remain strong, even going into the third quarter; and we feel like we’re well positioned.

Jennifer Davis – Lazard Capital Markets

Great. Thanks, then. Best of luck – not that you need it!

Operator

Thank you. Our next question today comes from David Wu from Telsey Advisory Group.

David Wu – Telsey Advisory Group

Hi, good morning everyone. Congrats on a very solid quarter. First on the credit side, you mentioned that credit participation is up a little bit from last year and talked about the strong bridal business as a driver there. But can you also talk about perhaps how the approval rates have been trending and if you’ve made any meaningful changes at all with respect to the scorecards or the financing arrangements, such as the interest rates that you’re charging?

Ronald Ristau

Sure. We have made no changes in the scorecards nor have we done anything to impact approval rates. Approval rates are about the same as they were last year. There’s been no real movement in approval rates. As I mentioned, the bridal category, which is always strongly supported by credit because oftentimes people in the bridal market are young people just getting started in their lives, does increase the penetration on a natural basis and also the fact that we have introduced the Neil Lane and Tolkowsky products, which are slightly higher in price, would carry a little bit higher average financing. But nothing of any significance other than that, and we just called it out because the bridal business, we think having our own in-house credit is a very, very strong competitive advantage and enables us to keep capturing market share in bridal.

David Wu – Telsey Advisory Group

Great.

Ronald Ristau

But we haven’t changed anything from a—there’s no changes from a credit scoring perspective that’s driving any of that.

David Wu – Telsey Advisory Group

Excellent. And then secondly, can you talk about any new products launches in the fashion jewelry category in the back half of the year, especially as you start to comp against the Charmed Memories launch in the fourth quarter?

Michael Barnes

Well, anything that we haven’t launched yet, we certainly wouldn’t be talking about anyway. But we’ve got some great fashion jewelry offerings out there. We mentioned that the Le Vian range has continued to be strong for us as well, and the beads continue to be very strong for us. You know, Charmed Memories is not even comped yet, so we still have a big opportunity there and we’ve seen some great increases in the business for Charmed Memories. And Pandora, as I mentioned, continued to have very strong double-digit comps, and that’s on a like-for-like comp basis. So we feel pretty good.

Another thing that I did mention in the call was that some of the fashion jewelry in the U.K. where we carry more fashion lines has done very well for us, including DKNY and the Guess jewelry.

David Wu – Telsey Advisory Group

Great. And then just lastly, in terms of the real estate out there, are you seeing better opportunities in the malls and any changes at all to your store expansion plans?

Michael Barnes

Well, our store expansion—you know, this year we had been quoting around 25 doors. As we see the year coming into the back half and have a better, clearer picture of the store opening dates, it looks like we’re probably going to open about 23 doors in the U.S. total. And next year as we look forward to new store openings, basically we’re still not seeing the kind of development we would like to see, because we have an appetite to open a lot more stores than we’re able to find great real estate for right now. Having said that, as visibility becomes more and more clear for next year, we do think that we can open at least the same number of stores and probably even more than what we’re opening this year in the United States. But we don’t see the substantial increase in development that would be needed to drive that number much, much higher.

David Wu – Telsey Advisory Group

Excellent. Thank you very much.

Michael Barnes

Thank you.

Operator

Our next question comes from Anthony Lebiedzinski from Sidoti & Company.

Anthony Lebiedzinski – Sidoti & Co.

Good morning. A couple of questions. I realize that you don’t want to give much details about the price increases, but looking at the price increases versus consumers trading up, which one do you think was a bigger factor in the second quarter?

Ronald Ristau

I think it’s a little bit of both, and the trade-ups are occurring because, as we indicated, we have the higher priced merchandise which has been well received as relates to Neil Lane and Tolkowsky and products like that. But average prices have also gone up because of the price increase. Of the two, if you were going to weight them, I would guess it’s probably a touch more in the average price than it is trade-up.

Anthony Lebiedzinski – Sidoti & Co.

