Business context and reporting period
Signet Jewelers Limited’s Form 10-K reports Fiscal 2011, the 52 weeks ended January 29, 2011. The filing also provides fourth-quarter results for the 13 weeks ended that date. Signet is a specialty jewelry retailer operating in the US and UK; the US generated about 80% of annual sales. Fiscal 2011 results are compared primarily with the 52 weeks ended January 30, 2010.
Key financial metrics
| Metric | Fiscal 2011 | Prior year |
|---|---|---|
| Sales | $3,437.4 million, up 5.0% | $3,273.6 million |
| Gross margin | $1,242.9 million; 36.2% of sales | $1,065.6 million; 32.6% |
| Operating income and margin | $372.5 million; 10.8% | $264.5 million; 8.1% |
| Net income | $200.4 million | $157.1 million |
| Diluted EPS | $2.32 | $1.83 |
| Cash from operations | $323.9 million | $515.4 million |
| Free cash flow, excluding Make Whole Payment (non-GAAP) | $315.8 million | $471.9 million |
- Fourth quarter: Sales were $1,270.5 million, up 6.2%, and same-store sales rose 8.1%. Operating margin was 16.6%, versus 14.8%. Net income was $105.4 million, down from $115.5 million; excluding the debt-prepayment Make Whole Payment, net income was $134.9 million (non-GAAP).
- Margins and credit: Annual US same-store sales increased 8.9%, while UK same-store sales declined 1.4%. US net bad debt fell to 4.2% of US sales from 5.6%; 54.2% of US sales used Signet-provided customer financing. Net US customer-finance receivables were $927.7 million.
- Cash, debt and liquidity: Year-end cash was $302.1 million; long-term debt was zero after repayment of the private placement notes. Loans and overdrafts were $31.0 million, leaving reported net cash of $271.1 million (non-GAAP). The company had a $300 million revolving facility, undrawn at year-end, with $5.5 million of standby letters of credit issued. Working capital was $1,831.3 million.
- Other obligations: Future minimum operating lease payments totaled $2,103.9 million; these are lease commitments, not reported funded debt. Signet held $138.0 million of consignment inventory off balance sheet.
Material changes versus the prior comparable period
- Annual sales, gross margin, operating income and net income improved; the 270-basis-point operating-margin expansion reflected stronger US sales, improved US merchandise margins and lower bad debt.
- US sales increased 8.0%; UK sales declined 3.0% at constant exchange rates (non-GAAP), amid weaker UK discretionary spending and a smaller store base. Reported UK sales fell 5.5%, including unfavorable currency translation.
- Operating cash flow fell by $191.5 million, chiefly reflecting the prior year’s substantial inventory reduction and higher receivables and inventory in Fiscal 2011. Free cash flow also declined from the unusually high prior-year level.
- Interest expense rose to $72.8 million from $34.8 million, primarily because of the $47.5 million Make Whole Payment to prepay the remaining private placement notes. Excluding that payment, pretax income was $347.9 million and diluted EPS was $2.66 (both non-GAAP), versus reported Fiscal 2011 pretax income of $300.4 million and diluted EPS of $2.32.
- During Fiscal 2011, Signet changed extended-service-plan revenue and cost deferral to reflect expected claims-cost patterns. Prior-period figures were adjusted; management said the prior statements were not materially misstated, but the cumulative adjustment was material to Fiscal 2011 presentation.
Guidance, outlook, risks and unusual items
- For Fiscal 2012, management prioritized profitable market-share gains, improved gross margin, and an SG&A-to-sales ratio broadly similar to Fiscal 2011. It targeted capital spending of $110–$130 million and positive free cash flow of $150–$200 million (non-GAAP); these are objectives, not guarantees. No earnings-per-share guidance is provided in the filing.
- Planned investment included 105 major store refurbishments or relocations, 25 US openings and 36 US closures, and two UK openings and 22 UK closures. Management expected US store space to be broadly unchanged and UK space to decline about 3%.
- Management described US market conditions as stabilizing, but the UK outlook as pressured by austerity measures, higher inflation and the January 2011 VAT increase. Fiscal 2012 interest expense was expected at $6–$7 million and the effective tax rate at approximately 36%, subject to stated qualifications.
- The Truth in Lending Act changes were estimated to have reduced Fiscal 2011 operating income by $11.9 million. The $47.5 million Make Whole Payment was a significant non-recurring financing charge. The prior-year vacation-policy benefit of $13.4 million did not recur.
- Key risks include discretionary consumer spending and seasonal dependence on the holiday quarter; customer-credit losses and changing consumer-credit regulation; rising or volatile gold and diamond costs (diamond exposure is not hedged); foreign-exchange movements; supplier availability; competition; and execution of store investment and systems changes.
- Two employment-discrimination matters involving Sterling Jewelers remained pending: a private class action concerning compensation and promotion and an EEOC action alleging gender discrimination. Sterling denied the allegations and intended to defend them; the filing gives no clear estimate of potential loss.
- Management reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Reconcile reported and non-GAAP results, especially the $47.5 million Make Whole Payment and the adjusted Fiscal 2011 earnings and free-cash-flow figures.
- Review the extended-service-plan accounting change and its effects on restated comparative revenue, earnings, deferred revenue and assets.
- Monitor US customer receivable growth, delinquency trends, allowance adequacy and the impact of credit-law changes.
- Assess whether gross-margin gains can persist as gold and diamond costs, pricing and consumer demand change, particularly in the weaker UK market.
- Evaluate store-investment and cash-flow targets against substantial lease commitments and the pending employment litigation.