Signet Jewelers Ltd (SIG) 2018 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Signet Jewelers Limited Q2 Fiscal 2018 Results Conference Call.

(Operator Instructions) Please note that this call is being recorded today, August 24, 2017, at 8:30 a.m.

Eastern Time.

I would now like to turn the meeting over to your host for today's call, James Grant, Vice President of Investor Relations.

Please go ahead, James.

Good morning, and welcome to our Second Quarter Earnings Conference Call.

On our call today are Signet's CEO; Gina Drosos; and CFO, Michele Santana.

The presentation deck we will be referencing is available under the Investors section of our website, signetjewelers.com.

During today's presentation, we will, in places, make certain forward-looking statements and statements that are not historical facts are subject to a number of risks and uncertainties and actual results may differ materially.

We urge you to read the risk factors, cautionary language and other disclosures in our annual report on Form 10-K.

We also draw your attention to Slide #2 in today's presentation for additional information about forward-looking statements and non-GAAP measures.

And I will now turn the call over to Gina.

Thank you, James.

Good morning, and thank you for joining today's call.

It's great to be here today on my first earnings call as CEO of Signet and announcing encouraging second quarter earnings and a transformative acquisition.

Before I get into details about today's announcements, I want to first acknowledge the tremendous career and contributions of my predecessor, Mark Light, he retired last month.

I have been in touch with Mark and spoke to him this week.

His health is progressing well, and he is very appreciative of all the support and your well wishes.

Now I'd like to share some background, my initial observations, my immediate priorities and why I'm excited about Signet's future.

As many of you know, I had the privilege to serve as an Independent Director on Signet's board for 5 years, including as a member of the customer experience subcommittee and the Respect in the workplace committee.

I note firsthand that Signet is a great company with a strong foundation and many opportunities to accelerate its strategy and enhance its competitive advantage in a rapidly changing retail environment.

As a Director, I have worked closely with Signet's leadership team.

I have helped shape the recently refreshed VISION 2020 strategy, which I'm pleased to see is beginning to deliver result.

As you might also know, my career successes to this point are built on consumer-inspired strategies and innovation, changing category paradigms and developing an agile, entrepreneurial and efficient approach to business operations, often less is more and focus has been an important driver of my success with P&G and Assurex Health.

Over the last month, since my appointment, I have been studying various aspects of our business to start identifying Signet's highest return focus areas.

I have also been getting to know, listening to and learning from our talented and hardworking team members, both in the field and in our corporate centers.

Our team has incredible passion, dedication and expertise for guiding our mission.

We deliver outstanding value to the thousands of customers that choose us to help them celebrate the most memorable moments in their lives.

It is a humbling world and one that we never lose sight of.

Doing this well and improving every day is how Signet became the world's largest diamond jewelry retailer.

For a consumer-facing company like ours, this is a key factor in how we will grow our business going forward.

It is also clear that we still have work to do to better understand how our consumers want to shop and interact with us, how their jewelry desires are changing and how we can wow and delight them by meeting their demands more quickly and whenever and wherever they desire.

The retail jewelry shopping experience hasn't transformed in decades, and we can leverage our interactions and data analytics to leapfrog our consumer insights and with that deliver breakthrough innovation in products, assortment, experience, engagement and education.

Next, I'd like to highlight our focus on our OmniChannel strategy.

Our encouraging second quarter performance is a good indication that our OmniChannel strategy is starting to deliver and that we should intensify and accelerate our efforts to innovate and transform.

Already more than 2/3 of our consumers start their jewelry shopping journey online and bring photos with them to our stores.

We can build on their desire to browse and learn by creating more interest, engagement and points of connection through a seamlessly integrated OmniChannel experience.

For example, new visualization technologies in store can exponentially multiply access to over 100,000 diamonds in every store via connection to our virtual vault and try-on technology.

Customers can pick up online merchandise in stores to engage our team of jewelry experts or have products delivered to their home to try on and evaluate.

We see the acquisition of R2Net and the implementation of its digital capabilities as an important step toward achieving this goal.

This brings me to building a culture of agility and efficiency.

I spent 25 years growing, acquiring and scaling brands in the most agile division of a very large company.

And then spent 4 years leading a dynamic and very fast-growing technology-enabled company.

I know firsthand what having an entrepreneur's mindset and efficiency mentality with focus on fewer more important priorities and leadership at every level can do to transform our company and culture.

Signet has work to do in this area.

And we will reward our change agents and entrepreneurs throughout our company.

By doing this, we can better unlock our outstanding talent to innovate in all areas of our business.

We will test more fresh new ideas faster, products, trends and shopping experiences.

Signet has taken decisive steps to manage operating costs and deliver efficiencies across the supply chain, but we still have significant opportunities to become a more productive organization.

We are committed to driving profitable market share growth.

But we also need to be pragmatic in the environment in which we operate, one that is currently defined by heavy promotional spending.

Against this backdrop, it is critical that we deliver on the top line, while managing our operating expenses tightly to defend our margin.

We will examine all aspects of our business to drive productivity gains and cost savings across the organization, and we will share more details on our plans in the upcoming months.

In order to quickly adapt to the changing marketplace, we will keep building our culture of inclusion and embracing a rich diversity of ideas and experiences to further drive success and innovation, while bringing in fresh new ideas from both inside and outside the industry.

