Liquidity & Capital Resources

Summary cash flow

The following table provides a summary of Signet’s cash flows for fiscal 2010, fiscal 2009 and fiscal 2008:

(1) Non-GAAP measure.
(2) Proceeds from issuance of Common Shares less purchase of treasury shares.
(3) Proceeds from short term borrowings less repayment of long term debt.

Reconciliation of changes in net debt⁽²⁾

The following table provides a reconciliation of Signet’s changes in net debt for fiscal 2010, fiscal 2009 and fiscal 2008:

(1) Proceeds from short term borrowings less repayment of long term debt.
(2) Non-GAAP measure.

OVERVIEW

Managements’s objective is to maintain a strong balance sheet, as it regards financial stability as a competitive advantage. Another important factor in determining financial stability is liquidity, or access to cash. In the current challenging economic environment these two factors take on additional importance.

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 trading; and
• working capital movements associated with changes in store space.

Other sources of cash are increased borrowings or the issuance of Common Shares for cash.

Impact of new store openings on cash flow
When analyzing cash flow, management believes it is important to distinguish between cash flows of the existing business and discretionary expenditures related to new store space. As there is very limited potential to open new stores in the UK, this relates to new store space in the US. Therefore working capital investment and capital expenditure related to new US store space is separately identified in the following discussion.

In fiscal 2010, one of Signet’s financial objectives was to achieve positive free cash flow of between $175.0 million and $225.0 million; non-GAAP measure. During the year, cash and cash equivalents increased by $220.2 million (fiscal 2009: $88.0 million) and debt decreased by $243.4 million (fiscal 2009: increase $160.6 million). The achieved decrease in net debt was therefore $463.6 million (fiscal 2009: $72.6 million). Net debt at January 30, 2010 was $7.9 million (January 31, 2009: $470.7 million); non-GAAP measure. Gearing at January 30, 2010 was 0.4% (January 31, 2009: 29.2%); non-GAAP measure. The peak level of net debt in fiscal 2010 was about $480 million (fiscal 2009: about $670 million).

Cash flow from 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, where the customer makes use of financing provided by Signet, the cash is received over a period of time. In fiscal 2010, 53.5% (fiscal 2009: 53.2%) of the US division’s sales were made using finance provided by Signet. The average monthly collection rate from the credit portfolio was 12.5% (fiscal 2009: 13.1%).

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 30, 2010 amounted to $134.6 million (January 31, 2009: $202.1 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 staff costs. 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.

Adjustments to reconcile net income/loss to cash flow provided by operations
The major adjustment to reconcile net income/loss to cash flow provided by operations is normally depreciation of property, plant and equipment. There can also be significant, unusual and non-recurring items, such as the $516.9 million impairment of goodwill in fiscal 2009.

In fiscal 2010, net income adjusted for non-cash items increased to $293.9 million (fiscal 2009: $259.8 million); non-GAAP measure. The adjustments for non-cash items were $129.8 million (fiscal 2009: $653.5 million), with depreciation and amortization being $108.9 million (fiscal 2009: $114.5 million). The decrease in depreciation reflected the planned reduction in space growth and store refurbishment as well as the impact of foreign exchange movements on the reported figure for the UK division.

Changes in operating assets and liabilitiesf
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 are normally relatively stable from January to August. 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 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 and the net change in store space. 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. For example, the cessation of the initiative to directly source rough diamonds in late fiscal 2009 reduced working capital requirements as did the growth in fiscal 2010 of differentiated merchandise ranges, which have a faster average merchandise turn. 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 net debt 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 line with Signet’s financial objectives for fiscal 2010, there was an inflow from operating assets and liabilities of $221.5 million (fiscal 2009: outflow of $95.4 million). Due to the seasonal trading pattern, the cash inflow from operating assets and liabilities was $4.9 million in the fourth quarter (fourth quarter fiscal 2009: outflow of $16.4 million). There was a decrease in inventory of $226.5 million (fiscal 2009: $12.7 million), following a realignment to a lower level of sales and the much reduced space growth in the US division. The level of accounts receivable rose by $32.4 million reflecting the increase in sales in the fourth quarter of fiscal 2010 in the US division.

