Signet Group plc Q2 2007 Earnings Call Transcript

| About: Signet Jewelers (SIG)

Wall Street Breakfast

Signet Group plc (NYSE:SIG)

Q2 2007 Earnings Call

September 5, 2007, 9:00 AM ET


Terry Burman - Group Chief Executive

Walker Boyd - Group Finance Director


John Baillie - SG Securities

Andrew Hughes - UBS Warburg


Terry Burman - Group Chief Executive

Good afternoon. I am pleased to welcome all of you in the room and those joining by webcast and conference call. I am Terry Burman Group Chief Executive and with me is Walker Boyd, Group Finance Director. Rob Anderson, Chief Executive of the U. K. Business is in the front row. I will present an overview of the business. Walker will summarize our financial results and then we will all take your questions.

During this presentation we will be discussing Signet's business outlook and making certain forward-looking statements. Any statements that are not historical facts are subject to a number of risks and uncertainties and actual results may differ materially. We therefore urge to read the risk and other factors and cautionary language in the annual report on Form 20-F that was filed with the SEC on the 4th May, 2007.

We also draw your attention to the slide and our press release which is posted on our website for more information on the risks and uncertainties. In the first half, Group total sales were up 9.2% and like-for-like sales by 3.2%. Profit before tax, grew 3.2% to $109 million. Earnings per share increased by 5.1% to $4.1. The Board has declared an interim dividend of $0.96. In sterling terms this represents an increase of 7.5% using the exchange rate as of Monday.

Turning now to the U. S. business. The retail environment was more challenging in the first half than in most recent years, and this has been reflected in sales performance of most U. S. retailers. Our reported like-for-likes were up 2.7%. On an underlying basis they increased by an estimated 2% after adjusting for the adverse impact of weather disruption over Valentine's Day and the benefit from the timing of a promotional event at the beginning of the fiscal year. The like-for-like run rate in the last 12 weeks of the period was about 3.8%.

Total sales increased by 7.6%. Operating profit was $126.3 million, little change from last year. Operating margin was 10.4% while expenses were tightly controlled limited like-for-like sales growth meant that there was no offset to the impact of new space and a slightly lower gross margin. Bad debt to total sales ratio was 2.8% comfortably within the range over the last 10 years, once again, demonstrating our consistent accounts receivable record.

As with all general retailers we are subject to the economic cycle and we have... and we have to manage the business accordingly. In a slower environment, we manage costs even more tightly and align our operations to market conditions without cutting at the muscle of the business.

Credit is a sales enabler not a sales driver, and our credit standards are strictly maintained. A period of slower market growth gives the opportunity to reinforce our competitive advantages and to continue to gain market share. Experience shows that those retail jewellers able to execute a strategy consistently through the cycle are long-term winners. Therefore, we continue to implement our proven growth plan. And I'll now look at these points in more detail.

There are a number of volume-related costs that adjust this slower sales growth. For example, staff incentives last year made up 23% of store payroll. About 35% of our mall stores are on turnover-related rents and a number of other expense categories such as store consumables and credit card fees also vary with sales. Store staffing hours can be flexed to some degree to take account of slower foot falling. We achieved this by varying part time hours in each store.

Recruitment of home office staffs to support the growth of the business has been reduced. We have also reviewed projects with the medium term horizon to identify those that could be deferred with minimal short term impact to the development of the business. So, for example, new creative work has been commissioned for the JB Robinson television advertising.

In merchandising, the open to buy has been adjusted to current expectations to ensure an efficient inventory. Our credit standards have not fundamentally altered for over a decade. There has been no significant change in credit performance in the first half which has remained comfortably within the range over the last 10 years although we have seen a slight decrease in approval rates this year.

Our collection procedures and strategies are continually monitored and refined to reflect current conditions. For example, we have recruited over 40 collectors.

As our credit operation is in-house, we are able to add resources as and when we believe it appropriate. The alternative is a third party changing their lending and collection practices due to wider credit market pressures without consenting the retailer. This potentially would have a significant impact on a payment method accounting for some 50% of our sales. Our book is made up of short term under 12 months, lower average balances under $1000 which helps reduce our credit risk. We also have an aggressive provisioning policy which means a performance issue would be reflected quickly in our quarterly results.

