Business in transition

In last year's annual report we commented that "several of the group's activities are currently in a state of transition and in varying stages of progress". This statement still holds true and over the past year we have seen some of the businesses moving towards sustainable performance while others like the Clicks brand are in the early stages of this transition.

Clicks endured a difficult year as it absorbed pharmacy chain Purchase Milton & Associates (PM&A) into the business; continued integrating pharmacy into the brand; faced the uncertainty around the new medicine pricing regulations, while at the same time being challenged by operational issues of high shrinkage and poor inventory management. Inevitably, profitability in the brand declined.

The group has taken decisive action to address this underperformance and we are encouraged by the early signs of a recovery in Clicks towards the end of the financial year and heartened by the financial proof that our pharmacy model is starting to deliver.

The management team of Clicks has been upweighted to meet these challenges and the board has every faith in Michael Harvey leading the brand back to its former pre-eminent position in the health and beauty sectors. The management team are committed to positioning the brand as a health and beauty focused drugstore, underpinned by the value proposition of "You Pay Less at Clicks". In order to achieve the recovery and implement the brand's vision and strategy, the management team will now have the added support of David Kneale and Keith Warburton and be able to draw on their wealth of experience.

The Discom brand has started to realise its true potential and we are encouraged by the improved returns from the brand. The business has been well managed through its transition period and we have seen an improvement in all the key financial metrics.

The structural changes that have taken place in the economy over the past decade have stimulated the growth of the middle class in our country. The growth and collective buying power of this market is highly appealing to retailers and we believe that Discom is ideally positioned to address this market.

Another business which has moved through a transitionary phase to a more robust performance is the Entertainment division (Musica and CD Wherehouse). The division has transformed itself into a broader-based retail entertainment destination and in three years has grown its non-music revenue from nil to 39% of total turnover. Despite the technological risks which challenge the music industry, this business has demonstrated a strong resilience and delivered a very pleasing performance.

After rapidly growing its store base over the past few years, The Body Shop is reaching market saturation and will now consolidate its store base and look to grow revenue from its existing stores.

UPD has produced outstanding results. It too is a business in transition as it adapts to a high volume, lower margin business model which has been necessitated by the introduction of single exit pricing. The prospect of further regulatory changes in the wholesale distribution sector cannot be ignored.

One of the group's major areas of transition has been on the technology front where the enterprise-wide information systems platform was successfully implemented at year-end. This will change business processes fundamentally and over the next few years many roles in the group will be redefined as we adapt to this new technology. Significant benefits are expected to flow from the new systems.

Financial performance

The group's overall financial performance has been disappointing, impacted by the poor results from Clicks. While there were strong performances from Discom, the Entertainment division and UPD, this was not sufficient to prevent an 8.6% decline in the operating profit from continuing operations to R358.6 million owing to the relative size of the Clicks brand.

Headline earnings from continuing operations declined by 8.5% from R242.1 million to R221.6 million, with diluted headline earnings per share reducing by 5.3% to 63.2 cents per share. Shareholders received a total dividend of 29.7 cents per share for the year (2004: 35.0 cents per share).

The group's trading performance is covered in the Chief Executive's Report while a detailed analysis of the financial performance is contained in the Chief Financial Officer's Report.

Board and management

The recent appointments of Keith Warburton as chief financial officer and David Kneale as deputy chief executive, which are detailed in the Chief Executive's Report, will significantly strengthen our senior management resources and ensure that we once again have the top talent to restore the group's performance. Both come with impressive credentials in their areas of expertise and their appointments also create succession management opportunities for the future.

While we have always invested in our own talent and promoted from within our ranks wherever possible, it has been necessary to attract external executives to add depth to our senior executive team. The board believes that the team of Keith, David, Trevor Honneysett and Michael Harvey has the energy, experience, expertise and ability to rejuvenate all of the businesses in the group and, in particular, the Clicks brand.

The group has also acknowledged the need to be more competitive in attracting and retaining senior executives and during the year an incentive programme was introduced which closely aligns executive performance with the creation of shareholder value.

Six million share appreciation rights have been made available and the group is required to exceed exacting share price targets before executives benefit from this scheme; by year-end, a total of 3.8 million rights were granted to nine senior employees, excluding executive directors. Additional rights will also be granted to the newly-appointed members of the group executive.

One of our longest serving directors, Raymond Godfrey, has decided to take early retirement from the group after 35 years' service. We thank him for his contribution both as a director and as an executive where he served in various leadership positions, including managing director of Clicks, country leader of New Clicks South Africa and group merchandise leader.

The board has also approved the establishment of a transformation committee to formulate a black economic empowerment strategy for the group and drive transformation into the business.

Corporate governance

The group complies in all material respects with the governance requirements of King ll. We regularly review our structures and processes to ensure that the group adheres to best practice in corporate governance. During the year the board evaluation process was extended to include reviews of individual directors by the chairman as well as reviews of the board sub-committees.

Prospects

While the strong retail markets are expected to continue in the short term, the downward inflationary pressures on FMCG retailers will make it increasingly difficult to achieve top-line growth. Meaningful growth is therefore likely to be achieved primarily through market share gains from improved trading.

As outlined earlier in this report, our businesses are all in a state of transition. In the year ahead, we anticipate continued strong growth from Discom, the Entertainment division and UPD, and expect Clicks to show an improved performance off a low base. However, the full benefits of the turnaround in Clicks will only be realised in the medium term.

The directors and management believe that the group now has a clearer focus, a more experienced senior management team and a stronger platform for growth which is expected to contribute to improved profitability and earnings in the year ahead.

Thanks

We would like to thank our shareholders for your continued support and loyalty during a difficult period for the group. We trust that your investment will yield satisfactory returns over the medium term as the group strives to deliver to its true potential. Thank you to our customers, suppliers and business associates for your support.

In closing, I would like to express my gratitude to my fellow directors, chief executive Trevor Honneysett and the senior management team for their capable leadership of the group in a challenging year. The contribution of our staff of almost 9 000 people does not go unnoticed and I extend my thanks to every one of you.

DAVID NUREK
Independent non-executive chairman