Okay, that’s helpful. And the U.K. business is certainly a pleasant surprise in my view on the year. Now, do you have any sense as to what your share is of the U.K. market, and also do you plan to do any website enhancements for your U.K. business?

Michael Barnes

We have been working on the websites in the U.K. Now as I’ve said, we’re seeing double digit increases on the web business there as well. It’s something that we will continue to work on. We think that the web presence is very, very important to our company on a go-forward basis. It’s where the world has gone to now. Social networking and the web is something that we continue to focus on and invest in, both in the U.K. and in the U.S. market. As far as share in the U.K., we don’t have any exact number on what our share of the market is there. We feel like—we do know that we are far in a way the market leader, but it’s hard to get a good number on the U.K. market. It’s a lot easier in the U.S., unfortunately; but we do track how we’re doing retail-wise, and as I have mentioned, we definitely outperformed the overall discretionary retail market within the U.K., so we feel like we are definitely holding our own on market share and possibly even gaining.

Anthony Lebiedzinski – Sidoti & Co.

My last question here is on the shareholder distribution. So certainly I saw the news about the cash dividend, so on an annualized basis you’ll pay out 35 million given your share count now, and you have well over $400 million in cash and will generate a lot of free cash flow this year. So what is your thinking—you know, going forward, would you like to increase the dividend or is a share buyback still perhaps something you’re thinking about?

Michael Barnes

Well, you know, this is something that the Board has been looking at for a long time, along with management here; and we thought it was very important to our shareholders to show that we felt like the financial strength that we had and the strong cash flows that we’ve been generating, we think that those are definitely something that we can continue to count on, and we felt it was a good time to give some value back to the shareholders and still retain the financial flexibility to make investments into our business, which is still the most important place where we can reinvest for the shareholder value. This was a great start, quite frankly, and we’re very, very happy to be able to announce the dividend today; and we think it’s something that hopefully we will be able to add onto over the years as we move forward.

I wouldn’t count out other methods of returning value to the shareholders. We keep our options open on that. Again, investing back into our business is our number one priority. We were able to do this and announce this dividend without having to change our financial flexibility in any way whatsoever, and we’re glad that we were able to. You know, shareholders—I’m sorry, share repurchases is something that I wouldn’t necessarily count out for the future. At some point in time, that’s something—I think it’s also a great way to return value to the shareholders, and so we will continue to study and keep that open for the future. But this was just a fantastic start for us, and we’re very happy to be able to announce it.

Anthony Lebiedzinski – Sidoti & Co.

Okay, thank you.

Operator

Our next question comes from Ike Boruchow from JP Morgan.

Ike Boruchow – JP Morgan

Hey, good morning. Congratulations on a great quarter, guys. I guess, Ron, I was pretty impressed with the product margins in the U.S. They had started to sequentially—the rate of change had started to come down in Q1, and then all of a sudden ticked back up from a 70 basis points increase in Q1 to 110 in Q2. Can you talk about exactly what drove that change, and how should we think about the back half in terms of commodity costs and how that could be offset by your price increases and less discounting?

Ronald Ristau

Well first of all, I would say that when we started the year, we said we had an expectation that our gross margins in total would increase for the Company. We stay with those statements that the gross margin ratio in total will increase. The gross merchandise margin is only a piece of that because we are also getting improvements in bad debt and leverage on the real estate costs, which I indicated in the conference call.

The gross margin acceleration into the second quarter, I think, is more a factor of mix, more of the timing of some of our price increases. Price increases and the net effect of them over the year, they change a little bit by quarter, you get the most impact when you first start to do them. So we do them usually in the April/May timeframe, so it’s a little bit more impact in that second quarter. And the commodity prices rise over time, so I would say that the margins will be better but you can’t—you can’t naturally just take this quarter and project it forward. It does vary somewhat. (Inaudible) your other question, okay?

Ike Boruchow – JP Morgan

That’s helpful. And then Mike, you gave us some helpful color on the U.S. and how that business trended throughout the quarter and quarter-to-date. I’m just curious about the U.K. I know it’s a smaller segment to your business, but there’s been a lot of macro headlines with problems over there. Any commentary on what you’ve seen in the last couple weeks in that region?

