|Organization and summary of significant accounting policies
Signet Jewelers Limited (“Signet” or the “Company”), a holding company incorporated in Bermuda, is the world’s largest retailer of diamond jewelry. The Company operates through its 100% owned subsidiaries with sales primarily in the United States (“US”), United Kingdom (“UK”) and Canada. During the first quarter of Fiscal 2019, the Company realigned its organizational structure. The new structure is expected to allow for further integration of operational and product development processes and support growth strategies. In accordance with this organizational change, beginning with quarterly reporting for the 13 weeks ended May 5, 2018, the Company identified three reportable segments as follows: North America, which consists of the legacy Sterling Jewelers and Zale divisions; International, which consists of the legacy UK Jewelry division; and Other. The “Other” reportable segment consists of all non-reportable segments, including subsidiaries involved in the purchasing and conversion of rough diamonds to polished stones and unallocated corporate administrative functions. See Note 6 for additional discussion of the Company’s segments.
On September 12, 2017, the Company completed the acquisition of R2Net Inc., a Delaware corporation (“R2Net”). See Note 5 for additional information regarding the acquisition.
In October 2017, the Company, through its subsidiary Sterling Jewelers Inc. (“Sterling”), completed the sale of the prime-only quality portion of Sterling’s in-house finance receivable portfolio to Comenity Bank (“Comenity”). In June 2018, the Company, through its subsidiary Sterling, completed the sale of all eligible non-prime in-house accounts receivable to CarVal Investors (“CarVal”) and Castlelake, L.P. (“Castlelake”). See Note 4 for additional information regarding the transaction.
Signet’s sales are seasonal, with the fourth quarter accounting for approximately 35-40% of annual sales, with December being by far the highest volume month of the year. The “Holiday Season” consists of results for the months of November and December. As a result of the Company’s seasonality, it anticipates operating income will be almost entirely generated in the fourth quarter.
The Company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued. There are no material related party transactions. The following accounting policies have been applied consistently in the preparation of the Company’s consolidated financial statements.
(a) Basis of preparation
The consolidated financial statements of Signet are prepared in accordance with US generally accepted accounting principles (“US GAAP” or “GAAP”) and include the results for the 52 week period ended February 1, 2020 (“Fiscal 2020”), as Signet’s fiscal year ends on the Saturday nearest to January 31. The comparative periods are for the 52 week period ended February 2, 2019 (“Fiscal 2019”) and the 53 week period ended February 3, 2018 (“Fiscal 2018”). Intercompany transactions and balances have been eliminated in consolidation. Related to the adoption of new accounting pronouncements disclosed in Note 2 and the change in segments disclosed in Note 6, Signet has reclassified certain prior year amounts to conform to the current year presentation.
(b) Use of estimates
The preparation of these consolidated financial statements, in conformity with US GAAP and US Securities and Exchange Commission (“SEC”) regulations, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Estimates and assumptions are primarily made in relation to the valuation of accounts receivable, inventories, deferred revenue, derivatives, employee benefits, operating lease liabilities income taxes, contingencies, asset impairments, indefinite-lived intangible assets, depreciation and amortization of long-lived assets as well as accounting for business combinations.
The reported results of operations are not indicative of results expected in future periods.
(c) Foreign currency translation
The financial position and operating results of certain foreign operations, including the International segment and the Canadian operations of the North America segment, are consolidated using the local currency as the functional currency. Assets and liabilities are translated at the rates of exchange on the balance sheet date, and revenues and expenses are translated at the monthly average rates of exchange during the period. Resulting translation gains or losses are included in the accompanying consolidated statements of shareholders’ equity as a component of accumulated other comprehensive income (loss) (“AOCI”). Gains or losses resulting from foreign currency transactions are included within other operating income (loss) in the consolidated statements of operations, whereas translation adjustments and gains or losses related to intercompany loans of a long-term investment nature are recognized as a component of AOCI.
(d) Revenue recognition
The Company applies a five-step approach in determining the amount and timing of revenue to be recognized: (1) identifying the contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations in the contract; and (5) recognizing revenue when the corresponding performance obligation is satisfied.
See Note 3 for additional discussion of the Company’s revenue recognition.
(e) Cost of sales and selling, general and administrative expenses
Cost of sales includes merchandise costs net of discounts and allowances, freight, processing and distribution costs of moving merchandise from suppliers to distribution centers and stores inclusive of payroll, inventory shrinkage, store operating and occupancy costs, net bad debts and charges for late payments prior to credit outsourcing. Store operating and occupancy costs include utilities, rent, real estate taxes, common area maintenance charges and depreciation.
