Signet Jewelers Limited — Form 10-Q Summary
Reporting period: Third quarter and first 39 weeks of Fiscal 2011, ended October 30, 2010. Comparisons are with the corresponding Fiscal 2010 periods. The unaudited company operates jewelry retail businesses in the US and UK, including Kay Jewelers, Jared, H.Samuel and Ernest Jones. Its business is highly seasonal, with a significant share of sales and operating profit typically generated in the fourth quarter.
Financial performance
| Metric | 13 weeks ended Oct. 30, 2010 | 13 weeks ended Oct. 31, 2009 | 39 weeks ended Oct. 30, 2010 | 39 weeks ended Oct. 31, 2009 |
|---|---|---|---|---|
| Sales | $641.8m | $611.4m | $2,166.9m | $2,076.8m |
| Gross margin | $193.6m (30.2%) | $163.0m (26.7%) | $724.4m (33.4%) | $634.2m (30.5%) |
| Operating income/(loss) | $18.5m (2.9%) | $(5.9)m | $162.0m (7.5%) | $87.3m (4.2%) |
| Income/(loss) before tax | $12.0m | $(13.3)m | $140.8m | $60.8m |
| Net income/(loss) | $6.0m | $(8.7)m | $95.0m | $41.6m |
| Diluted EPS | $0.07 | $(0.10) | $1.10 | $0.49 |
Third-quarter sales increased 5.0% as reported (6.0% at constant exchange rates); year-to-date sales rose 4.3% (4.9% at constant exchange rates). Same-store sales grew 7.2% in the quarter and 5.8% year to date. The US drove growth: quarterly same-store sales rose 9.7%, while UK same-store sales declined 0.6%.
Gross-margin improvement reflected higher prices, lower diamond costs, reduced discounting, better US receivables performance and US store-occupancy leverage; higher gold costs and currency effects were offsets. SG&A rose 2.1% in the quarter and 1.5% year to date, but fell as a share of sales. Other operating income declined, primarily due to amendments to the Truth in Lending Act.
Cash flow, debt and liquidity
- For the first 39 weeks, operating cash flow was $196.9m and investing cash outflow was $39.5m, producing free cash flow of $157.4m, compared with $318.8m a year earlier. The prior-period cash generation benefited from working-capital movements; current-period inventory increased $125.9m, reflecting seasonality.
- In the third quarter alone, operating cash flow was a use of $57.7m and free cash flow was a use of $82.8m, including a $166.2m inventory increase.
- At October 30, cash and cash equivalents were $414.9m and loans and overdrafts were $266.7m, giving reported non-GAAP net cash of $148.2m. The company had reported net debt of $160.7m at October 31, 2009. The $300m revolving credit facility, maturing in June 2013, was undrawn.
- Inventory was $1,297.4m, up from $1,173.1m at January 30, 2010. Accounts receivable was $769.5m. The filing does not provide a single summary measure of liquidity beyond the reported cash, borrowings and facility.
Material changes, outlook and notable items
- Debt prepayment: Signet announced it would repay $229.1m of Private Placement Notes on November 26, 2010. The $47.5m make-whole premium, including the cost of an interest-rate protection agreement, was expected to be recorded in the fourth quarter. Management estimated a net adverse Fiscal 2011 diluted-EPS impact of $0.32, including a $0.02 per-share benefit from reduced interest after repayment; it estimated a $0.13 per-share benefit in Fiscal 2012. The company said the prepayment would improve financial and operational flexibility and reduce future interest expense by $101.7m over the Notes’ remaining term.
- Fiscal 2011 outlook: Free cash flow before the Notes prepayment and make-whole payment was expected toward the upper end of the previously stated $225m–$275m range. Management expected US gross merchandise margin to be at least level with Fiscal 2010; UK gross merchandise margin was expected to remain somewhat below Fiscal 2010. The anticipated effective tax rate was 32.5%. No full-year sales or EPS guidance is provided in the filing text.
- Management estimated the net direct adverse effect of Truth in Lending Act amendments on Fiscal 2011 operating income at $15m–$17m. Additional fourth-quarter expense of approximately $7m–$9m was expected, primarily related to the incoming CEO’s compensation for amounts forgone at his prior employer; about $2m of additional costs were anticipated for relocating certain central functions to the US.
- Signet corrected its extended-service-plan revenue accounting in the quarter, extending the deferral period and changing how direct costs are recognized. It adjusted prior-period comparative figures; management said prior periods were not materially misstated, but the cumulative adjustment would have been material to Fiscal 2011 statements if recorded only in the current period. The correction affected revenue, deferred revenue and related balance-sheet amounts.
- Tax items included $4.5m of previously unrecognized tax benefits recognized during the first half, including benefits related to a UK financing-arrangement settlement and expiration of a US statute of limitations. Management believed substantially all of the remaining unrecognized tax benefits at January 30, 2010 could potentially be reduced within the following 12 months.
- Mike Barnes was appointed CEO effective January 30, 2011, succeeding Terry Burman. The company disclosed private-plaintiff and EEOC lawsuits alleging gender discrimination in US store-level compensation and promotions; Sterling denied the allegations and said it would defend the cases. Claimed monetary relief was unspecified.
Risks and investor verification points
- Verify the final cash cost and accounting treatment of the November 2010 Notes prepayment, including the make-whole premium and its actual EPS impact.
- Track holiday-quarter sales, margins, collections and inventory conversion: results are seasonal, and third-quarter working capital absorbed substantial cash.
- Assess the durability of US same-store-sales and bad-debt improvements, and the continuing weakness in UK sales and margins.
- Monitor gold and diamond costs, foreign-exchange movements, consumer-credit regulation and receivables credit quality; the filing identifies these as relevant exposures.
- Review the extended-service-plan accounting correction and its effects on reported comparatives and deferred revenue; verify future disclosures on financing-receivable credit quality.
- Follow the discrimination litigation and related potential costs. The filing does not quantify any probable loss or provide a clear estimate of exposure.