A strong balance sheet and operating margin enables us to continue to leverage our competitive advantages. We are able to maintain a focus on training and customer service, marketing as a percent of sales and still grow our share of voice, inventory that is our customer selection and the store remodeling program.

Supply chain expertise and size allows us to better manage commodity cost pressures. This is even more important in a slower growth environment. Strict real-estate criteria, which have been consistently applied means that we did not have marginal real estate that is particularly exposed to trading conditions. High store productivity, strong balance sheet and consistent growth make us an attractive tenant for landlords, particularly at times when competitors are under pressure.

Our sustainable competitive advantages have enabled us to consistently gain market share over the last 10 years. The most meaningful gain came in 2001 in the downturn, when we remained committed to our strategy while weaker competitors were forced to reduce important key areas like advertising and inventory. Not only have we outperformed the jewellery industry, but our growth has been comfortably ahead of the retail sector.

This market share growth has been driven by Kay which has become the number one speciality brand by sales and by Jared which has become the number four brand.

The increase in consolidation within the sector is also highlighted on the slide. As you can see the top five brands in 1999 had a 13.5% market share. In 2006, their share was 16.8%. Kay's significant out-performance has greatly increased our ability to promote the brand with further advertising support, providing advertising leverage... additional leverage of our competitive advantage in marketing. For example, the Kay television impressions over Valentine's Day were up 34% compared to three years ago. And now we would like to show you one of the ads that ran this year.


We would really like to show to you through a sound.

[Advertisement]... but I guess that's not to be.

There we go. I don't know what that means. Thank you.


Here we go. Research shows that these ads continue to be very effective in terms of driving customer traffic into our stores. Our marketing leverage has been very important in driving our high store productivity which is a major factor between our.... our superior... behind our superior operating margin. This is achieved even though some 35% of our store portfolio is under five years old and is therefore still increasing store contributions. Contribution to sales have not yet reached maturity.

Turning now to our space expansion program. In fiscal '08, we expect the net space increase of about 10% including a further acceleration of the rollout of the Kay off-mall formats. This space growth is equivalent to opening the 8th largest speciality jewellery chain in the U. S. Jared openings will be less than last year at 19 stores. Three stores actually slipped into fiscal '09 due to abnormal planning and development issues.

Our disciplined approach to real estate enables us to continue to expand through the economic cycle. We maintain our strict operational real-estate criteria with particular focus on a high traffic flux. For Kay in both mall and off-mall locations, this means prime corner sites in superior centers. For Jared, the preferred position is on entry pads with good visibility of the store and easy access from a major highway.

The sales forecast model is based on experience and similarly located stores and is regularly reviewed to take account of the changing trading patterns.

The financial hurdle rate is a 20% pre-tax internal rate of return over a five-year period assuming the working capital is unwound. This year, our space growth program requires an investment of about $200 million in fixed and working capital. New space constrains operating margin, inventory turn and return on capital employed. Until the stores reach maturity, this is particularly so if the pace of expansion is increasing as it has been over the last few years.

However, new stores help leverage home office overheads and bring buying and advertising scale, so reinforcing the competitive advantages discussed earlier. Our space growth is also increasing long-term shareholder values. The IRR hurdle is substantially higher than the Group's cost of capital.

We also announced our preference for growth through organic or acquisition strategies. We continue to look for opportunities to pursue both. We financially evaluate them in terms of maximizing long-term shareholder value, taking into account the risks involved and both have pluses and minuses.

With acquisitions scale is achieved sooner particularly in marketing and buying. There is opportunity to leverage central functions faster and the development of the second national mall brand is accelerated. However, we have plenty of opportunity for organic growth and it is lower risk. All real estate inorganic growth is handpicked to satisfy our strict criteria. If we made an acquisition this would not be the case.

Internal expansion also means inventory is selected by our merchandising department, which has a strong record. Our number of competitors have had inventory write-downs and elements of the any acquired inventory may not be consistent with our quality requirements.

Newly opened stores have staff trained to our standards and all branch managers are appointed from within the division. The biggest challenge in our last acquisition Marks & Morgan in 2000 was to instill our customer service standard and culture in the storage staff.

Organic growth means that the investment in infrastructure can be matched it, the increase in store numbers, and acquisition would achieve scale ahead of the infrastructure particularly the availability of the suitably trained staff in both the field and home or office.