We will be an employer of choice and a leader in training, engagement, development and diversity.

And with that, I will now tell you more about our transformational decision to acquire R2Net and how it will help us accelerate our Customer-First OmniChannel strategy.

Moving to Slide 4. We are thrilled to add JamesAllen.com, a fast-growing online jewelry retailer to our rich brand portfolio.

James Allen has grown sales more than 2.5-fold in the last 2 years and has a very attractive average transaction value and know how to sell diamonds online.

Projected fiscal 2018 revenue is greater than $200 million.

James Allen also has a very strong millennial appeal, which is a key growth demographic for us.

In addition, R2Net owns Segoma Imaging Technologies.

Together they offer a robust suite of innovative technologies to deliver a next-generation digital shopping experience for jewelry.

This transaction will accelerate the execution of our OmniChannel strategy by quickly ramping up our digital innovation capabilities to more seamlessly integrate our digital and physical retail platforms.

Signet has been partnering with R2Net for the past decade on our Jared business since 2007, including our Jared Design-a-Ring web platform.

Our companies work well together, and we believe this existing relationship will help ensure a smooth implementation process.

As part of the acquisition, we are also bringing a very talented group of employees on board, our winning team.

In addition to his role as President of James Allen jewelers, R2Net Co-founder and CEO, Oded Edelman, will become Chief Digital Innovation Adviser of Signet, where he will report directly to me and assume the responsibility for driving the digital innovation strategy across all Signet brands.

And as a sign of commitment to the long-term vision of Signet and R2Net, Oded and the other R2Net founders will invest a significant portion of their transaction proceeds in Signet shares.

This acquisition marks an important step for Signet, as we build scalable, digital capabilities for our OmniChannel transformation.

And now moving to key takeaways of the second quarter on Slide 5. We delivered same-store sales growth of 1.4%, earnings per share of $1.33 and operating profit margin expansion of 100 basis points.

Fashion and branded bridal jewelry led the category growth, helped by a stronger response to bridal promotions, while Kay Jewelers, Peoples and Piercing Pagoda led banner growth.

Our encouraging results were underpinned by e-commerce platform improvements and a strong Mother's Day, which led to key learnings around effective marketing through simpler and more targeted messaging.

While the industry remained highly promotional, we tightly managed our cost base, which helped Signet deliver top line growth, EPS growth and operating margin expansion during the quarter.

Moving to Slide 6. While I'm only a few weeks in, I'd also like to briefly update you on a number of critical initiatives that the management team has been leading and that I've dived into quickly.

Starting with OmniChannel.

We've been working hard since the beginning of the year to stabilize the issues we had on our e-commerce sites and to improve the overall customer experience.

During the quarter, we made a number of enhancements, including improvements to user experience, traffic-driving search engine optimization and digital marketing capabilities and enabling greater integration of digital technology in stores.

This is reflected in our e-commerce sales increase of 18.1%.

Just about 10 days ago, we delivered a major upgrade to all of the Zales division websites.

The new Hybris technology has immediate search and user experience benefits and also enables easier future improvements.

This launch was executed successfully.

And conversion rates are already trending in a strong positive direction.

We will continue to focus on enhancing our OmniChannel platforms and look forward to implementing R2Net to give us a leading e-commerce brand and accelerate our digital innovation capabilities.

Moving to the strategic decision to outsource our credit portfolio.

During the second quarter, we announced the sale of the prime portion of our credit portfolio and outsource servicing of our secondary book to de-risk our balance sheet and streamline our focus on our core business.

I'm highly committed to this decision and to ensuring excellent execution and maximizing value for our shareholders.

Since the announcement, we've made significant progress on the transition and are on track to complete this first phase in October, well before holiday.

We also launched our lease purchase program in partnership with Progressive Leasing ahead of schedule.

And we have been training our store teams to leverage this important tool.

Our intention continues to be full outsourcing of all of our credit programs.

We are actively engaged with a number of interested parties on Phase 2 and are examining a range of alternatives.

Michele will provide more details on credit in just a minute.

Finally, I'm encouraged by the team's plans for the holiday season.

We will continue to shift our marketing dollars toward digital resulting in more targeted efforts with higher ROI and consumer engagement.

And building on Mother's Day learnings, we will have simpler promotional messages with greater integration across marketing channels.

We will be launching new products, important line extensions and particularly in the fashion and gifting categories.

In summary, we believe we are well positioned for the upcoming holiday season, which together with the momentum we gained in Q2 gives us confidence in our ability to deliver our financial targets.

And with that, I will turn it over to Michele to discuss our second quarter results and fiscal 2018 guidance in detail.

Thank you, Gina.

All right.

So turning to Slide 7. For the second quarter, Signet's total sales were $1.4 billion, up 1.9% year-over-year or 2.8% on a constant currency basis.

Comp sales increased 1.4% compared to a decline of 2.3% in the prior year second quarter and compares to a 2-year comparable rate of 1.9%.

Of our comp sales increased, about 380 basis points of favorability was attributed to the performance and later timing of Mother's Day, which shifted to the second quarter.

Key events that contributed to this encouraging comp performance were solid Mother's Day's results and a successful July bridal event.

