Board and CEO’s Report

The Warehouse Group has delivered another strong performance

With an Adjusted Net Profit After Tax1 (Adjusted NPAT) for the financial year ended 31 July 2016 (FY16) of $64.1 million, which is above the guidance range of $61-$64 million indicated to the market.

Group retail sales for the year were $2,924.7 million, up 5.6% compared to last year. What is important to note is that all brands have contributed strong performances, reflecting consistency in The Warehouse and Warehouse Stationery, and improvements in Noel Leeming and Torpedo7.

1 Certain transactions, which the Group defines as unusual can make the comparisons of profits between years difficult. The Group monitors adjusted net profit which removes unusual items as a key indicator of performance and uses it as the basis for determining dividends and believe it helps improve the understanding of underlying business performance. A reconciliation of adjusted net profit to reported net profit is detailed on page 66 in note 5 of the Financial Statements.

Group Result

For the full year (a return to a normal 52 week period compared with the 53 week period in FY15), the Group Adjusted NPAT was 12.2% higher than last year. The second half of the year brought some challenges in the form of a weaker currency driving up the cost of goods sold, and a late start to what ultimately turned out to be a warm winter. Despite those challenges, the retail group reported 1.5% growth in operating profit for the second half at $35.4 million compared to $34.8 million in FY15, which is notable because the second half of FY15 was particularly strong and this year’s second half trading period was one week shorter.

This marks the third consecutive half-year where we have delivered profit growth year-on-year, and is part of a growing base of evidence pointing to the turnaround of the business. Sales growth remains strong at 5.6%. Cost control is delivering good profit leverage from that sales growth, already strong employee engagement is increasing, customers are responding well to our product and service strategies, and our physical store refit program is largely complete. Building on these foundations, there is still much opportunity to improve, which is outlined in our strategy below.

Reported Net Profit After Tax was $78.3 million, up 49.4% on last year, with gains recorded on some property sales (Kaitaia, Hamilton and Gisborne) and business disposals. During the year, the Group sold its interest in pet.co.nz, and acquired the remaining 20% shareholding in Torpedo7 Group and Westpac’s 50% shareholding in our financial services joint venture company.

This year, we have streamlined the reporting of our financial statements in line with industry moves to adopt simplified reporting, which is aimed at making the financial statements and their notes more accessible and approachable to users of the accounts. Part of that process has seen us split out the balance sheets for our retail and financial services businesses, now that the financial services business is launched and building scale.

During the year, the Group welcomed Nick Grayston as Group Chief Executive, taking over from Mark Powell in a smooth handover process. The Board has also recently announced the retirement of Ted van Arkel as Chairman of the Board, and the appointment of Joan Withers as incoming Chair, an appointment which took effect after balance date on 23 September 2016.

Our Chairman, Ted van Arkel, retired from the Board on 23 September 2016. We would like to sincerely thank Ted for his contribution during the five years that he was on the Board, firstly, as a non-executive director and secondly, as Chairman.

As an experienced professional director with significant retail knowledge, coupled with extensive commercial skills, Ted added a breadth and depth to the board where his influence and involvement were greatly appreciated over the years.

Eduard (Ted) van Arkel

Segment Performance

The Warehouse (Red Sheds)

A very strong first half year, combined with a solid second half year performance which faced with some currency and weather headwinds, delivered a good overall result with 12.3% profit growth for the year. Same store sales growth in the fourth quarter was up 5.1%, and 4.1% up for the full year.

The Red Sheds continue to focus on improving the product offer, moving more towards an Every Day Low Price strategy in key categories, and delivering excellent customer experience. Particularly strong growth was seen in the core Home, Apparel and Leisure categories. Good cost control and productivity improvement contributed to overall profit improvement.

Warehouse Stationery (Blue Sheds)

Warehouse Stationery delivered a consistently strong result, showing same store sales growth in the fourth quarter of 8.4%, and 6.5% for the full year. Sales growth in Warehouse Stationery translates consistently to profit leverage, with operating profit increasing 12.3% from $12.7 million in FY15 to $14.3 million in FY16.

The business delivered record results for this year’s Back to School season which was a key focus for FY16, and has relaunched its online offering on an updated platform.

