Signet Jewelers Limited — Q3 FY2018 Form 10-Q
Reporting period: 13 weeks ended October 28, 2017; year-to-date figures cover 39 weeks. Signet is a global jewelry retailer operating primarily in the U.S., U.K. and Canada. Results are highly seasonal: the fourth quarter normally generates almost 40% of annual sales and 45%–55% of annual operating income.
Financial performance
- Q3 revenue: $1.157 billion, down 2.5% year over year; same-store sales fell 5.0%. E-commerce sales rose 56.4% to $80.7 million, largely reflecting the R2Net acquisition.
- Q3 profitability: Gross margin was $321.1 million (27.8% of sales), versus $350.0 million (29.5%) a year earlier. Operating income fell to $5.5 million (0.5% margin) from $32.1 million (2.7%). Net loss was $3.9 million; loss attributable to common shareholders was $12.1 million, or $0.20 per diluted share, versus income attributable to common shareholders of $14.8 million, or $0.20 per share.
- Year to date: Revenue of $3.960 billion declined 4.3%; same-store sales fell 5.4%. Gross margin was $1.270 billion (32.1% of sales), versus $1.415 billion (34.2%). Operating income was $256.4 million (6.5% margin), down 29.6%; net income was $168.0 million and diluted EPS was $2.24, down 31.6% and 29.6%, respectively.
- Cash flow: Operating cash flow was $1.482 billion year to date, compared with $360.9 million. This included $960.2 million in proceeds from selling prime in-house finance receivables. Capital expenditures were $166.1 million; reported free cash flow was $1.316 billion and likewise includes the receivable-sale proceeds.
- Liquidity and debt: Cash was $113.4 million. Total debt and overdrafts were $996.1 million; net debt was $875.2 million, compared with $1.530 billion a year earlier. The current ratio was approximately 2.6, based on current assets of $3.462 billion and current liabilities of $1.318 billion. Signet reported compliance with all debt covenants.
- Other metrics: Accounts receivable declined to $640.1 million from $1.858 billion at January 28, 2017, primarily reflecting the sale of receivables. Inventory was $2.466 billion, down from $2.649 billion a year earlier. Common shares repurchased totaled $460 million year to date; common dividends declared were $0.93 per share.
Changes versus the prior comparable period
- Sales and same-store sales weakened, driven mainly by soft bridal demand and fewer customer transactions. Management cited weather-related incidents and credit-outsourcing process and systems disruptions; these factors were estimated to reduce Q3 same-store sales by 120 basis points.
- Q3 operating margin declined 220 basis points. Management attributed 170 basis points to net transaction costs related to credit outsourcing and the R2Net acquisition. The quarter included $22.4 million of credit-transaction costs and $8.1 million of R2Net acquisition costs; the credit transaction also generated a $10.2 million beneficial-interest gain.
- Year-to-date operating income also reflected a $20.7 million reversal of the allowance on receivables sold, the $10.2 million beneficial-interest gain, $28.3 million of credit-transaction costs, $9.4 million of R2Net acquisition costs and $3.4 million of CEO transition costs.
- Signet acquired R2Net, owner of JamesAllen.com and Segoma Imaging Technologies, on September 12 for $332.4 million net of acquired cash. Preliminary goodwill recognized was $348.5 million; purchase accounting remained subject to finalization.
- In October, Signet sold the prime-quality portion of Sterling’s in-house receivable portfolio to Comenity for $960.2 million and terminated its $600 million securitization facility. Comenity became the exclusive private-label credit-card issuer for specified Sterling brands, subject to stated exceptions. Signet retained non-prime receivables and outsourced their servicing to Genesis.
Outlook, risks and unusual items
- Management expected credit-process disruptions to continue and negatively affect fourth-quarter and full-year performance. It forecast a FY2018 effective tax rate of approximately 22%; the filing provides no clear overall full-year sales or EPS guidance.
- Management expected approximately 125 net store closures in FY2018, with roughly 90–100 openings and 215–225 closures, primarily among mall-based regional brands. The company also expects the U.K. pension plan freeze, with participant-selected effective dates in December 2017 or October 2019, to reduce future pension expense. A $3.7 million net curtailment gain and settlement loss was recognized in Q3.
- Risks highlighted include weak retail demand, credit-outsourcing execution and IT disruptions, acquisition integration, customer credit deterioration, competition, commodity and foreign-exchange exposure, and potential impairment if sales trends or other valuation assumptions worsen. Goodwill and indefinite-lived trade names exceeded carrying values at the latest assessment, but management warned further deterioration could result in impairment.
- The CFPB notified Signet that it was considering recommending enforcement action concerning in-store credit practices, promotions and payment-protection products; a New York Attorney General investigation into similar issues was ongoing. Signet said it could not estimate a possible loss or range. Employment-practices arbitration and shareholder litigation also remained unresolved, with potential losses not estimable. The EEOC matter was settled without monetary payment, subject to a three-year consent decree.
- Management stated disclosure controls were effective as of October 28, 2017. The filing identifies no material change in internal control over financial reporting beyond outsourcing non-prime credit servicing.
Important facts for investors to verify
- Whether holiday-quarter sales and transaction trends recover, and how much ongoing credit-outsourcing disruption affects results.
- How much recurring cash generation remains after excluding the $960.2 million receivable-sale proceeds and other working-capital movements.
- The final R2Net purchase-price allocation, integration results and impact on margins and earnings.
- Credit-portfolio performance after the sale and servicing transition, including collections, charge-offs and the economics of the Comenity profit-sharing arrangement.
- Developments in CFPB and NYAG investigations, employment arbitration and shareholder litigation, and any resulting financial exposure.
- Progress toward the store-closure plan, and whether sales trends or valuation assumptions create impairment risk.