Overall, total comp sales increases were driven primarily by higher-average transaction value across all store banners.

We also experienced increases in the number of transactions in Kay, Zales and Peoples, while the U.K. saw a double-digit percentage decrease in transactions.

By category, fashion jewelry led the sales performance closely followed by bridal, while watches declined with the exception of our prestige watches in the U.K. that had strong sales performance.

From a channel perspective, e-commerce led the growth with an 18.1% increase over prior year, while both malls and off-mall stores delivered sales growth.

Through the first half of the year, we have learned that agility in our approach to balancing sales and profit is particularly significant in today's consumer environment.

Signet is committed to strengthening its consumer relevance and market share and will continue to balance incremental promotions to drive top line with expense reductions to offset margin rate decline.

Our wins in the second quarter relating to our promotional messaging that consumers responded very strong to, combined with wins related to our ongoing e-commerce initiatives support our full-year guidance outlook.

Now I'll move to the income statement.

On Slide 8, our gross margin was $457.9 million or 32.7% of sales.

This represented a 120-basis-point decline over the last year period, and principally due to a strategic increase in promotional activity resulting in a lower merchandise margin rate.

However, gross margin dollars increased slightly due to the higher sales volume.

In addition, leverage on store occupancy cost of 30 basis points was offset by lower recovery rates associated with Signet store retrading program.

SG&A expense was $409 million or 29.2% of sales.

Total SG&A declined by $6.7 million or 1.6% over prior year and leveraged 110 basis points.

Included in SG&A were costs related to the CEO separation and R2Net acquisition of $4.7 million, which unfavorably impacted the leverage ratio or SG&A rate by 30 basis points.

During the quarter, we remained very disciplined and focused on cost reductions to offset the promotional impact on our gross margin rate noted above.

Cost reductions were primarily realized in payroll and payroll-related benefits in both stores and corporate as well as other select corporate expenses.

In the second quarter, Signet recognized a $14.8 million net gain related to the pending sale of a prime portion of receivables to ADS, which is expected to close in October.

The $14.8 million includes a noncash gain of $20.7 million related to the reversal of the allowance associated with these receivables, partially offset by $5.9 million of credit transaction cost related to legal, adviser and other expenses.

I will further discuss the impact of the credit transaction on Signet's financials in a few moments.

Other operating income was $71.9 million.

The $1.2 million increase was due to the Sterling division's higher interest income earned from higher outstanding receivable balances.

However, the rate of increase was tempered by a greater mix of reduced rate plans.

All of this led to operating margin expansion of 100 basis points, 70 basis points of which was attributable to the net credit transaction impact just described as well as CEO separation and acquisition costs.

Diluted earnings per share was $1.33, compared to $1.06 in the same quarter last year.

As a result of the imminent credit transaction proceeds, we purchased 8.1 million shares or nearly 12% of Signet shares in the second quarter at an average price of $56.91.

This accelerated buyback was motivated by the share price and the ability to fund the buyback using our revolving credit facility, combined with our confidence in the transaction closing in October.

This acceleration of share repurchases drove $0.07 of earnings per share in the quarter.

In addition, $0.08 of earnings per share in the quarter were driven by a combination of net noncash gain associated with credit transaction and related costs, partially offset by costs related to the CEO separation and R2Net acquisition.

The Mother's Day shift into Q2 also favorably benefited EPS by $0.15.

At the end of the quarter, there were $650.6 million remaining under Signet share repurchase authorization, following an incremental authorization of $600 million during the second quarter.

So turning to working capital and free cash flow, a few comments.

Net inventory ended the period at $2.3 billion, down 5.6% year-over-year.

This was primarily driven by our continued focus on working capital across the business.

In particular, we continue to manage Zales stores with less inventory per store to improve prominence and presentation of key collections.

Generally, we are delivering less breadth and more depth in key categories, which is driving overall inventory productivity.

Effective working capital management led to a solid free cash flow generation through the first half of the year.

Free cash flow for the year-to-date period was $304 million, up $96 million, compared to the same period last year.

Changes to accounts receivable also favorably affected free cash flow.

Before we turn to our receivable metrics, a couple other quick highlights.

We ended the quarter with $303 million of borrowings outstanding on our revolving credit facility.

As previously discussed, we funded the acceleration of share repurchases through our revolver.

The weighted average cost of borrowing on the revolver was 2.4% through the first half of the year.

So with that, we will move to our credit portfolio on Slide 10.

So I'll walk through our second quarter metrics and then spend some time discussing the impact of Phase 1 credit outsourcing for Q2 and beyond.

As you know, we are still managing our full credit portfolio until the closing of the transactions, which are expected in October, at which time our prime receivables will be sold to ADS.

Therefore, in the first table on the slide, you will see the key metrics for the full portfolio, including prime and nonprime receivables.

In the second table, we provided you our credit portfolios split between prime receivables held for sale and the residual or nonprime receivables.

So starting with the first table.

Our second quarter in-house credit sales in the Sterling division was $536 million, an increase of 1.3% over prior year.

In-house credit participation was 61.7%, down 140 basis points due to lower application volume of approximately 11%.

The average monthly payment collection rate for the second quarter was 10.3%, compared to 10.8% last year.