Selling, general and administrative expenses include store staff and store administrative costs; centralized administrative expenses, including information technology and cost of in-house credit prior to the Company’s outsourcing initiatives and subsequently third-party credit costs; advertising and promotional costs and other operating expenses not specifically categorized elsewhere in the consolidated statements of operations.
Compensation and benefits costs included within cost of sales and selling, general and administrative expenses were as follows:
Wages and salaries
Employee benefit plans
Total compensation and benefits
(f) Store opening costs
The opening costs of new locations are expensed as incurred.
(g) Advertising and promotional costs
Advertising and promotional costs are expensed within selling, general and administrative expenses. Production costs are expensed at the first communication of the advertisements, while communication expenses are recognized each time the advertisement is communicated. For catalogs and circulars, costs are all expensed at the first date they can be viewed by the customer. Point of sale promotional material is expensed when first displayed in the stores. Gross advertising costs totaled $388.9 million in Fiscal 2020 (Fiscal 2019: $387.8 million; Fiscal 2018: $360.5 million).
(h) In-house customer finance programs
Prior to the second quarter of Fiscal 2019, the North America segment operated customer in-house finance programs that allowed customers to finance merchandise purchases from its stores. Finance charges were recognized in accordance with the contractual agreements. Gross interest earned was recorded as other operating income in the consolidated statements of operations. See Note 13 for additional discussion of the Company’s other operating income (loss). In addition to interest-bearing accounts, a portion of credit sales were made using interest-free financing for one year or less, subject to certain conditions.
Prior to the credit transaction entered into in October 2017 (see Note 4), the accrual of interest was suspended when accounts became more than 90 days aged on a recency basis. Upon suspension of the accrual of interest, interest income was subsequently recognized to the extent cash payments are received. Accrual of interest was resumed when receivables were removed from the non-accrual status.
As a result of the credit transaction noted above, the Company revised its policy to suspend the accrual of interest when accounts became more than 120 days past due on a contractual basis to align with the processes utilized by the Company’s third party credit service provider for the Company’s remaining in-house finance receivable portfolio.
(i) Income taxes
Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements. Under this method, deferred tax assets and liabilities are recognized by applying statutory tax rates in effect in the years in which the differences between the financial reporting and tax filing bases of existing assets and liabilities are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is established
against deferred tax assets when it is more likely than not that all or a portion of the deferred tax assets will not be realized, based on management’s evaluation of all available evidence, both positive and negative, including reversals of deferred tax liabilities, projected future taxable income and results of recent operations.
The Company does not recognize tax benefits related to positions taken on certain tax matters unless the position is more likely than not to be sustained upon examination by tax authorities. At any point in time, various tax years are subject to or are in the process of being audited by various taxing authorities. The Company records a reserve for uncertain tax positions, including interest and penalties. To the extent that management’s estimates of settlements change, or the final tax outcome of these matters is different than the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made.
See Note 12 for additional discussion of the Company’s income taxes.
(j) Cash and cash equivalents
Cash and cash equivalents are comprised of cash on hand, money market deposits and amounts placed with external fund managers with an original maturity of three months or less. Cash and cash equivalents are carried at cost which approximates fair value. In addition, receivables from third-party credit card issuers typically converted to cash within five days of the original sales transaction are considered cash equivalents.
The following table summarizes the details of the Company’s cash and cash equivalents:
February 1, 2020
February 2, 2019
Cash and cash equivalents held in money markets and other accounts
Cash equivalents from third-party credit card issuers
Cash on hand
Total cash and cash equivalents
The Company’s supplemental cash flow information was as follows:
Non-cash investing activities:
Capital expenditures in accounts payable
Supplemental cash flow information:
Income tax paid (refunded), net
(k) Accounts receivable
Accounts receivable under the customer finance programs were presented net of an allowance for uncollectible amounts. This allowance represented management’s estimate of the expected losses in the accounts receivable portfolio as of the balance sheet date, and was calculated using a model that analyzed factors such as delinquency rates and recovery rates. In June 2018, the Company completed the sale of the remaining North America customer in-house finance receivables. Subsequent to the completion of the credit transaction, receivables issued by the Company but pending transfer are classified as “held for sale” and recorded at fair value in the consolidated balance sheet. See Note 21 for additional information regarding the assumptions utilized in the calculation of fair value of the finance receivables held for sale.
Prior to the credit transaction entered into in October 2017 (see Note 4), the Company calculated the allowance for uncollectible amounts as follows:
Record an allowance for amounts under 90 days aged on a recency measure of delinquency based on historical loss experience and payment performance information. The recency method measured the delinquency level by the number of days since the last qualifying payment was received, with the qualifying payment increasing with delinquency level.
