Liquidity & Capital Resources

Summary cash flow

The following table provides a summary of Signet's cash flow activity for Fiscal 2011, Fiscal 2010 and Fiscal 2009:

OVERVIEW

Management’s objective is to maintain a strong balance sheet, as it regards financial flexibility as a competitive
advantage.

Operating activities provide the primary source of cash and are influenced by a number of factors, such as:

• net income, which is primarily influenced by sales and operating income margins;
• changes in the level of inventory;
• proportion of US sales made using in-house customer financing programs and the average monthly collection rate of the credit balances;
• seasonal pattern of sales; and
• working capital movements associated with changes in store space.

Other sources of cash would be borrowings or the issuance of Common Shares for cash.

Net cash provided by operating activities
As a retail business, Signet receives cash when it makes a sale to a customer or when the payment has been processed by the relevant bank if the payment is made by credit or debit card. In the US division, if the customer makes use of financing provided by Signet, the cash is received over a period of time. In Fiscal 2011, 54.2% (Fiscal 2010: 53.9%) of the US division’s sales were made using customer financing provided by Signet. The average monthly collection rate from the credit portfolio was 12.6% (Fiscal 2010: 12.5%).

Signet typically pays for merchandise about 30 days after receipt. Due to the nature of specialty retail jewelry, it is usual for inventory to be held on average for approximately 12 months before it is sold. In addition, Signet holds consignment inventory, nearly all of which is in the US, which at January 29, 2011 amounted to $138.0 million (January 30, 2010: $134.6 million). The principal terms of the consignment agreement, which can generally be terminated by either party, are such that Signet can return any or all of the inventory to the relevant supplier without financial or commercial penalties. When Signet sells consignment inventory, it becomes liable to the supplier for the cost of the item. The sale of any such inventory is accounted for on a gross basis (see principal accounting policies, Item 8).

Signet’s largest class of operating expense relates to store and central payroll and benefits. These are typically paid on a weekly, two weekly or monthly basis, with annual bonus payments also being made. Operating lease payments in respect of stores occupied are normally paid on a monthly basis by the US division and on a quarterly basis by the UK division. Payment for advertising on television, radio or in newspapers is usually made between 30 and 60 days after the advertisement appears. Other expenses have various payment terms, none of which are material.

Signet’s working capital requirements fluctuate during the year as a result of the seasonal nature of sales, and movements in the pound sterling to US dollar exchange rate. The working capital needs of the business normally decline from January to August, as inventory and accounts receivable decrease from seasonal peaks. As inventory is purchased for the fourth quarter, there is a working capital outflow which reaches its highest levels in mid to late November. The peak level of working capital is typically $100 million to $150 million above the typical January to August level, and can be accentuated by new store openings. The working capital position then reverses over the key selling period of December.

The change in inventory and receivables in the US division is primarily driven by the sales performance of the existing stores, the net change in store space and the seasonal pattern of sales. The value of inventory in the UK division is also impacted by movements in the pound sterling to US dollar exchange rate. Growth or decline in same store sales will normally result in a smaller proportionate movement in inventory than in same store sales. Changes in the sourcing practices and merchandise mix of the business can also result in changes in inventory. In the US, a change in receivables would proportionately reflect changes in sales if credit participation levels remain the same and receivable collection rates were unaltered. Changes in credit participation and the collection rate also impact the level of receivables. Movements in deferred revenue reflect the level of US sales and the attachment rate of warranty sales. Therefore if sales increase, working capital would be expected to increase. Similarly, a decrease in sales would be expected to result in a reduction in working capital.

Investment in new space requires significant investment in working capital, as well as fixed capital investment, due to the slow inventory turn, and the additional investment required to fund sales in the US utilizing in-house customer finance. Of the total investment required to open a new store, between 60% and 70% is typically accounted for by working capital. New stores are usually opened in the third quarter or early in the fourth quarter of the fiscal year. A reduction in the number of store openings results in the difference between the level of funding required in the first half of a fiscal year and the peak level being lower, while an increase in the number of store openings would have the opposite impact.

In Fiscal 2011, net cash provided by operating activities was $323.9 (Fiscal 2010: $515.4 million), a reduction of $191.5 million. Net income increased by $43.3 million to $200.4 million (Fiscal 2010: $157.1 million), with depreciation reducing by $11.3 million to $89.7 million (Fiscal 2010: $101.0 million).

In Fiscal 2011, accounts receivable rose by $78.7 million (Fiscal 2010: $32.4 million). Inventory levels were up by $19.5 million, an increase of 1.7% (Fiscal 2010: $226.5 million decrease), while sales increased by 5.0%. This reflected further management action to improve the productivity of inventory, such as the development of branded differentiated and exclusive ranges. In Fiscal 2010, management realigned inventory primarily in response to the lower level of sales experienced in Fiscal 2009. The Fiscal 2010 reduction, which took place mainly in the US division, was achieved by tight control of purchases rather than discounting, as the US division’s procedures are designed to minimize clearance merchandise. Other movements in operating assets and liabilities in Fiscal 2011 primarily reflect timing differences and an increase in deferred revenue as a result of increased sales in the US division.