The adverse impact of exchange rate changes on currency swaps was $0.7 million (fiscal 2009: $49.6 million). Signet historically swapped significant amounts of pound sterling deposits and inter-company balances into US dollars on a short term basis to reduce the level of US dollar debt. These cash and inter-company balances, the size of which fluctuated during the year, reflected an historic restriction on dividend payments by the UK division, which was lifted in the fourth quarter of fiscal 2009, following a ruling by the High Court of Justice of England and Wales. As a result, Signet greatly increased its ability to reduce the size of its pounds sterling deposits and inter-company balances on a permanent basis by paying dividends up through the corporate structure. This enabled Signet to meaningfully reduce its cash flow exposure to changes in the pound sterling to US dollar exchange rate.

In fiscal 2010, investment in inventory and receivables associated with US space growth was reduced by $38.4 million to $28.2 million (fiscal 2009: $66.6 million) reflecting only seven new mall stores and seven new Jared locations (fiscal 2009: 46 mall stores and 17 Jared locations). Of the working capital investment of $28.2 million in new US space in fiscal 2010, $12.0 was for inventory and $16.2 million related to customer financing (fiscal 2009: $39.6 million and $27.0 million respectively). An inflow from inventory and repayment of customer financing arose from US store closures that occurred in calendar 2009. In the UK division, the change in net store space was not significant. The following tables provide a summary of movement in inventory and account receivables as a result of new space growth in the US and the performance of the rest of Signet’s operations for fiscal 2010, fiscal 2009 and fiscal 2008:

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 refurbishment and relocation carried out, and
• provision of divisional head offices, which include its US and UK distribution facilities.

In addition, purchases of intangible assets, primarily of information technology 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 36% of the investment in a new Jared store and for about 33% of the investment in a mall store. 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.

Net cash flow used in investing activities was $43.5 million (fiscal 2009: $113.3 million), as a result of reduced capital investment in the existing businesses on both sides of the Atlantic and a reduced rate of US new space growth.

The following table provides a summary of capital expenditure as a result of new space growth in the US, other additions in the US, and of capital additions in the UK and unallocated, for fiscal 2010, fiscal 2009 and fiscal 2008:

In fiscal 2010, in both the US and UK divisions, capital additions were less than depreciation and amortization. This was a result of the use of more cautious sales forecasts in the investment appraisal process reflecting the challenging economic environment. As a result fewer new stores were opened, fewer stores were refurbished and more stores were closed rather than refurbished at the end of leases. Investment in information technology was temporarily reduced.

Free cash flow

Free cash flow is net cash provided by operating activities less net cash flow used in investing activities; non-GAAP measure. Positive free cash flow in fiscal 2010 was $471.9 million (fiscal 2009: $51.1 million; fiscal 2008: $1.4 million), primarily as a result of a significant realignment of working capital to reflect lower sales in the existing business. This was achieved even though net income adjusted for non-cash items; non-GAAP measure; declined from $333.6 million in fiscal 2008 to $293.9 million in fiscal 2010. In fiscal 2009, a reduced level of cash being invested in working capital in the existing business and a lower level of investment in new US space than in fiscal 2008 led to an increase in free cash flow. Management believes that there is limited scope for a further reduction in working capital. Other factors for the increase in free cash flow in fiscal 2010 were a higher net income adjusted for non-cash items, a reduction in investment in the existing business and reduced investment in new US store space.

To reflect the impact of investment in new US space on cash flow, the following summary provides an analysis of free cash flow before such investment and the working capital and capital expenditure required by new US space.

(1) Non-GAAP measures.

In fiscal 2010, net income adjusted for non-cash items was $293.9 million, an increase of $34.1 million on fiscal 2009 reflecting an improvement in profitability. In fiscal 2010, a management objective was a reduction in working capital and $249.7 million was generated from changes in operating assets and liabilities, excluding the impact of new US stores (fiscal 2009: use of $28.8 million). The level of investment in the existing business in fiscal 2010 was $33.4 million (fiscal 2009: $74.3 million). This level of investment was temporarily below the current level of maintenance capital expenditure of about $75 million to $80 million. Free cash flow before investment in new US stores increased to $510.2 million in fiscal 2010 from $156.7 million in fiscal 2009.

Reflecting the change in strategy, with a focus on strengthening the balance sheet by focusing on cash generation rather than US space growth, and the uncertain economic outlook which resulted in few investment opportunities satisfying management’s investment hurdle rate, investment in new US space decreased to $38.3 million in fiscal 2010 (fiscal 2009: $105.6 million).

