Group Leader’s Report

“We have the opportunity to rejuvenate the 35-year-old Clicks brand
by introducing an entirely new category of merchandise.”

Introduction
Over the past few years our commentary in the annual report has focused increasingly on the group’s healthcare strategy, and we have shared with shareholders our vision of providing affordable healthcare to a wide range of the South African population.

Our healthcare strategy has been intensified over the past four years as we assembled the component parts of an integrated channel to market, in anticipation of the legislative changes. Our broad retail base and ownership of the distribution network will give the group the power to influence prices and offer more affordable healthcare products and services to customers.

The long-awaited changes to the legislation were announced in May this year, allowing lay-ownership of retail pharmacies for the first time ever. We are now able to integrate a more essential healthcare commodity into the existing health, beauty and lifestyle categories of merchandise.

I recognise that the group has probably placed too much emphasis on the healthcare strategy while trying to second guess Government and anticipate the outcome of the pharmacy legislation. In mitigation, the legal process took longer than we expected. Fortunately when the changes were announced they were substantially in line with our expectations.

While waiting for the regulatory changes we did not focus enough attention on our core Clicks brand, which has lost some ground in the competitive lifestyle category (homeware, confectionery and stationery).

We now have the opportunity to rejuvenate this 35-year-old brand by introducing an entirely new category of merchandise and position Clicks as a pre-eminent healthcare provider, while at the same time repositioning our lifestyle offering.

As the forerunners in this move to corporate retail pharmacy we have come to learn that pioneering can be painful. We have not been without our detractors and have had to absorb criticism from several quarters, with many believing that the group had taken undue risk without a guaranteed outcome.

Pharmacy implementation
Following the legislative changes we have been able to respond rapidly to the challenge of introducing pharmacy into the group. A multi-functional integration team was assembled to spearhead the pharmacy project, including healthcare specialists, pharmacists and the relevant brand leaders.

Clicks will be our pharmacy brand in South Africa. Besides the brand’s equity, the format of the store is ideally suited for the full extension of the healthcare category which will include a dispensary.

Our vision within Clicks is to create an experience of pharmacy that has never been seen in this country, as we seek to combine the best elements of Clicks with the best of pharmacy.

The implementation plan includes the conversion of most of the PM&A pharmacies to Clicks Pharmacy during the year ahead, introducing dispensaries into new Clicks stores as well as many of the stores identified for refurbishment.

Trading performance
Operating profit rose by 20% from R319 million to R382 million, although this increase is inflated by the inclusion of UPD which was acquired during the year. When the contribution from UPD is excluded, profits grew at a pedestrian 3%.

The Clicks brand continues to contribute the lion’s share and accounted for 68% of the group’s profits, with newcomer UPD contributing 14% and the Australian operations 13%.

The 10.3% decline in the group’s operating margin from 5.8% to 5.2% can be attributed to the lower margin profile within UPD’s business and the change in product mix as a result of the disappointing sales of the higher margin lifestyle merchandise.

Stock levels at year-end – excluding UPD – were 16% higher than last year, mainly as a result of the additional stocks required for the promotional strategy being pursued by the Clicks and Discom brands, the increased volumes of lifestyle imports and the earlier landing of these stocks, as well as the growth in The Body Shop stores. We have made a concerted effort to ensure that we have stock in stores, with a lower out-of-stock position.

The leadership teams of the brands have been strengthened and delivery-based strategies agreed with the board. We are confident that this will go some way to addressing the areas of under-performance which impacted on our results this year.

The performance of the trading brands is covered in detail from pages 16 to 37.

New Clicks South Africa
The performance of the core Clicks brand was impacted by the poor lifestyle sales which only showed a 4% growth. The health and beauty categories, however, have both grown market share, lifting sales by 18%. The brand’s total turnover growth was 11.3%.

The new leadership team has taken strong remedial action to reverse the decline in homewares by anticipating customer needs and focusing on the presentation of merchandise in its promotional campaigns. At the same time Clicks has returned to its value proposition of “You pay less”. Early indications are that the recently introduced homewares range is meeting customers’ expectations for both value and quality.

At the interim stage we advised shareholders that Discom was expected to post a profit for the full year but we have not achieved this target. This was mainly due to the late arrival of the imported homewares merchandise and the slower than expected improvement in shrinkage levels.

However, Discom has continued to show a turnaround in performance as an African beauty and hair care specialist, reducing its operating loss from R20.6 million to R5.6 million.

The group’s most recent acquisition, UPD, is performing ahead of expectations after its first eight months in the group. Besides a profit contribution of R54.3 million, we are also benefiting from UPD’s distribution capability and the lower prices they are able to secure for their independent pharmacy customers and group companies.

PM&A has continued to improve its operating performance and showed a profit before interest and goodwill write-off for the second half of the year. We are confident that the sales and profitability of the pharmacy business will improve further once it is integrated into Clicks.

The music division showed a steady performance, despite the slowdown in sales in the music industry, and increased profit by 19.6%. In anticipation of declining music sales, the division has undertaken a strategic shift by broadening its product offering to other areas of entertainment, including gaming, DVD and lifestyle merchandise.