The jewellery sector has a record of growth with sales increasing by a compound rate of 4.9% per annum over the last 10 years. We have consistently outperformed the sector with our market share increasing to 4.3% of jewellery sales and 8.8% of the speciality market.

Our total sales growth has been about 12% per annum driven by both like-for-like sales growth and the doubling of store space. In aggregate, the new stores have exceeded our demanding investment hurdle rate. We expect the jewellery market to continue to grow reflecting increases in disposable income and a strong bridal market. We're well positioned to take advantage of this as about 45% of our sales are in the engagement bridal and the anniversary category.

Kay and Jared are targeted at the heart of the market with some 60% of jewellery sales being made by households with an income of $35,000 to $150,000. We also have a significant opportunity to add stores with planned space growth of 8% to 10% per annum in our existing concepts. Of this over 85% is expected to come from Jared and Kay in out of mall locations where the competition is largely from independent jewellers.

At a time when many of our competitors are restructuring under new management and endeavoring to put into place disciplines and practices that are embedded in our business, we have a robust organic growth plan, which means we are well positioned to gain further profitable market share.

And now I would like to turn to the U. K. business. Like-for-like sales were up 4.6%. Sorry, I am just having trouble with my throat today. Like-to-like sales were up 4.6% reflecting improved execution and some benefit from the weather. Total sales were up 4.2% at constant exchange rates due to the closure of some H. Samuel stores. This impact is expected to be greater in the second half. The normal seasonal operating losses largely eliminated despite a fall in gross margin.

A strong launch performance is a feature of the first half particularly in Ernest Jones. Diamonds continue to outperform in H. Samuel. In Ernest Jones, they also did well growing in line with the like-for-like sales increase. Overall diamond participation in the U. K. business showed another increase.

Both chains continue to gain benefit from improved customer service and the ongoing focus on staff training. This is a competitive advantage that can only be built over time through a disciplined and carefully planned program.

In the past two years we have significantly improved the content and quality of training and supporting materials. For example, I'd now like to show you a clip from a video for new recruits which show some of our U. K. store managers emphasizing the importance of customer service.


This investment and training has been very well received by our store staff and is recognized to be sector leading by third parties, such as the National Association of Goldsmiths and the British Horological Institute.

We are also looking to improve customer service by offering a store card. We have been treating... we have been testing our card in four areas, two each for H. Samuel and Ernest Jones. And we have now decided to roll it out across both chains in time for Christmas. The cards will be operated in conjunction with GE Money and are designed utilizing our U. S. experience to increase customer conversion, lift up the average transaction value and reinforce customer loyalty.

We continue to improve the customer experience by investing in the store environment. For H. Samuel, we are now implementing an enhanced format, and for Ernest Jones, we are about to begin testing an improved design.

We began to fundamentally change the format of the stores in 2001. The objective was to improve customer service to facilitate the sale of diamonds, fine jewellery and more expensive watches thereby lifting store productivity and profitability. The design drew on our U. S. experience with an open layout with display counters replacing the traditional self-select window booth-based based presentation, which is still prevalent among U. K. jewellers.

This open format makes it much easier for sales staff to interact with customers and improves merchandise presentation. The designs are also less intimidating and have significantly increased the differentiation of our brands. So, this slide shows one of the first mall stores to be refurbished highlighting the dramatic difference in appearance from the window-based store.

More importantly, the redesign is fundamental to the long-term changes in the business which are driving performance. This particular store is now five years old and in the intervening years we have learned lessons which have influenced the enhanced design, we now apply to the H. Samuel refits. Those enhancements include improved presentation of jewellery and clear displays of branded products, easier customer flows within the store which is particularly important at busy times, better usage of signage and lifestyle images and there is also a new logo.

We believe these changes to be a further significant step forward that have again increased the differentiation of the H. Samuel stores from its competitors. 217 H. Samuel outlets were in the open store format at the end of last year accounting for about 65% of sales. 21 stores are scheduled for refit or resite in the current year at a cost of about $5 million. It's planned to close about 25 stores this year as appropriate property transactions become available or leases expire.

The balance of the planned refurbishment program will be completed in fiscal 2009 and 10. During this time, H.Samuel will increasingly be focused on larger markets where bigger stores enable us to offer better customer service and wider selection. These stores generate a higher operating margin and a better return on invested capital.

Similarly, the Ernest Jones format has also moved to an open customer focused design over the last six years. The change has been made in fewer stores in H. Samuel and that's just the shape of the refit cycle.

