Signet Jewelers Limited — Q2 FY2011 Form 10-Q
Business context and reporting period. Signet is a specialty jewelry retailer operating in the US and UK, with brands including Kay Jewelers, Jared, H.Samuel and Ernest Jones. This unaudited filing covers the 13 weeks ended July 31, 2010 and year-to-date 26 weeks; comparisons are with the periods ended August 1, 2009. Amounts are in US dollars unless noted. Signet states that sales and operating profit are highly seasonal, with a significant share generated in the fourth quarter.
Financial performance
| Metric | Q2 FY2011 | Q2 FY2010 | 26 weeks FY2011 | 26 weeks FY2010 |
|---|---|---|---|---|
| Sales | $722.8m | $710.8m | $1,532.8m | $1,473.4m |
| Gross margin | $239.8m; 33.2% | $221.5m; 31.2% | $536.1m; 35.0% | $477.0m; 32.4% |
| Operating income | $63.3m; 8.8% | $46.6m; 6.6% | $148.8m; 9.7% | $99.0m; 6.7% |
| Net income | $40.7m | $27.6m | $92.7m | $53.9m |
| Diluted EPS | $0.47 | $0.32 | $1.07 | $0.63 |
| Operating cash flow | $70.4m | $97.0m | $254.6m | $295.0m |
| Free cash flow* | $62.3m | $87.9m | $240.2m | $277.5m |
- Q2 sales increased 1.7% as reported and 3.6% at constant exchange rates; same-store sales rose 4.5%. Year-to-date sales grew 4.0% as reported and 4.4% at constant exchange rates; same-store sales rose 5.2%.
- US sales increased 5.1% in Q2 and 6.0% year to date; US same-store sales increased 5.9% and 6.6%, respectively. UK sales declined 10.3% and 3.8% as reported, but declined 2.0% and 1.8% at constant exchange rates; UK same-store sales fell 0.5% and 0.4%.
- US operating income was $63.3m in Q2 and $154.4m year to date. UK operating income was $4.7m and $3.3m, respectively. Q2 consolidated net income rose 47.5%; year-to-date net income rose 72.0%.
- Gross margin rate improved 200 basis points in Q2 and 260 basis points year to date. Management attributed improvement to price increases, lower diamond costs and improved bad-debt performance, partly offset by higher gold costs and UK currency effects.
Balance sheet, liquidity and debt
- At July 31, 2010, cash and cash equivalents were $485.4m, total borrowings were $254.0m, and net cash was $231.4m. This compares with net debt of $200.5m a year earlier and $7.9m at January 30, 2010.
- Long-term debt was $229.1m; loans and overdrafts were $24.9m. The $300m revolving credit facility was undrawn, and Signet reported compliance with all debt covenants.
- Current assets were $2,485.3m and current liabilities $603.0m. Inventory was $1,126.2m, down from $1,279.2m a year earlier; accounts receivable was $797.2m, up from $766.2m.
- Year-to-date operating cash flow and free cash flow decreased from the prior year, despite higher earnings, as changes in operating assets and liabilities generated $111.2m versus $172.7m. Management said seasonal increases in inventory and receivables are expected in the second half.
- Signet prepaid $50.9m of private placement notes in March and reduced its revolving facility from $370m to $300m.
Outlook, commentary and material matters
- Management raised its FY2011 positive free cash flow expectation to $225m–$275m from $150m–$200m. Capital expenditure guidance remained about $80m; controllable costs were expected to be little changed from FY2010 at constant exchange rates.
- The outlook for the rest of FY2011 was described as uncertain. Management plans continued investment, increased holiday-season advertising and broader availability of differentiated merchandise.
- Management expects US gross merchandise margin for FY2011 to be broadly similar to FY2010; selective price increases implemented in August were intended to address higher commodity costs, which may pressure second-half margins. UK gross merchandise margin is expected to remain somewhat below the prior year.
- Management expects the net direct adverse effect of Truth in Lending Act amendments to be $15m–$17m for FY2011, at the lower end of its prior range. Other operating income declined year over year, primarily reflecting these amendments.
- The Q2 effective tax rate was 29.0%; year-to-date it was 30.9%. The year-to-date tax expense included $4.5m of recognized benefits from previously uncertain tax positions. Management anticipated a 32.5% FY2011 effective tax rate and said substantially all such tax benefits could potentially be resolved over the next 12 months.
- Signet faces private and EEOC lawsuits alleging gender discrimination in US store-level compensation and promotions. The claims seek unspecified monetary and non-monetary relief; the company denies the allegations and intends to defend them vigorously.
- Market risks include foreign exchange, precious-metal prices, interest rates and counterparty exposure. Signet uses currency and commodity derivatives for hedging, not trading. The filing also notes risks from economic conditions, competition, consumer-credit regulation and seasonality.
- Ron Ristau became CFO on June 25, 2010, succeeding the retiring CFO. The CEO search was ongoing. Management reported disclosure controls were effective and no material change in internal control during the quarter.
*Free cash flow is a non-GAAP measure defined by Signet as operating cash flow less investing cash outflows; it is not necessarily cash available for discretionary spending.
Important facts for investors to verify
- Whether stronger US sales and margin gains persist, particularly as higher commodity costs and planned pricing changes affect the second half.
- Whether UK trading and margins improve, and the impact of sterling movements on reported results.
- Whether the raised free-cash-flow target is achieved after seasonal inventory and receivables build, with planned capital spending of about $80m.
- The durability of lower bad-debt expense and the performance and risk profile of the $797.2m receivables balance.
- Progress and potential financial consequences of the discrimination litigation and uncertain-tax-position settlements.