Financial instruments and fair value

6 Months Ended

Jul. 28, 2012

Financial instruments and fair value

8. Financial instruments and fair value

Signet’s principal financial instruments are comprised of cash, cash deposits/investments and overdrafts, accounts receivable and payable, derivatives and a revolving credit facility. Signet does not enter into derivative transactions for trading purposes. Derivative transactions are used by Signet for risk management purposes to address risks inherent in Signet’s business operations and sources of finance. The main risks arising from Signet’s operations are market risk including foreign currency risk and commodity risk, liquidity risk and interest rate risk. Signet uses these financial instruments to manage and mitigate these risks under policies reviewed and approved by the Board.

Market risk

Signet generates revenues and incurs expenses in US dollars and pounds sterling. As a portion of Signet’s UK division purchases are denominated in US dollars, Signet enters into foreign currency forward exchange contracts, foreign currency option contracts and foreign currency swaps to manage this exposure to the US dollar. The fair value of these contracts is recorded in other assets and other liabilities.

Signet holds a fluctuating amount of pounds sterling cash reflecting the cash generative characteristics of the UK division. Signet’s objective is to minimize net foreign exchange exposure to the income statement on pound sterling denominated items through managing this level of cash, pound sterling denominated intercompany balances and US dollar to pound sterling swaps. In order to manage the foreign exchange exposure and minimize the level of pound sterling cash held by Signet, the pound sterling denominated subsidiaries pay dividends regularly to their immediate holding companies and excess pounds sterling are sold in exchange for US dollars.

Signet’s policy is to minimize the impact of precious metal commodity price volatility on operating results through the use of outright forward purchases of, or by entering into options to purchase, precious metals within treasury guidelines approved by the Board. In particular, Signet undertakes some hedging of its requirement for gold through the use of options, forward contracts and commodity purchasing, while fluctuations in the cost of diamonds are not hedged.

Liquidity risk

Signet’s objective is to ensure that it has access to, or the ability to generate sufficient cash from either internal or external sources in a timely and cost-effective manner to meet its commitments as they become due and payable. Signet manages liquidity risks as part of its overall risk management policy. Management produces forecasting and budgeting information that is reviewed and monitored by the Board. Cash generated from operations and external financing are the main sources of funding supplementing Signet’s resources in meeting liquidity requirements.

The main external source of funding is a $400 million senior unsecured multi-currency five year revolving credit facility, under which there were no borrowings as of July 28, 2012, January 28, 2012, or July 30, 2011.

Interest rate risk

Signet may enter into various interest rate protection agreements in order to limit the impact of movements in interest rates on its cash or borrowings. There were no interest rate protection agreements outstanding as of July 28, 2012, January 28, 2012 or July 30, 2011.

Credit risk and concentrations of credit risk

Credit risk represents the loss that would be recognized at the reporting date if counterparties failed to perform as contracted. Signet does not anticipate non-performance by counterparties of its financial instruments, except for customer in-house financing receivables as disclosed in Note 6. Signet does not require collateral or other security to support cash investments or financial instruments with credit risk; however it is Signet’s policy to only hold cash and cash equivalent investments and to transact financial instruments with financial institutions with a certain minimum credit rating. Management does not believe Signet is exposed to any significant concentrations of credit risk that arise from cash and cash equivalent investments, derivatives or accounts receivable.

Derivatives

Signet enters into forward foreign currency exchange contracts and foreign currency option contracts, principally in US dollars, in order to limit the impact of movements in foreign exchange rates on its forecast foreign currency purchases. The total notional amount of these foreign currency contracts outstanding as of July 28, 2012 was $52.3 million (January 28, 2012 and July 30, 2011: $48.9 million and $51.0 million, respectively). These contracts have been designated as cash flow hedges and will be settled over the next 17 months (January 28, 2012 and July 30, 2011: 13 months and 20 months, respectively).

Signet enters into forward purchase contracts and option purchase contracts for commodities in order to reduce its exposure to significant movements in the price of the underlying precious metal raw material. The total notional amount of commodity contracts outstanding as of July 28, 2012 was $197.5 million (January 28, 2012 and July 30, 2011: $211.2 million and $195.5 million, respectively). These contracts have been designated as cash flow hedges and will be settled over the next 16 months (January 28, 2012 and July 30, 2011: 12 months and 18 months, respectively).

For derivatives that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (“OCI”) and reclassified into earnings in the same period in which the hedged item affects net income or loss. Gains and losses on derivatives that do not qualify for hedge accounting, together with any hedge ineffectiveness, are recognized immediately in other operating income, net.

Foreign currency contracts not designated as cash flow hedges are used to hedge currency flows through Signet’s bank accounts to mitigate Signet’s exposure to foreign currency exchange risk in its cash and borrowings.

The bank counterparties to the derivative contracts expose Signet to credit-related losses in the event of their non-performance. However, to mitigate that risk, Signet only contracts with counterparties that meet certain minimum requirements under its counterparty risk assessment process. As of July 28, 2012, Signet believes that this credit risk did not materially change the fair value of the foreign currency or commodity contracts.

