- Part I: Summary
- Part II: Risk Factors
- Part III: The Scheme of Arrangement and Share Capital Consolidation
- Part IV: Directors, Company Secretary, Registered Office and Advisers
- Part V: Presentation of Statisical Data and Other Information
- Part VI: Information on The Group
- Part VII: Directors and Corporate Governance
- Part VIII: Selected Financial Information
- Part IX: Operating and Financial Review
- Part X: Accountant's Reports and Financial Information
- Part XI: Interim Financial Information of The Group for The 26 Week Period Ended 2 August 2008
- Part XII: Additional Information
- Part XIII: Definitions
PART IX
OPERATING AND FINANCIAL REVIEW
The selected historical financial information discussed in this operating and financial review of the Group has been extracted from Part X, prepared in accordance with US GAAP. You should read the following discussion of the Group's financial condition and results of operations together with the rest of this document, including the financial information in Part X "Accountant's Reports and Financial Information" and should not rely solely on the summarised information contained in this Part IX.
1. KEY FACTORS AFFECTING RESULTS OF OPERATIONS
The Group's sales are seasonal with the first and second quarter both typically accounting for slightly more than 20 per cent of annual sales, the third quarter accounting for a little under 20 per cent and the fourth quarter accounting for about 40 per cent of sales, with December being by far the most important month of the year. Due to operating leverage the operating income of the Group is even more seasonal, with nearly all the UK division's, and a little over 50 per cent of the US division's, operating income occurring in the fourth quarter. Group costs occur broadly evenly during the year, while net interest costs are higher in the second half of the year reflecting the peak in working capital requirements ahead of the key Christmas trading period.
The key drivers of operating profitability are the:
- rate of sales growth;
- balance between like for like sales growth and sales from new store space;
- achieved gross margin;
- level of cost increases experienced by the Group; and
- movements in the US dollar to pound sterling exchange rate, as the minority of the Group's operating income is generated in the UK and the Group has reported its results in US dollars.
The gross merchandise margin percentage in retail jewellery is above the average for speciality retailers, reflecting the slow inventory turn. The trend in gross merchandise margin depends on the Group's pricing policy, movements in the cost of goods sold, changes in sales mix and the direct cost of providing services such as repairs.
In general, the gross merchandise margin percentage on gold jewellery is above that of diamond jewellery, whilst that of watches and gift products is normally below that of diamond jewellery. Within the diamond jewellery category the gross merchandise margin percentage varies depending on the proportion of the merchandise cost accounted for by the value of the diamonds; the greater the proportion, the lower the gross merchandise margin percentage. In addition, the gross merchandise margin percentage of a Jared store is slightly below the mall brands, although at maturity the store contribution percentage of a Jared site is similar to that of a mall store.
A change in merchandise mix will therefore have an impact on the Group's UK and US division's gross merchandise margin percentage and a change in the proportion of sales from Jared will have an impact on the gross merchandise margin percentage of both the US division and Group. In the US division the growth of Jared and the increase in sales of higher value diamonds, both of which are helping to drive like for like sales growth, means that the US gross merchandise margin percentage is expected to show a small decline in most years.
The cost of goods sold used to arrive at gross margin takes into account all costs incurred in the purchase, processing and distribution of the merchandise and all costs directly incurred in the operation and support of the retail outlets.
To maintain the operating income margin, the Group needs to achieve like for like sales growth sufficient to offset any adverse movement in gross margin, the increase in operating costs (including the net bad debt charge) and the impact of immature selling space. Like for like sales growth above the level required to offset the factors outlined above, allows the Group to achieve leverage of its fixed cost base and improve operating margin; slower sales growth results in reduced operating margin. There are not any known trends or uncertainties in future rent or amortisation expenses that could materially affect operating results or cash flows.
The Group's target of 8 per cent to 10 per cent net new store space growth in the US, with a slight decline in space in the UK, means lower like for like sales growth is required in the UK than in the US to maintain operating margin. As the planned new space growth of about 4 per cent in the US in 2008/09 is below that achieved in 2006/07 and 2007/08, a lower rate of like for like sales growth would be required to maintain the US operating margin than has recently been the case. In addition, the actions taken to control costs in 2008/09 further reduced the required level.
The impact on operating income of sales variances (either adverse or favourable) is less in the US division than the UK, as certain variable expenses such as sales-related rent and staff incentives account for a higher proportion of costs in the US business than in the UK division. The impact on operating income of a sharp increase or decrease in like for like sales performance is marked. This is particularly the case if the change in sales growth is unexpected and occurs in the fourth quarter. A key factor in driving operating margin is the level of average sales per store, with higher productivity allowing leverage of expenses both in store and in central functions.
Movements in the US dollar to pound sterling exchange rate have an impact on the reported results of the Group as the UK division's results are translated into US dollars. A one cent movement in the exchange rate impacts income before income taxes by some $0.5 million. The Directors believe it is inappropriate to hedge this exposure as the UK division's sales and costs are denominated in pounds sterling.
The results of the Group's operations are affected by many factors. This section sets out certain key factors that the Directors believe have affected the Group's results of operations or could affect its results of operations in the future. For a discussion of certain factors that may adversely affect the Group's results of operations and financial condition, please also see Part II "Risk Factors".