In the fourth quarter of Fiscal 2011, due to the seasonal sales pattern, accounts receivable increased by $166.3
million (13 weeks to January 30, 2010: $127.9 million) and inventory decreased by $106.4 million (13 weeks to
January 30, 2010: $127.3 million).

Investing activities
Investment activities primarily reflect the purchases of property, plant and equipment related to the:

• rate of space expansion in the US,
• number of store refurbishments and relocations carried out, and
• provision of divisional head offices and systems, which include the US and UK distribution facilities.

In addition, purchases of intangible assets, primarily of information technology software for use in the business, are also made.

When appraising a store investment, management uses an investment hurdle rate of a 20% internal rate of return on a pre-tax basis over a five year period, assuming the release of working capital at the end of the five years. Capital expenditure accounts for about 35% of the investment in a new store in the US division. The balance is accounted for by investment in inventory and the funding of customer financing. Signet typically carries out a major refurbishment of its stores every ten years but does have some discretion as to the timing of such expenditure. A major store refurbishment is evaluated using the same investment procedures and criteria as for a new store. Minor store redecorations are typically carried out every five years. In addition to major store refurbishments, Signet carries out minor store refurbishments where stores are profitable but do not satisfy the investment hurdle rate required for a full refurbishment; this is usually associated with a short term lease renewal. Where possible, the investment appraisal approach is also used to evaluate other investment opportunities.

In Fiscal 2011, net cash used in investing activities was $55.6 million (Fiscal 2010: $43.5 million), as a result of increased capital investment in the existing businesses. In both the US and UK divisions, capital additions were less than depreciation and amortization, see table below. This was a result of the use of cautious sales forecasts in the investment appraisal process reflecting the challenging economic environment.

Free cash flow

Free cash flow is net cash provided by operating activities less net cash flow used in investing activities; non-GAAP measure, see Item 6. Positive free cash flow, excluding the Make Whole Payment, in Fiscal 2011 was $315.8 million (Fiscal 2010: $471.9 million; Fiscal 2009: $51.1 million) and significantly exceeded the Fiscal 2011 objective of $150 million to $200 million. The reduction in free cash flow in Fiscal 2011 compared to Fiscal 2010 is primarily due to the planned inventory realignment carried out by management in Fiscal 2010 that was not repeated in Fiscal 2011.

Financing activities
The major items within financing activities are discussed below:

Dividends
In the light of economic prospects and financial market conditions, as well as a focus on debt reduction, the Board concluded in January 2009 that it was not appropriate to pay equity dividends.

    Restrictions on dividend payments
Restrictions on “Shareholder Returns” that were contained in Signet’s amended borrowing agreements were eliminated with amendments to Signet’s Revolving Credit Facility in October 2010 and the prepayment of Signet’s Private Placement Notes in November 2010.

Under Bermuda law, a company may not declare or pay dividends if there are reasonable grounds for believing that the company is, or would after the payment be, unable to pay its liabilities as they become due or that the realizable value of its assets would thereby be less than the aggregate of its liabilities, its issued share capital and its share premium accounts.

Proceeds from issues of Common Shares
In Fiscal 2011, $11.3 million (Fiscal 2010: $1.0 million) was received from the issuance of Common Shares. Other than equity based compensation awards granted to employees, Signet has not issued Common Shares as a financing activity for over ten years.

Movement in cash and indebtedness
During Fiscal 2011, Signet repaid long-term borrowings of $280 million (Fiscal 2010: $100.0 million) and at January 29, 2011 had no long-term debt. Loans and overdrafts at January 29, 2011 were $31.0 million (January 30, 2010: $44.1 million) and cash and cash equivalents were $302.1 million (January 30, 2010: $316.2 million). Net cash at January 29, 2011 was $271.1 million (January 30, 2010: net debt $7.9 million); non-GAAP measure.

In Fiscal 2011, the peak level of debt was about $325 million (Fiscal 2010: about $570 million) and the peak level of cash and cash equivalents was about $490 million (Fiscal 2010: about $320 million).

Capital availability
Signet’s level of borrowings and cash balances fluctuates during the year reflecting its cash flow performance, which depends on the factors described above. Management believes that cash balances and the committed borrowing facilities (described more fully below) currently available to the business, are sufficient for both its present and near term requirements. In Fiscal 2011, the peak level of net debt was about $10 million and occurred in the first quarter (Fiscal 2010: about $480 million and occurred in the first quarter).

