Business context and reporting period
Signet Jewelers Limited is a jewelry retailer operating primarily in the U.S., U.K. and Canada through Sterling Jewelers, Zale (including Piercing Pagoda), UK Jewelry and Other. This unaudited Form 10-Q covers the 13 and 26 weeks ended July 29, 2017 (Fiscal 2018 second quarter and year to date); comparisons are to periods ended July 30, 2016. The business is highly seasonal, with almost 40% of annual sales and normally 45%–55% of annual operating income generated in the fourth quarter.
Financial performance and liquidity
| Metric | 13 weeks ended July 29, 2017 | 26 weeks ended July 29, 2017 |
|---|---|---|
| Sales | $1,399.6 million, +1.9% | $2,803.0 million, -5.1% |
| Gross margin | $457.9 million; 32.7% of sales | $949.1 million; 33.9% of sales |
| Operating income | $135.6 million; 9.7% of sales | $250.9 million; 9.0% of sales |
| Net income | $93.4 million | $171.9 million |
| Net income attributable to common shareholders | $85.2 million | $155.5 million |
| Diluted EPS | $1.33 | $2.36 |
| Operating cash flow | $353.0 million | $409.8 million |
| Free cash flow (non-GAAP) | $303.5 million | $304.1 million |
Quarterly same-store sales rose 1.4%, including a 380-basis-point benefit from the later timing of Mother’s Day; constant-currency sales increased 2.8%. E-commerce sales were $82.2 million, up 18.1%. Year-to-date same-store sales fell 5.5%; constant-currency sales declined 4.1%, and e-commerce sales increased 9.0% to $163.2 million. Gross margin declined 120 basis points in the quarter and 220 basis points year to date. The quarter’s operating margin improved 100 basis points year over year, while the year-to-date margin declined 220 basis points.
At July 29, cash and cash equivalents were $119.1 million and total debt was $1,652.6 million; reported net debt was $1,525.6 million. Current assets were $4,342.8 million and current liabilities $1,810.0 million. The $600 million asset-backed securitization balance was classified as current because the company expected to repay it within 12 months. Six-month capital expenditure was $105.7 million. The company repurchased 8.1 million shares for $460 million and declared common dividends of $0.62 per share during the first half.
Material changes versus prior comparable periods
- Second-quarter sales and earnings improved, but reported quarterly results included a net $14.8 million credit-transaction gain: a $20.7 million reversal of credit-loss allowances, partly offset by $5.9 million of transaction costs. Management attributed $0.15 of quarterly diluted EPS to the later Mother’s Day timing.
- First-half sales fell 5.1%, operating income fell 24.4% from $331.9 million, and diluted EPS declined 19.7% from $2.94. Weakness reflected lower sales and gross-margin deleverage; management cited declining mall traffic and consumer discretionary-income constraints early in the year.
- Six-month operating cash flow increased to $409.8 million from $309.2 million, aided by working-capital movements, including inventory reduction. Net bad-debt expense rose to $100.2 million from $88.9 million; net charge-offs were 5.5% of average gross receivables versus 5.0%.
- Reported debt increased from $1,417.6 million at January 28, 2017, mainly reflecting higher revolving-credit borrowings and the reclassification of securitization debt to current. Common shares outstanding were 60.3 million at quarter-end versus 68.3 million at fiscal year-end, following substantial repurchases.
- By segment, second-quarter Sterling sales rose 3.4%, Zale division sales rose 1.6%, and UK Jewelry sales fell 9.2% as reported (down 1.9% at constant exchange rates). Year-to-date sales declined across Sterling, Zale Jewelry and UK Jewelry; Piercing Pagoda grew.
Outlook, management commentary, risks and unusual items
- Management expected Fiscal 2018’s full-year effective tax rate to be approximately 24%; the filing provides no specific sales, operating-income or EPS guidance.
- The company expected the Comenity transaction to close in October 2017, subject to regulatory approval and customary conditions. It covers the prime-quality portion of Sterling’s in-house receivables, then estimated at approximately $1 billion, and includes a seven-year credit-card program agreement. Expected proceeds were intended to repay the securitization facility, the short-term R2Net acquisition loan and other revolving borrowings. The sale and program benefits remain subject to execution and transaction terms.
- After quarter-end, Signet agreed to acquire R2Net for $328 million in cash, subject to customary adjustments and closing conditions; closing was expected in Fiscal 2018’s third quarter, financed with a short-term loan.
- Fiscal 2018 plans called for approximately 165–170 store closures and 90–115 openings, with net selling square footage expected to be flat to down 1%; closures were focused mainly on underperforming mall-based regional brands, and openings primarily on Kay off-mall locations.
- Signet identified retail weakness, lower same-store sales, and a decline in its share valuation as impairment indicators for goodwill and indefinite-lived trade names. No impairment was recorded; management warned further deterioration in key inputs, especially sales trends, could result in an impairment charge.
- Legal matters include a gender-pay-and-promotion arbitration involving Sterling, with more than 10,000 employees opting into an Equal Pay Act collective action; potential loss could not be estimated. A separate EEOC case was resolved by a three-year-and-three-month consent decree requiring specified policy, training and reporting measures but no monetary payment. Consolidated shareholder securities litigation remained pending, with potential liability not estimable.
- Other key risks include consumer spending and mall traffic, credit losses and collection performance, foreign exchange, precious-metal costs, competition, cybersecurity and IT systems, regulatory changes and transaction approvals. Management stated disclosure controls were effective and there were no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether and when the Comenity receivables sale closes, its final proceeds and economics, and the resulting debt reduction and ongoing credit-program income.
- Whether the sales and margin recovery suggested by the second quarter is sustained after adjusting for Mother’s Day timing and the one-time credit-related gain.
- Receivables quality: collection rates, delinquencies, charge-offs and bad-debt expense, particularly as servicing and credit arrangements change.
- Debt and liquidity after the securitization repayment, revolving borrowings, R2Net financing and continued repurchases and dividends.
- Progress on R2Net closing and integration, planned store actions, and potential impairment or legal exposure, for which the filing gives no clear estimated loss value.