The following table summarizes the fair value and presentation of derivative instruments in the condensed consolidated balance sheets:

	Derivative assets
			Fair value
	Balance sheet location		July 28, 2012 $million			January 28, 2012 $million			July 30, 2011 $million
Derivatives designated as hedging instruments:
Foreign currency contracts		Other current assets		1.0			1.1			—
Foreign currency contracts		Other assets		0.2			0.1			—
Commodity contracts		Other current assets		3.1			16.1			20.8
Commodity contracts		Other assets		0.1			—			1.9
Total derivative assets				4.4			17.3			22.7
	Derivative liabilities
			Fair value
	Balance sheet location		July 28, 2012 $million			January 28, 2012 $million			July 30, 2011 $million
Derivatives designated as hedging instruments:
Foreign currency contracts		Other current liabilities		(0.2	)		(0.2	)		(1.4	)
Foreign currency contracts		Other liabilities		—			—			(0.1	)
Commodity contracts		Other current liabilities		(6.3	)		(1.0	)		—
Commodity contracts		Other liabilities		—			—			—
				(6.5	)		(1.2	)		(1.5	)
Derivatives not designated as hedging instruments:
Foreign currency contracts		Other current liabilities		(1.3	)		—			(0.3	)
				(1.3	)		—			(0.3	)
Total derivative liabilities				(7.8	)		(1.2	)		(1.8	)

The following tables summarize the effect of derivative instruments on the condensed consolidated income statements:

	Amount of  gain/(loss) recognized in OCI on derivatives (Effective portion)					Location of gain/(loss) reclassified from accumulated OCI into income (Effective portion)		Amount of gain/(loss) reclassified from accumulated OCI into income (Effective portion)
	13 weeks ended							13 weeks ended
	July 28, 2012 $million			July 30, 2011 $million				July 28, 2012 $million		July 30, 2011 $million
Derivatives in cash flow hedging relationships:
Foreign currency contracts		0.9			1.1		Cost of sales		0.1		—
Commodity contracts		(2.1	)		14.3		Cost of sales		5.8		3.4
Total		(1.2	)		15.4				5.9		3.4

	Amount of gain/(loss) recognized in OCI  on derivatives (Effective portion)						Location of gain/(loss) reclassified from accumulated OCI into income (Effective portion)		Amount of gain/(loss) reclassified from accumulated OCI  into income (Effective portion)
	26 weeks ended								26 weeks ended
	July 28, 2012 $million			July 30, 2011 $million					July 28, 2012 $million		July 30, 2011 $million
Derivatives in cash flow hedging relationships:
Foreign currency contracts		0.1			(0.7	)		Cost of sales		0.2		(0.1	)
Commodity contracts		(14.2	)		33.1			Cost of sales		14.3		6.4
Total		(14.1	)		32.4					14.5		6.3

The ineffective portion of hedging instruments taken into other operating income, net in the 13 and 26 weeks ended July 28, 2012 was $0.0 million (13 and 26 weeks ended July 30, 2011: $0.4 million gain).

	Amount of gain/(loss) recognized in income on derivatives				Location of gain/(loss) recognized in income on derivatives		Amount of gain/(loss) recognized in income on derivatives
	13 weeks ended						26 weeks ended
	July 28, 2012 $million		July 30, 2011 $million				July 28, 2012 $million		July 30, 2011 $million
Derivatives not designated as hedging instruments:
Foreign currency contracts		1.1		0.3		Other operating income, net		1.1		0.7
Total		1.1		0.3				1.1		0.7

Fair value

The estimated fair value of Signet’s financial instruments held or issued to finance Signet’s operations is summarized below. Certain estimates and judgments were required to develop the fair value amounts. The fair value amounts shown below are not necessarily indicative of the amounts that Signet would realize upon disposition nor do they indicate Signet’s intent or ability to dispose of the financial instrument. Assets and liabilities that are carried at fair value are required to be classified and disclosed in one of the following three categories:

Level 1—quoted market prices in active markets for identical assets and liabilities

Level 2—observable market based inputs or unobservable inputs that are corroborated by market data

Level 3—unobservable inputs that are not corroborated by market data

Signet determines fair value based upon quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The methods Signet uses to determine fair value on an instrument-specific basis are detailed below:

	July 28, 2012 $million						January 28, 2012 $million						July 30, 2011 $million
	Carrying Value			Fair Value (Level 2)			Carrying Value			Fair Value (Level 2)			Carrying Value			Fair Value (Level 2)
Assets:
Forward foreign currency contracts and swaps		1.2			1.2			1.2			1.2			0.1			0.1
Forward commodity contracts		3.2			3.2			16.1			16.1			22.7			22.7
Liabilities:
Forward foreign currency contracts and swaps		(1.5	)		(1.5	)		(0.2	)		(0.2	)		(1.8	)		(1.8	)
Forward commodity contracts		(6.3	)		(6.3	)		(1.0	)		(1.0	)		—			—

The fair value of derivative financial instruments has been determined based on market value equivalents at the balance sheet date, taking into account the current interest rate environment, current foreign currency forward rates or current commodity forward rates. The carrying amounts of cash and cash equivalents, accounts receivable, other receivables, accounts payable and accrued liabilities approximate fair value because of the short-term maturity of these amounts.