The following table provides a summary of Signet’s cash flow activity for Fiscal 2011, Fiscal 2010 and Fiscal 2009:

The following table, which reflects the covenants in Signet’s revolving credit agreement, provides relevant measures of liquidity and capital resources as of January 29, 2011, January 30, 2010 and January 31, 2009:

^{(1) These non-GAAP measures are calculated in accordance with Signet’s credit agreements detailed below.
n/a - not applicable}

In addition to cash generated from operating activities, Signet also had funds available from various credit
agreements during Fiscal 2011. The principle agreements are outlined below.

Amended revolving credit facility agreement

The terms of the Amended Revolving Credit Facility Agreement (the “Facility Agreement”) which runs until
June 2013, inter alia, include:

• the ability by Signet to draw in the form of multi-currency cash advances and the issuance of letters of credit; and
• a margin of 2.25% above LIBOR, subject to adjustment depending on the performance of Signet, with the minimum being 1.75% above LIBOR and the maximum being 2.75% above LIBOR. Currently the margin under this agreement is 1.75%. Commitment fees are paid on the undrawn portion of this credit facility at a rate of 40% of the applicable margin.

The continued availability of the Facility Agreement is conditional upon Signet achieving certain financial performance criteria and abiding by certain operating restrictions, including those set out below:

• the ratio of Consolidated Net Debt to Consolidated EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) shall not exceed 2:1 for each quarter, except the third quarter when it shall not exceed 2.5:1;
• Consolidated Tangible Net Worth (total net tangible assets) shall not fall below $800 million; and
• the ratio of EBITDAR (Earnings Before Interest, Tax, Depreciation, Amortization, Rents and Operating Lease Expenditure) to Fixed Charges (Consolidated Net Interest Expenditure plus Rents and Operating Lease Expenditure) shall be equal to or greater than 1.55:1 for the trailing 12 months at each quarter end.

On March 19, 2010, the facility was reduced to its current level of $300.0 million, from $370.0 million. In October 2010, the facility was amended to eliminate the obligation to reduce the amount of the facility by 60% of any reduction in net debt from the prior year end, delete the annual limit on capital expenditure, increase the aggregate cost of assets that may be acquired in any fiscal year to $50.0 million and remove any restrictions on payment of dividends or share repurchases. There are no other material obligations under the Facility Agreement.

The Facility Agreement retains certain provisions which are customary for this type of agreement, including standard “negative pledge” and “pari passu” clauses.

No borrowings were drawn on the facility at January 29, 2011 (January 30, 2010: $0) and no borrowings were drawn on the facility during Fiscal 2011. Stand-by letters of credit of $5.5 million were issued under the facility at January 29, 2011 (January 30, 2010: $6.0 million), with no significant intra-period fluctuations.

Amended note purchase agreement
On January 30, 2010, Signet had $280.0 million of Private Placement Notes outstanding under its Note Purchase Agreement (the “Note Purchase Agreement”). On March 9, 2010, Signet made a repayment at par of $50.9 million. On November 26, 2010, Signet exercised its right to prepay in full the remaining $229.1 million of outstanding Private Placement Notes (the “Prepayment Date”). This resulted in a reduction in interest expense of $101.7 million over the remaining term of the Private Placement Notes. The prepayment required the payment of all accrued interest up to the Prepayment Date plus a premium as determined by the Make Whole provision contained in the agreement governing the Private Placement Notes. The Make Whole premium was dependent on medium term US Treasury yields, and was $47.5 million, including an associated cost of hedging this payment against movements in US Treasury yields during the required notice period. Following the prepayment of the Private Placement Notes, various restrictions placed on Signet by the Note Purchase Agreement fell away. In particular restrictions under the Note Purchase Agreement on shareholder distributions, capital expenditure and acquisitions were removed.

The Private Placement Notes were Signet’s only material borrowings outstanding during Fiscal 2011.

Other borrowing agreements
Signet has, from time to time, various uncommitted borrowing facilities that it may use. Such facilities, if used, are primarily for short term cash management purposes, including issued but not cleared creditor payments and stand-by letters of credit. At January 29, 2011, Signet had borrowings of $31.0 million (January 30, 2010: $44.1 million), consisting of issued but not cleared creditor payments.

Cash balances
Signet has significant amounts of cash and cash equivalents invested in various ‘AAA’ rated liquidity funds and at a number of financial institutions. The amount invested in each liquidity fund or at each financial institution takes into account the credit rating and size of the liquidity fund or financial institution and are for various durations of up to one month and have an average duration of under seven days. As a result of its cash balances, Signet did not have intra-quarter borrowings apart from the Private Placement Notes and issued but not cleared creditor payments.

Credit rating
Signet does not have a public credit rating.