Ahead of the heavier Ernest Jones refit program in fiscal 2009 and beyond, we are testing an enhanced design this year. It's intended to make the stores more distinctive from their competitors by modernizing the image with stronger branding of the Ernest Jones name.

We believe the design will increase the attraction of Ernest Jones to the more fashioned conscious customer. The internal layout of the store has been revised to further facilitate the selling process. Visual merchandising has also been improved which will appeal to the superior watch brands and provide greater clarity of presentation within the jewellery category. These are illustrations of the design and one of the first locations to be refurbished will be Bluewater. It's planned to open at the end of this month.

Reflecting the refit cycle only 38 Ernest Jones stores were in the more customer focused format at last year end, accounting for about 19% of the EJ sales. Six locations are scheduled for refurbishment in the enhanced store format this year and two Leslie Davis stores will also be refitted. In addition, three Ernest Jones stores are expected to be relocated. The cycle means that some 150 stores are scheduled for refit or resites, starting in fiscal '09 and ending in fiscal 2011. And this will require an investment of about $35 million.

The continuing store investment in both H. Samuel and Ernest Jones is complemented by the further development of customer service levels through enhanced staff training. Combined with merchandising and marketing initiatives this means that we have the opportunity to increase sales in a challenging U. K. marketplace.

And now I would like to hand over to Walker to review the financials.

Walker Boyd - Group Finance Director

Good afternoon. Group operating profit for the six months of $116.9 million represents an increase of 5.3% at constant exchange rates and reflects a stable U. S. performance and improvement in the U. K. and some increase in central costs.

Financial costs have increased principally as a result of the $100 million 2006-2007 buyback program. Correspondingly, pre-tax profit again on a constant rate basis increased by 3.8% or 3.2% on a reported basis. Sales growth in the U. S. was 7.6% with new space contributing 4.9%. The underlying like-for-like sales growth was estimated to have been 2% with the benefit of a timing promotional event at the beginning of the half, more than offsetting the adverse impact of weather disruption over Valentine's Day.

The U. K. like-for-like was 4.6% with space changes adverse by 0.4%. Exchange movements as a result of an average rate of $1.99 against $1.81 a year ago had a favorable impact on reported sales. At the Group level, like-for-like growth was 2.8% on an underlying basis and total sales at constant exchange rates were up 6.7%.

Looking at the geographical split, U.S. operating profits were little changed at $126.3 million although operating margin of 10.4% was down from 11.1%.

In the U. K. where profits are much more skewed to the fourth quarter, the normal seasonal deficit was virtually eliminated with an improvement from an operating loss last year of $6.8 million at constant rates to only $600,000 in the current period.

Group costs show an increase of $1.5 million at constant rates, primarily attributable to exchange losses largely arising on dividend payment and an increase in professional costs.

In the U. S. gross margins fell as anticipated by around 30 basis points. Reflecting tight cost control during the period, expenses remain steady as a percent of sales despite the lower like-for-like sales growth and a higher bad debt ratio. As usual, new space constrained operating margin by 40 basis points.

In the U. K. the gross margin also eased by 30 basis points, but the improved like-for-like together with continued cost control of proper costs, through our expense leverage of 190 basis points as I said largely eliminating the seasonal loss.

Dealing with the gross margin environment in more detail. In the U. S. the same mix factors which have driven like-for-like sales had an adverse effect on gross margin percentage, were again evidenced in the first half.

With regard to commodity cost, pressures have been somewhat less in the first half with polished diamonds which account for about half of our cost of goods sold, largely stable in our qualities over the last 18 months. Gold although only representing about 17% cost of goods, has seen an increase of 40% over the same period adversely impacting margin in the first half.

Market pricing has remained stable in the first half with little evidence of commodity cost increases being passed through to the consumer. We have gained meaningful offset to commodity cost increases from supply chain improvements and our initiative of processing rough diamonds continues to develop with a further significant volume increase plan in '08, '09.

In the U. K. commodity cost increases have again had only a marginal impact with the small decrease in gross margin, attributable to a strong performance during the sale period and further success in more targeted promotions throughout the first half.