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. No equity dividends were paid in fiscal 2010 (fiscal 2009: $123.8 million).

Restrictions on dividend payments
Under the amended borrowing agreements, (see page 80 of Form 10K for details) no “Shareholder Returns” (defined as including dividends, share buybacks or other similar payments) may be made in fiscal 2010 or fiscal 2011.

In fiscal 2012 and fiscal 2013, Shareholder Returns may only be made to the extent that amounts of any February 2011 or 2012 prepayment offer to Note Holders are not accepted by the Note Holders. The minimum amount of each such offer being the Note Holders’ pro rata share of 60% of any reduction in net debt that occurred over the preceding fiscal year. In addition, such Shareholder Returns may only be made if:

• the fixed charge cover is above 1.7:1,
• Signet is in compliance with the amended facility, and
• Signet can demonstrate projected compliance with the fixed charge cover for the following 12 months.

Subsequent to January 2013, Shareholder Returns may be no greater than the amount of an additional prepayment offer rejected by the Note Holders and may only be made if:

• previous offers have been made to prepay an aggregate of $190 million of the Notes, inclusive of the $100 million March 18, 2009 prepayment, and
• an additional prepayment offer at a 2% premium to par has been made, the size of which is at Signet’s discretion.

In addition, 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 2010, a sum of $1.0 million (fiscal 2009: $0.1 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.

Purchases of treasury shares
Signet may repurchase Common Shares in the open market pursuant to programs approved by the Board but is currently restricted from doing so by its borrowing agreements (see page 80 of Form 10K). No repurchases of Common Shares took place in fiscal 2010 or fiscal 2009. In fiscal 2008, $29.0 million was utilized for such repurchases.

Movement in cash and indebtedness

During fiscal 2010, Signet reduced short-term borrowings by $143.4 million (fiscal 2009: increase $160.6 million) and repaid long-term borrowings of $100.0 million. Cash and cash equivalents increased by $220.2 million (fiscal 2009: $88.0 million). The US dollar to pound sterling exchange rate moved from $1.45 at January 31, 2009 to $1.60 at January 30, 2010, with the average exchange rate used in the preparation of Signet’s income statements being $1.59 (fiscal 2009: $1.75). Signet holds a fluctuating amount of pounds sterling reflecting the cash generative nature of the UK division. Movements in the exchange rates prevailing at the time of these flows create exchange rate movements on the cash balances with an adverse impact of $0.8 million on cash and cash equivalents, and $nil on debt (fiscal 2009, adverse impact of $32.9 million and a gain $9.4 million respectively).

Net debt; non-GAAP measure; at January 30, 2010 was $7.9 million (January 31, 2009: $470.7 million), a decrease of $462.8 million (fiscal 2009: $141.4 million increase). Debt at January 30, 2010 was $324.1 million (January 31, 2009: $567.5 million), with cash and cash equivalents amounting to $316.2 million (January 31, 2009: $96.8 million). Gearing, that is the ratio of net debt to shareholders’ equity, was 0.4% (January 31, 2009: 29.2%); non-GAAP measure. The peak level of net debt in fiscal 2010 was about $480 million (fiscal 2009: about $670 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 2010, the peak level of net debt was about $480 million (fiscal 2009: about $670 million). In fiscal 2011, the peak net debt is expected to be lower. The following table provides a summary of the Signet’s working capital position and capitalization as at January 30, 2010, January 31, 2009 and February 2, 2008:

The following table provides a summary of the Signet’s working capital position and capitalization as at January 30, 2010, January 31, 2009 and February 2, 2008:

(1) Non-GAAP measure.

The following table provides relevant measures of liquidity and capital resources as at January 30, 2010, January 31, 2009 and February 2, 2008:

(1) Non-GAAP measure.
(2) These non-GAAP measures are calculated in accordance with Signet’s credit agreements detailed below. 