Michael Barnes

Yeah, I think definitely it’s a much tougher marketplace right now, and I think that within that marketplace on a comparative basis, we have outperformed the overall retail sector. It’s difficult, but we are continuing, as I mentioned, to put new initiatives in place, new product ranges. We’re leveraging some of the success that we’ve seen in the U.S. with brands like Le Vian and Tolkowsky Diamonds, et cetera. We have the Amanda/Wakeley, which is in the U.K. only, which is also a very popular range for us and has done very well. So there’s a lot of things we’re doing. We’re continuing our investments, as we mentioned, and the U.K. business is still very stable for us. It’s tough, but as things get better, we think we’re well positioned.

Ike Boruchow – JP Morgan

Okay. All right, thanks. Best of luck, guys.

Michael Barnes

Thank you.

Operator

Our next question comes from Bill Armstrong from C.L. King & Associates.

Bill Armstrong – C.L. King & Associates

Good morning. Just a kind of follow-up on that last question. You’ve now had two straight quarters of positive comps in the U.K., and it looks like you’ve also reduced the number of store closings you’re planning for this year there. So in light of the generally difficult macro environment in the U.K., what are you seeing that’s maybe offsetting all that, that would be driving positive comps and telling you to maybe not close as many stores.

Michael Barnes

Well you know, as I’ve said, I think that our business is pretty stable there right now. Yeah, it was great to see, as slight as it was, to see some sequential improvement in the comps and have another positive comp quarter. That’s fantastic for us in that marketplace. You know, it’s the execution. It’s the training that we give to our team members and our associates and our store managers, and the way that they execute and the great product offerings that we have out there. At the end of the day, it’s all about execution and product, and I think that we are far in a way the leader in those two categories, and I think that results show that.

Bill Armstrong – C.L. King & Associates

Okay. And in the U.K., you’ve got Le Vian and Tolkowsky. Are those new initiatives over there?

Michael Barnes

They’re not fully rolled out yet, so we have been testing in the U.K. market but we have increased doors in recent quarters.

Bill Armstrong – C.L. King & Associates

Okay, so it’s not a complete rollout yet. Will we see a complete rollout by holiday? Is that the plan?

Michael Barnes

You know, honestly I don’t have the rollout plan for those two brands in front of me, but I do know in the second quarter we increased doors. So they are fairly new, as Ron just kind of mentioned, and we have been increasing our doors. So I mean, they’re working. I’ll put it that way. We’re seeing great business with those brands. Our exclusive and our differentiated brands in both the U.K. and the U.S. continue to help us drive a very strong business performance.

Bill Armstrong – C.L. King & Associates

Would those brands have been basically non-comp in the second quarter, then – Le Vian and Tolkowsky in the U.K.?

Ronald Ristau

More or less. Le Vian, probably a little bit less because there has been some Le Vian, but Tolkowsky, more non-comp.

Michael Barnes

Yeah, more non-comp. We definitely rolled quite a few doors of Tolkowsky in the U.K. in the second quarter.

Bill Armstrong – C.L. King & Associates

Okay. And then in the U.S., is Tolkowsky completely rolled out now, or are we still working on that?

Michael Barnes

No, we’re still working on that as well in the U.S., so with the success that we’ve seen so far, obviously we still have a long way to go in getting it rolled out. So it will be a while before we see that on a comp basis.

Bill Armstrong – C.L. King & Associates

Got it. Okay, great. Thank you.

Operator

From Deutsche Bank, we will take our next question from Rod Whitehead.

Rod Whitehead – Deutsche Bank

Hi there. Congratulations again on a good quarter. Just coming back to the prices – firstly, Pandora have basically said they’ve had a big problem and they feel that they put their prices up too quickly and too much. So first, I was wondering whether just in the last month or two you’ve seen the same resistance to Pandora higher prices that they’ve seen elsewhere in the U.S. They specifically said their sales are down 30% in the U.S. But secondly, moving away from Pandora, like Pandora you’ve seen a big increase in the gross margin despite higher input costs. At what point should we be concerned that you might be being too aggressive on price increases? How do you yourself kind of monitor that issue?