Noel Leeming

Noel Leeming’s operating profit was a strong turnaround in performance from a softer FY15 result, increasing 87.6% from $6.4 million in FY15 to $12.1 million in FY16. Significant growth in sales overall for the year reflects Noel Leeming’s leadership position in key growth categories such as cellular.

The business continues to grow market share with same store retail sales growth in the fourth quarter a very strong 16.7%. The company’s focus on people and services continues to drive results in a highly competitive technology and appliances market.

The exit of Dick Smith from the market has consolidated already strong momentum in gaining market share.

Torpedo7 Group

FY16 has seen a positive turnaround in performance for Torpedo7, with operating profit of $3.4 million a significant improvement on the breakeven result in FY15. Total Torpedo7 sales grew 13.3% in the year. Of particular note this year has been the improved performance of the retail stores and the ‘1-day’ daily deals business.

A new chief executive, Andrew Scott, has been appointed to lead the Torpedo7 Group, after a year of interim leadership while the business searched for a permanent CEO. Thanks in particular to Matt Campbell for leading the business through the first half of FY16.

Financial Services

The Financial Services business launched to the market in FY16, with a range of retail-oriented Visa credit card products and insurance offers. The acquisition of Westpac’s shares in the joint venture company, The Warehouse Financial Services Limited, was also completed. The business recorded an operating loss of $3.4 million compared to a $1.8 million loss in FY15, in line with expectations and reflecting the early-stage losses anticipated as the business starts to build scale. Our strategy outlines in more detail where we see the future heading for financial services.

Online

All of the Group’s retail brands are trading online. In addition to straight forward home delivery, all brands offer ‘click and collect’ (order online and pick up in store) and ‘endless aisles’ (order extended ranges from within smaller stores) services. Total Group online sales were $185.8 million, up 22.0% compared to last year. The Group includes four of the top ten retailer websites in New Zealand (Nielsen) with online sales now representing over 6% of total Group sales.

Brand Strategies

Getting fit – a drive to profit growth through excellent retail fundamentals

Winning the digital future – repositioning the product and service experience to meet changing customer needs and competition, enabled by digital technology.

The Warehouse
Helping New Zealand families flourish.
Warehouse Stationery
Providing customers with everything they need to Work, Study, Create, Connect.
Noel Leeming
Making Kiwi lives better through technology.
Torpedo7 Group
Develop each Torpedo7 Group brand to be New Zealand’s leading retailer in their respective segment.
Financial Services
To be a leading New Zealand Retail Financial Services Company.

Strategy

The Group has stabilised its performance following a period of investment catch-up that was necessary after a phase of under-investment and sales decline in the late 2000s. The last 18 months show clear signs that the trading results are recovering, which indicates the business foundations and brand strategies are sound. The next phase of our strategy is to build sustainable profit growth, deliver returns on the investments made to date, and position the company to compete strongly in the future.

Our strategy is not a change in direction, it can be better described as a sharpened focus on those essential elements that are critical to the achievement of sustainable profit growth and the success of the business. It builds on the foundations of the past rather than abandoning and reworking the good work that has gone before.

Our strategy can be summarised as a drive to profit growth through operating efficiency, and repositioning the product and service experience to meet changing consumer needs enabled by digital technology.

Changing face of retail

The consumer landscape is changing rapidly as people’s lives get busier, and more connected to technologies which increases the complexity, richness and choice of shopping experiences. Technology is not only impacting how customers engage in retail activities, but it is also transforming the businesses who deliver those experiences, enabling more competition from non-traditional players as well as giving rise to different business models and ways to deliver value to customers.

Key trends are emerging in retail as the impact of these changes are felt; the rise of omnichannel which recognises that customers want a seamless experience whether they interact physically or virtually. Data analytics are transforming how retailers understand customer demand and behaviour, transforming the approach and investment in marketing. Physical space requirements are changing, still reflecting their importance in the channel mix, but requiring a flexibility and adaptability previously not needed. In addition the shopping experience is becoming much more of a focus than the task of putting products into customers’ hands.

While the Group has made some good progress addressing these challenges, now it needs to design these as fundamental parts of a successful retail business rather than as adjuncts to a traditional model.

To be successful in the future our retail brands need to:

  • Focus on core retail competencies that need evolving
  • Simplify their businesses and remove unproductive complexity and cost
  • Be fundamentally more agile in being able to adapt to changing customer demand
  • Shorten the cycle times in our business to remove risk
  • Innovate our marketing activities and mix.

