Signet Jewelers Limited — Form 10-Q Summary
Reporting period: Fiscal 2015 third quarter, the 13 weeks ended November 1, 2014, and year to date, the 39 weeks ended November 1, 2014. Amounts are in U.S. dollars unless noted. The filing is unaudited. Signet operates jewelry retail businesses including Sterling Jewelers, UK Jewelry, Zale Jewelry and Piercing Pagoda.
Business context and comparability
Signet acquired Zale Corporation on May 29, 2014, for total consideration of $1.458 billion, including repayment of Zale debt. Zale contributed $331.4 million of third-quarter sales and $578.9 million of year-to-date sales after acquisition. Accordingly, reported year-over-year sales growth largely reflects the acquisition; the periods are not directly comparable. Signet reported 3,602 stores at November 1, 2014. Its business is highly seasonal: the fourth quarter typically generates nearly 40% of annual sales and 45%–55% of operating income, with December the key sales month.
Key financial metrics
| Metric | 13 weeks ended Nov. 1, 2014 | Prior-year quarter | 39 weeks ended Nov. 1, 2014 | Prior-year YTD |
|---|---|---|---|---|
| Sales | $1,177.9 million | $771.4 million | $3,459.9 million | $2,645.2 million |
| Same-store sales | Up 4.2% | Up 3.2% | Up 4.1% | Not stated here |
| Gross margin | $345.9 million; 29.4% of sales | $239.2 million; 31.0% | $1,162.1 million; 33.6% | $931.7 million; 35.2% |
| Operating income | $10.7 million; 0.9% margin | $51.6 million; 6.7% | $244.9 million; 7.1% | $299.9 million; 11.3% |
| Net income (loss) | $(1.3) million | $33.6 million | $153.3 million | $192.8 million |
| Diluted EPS | $(0.02) | $0.42 | $1.91 | $2.39 |
| Net cash used in operations | $(208.1) million | $(80.4) million | $(24.2) million | $(21.9) million |
| Free cash flow (non-GAAP) | $(283.2) million | $(133.7) million | $(189.3) million | $(128.8) million |
Management’s adjusted, non-GAAP results were $35.7 million operating income and $16.5 million net income, or $0.21 diluted EPS, for the quarter; year-to-date adjusted operating income was $320.6 million and adjusted net income was $205.5 million, or $2.56 diluted EPS. These adjustments exclude acquisition accounting effects, transaction and integration costs, and severance; they are not GAAP measures.
At November 1, cash was $87.6 million; accounts receivable was $1,292.1 million and inventory was $2,674.6 million. Current assets totaled $4,267.9 million and current liabilities $1,417.1 million. Total loans, overdrafts and long-term debt were $1,593.1 million; reported net debt was $1,505.5 million. The company had $233.4 million available under its revolving credit facility and reported compliance with debt covenants. Debt includes $398.4 million of 4.7% senior notes due 2024, $600 million of securitization financing and a $395 million term loan; a further $145 million was drawn on the revolving facility.
Material changes and management commentary
- Reported third-quarter sales rose 52.7%, primarily because Zale was consolidated. Same-store sales increased 6.8% at Sterling and 3.7% at UK Jewelry; Zale’s same-store sales fell 0.9%. Year-to-date same-store sales rose 5.4% at Sterling and 4.1% at UK Jewelry.
- Reported operating income fell sharply in the quarter. Management attributed pressure to Zale’s operating loss, acquisition-related purchase accounting and costs, and higher financing expense. Zale’s quarter operating loss was $34.5 million, including $13.6 million of purchase-accounting effects; the Other segment included $11.4 million of transaction, integration and severance costs.
- Adjusted gross margin rate declined 40 basis points in the quarter and 90 basis points year to date, mainly because Zale has a lower gross-margin structure. Adjusted SG&A as a share of sales increased 190 basis points for the quarter; management cited Zale, expense timing, advertising, incentive compensation and central support costs.
- Net interest expense increased to $12.6 million for the quarter and $28.1 million year to date, compared with $0.9 million and $2.8 million, respectively, in the prior periods, principally reflecting acquisition financing.
- Operating cash outflow in the quarter reflected seasonal holiday inventory procurement and working-capital movements. Year-to-date inventory purchases used $321.1 million of cash; capital expenditures were $165.1 million, up from $106.9 million. The Zale acquisition used $1,429.2 million of investing cash.
- Management forecast a 29.3% full-year Fiscal 2015 effective tax rate. The filing provides no numerical earnings or sales guidance. Management describes integration and synergy realization as objectives, but does not quantify expected synergies here.
Risks, contingencies and unusual items
- Integration execution, anticipated synergies, Zale’s operating performance and substantial acquisition debt are key risks. Management cautions that integration costs may exceed expectations or benefits may not be achieved.
- Acquisition-related goodwill was $497.5 million and acquired intangible assets were $461.3 million at quarter-end. The Zale purchase-price allocation remained preliminary; management noted that future impairment charges may be required if performance or assumptions deteriorate.
- Signet faces commodity-price and supply risks, particularly for diamonds and gold, as well as foreign-exchange, variable-interest-rate, liquidity and customer-credit risks. The filing notes that a significant portion of acquisition debt carries variable rates.
- Legal matters include pending appeals in employment-discrimination litigation, Zale acquisition-related stockholder litigation and appraisal petitions covering approximately 8.8 million Zale shares. Management stated that possible outcomes or loss ranges could not be estimated. Two Zale wage-and-hour cases had tentative settlements for immaterial amounts, subject to approval; another is being defended.
- Controls and procedures were assessed as effective at November 1, 2014. Signet intended to include Zale in its annual internal-control assessment but was allowing time to incorporate Zale’s operations.
Important facts for investors to verify
- How much of future sales and earnings growth is organic versus attributable to Zale, and whether Zale’s same-store sales and segment losses improve.
- Progress on integration, realized synergies, and the amount and duration of remaining transaction, severance and purchase-accounting costs.
- Inventory levels, holiday-season sell-through and cash conversion, given the substantial inventory build and negative quarterly free cash flow.
- Debt repayment capacity, variable-rate exposure, securitization terms, covenant headroom and the availability of revolving credit.
- Final Zale purchase-price allocation and any resulting changes to goodwill, intangible assets, deferred revenue or impairment risk.
- Developments and potential financial exposure in the employment, merger-challenge and appraisal litigation.