Michael Barnes

Well on the first question regarding Pandora, we continue to see Pandora be a very strong business for us at Jared, and we’ve continued to see strong double-digit comps. I think that if you look at the way we manage that business and how we assort it and how we choose our SKUs, that we’ve done a very good job remaining in the sweet spot for our customers in both price and what we’re offering to them in terms of newness in fashion. So that business continues to be strong for us. I think a lot of it has to do with the fantastic execution that the team has done, both here at the home office and in the field. So that remains strong.

As far as price increases and increased gross margin, you know, a lot of the gross margin increases, as Ron has mentioned earlier, come through productivity, better bad debt percentages, et cetera; and we have said in the past that our gross merchandise margins, we would keep them relatively in line with prior years. How do we monitor that? Very, very carefully is how we monitor it. We watch the sales reaction with any price increases that we do at any time on a very detailed level, and we put a lot of work and study into it in advance. And we have said in the past, if we see an overall net negative impact from price increases, that we would have to really consider that on a go-forward basis. But so far, again, I think the team has just done a fantastic job of planning it well, executing it well, and following up with a very careful look at sales post-any price increases that we’ve done.

Ronald Ristau

And Rob, just to again point out, we always maintain a range of pricing for our consumers and a range of price choices. So we’ve been very successful at this and our price increase program, as Mike indicated, very artfully and skillfully done, and we have seen no change.

Rob Whitehead – Deutsche Bank

Thank you.

Operator

Our next question comes from John Baillie from Société Générale.

John Baillie – Société Générale

Hi, good morning gentlemen. It’s John Baillie. Just on the real estate market on both sides of the Atlantic, I’m just wondering in the U.S. malls where certainly in the last couple years, you’ve just been paying base rents. Given the strength of your sales, how close are you to getting to trigger incremental payments on the Kay stores as you get the good like-for-like growth? And secondly in the U.K. with rent reviews, what is your experience? Are you getting unchanged rents or even cuts in rents as the reviews come up?

Ronald Ristau

Let me take that, John. The percentage rent is not significant. We continue to leverage our real estate costs and continue to believe that that will be true in the future. So while we do occasionally run into a percentage rent situation, it’s well baked into our forecasts and not a significant issue for us.

Relative to real estate costs, real estate costs continue to be—you know, they’re always up to negotiate on real estate costs. We do see in some of the areas in the U.K. that are falling out of favor, people willing to make rent concessions, and we do get some benefit. But it’s in the tune of hundreds of thousands, maybe a couple million dollars. It’s not all that significant to us. We work at it constantly, but real estate prices have been stubbornly slow to adjust to some of new economic realities. So it’s an ongoing effort for us.

John Baillie – Société Générale

Right. So it still sounds as if there’s no—there’s certainly no real upward pressure on either side of the pond. Is that the reading?

Ronald Ristau

No, we’re not seeing any unusual pressure other than normal pressure on real estate prices. No.

John Baillie – Société Générale

Okay, thank you.

Tim Jackson

Hello, Operator?

Operator

We will now take our next question from David Berman from Berman Capital Management.

David Berman – Berman Capital Management

Hi guys. Great job on the numbers and the dividend. We want to see more dividends and share repurchases. Good job from our side. I just wanted to ask you a question on the cost increases of gold and things like that. There’s obviously a lag effect because your inventories are at a lower cost. So the question becomes how do you decide—how are you deciding when to raise your prices? Are you waiting for the prices of your cost to go up, or are you doing it now? Because there could be windfall benefit, obviously, in your inventory – and how much is that, roughly?