This decline was principally due to increased usage of extended payment credit plan resulting in lower required schedule payments when expressed as a raise.

The collection rate decline combined with slightly higher credit sales resulted in an increase in our gross accounts receivable of $47 million or 2.7% over the prior year.

Interest income from finance charges, which makes up virtually all of our other operating income on our income statement, was flat at $70 million to last year.

Net bad debt expense was approximately $58 million or $3 million higher than last year.

And when taken together with finance income, generated an operating profit of $12 million.

This net combination was down $3 million to last year.

So this net reduction, when compared to prior year is primarily related to lower finance charges associated with the aforementioned increase in reduced rate extended term payment plans, which are targeted to higher type of profile customers as compared to our average plan.

At the end of the second quarter, reduced rate extended payment term plans represented about 22% of the portfolio, compared to 9% in the prior year.

So moving to the bottom portion of the slide.

At the end of the second quarter, $1,056,000,000 of receivables, representing the portion of the in-house finance portfolio that will be sold to ADS were reclassified as held for sale.

Related to this classification, the allowance for bad debt associated with this portfolio was reversed in the second quarter, resulting in a noncash gain of $21 million.

The residual growth receivables totaled approximately $736 million at the end of the second quarter.

The related allowance in Q2 for this residual part of the portfolio was $114 million or 15% of gross receivables.

For comparative purposes, had the portfolio been bifurcated in the same manner in the prior year, the residual receivables would have totaled $744 million, with an allowance of $110 million or 15% of gross receivables in the second quarter last year.

So turning our attention to Slide 11.

I'd like to outline the key financial impact and considerations beyond Q2 from the Phase 1 of our outsourcing.

As a reminder, Phase 1 includes a sale of prime portion of accounts receivable to ADS at par value and the conversion to Genesis Financial as our servicing provider for the remainder of the receivables.

Starting with the onetime cost and gains associated with the transaction in the left-hand box.

As I mentioned earlier, we've recognized a pretax noncash gain of $21 million during the second quarter due to the reclassification of our prime receivables as assets held for sale.

We also incurred $5.9 million in transaction cost during the quarter.

For the full year, we expect total transaction cost to be approximately $35 million.

So moving to Q3 upon the close of the transaction.

One, we expect to receive estimated proceeds of $1 billion, of which $600 million will be used to repay our ADS facility.

As we said during the initial announcement of our credit outsourcing, we earmarked the remainder of the proceeds or $400 million for share repurchases.

Based on the compelling share price and availability on our revolver, we accelerated this intent and repurchased the $400 million of shares in the second quarter.

As such, the residual $400 million of transaction proceeds will be utilized to repay the short-term loan associated with the financing of the R2Net acquisition with further residual proceeds used to repay the revolver borrowings.

In addition, in the Q3 period, we will also recognize what is called the beneficial interest gain, initially a noncash P&L gains that we estimate will be $10 million pretax.

The beneficial interest effectively represents a receivables for the present value of expected future profit sharing payments related to the receivables sold to ADS.

This asset will then be reduced in the future via payments received from ADS.

So post closing of the transaction that we expect to occur in October, other ongoing considerations that will impact our operating profit will include the following, of which I'll also provide the financial impact to Q4.

We expect approximately a $22 million decline in our EBIT in the fourth quarter.

This decline will be driven by the combination of the following: The elimination of the net contribution associated with the prime portfolio, which is finance charge plus our late fee less our bad debt expense.

The net combination of these is expected to unfavorably impact EBIT by $28 million.

Now this will be partially offset by recurring SG&A savings associated with the elimination of our in-house credit operations, net of servicing cost associated with Genesis Financial, plus the ADS net economic profit sharing.

The net SG&A savings is estimated to be favorable to EBIT by $6 million.

The estimated $0.50 accretion and EPS related to the $400 million of share repurchases executed in the second quarter will more than offset the decline in earnings associated with the impact that I just outlined.

In addition, interest expense savings of $4 million related to the ADS facility will favorably benefit net income.

Finally, as I mentioned on the previous slide, post the sale, our allowance metrics will move unfavorably given the sale of our highest quality receivables.

Our allowance will become smaller in dollars, but our allowance as a percentage of a smaller receivable base will look less favorable when compared to the rates associated with our historical total receivable.

I wanted to be ensure -- I wanted to be sure to explain this dynamic in advance.

Finally, as mentioned, the transaction is expected to close in late October, ahead of the holiday season, and is also expected to have no material impact on our net sales.

Signet will continue to fund the sales associated with the nonprime receivables until Phase 2 is complete.

We have updated our financial annual guidance to include all aspects of these impacts, which brings me to my final slide.

We are reiterating our fiscal 2018 same-store sales guidance and earnings per share as well as updating components to our annual EPS guidance to reflect the impact of the strategic outsourcing of credit, CEO separation costs and the anticipated transaction costs associated with the R2Net acquisition announced today.

Lessons learned in Q2 have caused us to pivot from our previously communicated views in how we achieve our bottom line.

As Gina and I have both suggested earlier in the call, we recognized the need to be agile in the current environment with promotional messaging, while still being accountable to drive earnings.

As a result, we expect to be incrementally more promotional in the back half of the year, which will likely result in a slight deleverage of our gross margin rate.