Although coming off a low base, The Body Shop showed a 93.5% growth in profit as it expanded the network of stores nationally to 18. The relationship with The Body Shop parent company allows the group access to a worldwide network and exposes us to current international beauty retailing trends. We are confident of The Body Shop’s continued growth, although at a slower rate than in the past.

New Clicks Australia
New Clicks Australia (NCA) experienced a difficult trading period and its results were further hampered by the strengthening of the Rand against the Australian dollar (A$). These factors led to a decline in NCA’s contribution to the group’s headline earnings.

During the year NCA implemented its pharmacy strategy under the Priceline Pharmacy banner. The model adopted in Australia enables pharmacists to continue owning and managing the pharmacy, while Priceline provides ‘front shop’ expertise and services. This provides pharmacists with a more sustainable business with higher margin and increased turnover. Seven pharmacies were opened and further stores are planned for the new financial year.

Priceline increased operating profit by 34.8% to A$29.6 million. This includes an amount of A$5.2 million from the sales of two Priceline stores during the year.

Price Attack, which was acquired in July 2002, was successfully integrated into NCA.

House was repositioned during the year to create a differentiated offering as the homewares market has witnessed several new entrants and increasing competition from existing players.

A new management structure was implemented to enable NCA to operate as an independent business. Brand leadership was also strengthened, with new leaders being appointed for Priceline and Price Attack, while a new brand team was assembled for House.

Key focus areas
Together with the implementation of the pharmacy strategy and addressing the challenges in the trading brands, the group needs to focus on managing costs more effectively.

The growth in expenses has been out of line with the growth in sales in recent years, mainly as a result of increasing staff numbers. In the year ahead we will be addressing this issue vigorously and looking to align the shared services infrastructure with the needs of the brands to create a more affordable cost platform. An inability to address our cost structure effectively will ultimately affect our ability to offer value to customers.

The centralised distribution process introduced into the group in 1998 has taken longer to generate the full benefits than was originally anticipated. We have focused our energies on the distribution centres (DC) which is the supply side of supply chain management. The group has improved stock control through the DCs and benefits have been achieved through increased volumes.

Critically, we now need to improve the management of stock in the stores, achieving a balance between adequate stock levels to meet customer needs and not carrying excessive stock in stores. We have implemented a merchandise planning system for the lifestyle category of our business to address this issue and are already seeing the early benefits.

Finally, we are also implementing new financial systems aimed at improving the speed and quality of our information.

Leadership
The board’s decision to operate the businesses in South Africa and Australia independently of one another has resulted in several changes to the leadership structure of the group. We have disbanded the Group Strategic Forum which was the co-ordinating and integrating mechanism between the two regions, and will no longer have executives holding positions in both countries. The management forums in both South Africa and Australia have been structured for an enhanced focus on implementation and delivery, with several new appointments being made.

Following the resignation of group finance leader, Peter Green, we appointed André Vermeulen as head of finance in South Africa and Trevor Harris as his counterpart in Australia. Other changes to the South African management forum included the appointment of Lara Bryant as brand leader of Clicks, Errol Gray as strategic development leader, and Heather Mac as head of organisational development. Kevin Vyvyan-Day also joined the forum following the group’s acquisition of UPD.

The Australian management forum was bolstered by the appointments of Phillip Smith as brand leader of Priceline and Priceline Pharmacy, Carmelo Francese as brand leader of Price Attack, and John Stapleton as merchandise leader. Amanda Brook was appointed to the newly-created position of pharmacy retail services leader.

Prospects
We welcome the recent reductions in interest rates and applaud the authorities for their efforts to bring rates down to more realistic levels in order to stimulate growth. An environment of lower interest rates is undoubtedly positive for the retail industry as consumers have more disposable income. However, besides the commercial benefit, there is also a psychological impact as consumers now have less debt to service and this boosts consumer confidence which is ultimately positive for the country.

The first Clicks Pharmacy should be opened before the end of the year, with a substantial number of pharmacies planned for the year ahead. Pharmacy dispensaries will allow Clicks to offer an essential commodity to customers for the first time and ensure that a higher volume of sales will be generated through an existing infrastructure.

The pharmacy offering, together with an improved lifestyle merchandise range, will lead to the emergence of Clicks as the pre-eminent healthcare brand.

The legislative changes introduced this year mark the first moves towards liberating pharmacy ownership and we are hopeful that the authorities will in future allow open market principles to apply in an environment where there is strict control over ethical standards.

Discom is expected to return to profitability this year as the benefits of the restructuring and repositioning become evident, while all other divisions are projected to continue their sound profit contributions.

Resources will be applied to increasing stock turns through the distribution centres and within stores, and we will also focus on improving our working capital management.

Thanks
Despite another challenging year for the group, I have once again been encouraged by the commitment, drive and energy of our people. There is a mood of optimism within the group that has not been evident for a while, and much of this can be ascribed to the certainty around our healthcare and pharmacy strategy. I would like to thank the chairman and directors for their guidance during the year, and also all the people of New Clicks for their efforts in what has been a tough period. We end the year stronger and wiser, and trust that the rewards of our endeavours will be reaped in the year ahead.

TREVOR HONNEYSETT
Group Leader