Ronald Ristau

On pricing, we take—first of all, the first person we think about when we think about pricing is the consumer and not putting through price increases rapidly if we do not have to. Our inventories work on an average basis so that we can see the average costs move over time, and they move slowly and predictably in our systems because of the way that we manage them. And don’t forget, we’re also, as Mike has pointed out, have active commodity hedging programs which tend to slow the rate of increase in commodities versus the general market in our systems. So with all those things working together, we do not seek to make windfall pricing changes in our business because we’re focused on the consumer more than anyone else or on short-term profit capabilities. So that really would not be something that we would look to do. We try to be predictable on our price increases. We try to do it at certain points in time during the year, and certainly as we’re getting ready for Christmas and holiday and the preparation of our websites and our catalogues and everything, we kind of lock in our pricing and don’t move too much beyond certain points in time in the year. So I hope that answers your question.

David Berman – Berman Capital Management

Yeah, but at some point obviously you’re going to have to raise prices, let’s say, on some of the gold stuff that you sell, and whether the customer likes it or not (inaudible), I mean, it is what it is, right?

Ronald Ristau

It is what it is, and we do raise prices on a predictable timeline for our consumers in most cases. We do it, David—let me try to be less obtuse. We do it to a certain point in time. We do not do it in general past August or September because, number one, we know what the prices are going to be based upon our inventory cost analysis, how it’s going to roll through. We’ve already made those decisions and can see that coming, so we know what our margins will be in the second half of the year. We will take a look at that again after the Christmas and Valentine’s Day timeframe, but with an inventory turn that moves in round numbers about once a year, we’ve got predictability in those rates and costs forward at least—over a six month time frame.

David Berman – Berman Capital Management

Right. And from a point of a view of cost to inventory, I presume in market value the cost is a lot higher than what is shown in the books.

Ronald Ristau

Well yes, and that’s—well, that would be true if we went out to replace the inventory today. It would cost us much more in total, but luckily we never have to do that. We only have to replace as we sell. The second thing is, it speaks to the quality of our inventory program because don’t forget our inventory costs are slowly going up on a per-item basis on the commodity costs roll into the inventory. And for us to report on the increased sales only a 6% increase of inventory is really an outstanding job in inventory management by our teams in both companies, watching the unit SKU movements, editing the lines where we see any slow-up in the turn on SKUs, and buying into those things that are performing well. So we’ve really done an outstanding job on inventory management in order to limit the increases to what we have, David.

David Berman – Berman Capital Management

I guess given the nature of your business, inventory management is probably more important than almost any other retailer, so—

Ronald Ristau

Inventory management is key. We do have the one benefit of other retailers in that our inventory doesn’t turn bad as quickly as some other lines. But we are very focused on inventory management and support it with an excellent team in our impact teams and excellent system support. So it’s a true competitive strength for our company.

David Berman – Berman Capital Management

Yeah, I meant especially from a (inaudible) point of view, because obviously the values are higher and you’ve got to really control it very carefully. But anyway, good job and thank you very much for the great results. Well done, guys.

Operator

Our next question comes from Michael Lopiano from Fidelity International.

Michael Lopiano – Fidelity International

Gentlemen, congratulations on the great result; but how are you guys thinking about returns, and given that you have a cash pile now which is about 15% of your market cap, (inaudible) about returns like incremental capital versus share buybacks and organic reinvestment, given that returns on capital organic investment issues are probably 20, 25% at best versus where your share price is trading at versus most measures of intrinsic value, which suggests that you’re probably at least 50% undervalued. It just seems to me that buyback would be very accretive at the current juncture. What are your thoughts?

Michael Barnes

Yeah, I think buybacks are a great vehicle as well, quite frankly; but we also think that dividends are, and as I said, we’re very pleased that we did announce a dividend. And if you look at the ongoing economic environment and the volatility that is out there, I think that really just speaks to the strength of our company. So this was a really good start for us. We think initiating an ongoing dividend of $0.10 a share, which would equate to $0.40 annually, is a great start. It doesn’t mean it’s the end-all finalization of us looking at our capital structure and our balance sheet. That’s something that’s going to be ongoing. You know, the management and the Board here takes that very seriously. We needed to start somewhere. This was a great way for us to start and give back some value to the shareholders. We will continue to look at other alternatives, and it doesn’t mean that we wouldn’t use other distribution methodologies, including share buyback, at some point in time in the future. But right now with the opportunities that we have for our businesses and with the situation of where the economy is at and the fragile nature of it, we think it’s a good start and we should just take things step by step.