In addition to cash generated from operating activities, Signet also has funds available from various credit agreements. 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 from March 2009 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. 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 Net Worth (total net tangible assets) shall not fall below $800 million;
• 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 excluding Service Charges and Rates) shall be equal to or greater than 1.4:1 for the trailing 12 months at each quarter end to January 2012, then increasing to 1.55:1 until January 2013 and then to 1.85:1 for subsequent periods;
• beginning with fiscal 2011, the facility will be reduced, on a pro rata basis with the Notes outstanding (see below), by 60% of any reduction in net debt from the prior year end;
• no “Shareholder Returns” (defined as including dividends, share buybacks or other similar payments) shall be made during fiscal 2010 or fiscal 2011, and thereafter such returns may only be made if the amended fixed charge cover is above 1.7:1, there are no subsisting defaults and the directors confirm that they expect Signet to continue to comply with the covenant in the following 12 months; and
• capital expenditure shall not exceed $71 million in fiscal 2010, $93 million in fiscal 2011, $115 million in fiscal 2012 and $205 million in fiscal 2013.

The Facility Agreement retains certain provisions which are customary for this type of agreement, including standard “negative pledge” and “pari passu” clauses. The facility was undrawn at January 30, 2010 (January 31, 2009: $135 million).

A change was agreed with Signet’s Revolving Credit Facility banking group that the facility be reduced to $300 million from $370 million on March 19, 2010.

Amended note purchase agreement
The original Note Purchase Agreement took the form of fixed rate investor certificate notes (“Notes”). At January 31, 2009, the Notes outstanding were Series (A) $100 million 5.95% due 2013; Series (B) $150 million 6.11% due 2016, and Series (C) $130 million 6.26% due 2018.

The terms of the amended Note Purchase Agreement (“Amended Note Purchase Agreement”), where they are different to those in the Facility Agreement disclosed above, are, inter alia:

• the coupon increased by an additional 2.0% (subject to a further 1.0% increase until fiscal 2013 if the amended fixed charge coverage ratio is less than 1.6:1, and an additional 1.0% increase if Note Holders are subject to increased capital charges as a result of a requirement to post additional reserves under applicable insurance regulations, as determined by the insurance regulator);
• a prepayment of $100 million at par plus accrued interest on March 18, 2009. Subsequent prepayment offers, at par, to be made in February/March of each of the following calendar years—2010, 2011, 2012 and 2013. The minimum amount of each such offer being the Note Holders’ pro rata share of 60% of any reduction in net debt that occurred over the preceding fiscal year (the “Required Offers”). Any proportion of the 2011, 2012 or 2013 offers rejected by Note Holders may be applied to Shareholder Returns, as defined in the Facility Agreement;
• Subsequent to January 2013, Shareholder Returns may be no greater than the amount of an additional prepayment offer rejected by the Note Holders and may only be made if:
  • previous offers have been made to prepay an aggregate of $190 million of the Notes, inclusive of the $100 million March 18, 2009 prepayment,
  • an additional prepayment offer at a 2% premium to par has been made, the size of which is at Signet’s discretion, and
• restrictions on capital expenditure similar to the Facility Agreement for fiscal 2010, fiscal 2011, fiscal 2012 and fiscal 2013, provided that in fiscal 2012 and 2013 the Required Offers have been made, otherwise the restrictions on capital expenditure in fiscal 2012 will be $85 million and in fiscal 2013 and thereafter will be $100 million. No unspent capital expenditure is able to be carried forward.

In accordance with its borrowing agreements, Signet made a prepayment at par to its Note Holders on March 9, 2010 of $50.9 million. Following this repayment there were $229.1 million of Notes outstanding, comprising: Series (A) $58.9 million due 2013; Series (B) $89.1 million due 2016, and Series (C) $81.1 million due 2018, with a weighted average coupon of 8.12%.

Signet has the right to prepay the remaining outstanding notes at any time, with such prepayment being made at a premium to par as determined by the provisions of the ‘Make Whole’ calculation contained within the Amended Note Purchase Agreement. Variations in the ‘Make Whole’ premium amount are largely determined by movements in 3, 6 and 8 year US Treasury yields.

Asset backed variable funding note conduit securitization facility
In October 2008, a 364 day $100m Series 2007 asset backed variable funding note conduit securitization facility for general corporate purposes was entered into. Under this securitization, interests in the US receivables portfolio are sold to Bryant Park, a conduit administered by HSBC Securities (USA) Inc. This facility was not utilized and was terminated in April 2009.

Other borrowing agreements
At January 30, 2010, Signet had borrowings of $44.1 million (January 31, 2009: $52.5 million) under various bank overdraft facilities.

Credit rating

Signet does not have a public credit rating.