Turning to the balance sheet, net debt increased by $121.6 million, since the start of the financial year as we completed the 2006-2007 repurchase program at a net cost of $23.5 million. And we have also seen a somewhat higher than normal seasonal output. This is largely due to an adverse movement in working capital, which resulted from an acceleration in vendor payments, reflecting overall advantageous terms. The net impact of higher capital spend and lower tax was minimal but both interest and dividends showed meaningful increases.

Interest was largely higher as a result of the impact of the $100 million 2006 share repurchase program, with dividends reflecting last year's 10% staffing increase and the impact of the weakening dollar since last year. For the full year, we would expect capital spend of about $170 million for the Group and the cash outflow before exchange adjustments and movements in equity is expected to be between $90 million and $110 million, slightly higher than previously anticipated again as a result of the timing differences caused by the accelerated vendor payments.

I now hand you back to Terry.

Terry Burman - Group Chief Executive

Thanks Walker. We will be pleased to take your questions now. We'll start with those people present in the room before going to those joining us by conference call and then return to the auditorium for any final questions. Please state your name and organization and if you are in the room please wait for a microphone so that those joining by telephone can hear.

Question And Answer

Unidentified Analyst

Could you talk about your credit experience in a bit more detail? Have you changed your credit criteria tool or seen any different behavior in the credit book? And what's the thinking behind taking on... is there a specific reason why you have taken on the 40 more collection agents?

Walker Boyd - Group Finance Director

I think if we look at the statistics on the credit portfolio and I think you have to believe me, when credit statistics are after sales and margins, the most poured over statistics, we have in the business, I think if you look at the individual ratios apart from the bad debt loss, you look at exit rates, you look at the participation, you look at the monthly collection rate. All of these, I would say are symptomatic. The movements in that are symptomatic of a tighter consumer.

Having said that and none of these movements show any sense of direction that there is a fundamental change in the performance of the portfolio. So, in that sense, yes I think the performance reflects economic situation. But no fundamental change. And the comment that Terry made in terms of the loss rates have been comfortable in the range over the last 10 years, I would apply equally to these other key statistics, I have mentioned.

I think the investment in more collectors I think that is one area where we would say that keeping the receivables in-house is a competitive strength particularly into this environment allows us to manage the credit portfolio at our strategy. We have maintained credit standards overall in terms of the overall level of acceptance, deterioration in consumer balance sheet says exit rates go down a little. The other symptom then is people trend to take slightly longer to pay, and that's where we think it appropriate then to invest in an additional collection response. And I think that is to add advantage as opposed to if we had credit on a third party basis with a bank. I think we take a different view in terms of their balance sheet ratios and come down on the exit rate much more dramatic, and clearly that will have a much of a greater impact on our business model than the additional cost of 40 additional collectors. So, we will respond to the performance of the portfolio, but we continue to strongly believe that keeping the receivables in-house is a very strong competitive advantage particularly in these uncertain credit times.

Unidentified Analyst

Thanks a lot. And so while I got the mic and Terry, you mentioned that you're moving to national network TV advertising for Jared. Could you talk for a bit implications that what the advantages would be relative to what you have been doing, and whether there is an additional cost?

Terry Burman - Group Chief Executive

The cost... for Jared, the cost will stay in proportion to its sales, and Jared's growth makes it possible for us to increase the advertising budget that we spend on media. The significant... there are several significant benefits to national network advertising versus the regional advertising that... the local advertising that we were doing. First of all the impressions are of a higher quality. It just opens up opportunities to buy higher quality impressions rather than those impressions that are saved for the local markets.

Secondly, it gives us an opportunity to do add-ons. With any TV buy there are promotional opportunities. So for instance in Kay we are sponsoring the American music awards and we have done so far several years. We have the Kay lounge in the back where they interview the award winners. And this gives us an opportunity while we pay for our adds on the program but it gives us an opportunity for extra promotional mentions. For instance, when they go to a commercial they say American music awards brought to you by Kay Jewelers. We've never had this kind of opportunity and there is many of these that we do for Kay throughout the year. We never had these opportunities before in Jared. We'll now start to achieve them. So you get more for your money in terms of quality impressions. You also get more for your money in terms of these promotional opportunities which can tie into your buy, by allocating additional money to certain programs that you hence [ph] select.

Finally and the biggest benefit of going to national advertising is we have been able to as we've increased our sales and allocated the same percentage of sales to advertising cost in Kay, we have been able to raise our... the number of impressions that we have every year. In Jared, however, because all the advertise has been local all the additional new money has gone into funding the local advertising and adding new local areas to our advertising buy.