Record a 100% allowance for any amount aged more than 90 days on a recency measure of delinquency and any amount associated with an account the owner of which has filed for bankruptcy.
Subsequent to the sale of its prime portfolio and until the sale of its non-prime accounts receivable portfolio, the Company measured delinquency under the contractual basis which aligned with the processes and collection strategies utilized by the Company’s third party credit service provider for the remaining in-house finance receivable portfolio. Under this measure of delinquency, credit card accounts were considered delinquent if the minimum payment was not received by the specified due date. The aging method was based on the number of completed billing cycles during which the customer failed to make a minimum payment. Management utilized the delinquency rates identified within the portfolio when calculating the overall allowance for the portfolio.
Due to the reclassification of the non-prime accounts receivable portfolio to “held for sale” in the first quarter of Fiscal 2019, the Company no longer records allowances for uncollectible amounts or bad debt expense.
See Note 14 for additional discussion of the Company’s accounts receivables.
Inventories are primarily held for resale and are valued at the lower of cost or net realizable value. Cost is determined using weighted-average cost, on a first-in first-out basis, for all inventories except for inventories held in the Company’s diamond sourcing operations, where cost is determined using specific identification. Cost includes charges directly related to bringing inventory to its present location and condition. Such charges would include warehousing, security, distribution and certain buying costs. Net realizable value is defined as estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Inventory reserves are recorded for obsolete, slow moving or defective items and shrinkage. Inventory reserves for obsolete, slow moving or defective items are calculated as the difference between the cost of inventory and its estimated market value based on targeted inventory turn rates, future demand, management strategy and market conditions. Due to the inventory being primarily comprised of precious stones and metals including gold, the age of the inventory has a limited impact on the estimated market value. Inventory reserves for shrinkage are estimated and recorded based on historical physical inventory results, expectations of future inventory losses and current inventory levels. Physical inventories are taken at least once annually for all store locations and distribution centers.
See Note 15 for additional discussion of the Company’s inventories.
(m) Vendor contributions
Contributions are received from vendors through various programs and arrangements including cooperative advertising. Where vendor contributions related to identifiable promotional events are received, contributions are matched against the costs of promotions. Vendor contributions received as general contributions and not related to specific promotional events are recognized as a reduction of inventory costs.
(n) Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated depreciation, amortization and impairment charges. Maintenance and repair costs are expensed as incurred. Depreciation and amortization are recognized on the straight-line method over the estimated useful lives of the related assets as follows:
Ranging from 30 – 40 years
Remaining term of lease, not to exceed 10 years
Furniture and fixtures
Ranging from 3 – 10 years
Equipment and software
Ranging from 3 – 7 years
Computer software purchased or developed for internal use is stated at cost less accumulated amortization. Signet’s policy provides for the capitalization of external direct costs of materials and services associated with developing or obtaining internal use computer software. In addition, Signet also capitalizes certain payroll and payroll-related costs for employees directly associated with internal use computer projects. Amortization is charged on a straight-line basis over periods from three to seven years.
Property, plant and equipment are reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Potentially impaired assets or asset groups are identified by reviewing the cash flows of individual stores. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset, based on the Company’s internal business plans. If the undiscounted cash flow is less than the asset’s carrying amount, the impairment charge recognized is determined by estimating the fair value of the assets and recording a loss for the amount that the carrying value exceeds the estimated fair value. The Company utilizes historical experience, internal business plans and an appropriate discount rate to estimate the fair value. Property and equipment at stores planned for closure are depreciated over a revised estimate of their useful lives.
See Note 16 for additional discussion of the Company’s property, plant and equipment.
(o) Goodwill and intangibles
In a business combination, the Company estimates and records the fair value of identifiable intangible assets and liabilities acquired. The fair value of these intangible assets and liabilities is estimated based on management’s assessment, including determination of appropriate valuation technique and consideration of any third party appraisals, when necessary. Significant estimates in valuing intangible assets and liabilities acquired include, but are not limited to, future expected cash flows associated with the acquired asset or liability, expected life and discount rates. The excess purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Goodwill is recorded by the Company’s reporting units based on the acquisitions made by each.
Goodwill and other indefinite-lived intangible assets, such as indefinite-lived trade names, are evaluated for impairment annually. Additionally, if events or conditions were to indicate the carrying value of a reporting unit or an indefinite-lived intangible asset may be greater than its fair value, the Company would evaluate the asset for impairment at that time. Impairment testing compares the carrying amount of the reporting unit or other intangible assets with its fair value. When the carrying amount of the reporting unit or other intangible assets exceeds its fair value, an impairment charge is recorded.
