Chief Financial Officer's report
Investing to support the four pillars of the strategy
Chief Financial Officer's report
Investing to support the four pillars of the strategy
Our close and careful management of all aspects of the business produced a good set of results despite the highly competitive market environment.
Can you summarise Debenhams’ performance in 2013?
Our performance is summarised in figure 1. Our close and careful management of all aspects of the business meant that in a challenging market we delivered gross transaction value of £2.8 billion, revenue of £2.3 billion, operating profit of £168.0 million, profit before tax of £154.0 million and earnings per share of 10.2 pence. We consider this to be a solid performance in light of the highly competitive market environment which was also impacted by poor weather affecting the profitability of the UK and a write-off arising out of the closure of the Romanian franchise stores in the International business.
What do you see as the key areas for investment over the next few years?
Investment will be targeted at supporting the four pillars of our strategy and the evolution of Debenhams from a UK department store operator to an international, multi-channel business.
Capital expenditure will continue to be invested behind the four pillars including the store modernisation programme and the 16 new UK stores scheduled to open during the next four years. We are also investing in systems across the business in particular to support our fast-growing multi-channel activities. Much of the revenue investment – primarily to support product development and our marketing activities – has been made now and our focus will be on achieving a return on this investment.
Why have you changed the way you guide on the cost base?
In the past we gave guidance for key cost categories as a percentage of Group sales. This was useful when the business was principally a UK store model. However, with the growth of sales from multi-channel and international operations, this guidance became less useful. Starting at the interim results in April 2013, we now provide guidance by geographic segment and, within each segment, break the analysis down into store costs, online costs and other costs as appropriate.
There has been a lot of commentary about the change to IAS 19. Can you explain what this accounting standard does and how the change will impact Debenhams?
In 2013, Debenhams benefited from a pension credit of £11.3 million under IAS 19 “Employee Benefits“ (2012: £11.7 million). The purpose of this accounting standard is to put a notional impact of a defined benefit pension scheme onto the profit and loss account. From our financial year 2014, the method of calculating this impact is changing. Currently, IAS 19 calculates an income on a scheme’s assets and an expense on its liabilities to give a net income or cost (where asset returns and interest rates can be different) which can be taken in either operating profit or the interest line. The revised IAS 19 requires an income or expense to be calculated by applying a single interest rate to a scheme’s net surplus or net deficit. Under the revised standard, in 2014 there will be a charge to profit before tax of £2 million. Thus, there will be a negative impact on profit before tax of £13 million between 2013 and 2014 as a result of the change to IAS 19. It is important to note that the revision has no impact on the scheme, its members or the cash contribution that Debenhams has agreed with the trustees.
Why did you have to take a write-off in Romania?
We took a write-off of £3.8 million in the first half of 2013 following the closure of the six franchise stores in Romania in February which related to some outstanding receivables dating back to 2011. We have since strengthened our controls and the financial support behind receivables.
What are your priorities for capital allocation?
We have a very clear order of priorities for cash. The first is to invest in the four pillars of the strategy to build a leading international, multi-channel brand. In 2013 we spent £133.3 million on capital expenditure; you can see a breakdown of this spend on page 40. Secondly, we pay our shareholders a dividend and during 2013 spent £41.4 million of cash on the 2012 final dividend and 2013 interim dividend. Our third priority is to reduce net debt to a level around one times EBITDA over the medium-term. Finally, any spare cash generated over and above these requirements will be returned to shareholders through the share buyback scheme.
Sales and revenue
Group gross transaction value (GTV) increased by 2.5% to £2,776.8 million for the 52 weeks to 31 August 2013 (2012: £2,708.0 million) whilst Group revenue increased by 2.3% to £2,282.2 million from £2,229.8 million.
For the UK segment, GTV increased by 2.3% to £2,254.8 million (2012: £2,204.6 million) and revenue grew by 1.9% to £1,895.9 million. This was principally a result of:
- Continued strong growth in online sales to UK customers
- The benefits of the current store modernisation programme, under the first pillar of our strategy, which is delivering an increase of sales of c.6% in the first year following modernisation
- New stores opened during both 2012 and 2013
For the International segment, GTV of £522.0 million was 3.7% higher than last year and revenue increased by 4.5%. International growth was largely the result of:
- Increased trading with franchise partners
- A strong sales performance from the Danish business Magasin du Nord
Group like-for-like sales increased by 2.0%, principally driven by growth in online sales of 46.2% to £366.3 million (2012: £250.6 million) which offset the weather-impacted performance of the UK stores.
The components of sales growth in 2013 are shown in figure 2.
Own bought products accounted for 76.7% of the sales mix (2012: 76.7%). UK own bought sales mix was essentially unchanged at 79.9% (2012: 80.0%) whilst International increased to 63.0% (2012: 62.6%). Overall, own bought sales grew by 2.5% whilst concession sales were 1.9% higher than the previous year.
Group gross margin was unchanged from the prior year. This reflected a good recovery in the second half of the year due to a combination of better intake margin and mix which more than offset a decline of 20 basis points in the first half which was caused by increased promotional activity and the impact of bad weather in the UK.
