Business context and reporting period
Signet Jewelers Limited is a jewelry retailer operating primarily in the U.S., U.K. and Canada through Sterling Jewelers, Zale (including Zale Jewelry and Piercing Pagoda), UK Jewelry and Other. This unaudited Form 10-Q covers the 13 and 26 weeks ended July 30, 2016 (Fiscal 2017 second quarter and year to date), compared with periods ended August 1, 2015. The business is highly seasonal: almost 40% of annual sales and typically 45%–55% of annual operating income occur in the fourth quarter.
Financial performance and position
| Metric | Second quarter | Year to date |
|---|---|---|
| Sales | $1,373.4 million, down 2.6%; same-store sales down 2.3% | $2,952.3 million, up 0.4%; same-store sales up 0.2% |
| Gross margin | $464.9 million; 33.9% of sales, versus 34.8% | $1,065.3 million; 36.1% of sales, versus 35.9% |
| Operating income and margin | $119.9 million; 8.7%, versus $100.8 million and 7.2% | $331.9 million; 11.2%, versus $277.0 million and 9.4% |
| Net income | $81.9 million, versus $62.2 million | $228.7 million, versus $181.0 million |
| Diluted EPS | $1.06, versus $0.78 | $2.94, versus $2.26 |
| Operating cash flow | Not separately stated in the filing’s cash flow statement | $309.2 million, versus $210.6 million |
| Free cash flow | Not separately stated in the filing’s cash flow statement | $208.2 million, versus $111.7 million |
Reported results were affected by Zale purchase-accounting adjustments and integration costs. On Signet’s non-GAAP adjusted basis, second-quarter operating income was $129.6 million (9.4% margin) and adjusted diluted EPS was $1.14, down from $149.5 million (10.5%) and $1.28. Year-to-date adjusted operating income was $352.2 million (11.9% margin) and adjusted diluted EPS was $3.10, up from $343.5 million (11.6%) and $2.91.
Second-quarter sales weakness was broad-based and especially pronounced in energy-dependent regions; management attributed approximately half of the sales decline to those regions. eCommerce sales were $69.6 million, or 5.1% of sales, versus $65.9 million and 4.7%. Piercing Pagoda performed relatively well, while Sterling and Zale Jewelry same-store sales declined. U.K. sales fell in reported dollars largely because of currency translation; they increased 2.0% at constant exchange rates in the quarter.
At July 30, cash was $118.7 million; total debt was $1,578.4 million and net debt was $1,450.4 million. Current assets were $4,407.9 million and current liabilities $1,144.1 million. Long-term debt was $1,330.5 million; loans and overdrafts classified as current were $238.6 million. The company drew $200 million net on its revolving facility during the half. It reported compliance with debt covenants. Inventory was $2,418.3 million and customer accounts receivable was $1,650.6 million.
Material changes versus the prior comparable period
- Second-quarter reported operating income and EPS increased year over year, but adjusted operating income, margin and EPS declined. The prior-year quarter included $43.6 million of transaction and integration costs, including a $34.2 million appraisal-rights settlement; current-quarter integration costs were $5.3 million.
- Year-to-date reported and adjusted operating income and EPS improved. Lower acquisition-related costs versus the prior year materially contributed to the reported comparison.
- Gross margin rate declined in the second quarter, reflecting lower sales, fixed-cost deleverage and higher bad-debt expense. The company reported year-to-date net bad-debt expense of $88.9 million, versus $77.5 million.
- Net charge-offs as a percentage of average gross Sterling receivables rose to 5.0% from 4.6%; the average monthly collection rate fell to 11.3% from 12.0%. Management cited credit-plan mix and prior-year customer cohorts reaching charge-off thresholds.
- Cash from operations improved, while financing cash use increased, principally reflecting $375.0 million of share repurchases versus $81.9 million in the prior-year half. Cash declined by $19.9 million during the current half.
Outlook, commentary, risks and unusual items
- Management expects Fiscal 2017 effective tax rate of 27%–28%, compared with 28.9% in Fiscal 2016. The filing provides no overall sales or earnings guidance.
- For the remainder of Fiscal 2017, Signet anticipated 145–176 store openings and closures resulting in a net increase of 55–89 stores, with net selling square footage growth of 3.0%–3.5%.
- In July, Signet amended its credit facility: revolving capacity increased from $400 million to $700 million and the revolving and term loan maturities were extended to July 2021. The asset-backed securitization facility was extended to May 2018. The company also reported a $600 million balance on that facility.
- On August 24, 2016, after quarter-end, Signet agreed to issue $625 million of 5.0% Series A convertible preference shares to affiliates of Leonard Green & Partners, subject to closing conditions. Signet expected to use the proceeds to fund up to $625 million of common-share repurchases. The preference shares carry quarterly dividends, payable in cash or added to the liquidation preference at Signet’s option, and the investors’ designated director nominee is part of the stated closing conditions.
- Employment-practices litigation remains significant: 10,094 current and former employees had opted into an Equal Pay Act collective action by August 1. Signet said it could not estimate an outcome or potential loss. A separate EEOC case was remanded for further proceedings; Signet sought U.S. Supreme Court review. A Zale wage-and-hour action also received conditional collective-action and class certification. Signet disputes the allegations.
- A shareholder class action filed August 25 alleges securities-law violations related, among other things, to alleged difficulty ensuring customer jewelry safety during repairs, customer confidence and competitive pressures. Signet called the allegations without merit and said it could not estimate potential liability.
- Signet identified Brexit-related uncertainty as a risk to U.K. operations, economic conditions, currencies and hedging. Other cited risks include consumer spending, credit quality and regulation, competition, precious-metal costs, foreign exchange, IT/security disruptions, and integration of Zale.
Most important facts for investors to verify
- Whether the second-quarter sales and adjusted-margin weakness persists, especially in Sterling/Jared and energy-dependent markets, through the holiday season.
- Customer-credit performance: bad-debt expense, charge-offs, collection rates, receivables growth and the impact of extended-payment plans.
- Whether operating cash flow can sustain capital spending, dividends, debt service and planned buybacks, particularly after the proposed preference-share financing.
- Final terms, closing status, dilution and dividend implications of the $625 million preference-share transaction and associated common-share repurchase plan.
- Developments and potential financial exposure in employment, Zale wage-and-hour and shareholder litigation; the filing does not provide a clear estimate of potential losses.
- Currency effects on U.K. results and the consequences of Brexit, alongside progress on planned store growth and Zale integration.