Now with national TV we are going to be able to start increasing impressions as our sales and budget increase. So we'll be able to leverage our spend into increased impressions that come in from the increased budget from each new store and that will benefit the entire chain. We previously weren't able to do this, because we didn't have enough mass to be able to get over the hurdle to buy national advertising. But now that we have reached that hurdle, now we can invest in national and start increasing our impressions like we have in Kay.

Unidentified Analyst

Thanks a lot.

John Baillie - SG Securities

Hello, John Baillie from SG. Could you elaborate a little bit on the vendor payments and the change in terms, impact that's having on the margins and the scale of them?

Walker Boyd - Group Finance Director

I wouldn't overestimate the scale, but then obviously if you look our balance sheet you can see that our creditors have gone down more, you would expect them to go down more of this time of the year relative to year end, they have gone down more than that. But really there is a short term timing difference where we are paying vendor slightly earlier, and I think in effect using our balance sheet rather than their's which ours is clearly stronger. So, clearly it does have a benefit to the overall operating margin which is then slightly offset by higher interest charges. As I said, I would not overestimate the impact of it, if you look at, as you see it's effectively at two week timing difference in terms of the cycle of our year end vendor... our month end vendor payments.

John Baillie - SG Securities

And could I just ask also on outlet centers, whether you... I mean if they are working and whether you'll be... can accelerate the pace of expansion going forward?

Terry Burman - Group Chief Executive

Sure, just to tie up on Marcus' question I think he asked about the vendor payments whether they're impacting gross margin. No they have no impact on gross margin.

Walker Boyd - Group Finance Director

I will take up and discuss, so they impact SG&A rather than gross margin.

Terry Burman - Group Chief Executive

We are very pleased with the first year test of the outlet centers. We opened five... we opened four as you know give us a total of five and we're opening... we anticipate opening at between 5 and 10 next year. So, good result early days but a good result.

Andrew Hughes - UBS Warburg

Yes good afternoon. It's Andy Hughes from UBS. I have got couple of questions. Firstly it was on the level of cost growth, it seems to be in a lot lower in Q2 than Q1 if I am right on the numbers and that you have made this some sort of a step change into the cost savings initiatives, started the equations. Do you think that's... you have found as much as you think you need to do for the year? Or should we expect it to be even tighter on cost growth in the second half? And the same thing was on the H. Samuel store closures that you said... can you give us any indication firstly of where you think the ideal chain size would be for H. S and also what the P&L impact would be? I mean these stores are still profitable at store level and you're doing it long term DCF [ph] type regions?

Walker Boyd - Group Finance Director

YesI think on your first question particularly if you're asking about the U. S. I think looking at the Q2 and Q1 cost increases is difficult because you... if you recall at the end of Q1 we did say that there was a flip of advertising spend in the U. S. that had gone... for Mother's Day, gone more into Q1, which then reversed in Q2. So I think if you look quarter-on-quarter, the expense levels is somewhat distorting.

Having said that I think if you look at the overall half, which is the appropriate way to look at to eradicate that timing difference that we had at the end of Q1, I think both the U. K. and the U. S. have maintained underlying expense growth in the US obviously net of space growth in that low single digits. I think for the balance of the year, we... both divisions will continue to tight control costs. We don't have any specific cost cutting exercises, similar to for example what we had in U. K. at the beginning of 2006, when we reacted to the change in activity.

But overall continued tight control of cost will remain important. Clearly for the second half when you look at the amount of expenses which you can vary, they are somewhat less particularly the U. S., where advertising then takes a higher proportion of total sales. And the Terry has said we continue to invest in advertising at the same percent of sales. So, I would continue to look for underlying cost increases certainly in the low to slightly under mid single digits. But we don't have any plans for specific cost reduction exercise. I think it's just generally very tight control of day to day expenses.

As far as H. Samuel closures are concerned, I think I really where eventual portfolio goes is... there is a range I think where we will end up because there are a number of stores which have tend to be in smaller markets. They tend to have less space and therefore it's more difficult to reconfigure the store to meet the standards that we are trying to achieve. So a number of these stores, we will take decisions over the next two to three years as they come up for recycle. If it's appropriate to exit because we get good property deals, we may on the other hand, it could be that we continue to trade through the stores, with more minor refits and so that we at least maintain standards without necessarily fully refit against. So that is a great area, small number of stores but meaningful.