Now with that said, we have identified incremental cost reduction in SG&A that will enable us to leverage SG&A to offset the gross margin rate impact.

So back to the slide starting with our guidance of $7 to $7.40 and walking down.

You will see the net impact estimated from outsourcing of credit has diluted the EPS by approximately $0.16.

Again, this includes the effect from partial elimination of bad debt expense, late fees and finance income, SG&A savings, servicing costs, net profit sharing and interest expense savings.

Net transaction costs are estimated to be diluted to EPS by approximately $0.05 associated with the credit transaction.

This includes estimated transaction costs associated with legal, advisers, and implementation expenses, partially offset by the second quarter noncash gains recognized and the estimated beneficial interest gain to be recognized in Q3.

CEO separation costs are diluted to EPS by $0.03.

Transaction costs associated with the R2Net acquisition are estimated to be dilutive to EPS by approximately $0.10.

These costs include legal, adviser, accounting and financing.

Our guidance does not include any impact related to R2Net operations post closing.

We will update guidance for sales and EPS related to this announcement upon closing of the acquisition.

And finally, our guidance reflects the favorability to earnings per share of $0.50 related to the accelerated share repurchases completed in the second quarter.

Our effective tax rate will be closer to lower end of our previous guided range at 24%.

Our weighted average share count will drop materially by the year-end due to the Q2 share repurchases of 8.1 million shares.

CapEx and square footage guidance remains virtually unchanged.

Lastly, as you consider how to model the third and fourth quarters, I wanted to offer these directional comments about same-store sales and EPS.

Our same-store sales in Q4 will show notable sequential improvement over Q3, driven by.

One, Q3 is our smallest quarter and there is no key gift-giving holiday within.

Two, Q4 will have easier comp anniversary and will benefit from the deployment of several initiatives during the holiday season that we have already seen early successes in the second quarter.

And, as you know, Q4 will be a much larger contribution to full-year earnings per share versus Q3, as it represents about 40% of our annual operating income.

That concludes my prepared remarks.

And with that, I will turn the call back over to Gina.

Thanks, Michele.

Before we take your questions, I'd like to reiterate a few points.

First, I'm honored to lead Signet at this exciting moment in our winning history.

A time when we will leverage our strengths in new ways, develop new muscles and build our capabilities and culture at an accelerated and energizing pace.

We have many great assets to enable our future success.

We have a hard working, talented and passionate team.

We have the discipline and operational expertise that sets the gold standard in the industry.

We have recognizable and trusted brands that are part of consumers' most meaningful life moments.

But let me be crystal clear.

We also have a number of challenges that we need to decisively address.

We operate in a retail environment that is more dynamic and demanding than it has ever been.

Leading requires us to act faster, smarter and more efficiently.

I will not lose sight of this.

We will focus on clear strategic priorities that will help us gain momentum and lead growth once again.

I will strive to build a stronger, more agile and more innovative Signet every day.

By leveraging our strengths and keeping a laser focus on what's needed to deliver growth and profitability, I have great confidence that we will achieve the same success and create strong value for our consumers, employees and shareholders.

And with that, we'll now take your questions.

(Operator Instructions) And your first question comes from the line of Simeon Siegel with Nomura Instinet.

Gina, you're bringing in formed but new perspective to the leadership seat.

Any updates on your view on store counts and thoughts on the preferred store fleet size and maybe e-com penetration, especially just given you just bought an e-tailer?

So if you could disaggregate color between the main nameplate concepts and then the regionals that would be great?

Sure.

Thanks very much for your question and for the warm welcome.

We have been aggressively managing our real estate portfolio.

Year-to-date, we closed 98 stores and opened 53 for a net down of 45.

This is focused on regionals and underperforming mall stores.

We have a highly analytical point of view on this and are looking at ROIC every quarter on these stores.

But we do view our retail footprint as a competitive advantage and believe that we can do a much better job connecting our in-store and our online experiences.

And that's important because while jewelry customers begin their shopping journey online, 9 out of 10 jewelry shoppers want a store experience before they buy.

So going forward, we will continue to take advantage of lease optionality to exit unprofitable stores, strategically open fewer new stores with strong potential sales and ROIC and much better connection between the online and bricks and mortar parts of our business.

R2Net, I think, will play a strong role in helping us to build digital innovation capabilities to do this.

Great.

And then, Michele, if I can I think you mentioned, you spoke about the interest expense.

Any way to think about the interest income for the back half?

I know you had said it wouldn't be material to the statements.

But just to clarify, does guidance and the balance sheet now reflect contractual accounting for the nonprime book?

Yes.

Sure, Simeon.

So couple of things that turns us -- yes, I did mention interest expense savings, but also in my prepared remarks I talked about the interest income at least associated.

I don't know if you're talking about the finance charge income or if you're talking some other type of interest income.

But if you go back through the prepared remarks, that's included all factored into the guidance.

In terms of your question on a contractual basis, let me give some additional color there.

We expect that when we do converge, when we close the transaction in October, that we will convert to contractual, as we move to Genesis.

However, for Q3 reporting, our delinquency will be done as a final time on recency basis and the reason for that Simeon is due to the cycle billing times and the conversion date that's happening later in October.

Beginning with our last 7 billing cycles, which we have a total of 25 cycles in October, all accounts going forward will be aged and managed purely on the contractual basis.

