Final Results - Part 2

Smith WH PLC 26 October 2000 Part 2 FINANCIAL COMMENTARY AND ANALYSIS YEAR ENDED 31 AUGUST 2000 The financial performance of the Company continues to show good progress. For the third successive year good growth in earnings per share has been achieved - with earnings per share up five per cent. The Company also delivered a strong free cash flow of £83m (following free cash flow of £78m in the previous year) and finished the year with a robust balance sheet. Trading results The trading results can be summarised as follows: £m 2000 1999 Growth Comparable % Sales Growth % =================================================================== Sales UK Retailing 1,323 1,275 4% 5% Internet Trading 7 5 55% 55% International Retailing 204 186 10% 4% ------------------------------------------------------------------- Total Retailing 1,534 1,466 5% 5% Publishing * 105 28 - - News Distribution * 945 897 5% 5% ------------------------------------------------------------------- Total 2,584 2,391 8% 5% =================================================================== Operating profit UK Retailing 86 74 16% Internet Trading (8) (3) - International Retailing 12 13 -8% ------------------------------------------------------------------- Total Retailing 90 84 7% Publishing 16 4 - News Distribution 38 39 -3% ------------------------------------------------------------------- Total Trading Profit 144 127 13% Support Costs (12) (12) - Internal Rents 3 5 -40% ------------------------------------------------------------------- Total 135 120 13% =================================================================== * excludes sales to other WHS businesses RETAILING The results for retailing businesses comprise: £m 2000 1999 Growth Comparab % le Sales Growth % =================================================================== Sales High Street 1,058 1,033 2% 3% Europe Travel Retail 265 242 10% 9% ------------------------------------------------------------------- UK Retailing 1,323 1,275 4% 5% Internet Trading 7 5 55% 55% USA Travel Retail 192 178 8% 3% Asia Travel Retail 12 8 45% 5% ------------------------------------------------------------------- International Retailing 204 186 10% 4% ------------------------------------------------------------------- Total Retailing 1,534 1,466 5% 5% =================================================================== Operating profit High Street 69 60 15% Europe Travel Retail 17 14 21% ------------------------------------------------------------------- UK Retailing 86 74 16% Internet Trading (8)* (3) - USA Travel Retail 12 13 -8% Asia Travel Retail - - - ------------------------------------------------------------------- International Retailing 12 13 -8% ------------------------------------------------------------------- Total Retailing 90 84 7% =================================================================== * includes £1m of development costs UK Retailing Total retailing space has been reduced by 1% to 3.1m square feet. This includes the closure of 18 former John Menzies stores. The businesses had 716 stores at the year end. The Company is focusing on growing its sales within the core categories of books, magazines and stationery. Sales growth was led by progress in books, which grew by 7%. Magazine sales grew by 5% and core stationery sales by 5%, whilst electronic stationery sales were up 45%. However, in a market that was generally difficult, sales of music and video product declined by 5%. This showed a marked improvement in the second half of the year where sales were up 4%, driven primarily by DVD sales. Gross margin in core categories was held in a competitive retail market. Total expenses grew by only £4m - representing a 0.9 percentage point reduction as a proportion of sales. As a result retailing net margins rose to 6.5% from 5.8%. UK High Street This business operates 529 stores in the UK with 2.9m square feet of selling space. Sales by the business at £1,058m were up 2%, with like for like sales up by 3%, following the closure of 18 former John Menzies stores which were not considered suitable for re-branding. Gross contribution was £5m better than last year with gross margins in core categories flat year on year. The reduction in total expenses amounted to £4m. This included £3m of distribution costs savings, which partly reflected issues in the logistics area in the prior year, which have now been resolved. As a result, profits increased by 15% to £69m from £60m, following an increase of 12% in the previous year. Net margins grew to 6.5% of sales, compared with 5.8% in the previous year. Europe Travel Retail The business operates 187 stores with 0.2m square feet of selling space mainly focused on UK airports and railway stations. Sales at £265m were up 10% (9% like for like) reflecting a particularly strong performance in London stations (up 11%) and airports (up 9%). The business continued to benefit from the substantial refurbishment programme implemented last year. Gross contribution was £11m better than last year with margins up 0.9 percentage points. This was offset by £4m of increased turnover rents, with other expenses also up by £4m (10%), in line with sales growth. As a result, profits grew to £17m from £14m and net margins from 5.8% to 6.4%. Internet Trading These results include WHSmith Online retail and portal activities, internet kiosks in stores and the Connect2U business. Sales increased by 55% to £7m. Strategic alliances have now been reached with seven partners; BT, Open, Egg, MSN, Telewest, OnDigital and Carlton. Trading losses were contained at £7m compared to losses of £3m last year. In addition, we incurred £1m of expenditure relating to the development of Internet kiosks and Connect2U. Internet kiosks enabling High Street and Travel customers to use WH Smith Online have now been installed on a trial basis in 19 stores and the trial will be extended over the next 12 months. In March 2000, Connect2U was formed. This venture is owned 80% by WH Smith PLC and 20% by the software provider Axon Group plc. It provides a business to business internet trading portal, linking independent retail outlets (particularly in the CTN trade) to WHSmith News Distribution and other suppliers. The business has currently signed up 500 independent retail outlets. USA Travel Retail The business operates 503 stores with 0.51m square feet of selling space in airport