Essentially retail is moving from a supplier-push model to a consumer-pull model and we have to redesign our retail businesses to be able to profitably operate that way.

Both now and in the future we will focus on improving our relevance to customers.

NOW

  • Continue to improve our product offer, adjusted range and assortment showing clear value leadership
  • Grow our data capability so that we understand better what customers want
  • Continue to invest in our staff to deliver the best service and experience to our customers
  • Design a more comprehensive customer engagement model into our business.

FUTURE

  • Achieve integrated retail leadership in New Zealand, delivering on the promise of omnichannel integration and providing great customer experiences
  • Improve and integrate how we ‘give back’ and support our local communities
  • Leverage the strength of the Group better to solve customers’ problems.

In order to achieve sustainable profitability we need to:

NOW

  • Accelerate changes in our operating model to drive profit:
    • Range and assortment focus in Red
    • Continue our migration to Every Day Low Price (EDLP) in Red
    • Optimise our supply chain and dynamic sourcing to improve cost of goods sold
    • Improve our inventory utilisation and free up working capital
    • Reduce costs

FUTURE

  • Reduce complexity and improve efficiency
  • Reconfigure the use of physical space across the Group to support omnichannel and reduce costs
  • Invest in value and price leadership
  • Switch our model from supply-push to customer-pull

In Summary

The Warehouse Group needs to continue to change and accelerate is performance to be successful in tomorrow’s retail and consumer environment. We have made some good progress but now need to focus and bring some additional skills to reposition the business and invest in our digital future. Those investments will be funded from extracting operating cost savings, and represent modest incremental investments, not large, long duration investment projects.

We will focus on execution to extract that value from the business, with our strategy being delivered in market by each brand, supported by some core Group capabilities.

This will enable us to deliver our vision set by Sir Stephen Tindall all those years ago of: A company that drives sustainable profitability and helps Aotearoa New Zealand to flourish.

Balance Sheet

The Group remains focused on driving the performance of the current business portfolio, as a consequence M&A activity is limited. We have identified that the Group is not a good owner of small businesses, however successful they may be, and have divested our 50% interest in pet.co.nz.
The acquisition of Westpac’s share in our joint venture was part of the growth strategy in financial services. That acquisition brought $57 million of finance receivables onto the balance sheet, and the associated debt financing of $55 million which has been arranged under a securitization financing plan.

As mentioned above, the financial services balance sheet is disclosed separately as it will be operated under a very different capital structure (a high proportion of debt financing underpinning the lending book) than the retail business. The financial services business has been carved out of any banking and financing covenants in our senior debt instrument, or commercial banking facilities.

We continue to explore incremental property development opportunities (develop, sale and leaseback), which we may fund ourselves or via development partners depending on the scale of the development. The Newmarket property is disclosed as available for sale reflecting the fact that we have been in the market looking for a development partner to redevelop the Newmarket site. Should that project proceed, it will commence in FY17.

Dividend

The Directors are pleased to confirm the final dividend of 5 cents per share, bringing the total dividend for FY16 to 16 cents per share. This is in line with the dividend policy of a distribution between 75% and 85% of the retail adjusted net profit after tax, (excluding financial services). The strategy that has been developed, and is outlined below, has been constructed on the basis of the business self-funding the investment that the strategy requires.

Outlook

As our earnings are significantly influenced by the Christmas trading performance, it is too early to provide specific earnings guidance for FY17. However, the current business performance, coupled with key elements of the Group’s strategic plan, should ensure that Adjusted NPAT for the Group in FY17 is above that recorded in FY16.

The challenges that we face over and above the normal challenges expected include increasing competitive activity and pressure; both online as major players strengthen their offers, and offline as global competitors enter the New Zealand market. There are risks around customer demand, influenced by general economic conditions and a push towards higher savings levels, as well as particular factors such as potential slowing of activity linked to the Christchurch rebuild and the Auckland housing market. Global economic volatility is also a relevant input into domestic consumption, investment and funding.

An additional challenge is an internal one – our ability to execute the strategy outlined above. To effect the changes that we are aiming for will require a discipline and focus on execution which is a level above what the business normally experiences. Specific capabilities and approaches will be used to mitigate that risk.