Business context and reporting period
Signet Jewelers Limited’s unaudited Form 10-Q covers the 13 and 26 weeks ended August 2, 2014 (Fiscal 2015 second quarter and year to date). Signet operates jewelry retailers in the U.S., U.K. and Canada. It completed its acquisition of Zale Corporation on May 29, 2014; reported results include 65 days of Zale operations. The acquisition substantially limits comparison with the prior year.
Financial performance and position
| Metric | 13 weeks ended Aug. 2, 2014 | 13 weeks ended Aug. 3, 2013 | 26 weeks ended Aug. 2, 2014 | 26 weeks ended Aug. 3, 2013 |
|---|---|---|---|---|
| Sales | $1,225.9 million | $880.2 million | $2,282.0 million | $1,873.8 million |
| Gross margin | $409.0 million; 33.4% | $309.7 million; 35.2% | $816.2 million; 35.8% | $692.5 million; 37.0% |
| Operating income | $83.5 million | $105.5 million | $234.2 million | $248.3 million |
| Net income | $58.0 million | $67.4 million | $154.6 million | $159.2 million |
| Diluted EPS | $0.72 | $0.84 | $1.93 | $1.97 |
| Net cash from operations | $110.4 million | $13.4 million | $183.9 million | $58.5 million |
- Comparable sales: Reported same-store sales rose 4.8% in the quarter and 4.1% year to date. Excluding Zale, acquisition-related items and other specified costs, Signet reported organic same-store sales growth of 6.3% and 4.7%, respectively, and organic sales growth of 11.2% and 8.6%.
- Profitability: Reported operating income fell 20.9% in the quarter and 5.7% year to date. Management’s non-GAAP organic operating income was $124.1 million in the quarter and $283.2 million year to date, up 17.6% and 14.1%, respectively. Reported results include Zale’s lower-margin sales, acquisition accounting and transaction and severance costs.
- Cash flow and investment: Year-to-date capital expenditures were $90.0 million, versus $53.6 million. Free cash flow, a company-defined non-GAAP measure of operating cash flow less capital expenditures, was $93.9 million versus $4.9 million. Investing cash outflow was $1.519 billion, including $1.429 billion for Zale, net of cash acquired.
- Liquidity and debt: At August 2, cash was $215.0 million; current assets were $4.069 billion and current liabilities $1.174 billion. Inventory was $2.345 billion and accounts receivable $1.316 billion. Total loans, overdrafts and long-term debt were approximately $1.410 billion; management’s net-debt measure was $1.195 billion, compared with net cash of $228.3 million at February 1, 2014. The $400 million revolving facility was undrawn, and Signet reported covenant compliance.
- Acquisition financing: Signet issued $400 million of 4.7% senior notes due 2024, borrowed $600 million through a credit-card receivables securitization facility, and drew a $400 million five-year term loan. The amended revolving facility matures in 2019. The credit agreement requires a leverage ratio no greater than 2.50:1 and fixed-charge coverage of at least 1.40:1.
Material changes and unusual items
- Zale added $247.5 million of reported second-quarter sales, including acquisition accounting adjustments. Its same-store sales declined 0.9%; Zale Jewelry sales were $215.0 million and Piercing Pagoda sales $32.5 million.
- Zale acquisition consideration was $1.458 billion, including $478.2 million to extinguish Zale debt. Preliminary purchase accounting recorded $525.1 million of goodwill and $467.6 million of net intangible assets; valuations remained subject to change.
- Acquisition-related transaction and severance costs were $30.8 million in the quarter and $39.2 million year to date. Purchase-accounting adjustments reduced operating income by $11.5 million, including inventory fair-value step-up and deferred-revenue adjustments.
- Net interest expense rose to $13.7 million in the quarter and $15.5 million year to date, from $1.0 million and $1.9 million, respectively, reflecting acquisition debt and financing costs. The reported effective tax rate was 16.9% for the quarter and 29.3% year to date; the quarter’s rate was affected by acquisition financing and other items.
- Inventory increased from $1.488 billion at February 1, primarily reflecting Zale inventory acquired. The Sterling Jewelers customer-financing portfolio had $1.305 billion in net receivables and a $98.9 million allowance for credit losses.
- Dividends declared were $0.18 per share in each Fiscal 2015 quarter, versus $0.15 per share in each comparable prior-year quarter.
Outlook, management commentary and risks
Management forecast a 29.3% effective tax rate for full-year Fiscal 2015. The filing provides no full-year sales, earnings or EPS guidance. Management cited strength in Sterling’s bridal, fashion-diamond and watch categories and improving U.K. comparable sales; it also noted Zale sales disruption from merger-related changes and a different promotional cadence. Signet described Zale integration and realization of expected synergies as ongoing priorities.
Signet’s business is highly seasonal: the fourth quarter normally generates almost 40% of annual sales and about 45%–55% of operating income, with November and December especially important. Risks highlighted include diamond and gold supply and price volatility, consumer-credit losses, foreign exchange and financial-market exposure, acquisition integration and debt servicing, possible goodwill impairment, and litigation related to the acquisition and employment matters.
Significant contingencies remain unresolved. The EEOC appealed dismissal of its gender-discrimination action against Sterling; a separate related class-certification matter remained pending in arbitration. Zale acquisition stockholder litigation seeks rescission or damages, and appraisal demands covered approximately 9.0 million Zale shares; possible losses were not estimable. Zale wage-and-hour cases also remained, with tentative immaterial settlements in two matters and an unestimated exposure in another.
Important facts for investors to verify
- How Zale’s sales, comparable-store trends, margins and integration costs develop beyond the 65-day contribution included here.
- Whether preliminary Zale purchase accounting, including goodwill and intangible valuations, changes materially and whether acquired goodwill remains recoverable.
- Debt-service capacity, facility terms and covenant headroom, particularly given the increase in net debt and variable-rate securitization borrowing.
- Credit performance in Signet’s large in-house financing portfolio, including delinquency trends, charge-offs and adequacy of the allowance.
- Developments and potential financial exposure in the acquisition, appraisal and employment-related litigation, which the filing does not quantify.
- Execution against management’s stated tax-rate forecast and any subsequent full-year operating guidance.