So you'll see when we report Q4 that we will be moved to contractual.

So hopefully that helps.

Your next question comes from the line of Oliver Chen with Cowen and Company.

Your comments are really helpful.

We are curious about your comments around the promotional environment and what's happening with the industry at large and your thoughts on mom and pops.

And it sounds like you're very agile in thinking about this, but will the comparisons ease in context and how the environment is evolving relative to your strategies?

And then on the R2Net deal, could you just help us understand which features are you most excited about to help accelerate your own OmniChannel capabilities?

Would be curious about that.

And generally speaking, how the timing would work?

And what we should think about.

One of the topics you brought up a lot was speed, and it could be in relation to that or supply chain?

Curious about that as well.

Great.

Thanks, Oliver.

Let me start, and then, Michele, you can jump in with more details.

So first on the promotional activity.

So we've discussed our strategy to appropriately balance sales and margin, and you've heard in our Q2 discussion that we're willing in this environment to build profitable market share with higher levels of promotional spending, offset by cost savings.

Yes.

Oliver, if I could just add a couple points to that, and then we'll circle back to your R2Net questions.

As we said on the call, we are planning to be incrementally more promotional.

And with that, we expect that we will slightly deleverage our gross margin rate.

And as you know, that is a change from how we previously communicated our position before.

But given the promotional environment and the competition we see in the marketplace and the fact that we are going to go after market share, we absolutely believe it's the right thing to do.

But equally important is ensuring that we remain agile and flexible and being able to go after cost reductions to support a lower gross margin rate and ultimately drive the bottom line.

And then on your question regarding R2Net.

I'm really very excited about the technology they bring.

And the way I think about it is a pool of existing technology and a really robust R&D pipeline of future technology.

So if I talk a little bit about the existing technology.

There are 4 critical pieces that I call out.

One is diamond imaging cameras.

So they've developed an in-house capability to create real diamond images in 360-degree HD with a 40x super zoom on any device.

So it looks great in a mobile app as well as online.

It can look great in our stores.

And they are continually updating and improving these cameras.

So I think that's something that we would look to reapply in the reasonably near term.

The second is the 3D imaging technology.

And this is the rendering system, which provides interactive videos of any diamond with any ring.

So when the shopper is online, looking, they can look at over 100,000 different diamonds that are online and place that actually virtually into any setting to get a very clear idea of what that ring will look like.

It's unlike anything else that's available on the Internet today.

And that links up in my opinion with the ring try-on app so that -- and you can download this in the app store.

I'm not sure if you have been online, but it's really terrific technology.

And you can put an image of a selected ring to visualize how it would actually look on your hand, not someone else's hand or model's hand, but literally how any ring would look on your hand.

And then the fourth one I will call out, which is something that we've been talking about already at Signet that I think R2Net can help accelerate our capabilities is customer service and 24/7 chat.

They have a great capability, 24/7 that allows customer service team members to be more like jewelry consultants.

And in real time, they can work with the customer online, point out flaws in a diamond that might be being considered, show comparisons of other diamonds.

Really terrific technology.

So what we will do is first we need to close the deal, obviously.

We're thinking that will happen in sometime late September.

And then, as we begin to implement technology, we will certainly do that with an eye toward which of these we think could bring the biggest benefit to some of our existing Signet brands without disrupting anything to do with our e-commerce capabilities for holiday.

And Virginia, just one last question.

When you think about the individual banners between Jared and Zale.

There is different aspects from the consumer selling experience versus product execution.

Could you just dive a little bit deeper into where you see those opportunities specific to the banners because it feels like they're slightly different?

You're exactly right.

They are slightly different.

Zales, for example, has somewhat different customers than Kay and different from Jared.

And I think we have a great opportunity to improve and differentiate our assortment.

For example, in Zales, we want to look at higher price point fashion offerings than we've had traditionally in the past.

For Jared, we're looking at more branded merchandise and ways to really help Jared elevate its point of view.

We see the key competitor, if you will, for Jared as regional independence.

And so how do we position Jared to be able to reach to a higher income and discerning consumer.

And in Kay, the same, we've done very well with bridal brands.

And so we're looking at how we extend also this brand name into more bridal offerings, but also into fashion.

So understanding the consumer and who is shopping at each of our banners is an important first step that we've been working on and from that we'll be differentiating our assortment a bit more than we have in the past.

You next question comes from the line of Ike Boruchow with Wells Fargo.

I guess, Michele, you mentioned gross margin will be down a little bit in 2H.

And then -- correct me if I heard this wrong, but you're planning to offset that with some cost initiatives that you've identified.

Can you maybe talk to the specifics there?

Are these initiatives brand new to the business meaning will those cost savings wrap around to the first half of next fiscal year?

Sure, Ike.

So yes.

The plan that we have is that given the environment as we talked about and importantly some of the lessons that we learned from Mother's Day on how we drove our promotional messaging, which was much more streamlined, we will look to offset that through further cost savings on SG&A.

So some of these cost savings are continuing benefits of what we've done in the first half of the year.

So if you are looking the first half of the year, SG&A kind of excluding the CEO separation and the acquisition costs associated with R2Net are down about $20 million.