In the UK, store costs increased by 1.6% to £585.9 million (2012: £576.7 million) largely due to inflationary increases in rent, energy and payroll offset by a number of cost saving initiatives. UK online costs grew by 34.0% to £83.5 million (2012: £62.3 million), driven entirely by higher volumes. Importantly, online costs as a percentage of sales decreased by 270 basis points to 23.9% due to greater warehousing and distribution efficiencies arising from increased scale and bringing all own brand fulfilment in-house at the start of the second half. Other UK costs, which comprise those not directly attributable to either stores or online and include buying and merchandising, marketing and central functions, increased by 1.5%, largely due to inflation.
International store costs increased by 4.8% and other international costs by 2.9%, supporting the revenue store increase and associated bonus payments in Magasin du Nord.
The IAS 19 pension credit contained within operating profit was £11.3 million (2012: £11.7 million). See note 23 starting on page 116 for further details.
Group depreciation and amortisation of £94.6 million increased by 3.3% (2012: £91.6 million) largely reflecting the store modernisation programme.
Group operating profit declined by 4.0% to £168.0 million (2012: £175.0 million) with the UK down 3.1% to £139.8 million (2012: £144.3 million) and International down 8.1% to £28.2 million (2012: £30.7 million) for the reasons described above.
The net interest cost of £14.0 million represented a decrease of 16.2% from last year (2012: £16.7 million). See notes 8 and 9 on page 100 for further details.
Profit before tax
Group profit before tax for the year decreased by 2.7% to £154.0 million (2012: £158.3 million), largely due to lower operating profit for the reasons described above.
Taxation and profit after tax
The Group’s tax charge of £26.1 million on a profit of £154.0 million gave an effective tax rate of 16.9% compared with 20.8% for the prior year, due to a reduction in the headline rate of corporation tax, the resolution of historical issues in the current year and the recognition of tax losses at Magasin du Nord. See note 10 on page 101 for further details.
The lower taxation charge resulted in profit after tax increasing by 2.1% to £127.9 million (2012: £125.3 million).
Earnings per share
Total basic and diluted earnings per share were 10.2 pence, compared with 9.8 pence for the prior year. The weighted average number of shares in issue in 2013 was 1,254.5 million (2012: 1,281.3 million) largely due to the purchase of 23.9 million shares in the share buyback scheme.
Cash flow and uses of cash
Debenhams remains a highly cash generative business. Operating cash flow before financing and taxation was £107.8 million. Cash flow generation, the uses of cash and the movement in net debt are summarised in figure 3.
Capital expenditure during the year was £133.3 million, an increase of 12.4% versus the previous year (2012: £118.6 million). The key components of capital expenditure in 2013 are detailed in figure 4. We expect capital expenditure in 2014 to be in the region of £135 million. Thereafter, we anticipate it will fall back towards depreciation and amortisation at c.£100 million.
An interim dividend of 1.0 pence per share was paid to shareholders on 5 July 2013 (2012: 1.0 pence). The board has recommended a final dividend of 2.4 pence per share which will be paid to shareholders on 10 January 2014 taking the total dividend for the year to 3.4 pence (2012: 3.3 pence).
During the year 23.9 million shares were bought for a total expenditure of £25.1 million. All shares purchased since the share buyback programme commenced in 2012 have been transferred to treasury.
A further 14.3 million of shares were purchased after the year end, taking the total purchased over the 12 months to 23 October 2013 to £40.2 million (38.2 million shares), in line with our commitment.
After taking into account £25.1 million of share buybacks, the Group’s net debt position as at 31 August 2013 was £372.0 million (1 September 2012: £368.7 million). The ratio of reported net debt to EBITDA was 1.4 times, level with last year.
Key balance sheet items are summarised in figure 5.
Stock levels were managed very tightly during the year given the difficult market conditions. Total stock increased by 7.7% to £357.9 million with almost all of this increase attributable to online expansion and international growth. The stock value into UK department stores fell by 0.7%. Terminal stock at year end was in line with the historical average at 3.1%.
The Group provides a number of pension arrangements for its employees. These include the Debenhams Retirement Scheme and the Debenhams Executive Pension Plan (together the “Group’s pension schemes“) which both closed for future service accrual from 31 October 2006. Under IAS 19, the Group’s pension schemes’ net deficit as at 31 August 2013 was £20.0 million (1 September 2012: £57.3 million). Further information can be found in note 23 to the Group financial statements starting on page 116.
A triennial actuarial valuation was completed in March 2012 and discussions with the pension schemes’ trustees were subsequently concluded. The contributions from the Group and the investment strategies devised by the trustees are intended to restore the schemes to a fully funded position on an ongoing basis by the end of March 2022 (Debenhams Retirement Scheme) and August 2021 (Debenhams Executive Pension Plan). As a consequence of this agreed plan, annual contributions to the two schemes were set at £8.9 million, rising each year by RPI. The Group also pays the non-investment expenses and levies to the Pension Protection Fund.
Current pension arrangements for Debenhams’ employees are provided by a defined contribution pension scheme which is administered by Legal & General.
During the year, the Group extended £550.0 million of its £650.0 million senior credit facility from October 2015 to October 2016. At the same time, the Group repurchased £35.0 million of the £100.0 million facility that was not extended.
The senior credit facility contains fixed charge cover and leverage covenants, which were both met in full during the year. The directors believe that the Group has sufficient headroom to ensure compliance for the foreseeable future.
Financing risk and treasury management
The board has established an overall treasury policy which has approved authority levels within which the treasury function must operate. Treasury policy is to manage risks within the agreed framework whilst not taking speculative positions.
The policies and strategies for managing financial risks are disclosed in note 21 of the Group financial statements starting on page 109.
Chief Financial Officer