In terms of the overall impact, I think you have seen in the first half that we have reduced space. The overall impact on operating profit in absolute sterling terms is likely to be minimal, because these stores tend to have contributions in the low to mid-single digit percent. So, that when you get some savings in terms of overall support, the impact on as I say operating profit in absolute dollar terms is minimal. What we would do over time is to give a better return because these stores clearly have a constraining effect on operating margin and you then also have little lease of working capital. So return on capital percentages will tend to go up over time.

Andrew Hughes - UBS Warburg

Thank you.

Terry Burman - Group Chief Executive

I think, I would just add to that, there is a shift in the U. K. market to some bigger centers which obviously have an impact on the surrounding smaller market, shopping centers. So, you're seeing these examples that come to mind are the center that's built in Bristol or White City and they do... these bigger centers allow us the opportunity or give us the opportunity to open bigger stores, provide a larger selection of merchandise and better customer service. So if other retailers are doing the same thing and they are then that does tend to impact some of the smaller market areas with smaller stores, and you are really into... it's just a slow evolutionary market shift and we are optimizing our portfolio, because of that... because that's where the market is going.

Unidentified Analyst

[Indiscernible] from Credit Suisse over here. Just a couple of things. Talking about the U. S. expansion program obviously taking place against the backdrop of pretty difficult market conditions in the U. S. generally. Is this allowing you to sort of reduce proxy cost so to achieve much better proxy deals, should we be sort of factoring in... sort of cash inducements or lower rent per square foot, from what you are opening at the moment? And second question as far as the U. K. credit operation is concerned can you give us some idea of what you hope to achieve in terms of scale up the operation and profitability over what sort of time scale?

Terry Burman - Group Chief Executive

In terms of the U. S. there is a slowdown, there is not a... we are not going backwards in terms of retail sales. So, the property costs are... we haven't noticed any difference in property costs and don't anticipate any meaningful changes in the basic cost structure. Especially for the very best space and that's what we require, and the very best space is still rare, has more buyers and sellers. And we... for that space we would not expect any fundamental change in the... nor are we seeing any fundamental change in the pricing.

In terms of the credit card program, this is, I want to make it clear that... I want to emphasize that this is a third party program. So, I think your question went to scale it's not an issue like in the U. S. business where you would have scale up. The thing that we are trying to achieve is, this is a unique credit program with a lot of options and choices for the customer in terms of purchase plans that's modeled after our programs in our U. S. business and the offering if you will, in our U. S. business. As you know, we've got 50% of our sales approximately on credit in the U. S. business. So, we have not just adapted administering credit, but our sales people are very adapted selling it. And a lot of the program is about... a lot of the skill comes in matching the customers' needs with the appropriate payment plan suggesting it, knowing how to suggest credit, when to integrate into the sale or introduce it into the sale and how to close the sale with credit. We have taken those training methods over here and developed a unique credit offering certainly in the jewellery market with three different choices that we will be offering the customer this year in... or this holiday... this Christmas season with an interest free program, buy now pay later program, which is also interest free. And most of our sales are on those two programs. And then there is also a traditional interest bearing program. So, what we achieve... what we expect to achieve from it is that which we have achieved in our test in the four areas which is increase sales. How much you want to know, that's why you are smiling?

Unidentified Analyst

Yes that might be the idea behind it for asking us...

Terry Burman - Group Chief Executive

Well so you can... right.

Walker Boyd - Group Finance Director

I think it's important, when you say how profitable. We're not... just as in the States, we're not going to... is not being run as a profitable credit business, is not being run as a profit center. It is a sales enabler and clearly we would hope it will facilitate sales. In terms of profitability, it should be reflected more in the top line rather than looking as a separate profit center.

Terry Burman - Group Chief Executive

You can bet, for competitive reasons we are not going to share the lift that we get. But you can bet since we've been testing it and we're rolling it out, you can bet that it's the sales, more than cut... the incremental sales more than cover the cost to the program.

Unidentified Analyst

Jamie Asmoto [ph] from Deutsche Bank. Can you tell us whether there is any CapEx differential between the new Ernest Jones refit and the old ones and whether any of the watch brands contribute anything to this? And then secondly, just on watches in general, which have been strong industry wide and globally, what happened to gross margin in that product category?