Some of those benefits will continue to the back half of the year, such as our corporate payroll, store payroll savings.

We're also pushing in deeper into certain areas where we see further opportunities and select corporate expenses.

In addition, we're also making smart reductions in advertising.

Part of that is shifting advertising to higher ROI media.

For instance, shifting away from some of the traditional media into the social media, which is also very efficient, in terms of dollars.

And is also supported by recent research we've done in which we know that people need fewer visits to stores.

So our marketing is going to reflect that.

For instance, years ago, the bridal journey required 7 store visits on average.

But today, it's down to about 4 as a result of digital.

So we're kind of leaning into that.

So even though we're going to be diving deeper and reducing SG&A, we also at the same time are preserving or improving the customer experience through smarter allocation of our resources.

Got it.

That's very, very helpful.

And then just as a follow-up on Phase 2. Maybe, Michele, can you talk about your thoughts on potential timing as well as any other types of options or alternatives that you may be considering internally?

Yes.

So let me give you a little bit more color on Phase 2, just broadly some of the timing around that.

Very much what we've previously said at the time we had announced our phased approach remains in play in terms of our objective.

We are actively engaged, as Gina has mentioned on the call, in discussions with multiple interested parties and very committed to fully outsourcing the credit portfolio in a timely manner.

But keep in mind, we're also very focused on ensuring that we close the Phase 1 transaction in October before the holiday season.

So we're kind of running a parallel path.

What I would say and what we stated previously is that we expect Phase 2 to be completed at some point in FY '19, but we're going to continue to push forward on that path.

Your next question comes from the line of Paul Lejuez with Citi.

Have you thought about whether or not you're going to cross-market James Allen with your existing brands?

That's the first question.

And then just -- I think, a bigger picture is as you focus more on OmniChannel, any early thoughts on the required CapEx investments, as you think about next year?

And also if you can maybe touch on what we should be thinking about in terms of EBIT margin as you move more of your business online, as online continues to outperform in-stores?

Sure.

So just starting with your question on James Allen.

Our initial view is to run that as a largely independent division and keep JamesAllen.com as the very strong fast-growing e-commerce brand that it is now.

And then look to reapply technologies to kay.com, Zales.com, Jared.com and also in stores.

We will also over time look at whether a showroom type concept would make sense on James Allen to create some in-store excitement around that brand as well.

But I think we need to really get into more of an implementation phase before we get concrete ideas on that.

But that's at least the early thinking on that piece.

And yes, maybe, Paul, just in terms of your question, I believe, one was on CapEx related to the acquisition elevated levels going forward.

I mean, I would say I wouldn't anticipate any material elevation in our capital expenditures.

I think the way how we look at it is there's a pool of dollars for capital ex and capital expenditures and we will allocate that based on priority and ROI.

And then in terms of EBIT margin, as we -- shifting OmniChannel, e-commerce for store, our e-commerce margin is pretty healthy.

Keep in mind, we don't have the store, the related store expense, although we do have shipping cost associated with e-commerce, we are not having that store occupancy expense.

So it really isn't a drag on our margin for us.

Anything -- can you add anything on your store closings?

What sort of recapture rate you see on the sales as you're closing stores?

Yes.

So I will take that one.

We typically see around 30% recapture rate and that has a lot of upside in it.

So it's not a bad number now.

But we think, especially with some of our new clienteling system that we've rolled out to the field, we have an opportunity to increase that to up over 50%.

And so that's a real focus area for us.

I'd just add one more point on what Michele was saying about EBIT.

James Allen has a significantly higher average transaction value than any of our other websites.

And that gives us a great learning lab for how we can increase the purchase online for the rest of our websites.

And that in and of itself would be an improvement in EBIT for us.

Your next question comes from the line of Brian Tunick with RBC.

Gina, I was curious, I guess, first maybe your view on the softness in the jewelry category overall.

What are you seeing there?

Maybe any differently, obviously, you're making a big acquisition on the millennial front today.

But just curious what you think is going on in the last year and a half in the jewelry category?

And maybe what would help resuscitate it?

And then maybe, Michele, on capital allocation, can you maybe update us on your views of where the balance sheet and leverage ratios will come in at the end of the year?

Given this accelerated buyback, the credit sale, today's deal and maybe how you are prioritizing capital allocation maybe as we go into next year?

Sure.

So I think that the jewelry sector headwinds are really a combination of overall retail headwinds and the very rapid change in how consumers are choosing to shop.

And then secondly, a more sector-specific issue around the lack of excitement and innovation.

And those are 2 things where Signet is well positioned to strengthen our capabilities and to lead.

I will say that after 4 years of declining growth, we have recently started to see a reacceleration of the jewelry industry, low single-digit growth year-on-year in the last year.

And we've done a lot of consumer research, and we know that consumers of all ages, including millennials tell us that jewelry is among the top 3 gifts that they like to receive, and that diamond rings will continue to be how they choose to commemorate their engagements.

So I think there is significant resiliency in the jewelry industry across generations and as we can bring more exciting innovation, more visualization, more ability to be able to shop online for a purchase that traditionally people have thought you have to touch and feel and see in store, when we can magnify that diamond 40 times, turn it around 360 degrees and give people a great view of that online combined with 24/7 chat with diamond experts, I think, we'll be able to lead a change in jewelry industry growth rate.