Intangible assets with definite lives are amortized and reviewed for impairment whenever events or circumstances indicate that the carrying amount of the asset may not be recoverable. If the estimated undiscounted future cash flows related to the asset are less than the carrying amount, the Company recognizes an impairment charge equal to the difference between the carrying value and the estimated fair value, usually determined by the estimated discounted future cash flows of the asset.
See Note 18 for additional discussion of the Company’s goodwill and intangibles.
(p) Derivatives and hedge accounting
The Company enters into various types of derivative instruments to mitigate certain risk exposures related to changes in commodity costs and foreign exchange rates. Derivative instruments are recorded in the consolidated balance sheets at fair value, as either assets or liabilities, with an offset to net income or other comprehensive income (“OCI”), depending on whether the derivative qualifies as an effective hedge.
If a derivative instrument meets certain criteria, it may be designated as a cash flow hedge on the date it is entered into. For cash flow hedge transactions, the effective portion of the changes in fair value of the derivative instrument is recognized directly in equity as a component of AOCI and is recognized in the consolidated statements of operations in the same period(s) and on the same financial statement line in which the hedged item affects net income. Amounts excluded from the effectiveness calculation and any ineffective portions of the change in fair value of the derivatives are recognized immediately in other operating income (loss) in the consolidated statements of operations. In addition, gains and losses on derivatives that do not qualify for hedge accounting are recognized immediately in other operating income (loss).
In the normal course of business, the Company may terminate cash flow hedges prior to the occurrence of the underlying forecasted transaction. For cash flow hedges terminated prior to the occurrence of the underlying forecasted transaction, management monitors the probability of the associated forecasted cash flow transactions to assess whether any gain or loss recorded in AOCI should be immediately recognized in net income. Cash flows from derivative contracts are included in net cash provided by operating activities.
See Note 20 for additional discussion of the Company’s derivatives and hedge activities.
(q) Employee Benefits
The funded status of the defined benefit pension plan in the UK (the “UK Plan”) is recognized on the balance sheet, and is the difference between the fair value of plan assets and the projected benefit obligation measured at the balance sheet date. Gains or losses and prior service costs or credits that arise and are not included as components of net periodic pension cost are recognized, net of tax, in OCI.
Signet also operates a defined contribution plan in the UK, a defined contribution retirement savings plan in the US, and an executive deferred compensation plan in the US. Contributions made by Signet to these benefit arrangements are charged primarily to selling, general and administrative expenses in the consolidated statements of operations as incurred.
See Note 22 for additional discussion of the Company’s employee benefits.
(r) Debt issuance costs
Borrowings include primarily interest-bearing bank loans and bank overdrafts. Direct debt issuance costs on borrowings are capitalized and amortized into interest expense over the contractual term of the related loan.
See Note 23 for additional discussion of the Company’s debt issuance costs.
(s) Share-based compensation
Signet measures share-based compensation cost for awards classified as equity at the grant date based on the estimated fair value of the award and recognizes the cost as an expense on a straight-line basis (net of estimated forfeitures) over the requisite service period of employees. Certain share plans include a condition whereby vesting is contingent on Company performance exceeding a given target, and therefore awards granted with this condition are considered to be performance-based awards.
Signet estimates fair value using a Black-Scholes model for awards granted under the Omnibus Plan and the binomial valuation model for awards granted under the Share Saving Plans. Deferred tax assets for awards that result in deductions on the income tax returns of subsidiaries are recorded by Signet based on the amount of compensation cost recognized and the subsidiaries’ statutory tax rate in the jurisdiction in which it will receive a deduction.
Share-based compensation is primarily recorded in selling, general and administrative expenses in the consolidated statements of operations, consistent with the relevant salary cost.
See Note 26 for additional discussion of the Company’s share-based compensation plans.
(t) Contingent liabilities
Provisions for contingent liabilities are recorded for probable losses when management is able to reasonably estimate the loss or range of loss. When it is reasonably possible that a contingent liability may result in a loss or additional loss, the range of the potential loss is disclosed.
See Note 27 for additional discussion of the Company’s contingencies.
Dividends on common shares are reflected as a reduction of retained earnings in the period in which they are formally declared by the Board of Directors (the “Board”). In addition, the cumulative dividends on preferred shares are reflected as a reduction of retained earnings in the period in which they are declared by the Board, as are the deemed dividends resulting from the accretion of issuance costs related to the preferred shares.
See Note 8 and Note 9 for additional information related to the Company’s equity, including the preferred shares.