Signet Jewelers Limited — Form 10-Q Summary
Business context and period. Signet is a jewelry retailer operating primarily in the U.S., U.K. and Canada, including Kay, Zales, Jared, Peoples, H.Samuel, Ernest Jones and James Allen. This unaudited report covers the 13 and 26 weeks ended August 4, 2018 (Fiscal 2019 second quarter and year to date); comparatives are the periods ended July 29, 2017. The company reorganized reporting into North America, International and Other segments. Results are seasonal: nearly 40% of annual sales and typically 45%–55% of annual operating income occur in the fourth quarter.
Financial performance and liquidity
| Metric | Q2 FY2019 | 26 weeks FY2019 |
|---|---|---|
| Sales | $1,420.1 million, +1.5% reported; same-store sales +1.7% | $2,900.7 million, +3.5% reported; same-store sales +0.7% |
| Gross margin | $427.0 million; 30.1% of sales | $911.8 million; 31.4% of sales |
| Operating income (loss) | $(58.1) million; (4.1)% margin | $(632.3) million; (21.8)% margin |
| Net income (loss) | $(23.0) million; common-share diluted EPS $(0.56) | $(519.6) million; common-share diluted EPS $(9.27) |
| Operating cash flow | Not separately presented in the cited summary for the quarter | $452.6 million |
Q2 non-GAAP operating income was $48.6 million, versus GAAP operating loss of $58.1 million; year-to-date non-GAAP operating income was $72.7 million. Adjusted EBITDA, another non-GAAP measure, was $90.4 million for Q2 and $162.3 million year to date, down from $180.0 million and $340.7 million, respectively, in the comparable periods.
Year-to-date operating cash flow included $445.5 million of proceeds from the non-prime receivables sale. Capital spending was $56.1 million, producing reported free cash flow of $396.5 million under the company’s definition; that measure therefore includes the receivables-sale proceeds. Cash was $134.1 million at August 4, 2018, down from $225.1 million at fiscal year-end. Total debt was $788.9 million, including $71.0 million drawn on a $700 million revolving facility; net debt was $648.4 million. The company reported compliance with debt covenants. Current assets were $2,867.5 million and current liabilities $1,064.8 million, with inventory of $2,363.8 million.
Material changes versus prior periods
- Q2 sales increased $20.5 million, while gross margin fell 2.6 percentage points and the company moved from $135.6 million of operating income to an operating loss. Q2 included $82.8 million of transformation-related restructuring charges and $23.9 million of net credit-transaction charges.
- Year-to-date results included $448.7 million of non-cash goodwill and intangible impairment charges, $89.3 million of restructuring charges and $167.0 million of credit-transaction charges. The impairment followed a decline in market capitalization and revised valuation assumptions; it related principally to acquired goodwill and Zales trade names.
- Sales growth included James Allen, currency effects and additional revenue recognized under the new revenue standard ($23.9 million in Q2; $48.4 million year to date). It was partly offset by the prior-year 53rd-week calendar comparison and store closures. E-commerce sales were $150.3 million in Q2 and $296.8 million year to date, up 82.8% and 81.9%, respectively, on a reported basis.
- Signet completed the sale of eligible non-prime in-house receivables in June at a price based on 72% of par. It received $445.5 million at closing and recorded a further $17.1 million fair-value asset for contingent deferred consideration. Signet continues to originate non-prime receivables for forward sale under five-year arrangements.
- Signet repurchased 8.8 million shares for $485.0 million year to date and declared $0.74 per common share in dividends, versus $0.62 in the prior-year period.
Outlook, management commentary and risks
- The three-year Path to Brilliance transformation plan is expected to incur $170–$190 million of pretax charges, of which $80–$95 million are expected to be cash charges. Fiscal 2019 estimates are $125–$135 million of charges, including $40–$45 million cash charges. Signet expects approximately 200 net store closures in Fiscal 2019 and a 4%–5% net reduction in selling square footage.
- Management expects a Fiscal 2019 annual operating loss, citing first-quarter impairments and the effects of credit outsourcing and transformation initiatives. It attributed Q2 same-store sales partly to product assortment changes and clearance activity; clearance increased Q2 same-store sales by 240 basis points. Management also cited credit-outsourcing transition effects of approximately 160 basis points on Q2 same-store sales versus prior trends.
- Credit outsourcing reduced finance-charge income and brought transition costs; Q2 included $32.6 million of credit-outsourcing costs, partly offset by $10.4 million of savings from in-house credit operations. The company reported lower participation in North America credit and lease-purchase plans year to date, at 51.4% versus 54.2%.
- Further impairment remains possible if key valuation inputs deteriorate, particularly sales trends or market valuation. Other important risks include consumer spending, competition, merchandise costs and availability, foreign exchange, technology and cybersecurity, and execution of the transformation and omnichannel strategy. Signet disclosed approximately $2.8 billion of undiscounted operating lease commitments at February 3, 2018 and anticipates a significant increase in lease-related balance-sheet assets and liabilities when it adopts the new lease standard.
- Legal and regulatory matters include ongoing employment-practices arbitration, securities shareholder litigation and a derivative action; the company said potential losses could not be estimated. CFPB and New York Attorney General inquiries concerning credit practices remain ongoing; management said an unfavorable outcome in the CFPB matter was remote as of August 4, 2018. A separate EEOC case was resolved by a consent decree requiring specified injunctive and compliance measures, without monetary payment.
Important facts for investors to verify
- How much reported sales and cash flow reflect sustainable retail performance versus James Allen, revenue-accounting changes, clearance activity, currency and the receivables sale.
- Whether credit outsourcing stabilizes customer financing, sales trends and costs, and whether the contingent receivables-sale consideration is ultimately earned.
- Actual transformation charges, cash costs, savings, store closures and sales effects compared with management’s estimates.
- Whether subsequent market capitalization, sales and valuation assumptions lead to further impairment charges.
- Developments in the disclosed litigation and regulatory matters, and any changes to liquidity, debt, dividend or repurchase priorities.