Walker Boyd - Group Finance Director

I think the answer to your first question both your first questions are no. I think that we would expect the cost of the enhanced design, that we showed the photograph the cost per store is not going to be materially different from the existing millennium refits. So in terms of overall CapEx no there is no significant, no meaningful change. And no I think in terms of contribution that would be... we haven't received contributions in the past from watch suppliers and we would not anticipate that going forward.

In terms of overall gross margins, I don't think the gross margin on the watch category per se percentage has changed. Clearly the favorable mix or the mix to a... the movement in mix towards watches in the first half in EJ was one of the contributing factors to the overall 30 basis points decline in the gross margin. But again the payback in terms of the leverage we get from the extra sales is worth a few basis points in terms of adverse mix on overall gross margin percentage.

Unidentified Analyst

And is there any major intra-product group mix change within the watch category?

Walker Boyd - Group Finance Director

You mean within specific brands?

Unidentified Analyst

Either brands or price points, is it all moving to higher price points?

Walker Boyd - Group Finance Director

NoI think in... seven brands will do better than others and it would be wrong just to go into that at this time because that tends to be... different brands will perform better or worse so over a cycle. I think in terms of general movement, yes the move towards higher office [ph] selling price that applies both to the more fashioned brands within the... within the Ernest Jones and indeed to the more prestige brands both of which have been strong and in the period for the EJ. I love to say the prestige brands particularly so.

Unidentified Analyst

Thank you.

Andrew Hughes - UBS Warburg

Yes it is Andy Hughes, another quick, your table on market share the major brands and I know you've obviously been the best performer in that, which is notable that that Tiffany seems to going up in the ranks as well every year. And I guess fine luxury goods generally is performing very strongly in the market. My question is, there anything that they are doing as a group the higher end brands that you think you should be doing in terms of... in terms particularly product or pushing price points higher?

Terry Burman - Group Chief Executive

I was scrambling from a table because I thought you were referring it to but...

Unidentified Analyst

: On page 9.

Terry Burman - Group Chief Executive

No, I have got it. I think that sector of the market has been, the higher end sector of the market has been strong and I think that's more of a demographic issue than is anything else. Having said that for the past three years, we have meaningfully increased our average transaction values in both the mall stores and in Jared. I think the last two years we were in double digits, and this year we are in mid single digit if I memory serves me correctly. But that's not... we are always test... we are always probing and testing. And we are testing... as we test higher price points, the customers responded them, we are going to lift our ranges up to meet those higher average transaction values and then test it at an even higher level. So it's not... we are not pushing this. The customers are pulling the higher price points from us. So we are working on our basic principle which is pull merchandising versus push merchandising. We're reacting to that which the consumer is responding to in terms of our merchandise offering.

Unidentified Analyst

And I say, watch is in the area that worked very well, but do you think other accessories is that's an area where you could push out as well?

Terry Burman - Group Chief Executive

Our average price points are out there in every category and we've got a new merchandise offering. In Jared, we just put a branded diamond which is exclusive to us. It's called the peerless [ph] and what this is an ideal cut, ideal proportions in terms of the cut of the diamond that scores triple very high on a light reflection scale. So when the light reflection is measured it's brighter, it's more sparkly. And that's exclusive to us. It's something that our merchandise... our merchandise team developed the idea, went to several manufacturers and asked them to if they could produce it. Three of them were unsuccessful and had to dropout, two of them are able to produce it. We've got exclusive rights to this. It is a more expensive product, because to get the right proportion you have more waste when you are cutting the rough. It's probably more than you wanted to know about diamonds. But we're very proud of the program because it gives us a complete... it gives us a product offering that can't be duplicated by our competitors. So, we have got some thing special to offer and the program has been very successful. It's only in the Jared stores and we are taking all the production that the manufactures can cut. So, that's an example of our higher price point that's been successful in helping to drive our sales.

Unidentified Analyst

Thank you.

Terry Burman - Group Chief Executive

Any other questions in the room. Okay. We would now like to go to the conference call and operator would you tell us if there us any questions from the conference call.


: Thank you. [Operator Instructions]. We have no questions at this time.

Terry Burman - Group Chief Executive

This is like the fourth time in a row. Well thank you America. Thanks for your support. Any further questions from the room? All right, well thank you for attending.

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