Michael Lopiano – Fidelity International

Right, thanks very much. Take care.

Michael Barnes

Thank you.

Operator

Our next question comes from Michael Friedman from Cumberland.

Michael Friedman – Cumberland

Good morning. Thanks for taking my question. I guess I want to chime in similarly with the previous gentlemen, who probably owns a lot more stock than I do. I commend you on a great quarter. I commend the Board for taking the first step in implementing a dividend, but just looking at the stock market over the past few weeks, you don’t often have opportunities to buy a business as strong a quality as yours for four times EBITDA or seven times earnings ex-cash; and with $440 million sitting on your balance sheet and no long-term debt, to the extent the Board got comfortable implementing a dividend, I would urge you strongly to try to get comfortable maybe spending some of that sum to buy back stock, should it trade at a valuation, anything like that in the future, because it’s extraordinarily accretive. The opportunity doesn’t come around terribly often, and kind of whether you have $300 million plus theoretical debt capacity a lot higher than that on your balance sheet, or $400 million, you could be doing something very accretive.

Michael Barnes

Yeah, thank you for the comments and I agree with you – it’s something we need to watch very carefully. I will make sure that we do keep it as a Board topic with our Board, and we’ll see how things develop on a go-forward basis. Again, we just feel like it was a great way to start showing some value and sharing some value back to the shareholders, and we will be looking at other alternatives as we move forward through time.

Michael Friedman – Cumberland

That’s great. It was a great start and I commend you on it, and keep up the great work.

Michael Barnes

Thank you very much. Appreciate that.

Operator

As a reminder ladies and gentlemen, if you wish to ask a question, please press star, one on your telephone keypad. Our next question comes from David Berman from Berman Capital Management.

David Berman – Berman Capital Management

Hi. Just as regards the dividend question, I just wanted to revisit that for a second. What—in terms of the repurchasing, do you know what the accretion would be? Do you have a sense of how much it would be if you were to buy back stock?

Ronald Ristau

Sorry, David. I’m not sure we understand your question – accretion?

David Berman – Berman Capital Management

Yeah, the accretion in earnings per share. Do we have a sense of how much it would be? When you did the calculation of dividend versus the share buyback, do you have a sense of that?

Ronald Ristau

Well, it depends upon how many shares you buy back and at what price you buy them back at, I suppose.

David Berman – Berman Capital Management

No, no, obviously; but I’m just saying—because my sense is that—

Ronald Ristau

Well, our sense is that the dividend—we thought that the dividend was a good place to start, as Mike has said. We feel that it rewards our shareholders on a long-term basis. It represents long-term belief in the strength of our operating model, and therefore we chose to begin cash distributions with a dividend. And in the future—

David Berman – Berman Capital Management

Yeah, the only reason why I asked, and I’m pleased that you just articulated what you did, was because I’m in agreement with what you did and disagree with the gentleman before about using it for share buybacks. And I just wanted to share with the audience that you did do that calculation and do believe that the dividend was a superior method of returning shareholder cash.

Ronald Ristau

Well, thank you. We appreciate it and we understand the ongoing debate, which is a very interesting ongoing debate. So we appreciate the comment. Thank you.

David Berman – Berman Capital Management

Yeah, thank you very much.

Operator

As there are no further questions in the queue, that will conclude today’s question and answer session. I would now like to turn the call back for any additional or closing remarks.

Michael Barnes

Thank you for joining the call today. Our next scheduled results call is for the third quarter results and this is expected to be on November 22. We look forward to speaking to you all then. I hope to see many of you at the IR day in New York on Tuesday, October 4. Thank you all.

Operator

That will conclude today’s conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.

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