and hotel locations across the USA. Sales increased by 8% to £192m, 1% up on a comparable basis after space growth of 5%, and exchange rate effects. Following a disappointing first half, the second half saw strong growth, largely driven by a recovery in base sales, new store developments and the successful integration of the Hazelwood acquisition. Profits of £12m were down by £1m from the £13m in the previous year, with net margin reducing from 7.3% to 6.3%. The new style airport stores have been well received. These new formats, which strongly represent the WHSmith brand, will give joint focus to the traveller and the book enthusiast using cutting edge technology and will continue to be rolled out. Asia Travel Retail The business operates 20 stores with 27,000 square feet of selling space in Singapore, Hong Kong and Australia. Sales increased by 45% to £12m and the business achieved a break even result. The Company was awarded a contract to operate at Sydney airport in November 1999 and is now fully operational. PUBLISHING In May 1999 the Company acquired Hodder Headline PLC at a cost of £192m. In February 1999 the Company acquired Helicon Publishing PLC, the publisher of Hutchinson Encyclopedia for £6m. In September 1999, the Company purchased Wayland Publishing for a consideration of £4.5m. The results of these businesses for the year to 31 August 2000 were as follows: Proforma £m 2000 1999 % Growth ============================================================ Sales - Hodder 110 105 4% - Helicon 2 2 - Acquisitions/Disposals 7 3 -------------------- - Sub total 119 110 8% - less internal (14) (12) -------------------- Total 105 98 =================== Operating profit 16 12 40% =================== Like for like sales growth on a proforma basis was 4% while profits grew by £4m to £16m. Profit growth reflects the impact of the Wayland acquisition (£1m) and merger benefits (£2m). These results are net of internal sales to WHSmith retailing businesses of £14m versus £12m in 1999, up 13%. NEWS DISTRIBUTION The business is the UK's leading wholesaler of magazines and newspapers, operating from 53 depots throughout England and Wales. Total sales amounted to £1,047m, an increase of 5%. These included £102m (1999 - £98m) of sales to WHSmith retailing businesses. Profits of £38m were £1m down on the previous year, as the business continued to experience a transitional period of restructuring. SAP based operational systems were implemented during the year, adding £3m to the cost base. Once fully implemented these investments are expected to strengthen the operational capacity and competitive position of the business. Costs were also incurred in the development of a national distribution network for magazines aimed at offering retailer choice and improving supply chain efficiency. These amounted to £1m and will be higher in the current year as the full national distribution offer is implemented. Other profit items Centrally controlled support costs at £12m were in line with the previous year. Internal rents on the freehold property owned by the Company, which are charged to the businesses, were lower by £2m at £3m, reflecting asset sales. Amount written off investment in own shares On 3 August 1999, the Company purchased 950,000 of its own ordinary shares of nominal value of 55.55p each with an aggregate market value of £6m. These shares were held for the sole purpose of satisfying obligations under the Employee Share Schemes. At 31 August 2000 the carrying value of the remaining 858,801 shares in the schemes was restated to reflect the market value at that date. This has resulted in a charge of £2.2m in the Company's profit and loss account. Interest The results include interest income of £6m, compared with £14m in the previous year. The reduction of £8m arises principally from the impact of the acquisition of Hodder Headline PLC. Taxation The tax charge for the year is £39m, including £1m on international profits. The effective tax rate is 28 per cent in line with the previous year. This is below prevailing UK tax rates mainly to the reduction of taxation on foreign profits. Operating Leases In common with other retailers, the Company's stores are mainly held under operating leases, which are not regarded as debt for accounting purposes. The UK High Street leases are on standard 'institutional' lease terms, now typically with 15 year leases subject to five year upwards only rent reviews. The Travel Retail stores operate mainly through turnover related leases, usually with minimum rent guarantees, and generally varying in length from 5 to 10 years. The business has an annual minimum net rental commitment of £143m (net of £18m of external rent receivable). The total future rental commitment at the balance sheet date amounted to £1.1bn with the leases having an average life of 8 years. The net present value of these commitments is approximately £0.7bn. Although large, these commitments are characteristic of the sector and the risks associated with them depend on their liquidity which is mainly influenced by the quality and location of the sites. These are considered to be satisfactory. Fixed Charges Cover A key measure of financial strength for the businesses is fixed charges cover. The fixed charges comprise operating lease rentals, property taxes, other property costs and interest. These were covered 1.73 times by profits before fixed charges, a slight reduction from the previous year when the ratio was 1.81. Earnings Per Share Basic earnings per share amounted to 40.2 pence, up 5%. Earnings per share before non-operating items and goodwill amortisation was 41.3 pence, up 6%. The non-operating items consisted of the write down of our investment in own shares held in the Employee Share Schemes costing £2m and the proceeds on the disposal of Hodder Headline PLC operations in South Africa amounting to £1m. Dividends The Company's dividend policy is for the dividend to be covered two times by earnings. The Board is proposing a final dividend of 13 pence, which is an increase of 4%. The final dividend will, if approved, be paid on 2 February 2001 to shareholders registered at the close of business on 10 November 2000. This will give a dividend for the full year of 19 pence, which is also up 4%. The total cost of the dividend will be £48m. The dividend cover will be 2.1 times. Free Cash Flow and Cash Balances The operating free cash