chief financial officer’s report

The financial performance of New Clicks has continued to improve, with encouraging turnover growth over the past year and sound progress against several key performance measures.

• Group turnover increased by 14.8% to reach R10 billion for the first time. Retail turnover grew by 10.0% in a period when both Clicks and Discom experienced price deflation. UPD lifted turnover by 26.8%.
• Gross profit margin declined by 90 basis points as a result of the increased contribution of UPD to total group turnover. UPD’s business model by its nature is based on significantly lower gross margins than the retail businesses.
• Operating profit before capital items increased by 19.6% to R393 million. The group’s operating profit margin increased to 3.9% from 3.8% in 2005.
• Headline earnings grew by 25.5% with diluted headline earnings per share increasing by 23.7% to 71 cents per share.
• Inventory levels increased marginally by 0.2% over the previous year, despite a 14.8% increase in turnover. Inventory turn increased from 6.1 times to 6.9 times.
• Return on equity (“ROE”) improved from 14.2% in 2005 to 16.7%. The group has set a target to achieve a ROE of 30% in the medium term.

The group has adopted International Financial Reporting Standards (“IFRS”) for the year ending 31 August 2006 and all comparative figures have been restated. Readers should note that these standards are the subject of ongoing review and possible amendment by interpretive guidance from time to time from the International Financial Reporting Interpretations Committee.

Financial results – Income statement

The group’s trading performance is covered in more detail in the Operational Review.

Turnover

Clicks increased turnover by 8.8% while the same store turnover growth of 10.8% reflects the impact of the closure of a number of former PM&A stores during the year.

Discom recorded turnover growth of 10.5% and same store growth of 5.7%. This was a satisfactory performance given a deflationary climate, although a 19.1% increase from the inland division was neutralised by the underperformance of the Western Cape division in the review period.

Musica benefited from a net six new stores opened during the year, with turnover growing 17.6% and 10.8% on a same store basis.

After a slow start to the year, The Body Shop increased turnover in excess of 20% in the second half to deliver turnover growth of 11.8% for the year. Same store growth was 3.1%.

UPD repeated its buoyant growth of recent years, with a 26.8% increase in turnover reflecting the benefits of supply contracts to two private hospital groups and increased sales to Clicks.

Gross profit margin

Retail gross profit margins increased by 30 basis points to 27.1%, despite the increasing influence of dispensary which operates at a lower margin.

The UPD gross margin, which was impacted by the higher component of ethical sales resulting from the hospital contracts, declined from 4.0% to 2.9%. As a result of the implementation of IFRS, the logistics fees for UPD are also no longer reflected in gross profit.

Operating expenditure

Operating expenses were contained at a 9.5% increase on the prior year, with the major businesses generally maintaining expense growth below their level of turnover growth. UPD once again demonstrated disciplined cost management and showed a modest 1.6% increase in costs year-on-year.

In line with the group’s focus on simplifying the business, all group service costs have been allocated to the business units. While the basis of cost allocation will be further refined in the forthcoming year, the group will in future only attribute specific costs to group services that cannot reasonably be allocated to the businesses. These will include the costs, by way of example, of the chief executive’s office, the company secretariat and expenses associated with being listed on the JSE Limited.

This revised method of cost allocation will enable business units to assume full accountability for all cost management and further enhance the measurement of return on assets managed (“ROAM”).

Operating profit

Operating profit before capital items increased by 19.6%. Clicks showed a 13.3% increase. Discom continued its strong performance from the first half in recording a 37.8% increase in profit.

While Musica showed strong turnover growth, operating profit was negatively impacted by a R5 million inventory shortfall. This relates to prior year inventory valuation issues, a syndicated fraud uncovered earlier in the year and inventory control issues which have been addressed. Management has taken decisive action to tighten processes and minimise future inventory risk.

Interest

The increased interest charge reflects the higher level of average borrowings experienced by the group during the greater proportion of the review period.

Financial results – Balance sheet

Inventory

An intense focus on inventory management has resulted in inventory levels remaining flat over 2005. Discom reduced inventory by 13.8%, resulting in an increase in inventory turn from 4.4 to 5.6 times. Clicks, Musica and UPD all showed increased inventory turns.

Cash flow

Cash utilisation increased in the first half of the year, including less funding in respect of accounts payable. Cash generated in the second half of the year increased significantly as a result of improved inventory management outlined above and the refinement of the supplier payments process.

Shareholder distribution

The group has maintained its distribution cover ratio at 2.2 times. A distribution of 33.2 cents per share (2005: 29.7 cents) will be paid to shareholders, partly in the form of a dividend from retained income to utilise available STC credits accumulated by the group and the balance out of share premium.

Financial management priorities

The group has identified the following areas of focus for the year ahead:

• continue enhancing financial management and improving systems compliance;
• expedient expense management;
• cash flow generation; and
• improving ROAM through higher profitability and increased asset turnover, with a continued focus on inventory reduction and effective working capital management.

The improved cash flow generated as a result of these actions will offer the group the opportunity to continue to review the extent of its capital structure in order to improve ROE.

Keith Warburton
Chief financial officer