And, Brian, in terms of your question on capital allocation priorities, a few thoughts there.

The business has very strong cash flow generating capabilities.

And so we absolutely remain committed to one on preserving our financial strength and our flexibility to support growth and also maximize shareholder return.

This also will include strategic investments like the acquisition that we just announced today of James Allen.

And balancing that through returning capital to our stockholders through dividends and/or share repurchases.

So I'd say there is really no change in terms of those priorities that we have previously communicated.

When you think about the end of the year leverage ratio, what I probably point you to is we will probably be maybe low-end 3x, maybe slightly under that.

Your next question comes from the line of Rick Patel with Needham & Company.

Just a couple of questions on the competitive environment.

So first, are you still seeing a lot of liquidation sales go on from the independents like you did earlier in the year or is that lessening?

And then second, a major department store competitor is certainly accelerating its focus on jewelry with pretty good result so far.

How should we think about this competitive threat and what leverage Signet can pull to offset this pressure?

Well, first on the liquidation sales, I would say we are seeing fewer from the independents that we had -- than we had previously.

But we are seeing stronger promotional spend from department stores, very price-oriented promotional spend.

We take a view on this that we are leaders in this business for the long term.

And so we are very analytical about our promotions, willing to balance those to drive our top line growth.

But profitable share growth, winning in bridal, getting stronger in fashion, those are the key things that are most important to us.

It certainly is not all about price in our context.

So we are working harder to combine our promotions with equity building, advertising and other marketing so that we make sure we are building our brands over the long term.

Then, Michele...

Can you give us a little more color around the new initiatives for holiday?

I'm just curious about what's going to be difficult from last year from a merchandising perspective in terms of your existing brands and any other new brands you might look to scale that you may have tested over the last few months?

Yes.

So I don't want to give away too much from a competitive standpoint, obviously, but we have a number of new fashion brands that we have been working on.

Some of those are brands with -- which really speak to the heart and soul of consumer passion and which I think are great.

And some of which are really trend driven on very on style at the moment, designer-oriented brands building on the stacking trends that we've seen recently in the market.

So I think they're very strong.

We are focused on price points in the gift-giving range of $200 to $700.

So we have a very strong offering there.

And so what we are really aiming to do combining that with disciplined and smart promotional and marketing spend is to drive traffic into our stores and be very much part of consumers' holiday gift giving.

And if I could just pile and add one additional comment as well when we go through our holiday period this year, we will have our lease-to-own program with Progressive Leasing.

And when you think about that, currently about 45% of customers who apply for credit today are denied.

And so that does represent a great opportunity for those customers who can't seek credit.

And mentioned on the call, we are able to successfully roll that out ahead of schedule.

And so now it's really just a matter of our store associates kind of building their muscle related to that.

Your next question comes from the line of Scott Krasik with Buckingham Research.

Just wondering, it seems like the underlying sales trends, excluding the Mother's Day shift in the first quarter were maybe down mid-single digits or so, second quarter that's improved meaningfully.

So I'm just wondering how you view sort of your underlying transact for shifts, maybe how are sales in June and July and how you're thinking about that going forward?

So I'd say a couple of things on that and then, Michele, feel free to chime in.

So we had a very strong average transaction value growth across our banners and across our key national banners, led by Kay, certainly Piercing Pagoda, Zale as well.

We also saw transaction increases in the quarter.

So we are very pleased to see growth on both of those fronts.

You're right that ex the Mother's Day we would have been down slightly on a comp basis.

But coming out of the momentum that we had behind our bridal promotion in July, we are feeling very good about our guidance for the back half of the year.

Yes, absolutely.

I would say we are very much encouraged by our Q2 results.

We talked about strong performance going into the quarter and strong performance exiting the quarter with our July promotional event.

And I did provide some color on the call on how to think about Q3 and Q4.

Right.

And then so just lastly, an update on maybe the synergies, where you are there?

And then, I think you alluded to my next question that there you're finding some new savings.

Can you just further expand on that?

Sure.

We are looking for savings across our company.

But just to answer specifically synergies and related to the Zale acquisition, which are the synergies that we talk about the most.

Zale -- and I -- having been on the board for 5 years, I continue to be very excited about that acquisition, very good strategic decision for us and we're very committed to achieving business success.

What has gone well on that integration is our operational focus on synergies.

So we are on track to deliver the numbers that we've communicated previously.

What our big opportunity is?

To drive further benefit from that acquisition is on the sales growth side.

We haven't meaningfully improved our sales productivity.

And still our Kay average store sales are about 50% higher than a Zales, which gives us a tremendous opportunity, as we improve assortment, as we get our inventory right in the stores, as we update the look of the stores, as we bring technology like we talked about.

A tremendous opportunity to drive sales productivity.

And so while we will reach our synergy targets, I think the integration still has tremendous upside.

And as we fully embrace the ideas and talents of our Zales division team, we will be able to bring those to life.

And that's all the time we have for questions today.

I will turn the call over to Ms. Drosos.

Okay.

Thank you very much.

Our next call will be the release of third quarter earnings on November 21st.

So that's it.

Thank you.

Thank you, ladies and gentlemen.

That concludes today's call.

You may now disconnect.