flow available for the payment of dividends (before acquisitions and financing items) amounted to a highly creditable £83m following a strong performance of £78m in the previous year. £m 2000 1999 ================================================================ Profit before tax 140 134 Depreciation / Amortisation of 44 43 Goodwill ---------------------------------------------------------------- Cash Profit 184 177 Working capital (10) (9) Capital expenditure (60) (60) Disposal of Assets 1 8 Tax paid (27) (29) Provision spend (5) (9) ---------------------------------------------------------------- Free Cash Flow 83 78 ================================================================ The movement in working capital is in line with last year. This can be further analysed as follows: £m 2000 1999 ================================================================ Stock (10) 6 Debtors (15) (9) Creditors 12 (6) Exchange 3 - ---------------------------------------------------------------- Working Capital (10) (9) ================================================================ The £10m outflow in 2000 is due principally to significant investment in author advances amounting to £7m with the stock outflow of £10m offset by the £12m improvement in creditors. A high level of capital expenditure has been maintained as follows: £m ================================================================ New stores 9 Refurbished stores 30 News Distribution automation and systems 7 Other systems 8 Other 6 ---------------------------------------------------------------- Total 60 ================================================================ The provision spend relates principally to surplus properties and the reorganisation costs following the John Menzies retail acquisition. The total movements in net cash positions comprise: £m ================================================================== Opening net cash 105 Free cash flow 83 Dividends (47) Acquisition of businesses (23) Disposal of business 1 Proceeds from sale and leaseback of 2 freehold property Issue of shares 2 ------------------------------------------------------------------ Closing net cash 123 ================================================================== Balance Sheet The net assets comprise: £m £m ================================================================== Tangible assets 295 Goodwill 222 ------------------------------------------------------------------ 517 Stocks 216 Creditors less debtors (160) ------------------------------------------------------------------ Working Capital 56 Provisions (14) Dividends (33) Corporation Tax (45) ------------------------------------------------------------------ 481 Net Cash 123 ------------------------------------------------------------------ Net Assets 604 ================================================================== Tangible assets include £38m for the Company's interest in freehold and long leasehold property. The remaining freeholds comprise the Company's offices and depot in Swindon and certain small stores, which are not considered suitable for sale and leaseback. Return on Capital Employed Total capital employed and returns are as follows: ROCE with Operating operating Capital leases Employed ROCE capitalised £m ================================================================== High Street 184 38% 16% Europe Travel Retail 29 59% 28% ------------------------------------------------------------------ UK Retailing 213 40% 18% Internet Trading 8 - - International Retailing 62 17% 14% ------------------------------------------------------------------ Total Retailing 283 31% 16% Publishing 223 7% 7% News Distribution 6 - - Acquisitions 22 - - ------------------------------------------------------------------ Trading Operations 534 28% 17% Central items and property (53) - - ------------------------------------------------------------------ Total 481 29% 17% ================================================================== For the prior year, comparable average returns were 29% (17% after operating leases capitalised). Pensions The financial position of the Company is sensitive to the financial position of its main defined benefit pension fund which has £791m of assets. These assets are held by a trustee administered fund to meet long term pension liabilities to past and some present employees. The Company has undertaken to meet any shortfalls against these liabilities should they arise. The variable amount and length of defined benefit pension obligations inevitably gives rise to measurement issues in determining the financial position of the pension fund. Like many highly mature pension funds, the fund currently has a surplus of assets over liabilities. This surplus is estimated using actuarial assumptions and was formally valued for accounting purposes as at March 2000 at around 30 per cent of the fund. The effect of the surplus is to eliminate the cash and accounting cost of pensions, provided by the defined benefit fund, which would otherwise be around £14m a year. Financing Committed bank facilities amount to £165m from a number of banks. These mature in May 2002. Currency Approximately 8 per cent of the Company's turnover is earned in foreign currencies. The effect of fluctuations in exchange rates was to increase sales by £4m, with no significant impact on profit. Currency exposures mainly relate to the translation of foreign income. The supply of products from outside the UK is mainly paid for in sterling. Accounting for Goodwill Accounting for goodwill is regulated by Financial Reporting Standard 10, which requires goodwill on acquisitions to be capitalised and effectively permits the non amortisation of goodwill if the value of goodwill is not less than the amount in the accounts, can be calculated and is durable. The directors continue to take the view that these conditions apply to the goodwill on the original acquisition of Hodder Headline PLC. Accordingly, no amortisation has been provided on this goodwill, which amounts to £172m. It has also been decided not to amortise the goodwill arising on the acquisition by Hodder Headline PLC of Wayland, which is expected to generate a strong cashflow and to retain its value. The goodwill generated on the acquisition by WHSmith USA of Hazelwood is regarded as having a useful life of 20 years. MORE TO FOLLOW

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