SPUR CORP. LIMITED INTEGRATED REPORT 2014

Chief executive officer’s report

Pierre van Tonder

The difficult economic conditions of the last few years continued into 2014. Consumers’ disposable income and confidence levels were assailed by low and declining GDP growth, rising costs and high profile labour unrest. With spending under pressure, the industry saw wholesale discounting by many restaurant and quick-service restaurant retailers to attract customers. Competition was exacerbated by the continued growth in supermarket convenience foods. Constrained spending is particularly evident among lower and middle-income families, with marked spikes in mid-month and month-end payday spending patterns becoming the norm.

The group responded to these challenges by continuing to offer generous portions, value for money and excellent service. We focused on sound operational disciplines, menu positioning, innovative marketing and we invested in training our franchisee employees. Our aggressive promotions included our value breakfast offers and numerous weekday specials across our brands to boost business in quieter weekday trading periods.

Group performance

In the context of the above circumstances, we are pleased that we managed to report good operational results even against the high base set in the previous year. Revenue grew 9.1% to R732.6 million and profit before income tax increased 2.7% to R201.9 million. The group’s profit growth is distorted by exceptional and one-off items which, if excluded, result in a 9.9% increase on a comparable basis.

The group’s operating profit margin declined on the prior year. This is due to the adverse swing in the cost of the group’s long-term share-linked retention scheme (net of the related hedge) and write-offs associated with the underperforming Mohawk Spur in the UK. Other contributing factors include closure costs relating to the Captain DoRegos distribution centre, professional costs incurred for the acquisition of The Hussar Grill, an international restructure and the cost of defending tax assessments relating to the group’s international operations. The inclusion of The Hussar Grill retail restaurants, which operate at a lower margin than the franchise operations, has also reduced the group’s operating profit margin.

Local divisional performance

Spur Steak Ranches saw restaurant turnovers grow by 11.3% and turnover from existing business rise by 9.8%. In the face of rapid increases in raw material and input costs, menu price increases were contained to 3.4% and 3.9% in November 2013 and May 2014, respectively. Franchise revenue increased 10.6% to R198.5 million. Improved efficiencies saw profit before income tax increase 11.2% to R176.6 million, resulting in an improvement in the operating profit margin. The Spur Family Card loyalty programme has been a profound success and a key differentiating factor for the brand.

Our franchisees invested approximately R54.0 million in 63 revamps during the year, demonstrating their commitment to their businesses and the brand. Five existing outlets were relocated to improved trading sites and we opened nine new restaurants in South Africa.

Panarottis Pizza Pasta produced another excellent set of results, growing local restaurant sales by 28.2% on turnover growth of 15.2% from existing outlets. Franchise revenue increased 25.4% to R20.9 million and profit before income tax was R13.1 million, an increase of 32.8% on the previous year. Operating profit margin improved due to the benefits of economies of scale. We opened eight new restaurants, relocated four and revamped seven. Customers have responded well to our use of imported Italian ingredients, breakfast and Sunday lunch promotions and higher visibility on television and radio.

John Dory’s Fish Grill Sushi reaped the benefits of the groundwork laid in the past, producing an excellent financial performance. The division achieved 21.0% growth in total restaurant sales and its contribution to group profit before tax increased 16.7% to R7.7 million. Existing restaurant turnover increased 12.0% and franchise revenue rose by 21.8% to R14.3 million. The operating profit margin contracted slightly as a result of further investment in resources to ensure future expansion of the brand.

Five new restaurants were opened in Gauteng, KwaZulu-Natal and the Eastern Cape, and three were revamped during the year.

Captain DoRegos was affected by the sustained pressure on consumers, which is particularly evident in the lower LSM market this brand services. This pressure has also led to an extremely competitive trading environment with multiple players chasing decreased spending. Sales decreased by 13.8% to R164.8 million. Franchise revenue totalled R8.2 million and the brand contributed R2.2 million to profit before income tax.

Four new outlets were opened and we closed 15 underperforming outlets during the year. A restructuring aimed at rationalising the division’s cost base was concluded in the early part of the new financial year. This, together with further remedial actions to improve efficiency, is anticipated to yield an improvement in profitability in the year ahead.

The Hussar Grill has exceeded initial expectations for the six months since its acquisition. Three of the six restaurants are directly owned and three are franchised. The combined franchise and retail division generated revenue of R15.7 million and contributed R2.8 million to profit before income tax.

The manufacturing and distribution division’s contribution to group revenue declined 17.4% to R176.6 million. The Captain DoRegos distribution centre was closed in November 2013 and its operations absorbed into our outsourced distribution network. Excluding the distribution centre, revenue for the division increased 9.0% and profit before income tax increased 4.0% to R59.9 million, equating to a decline in operating profit margin from 40.8% in the prior year to 38.9%. The secret sauce factory experienced high growth in raw material and input costs that were not directly passed through to franchisees and customers in an effort by management to protect franchisee profitability and maintain competitive pricing. We will continue investing in improvements to enhance efficiency within the facility.

The strength of our procurement function and relationship with our distribution partner is still a core differentiator for the group. Our outsourced logistics service provider experienced a 13.5% increase in product volumes from the group for the year on the back of an increase in restaurant sales and the size of the procurement basket. This strategy remains critical to the success of the franchising system from a sustainability, food safety, quality and consistency perspective.

International

Turnover at international restaurants grew 20.2% in rand terms, with the depreciation of the rand against major currencies providing some support. Total restaurant sales in local currencies rose 6.6% for the year.

It is positive that the UK region maintained total restaurant turnover (when applying a constant exchange rate) despite pressure from increased competition and a decline in foot traffic caused by the slow economic recovery in the region. The contribution to group profit before income tax in the current year was impacted by a write-off of R3.5 million relating to the underperforming Mohawk Spur in Wandsworth. Our Australian operations are beginning to show signs of improvement with restaurant sales increasing 6.7% on a constant exchange rate basis. The current year loss in Australia includes an impairment loss of R2.5 million relating to the Panarottis outlet in Blacktown as well as a profit of R2.2 million realised on the sale of the group’s 80% interest in the Panarottis outlet in Tuggerah (which had previously been impaired). Trading losses for these two outlets had a negative impact on the division’s performance for the year.

In contrast, our operations in the rest of Africa and Mauritius produced strong results bolstered by the opening of seven new franchised restaurants in territories in which we already trade. We continue to develop our understanding of the challenges and opportunities in the various countries in which we operate and we are positive about future growth in these regions.

International operations produced a pre-tax profit of R1.5 million compared to a loss of R7.3 million (restated) in 2013. On a comparable basis (excluding one-offs, impairments, foreign exchange differences and other exceptional items) the division contributed R4.5 million to profit before income tax, up 49.2% on a comparable prior year number of R3.0 million.

Local restaurant revenue growth

To grow revenue in South Africa, we need to open new restaurants and increase sales in existing restaurants by continuing to meet the evolving needs of our customers. We have increased revenue per restaurant through innovations such as introducing value breakfast offers, aggressive midweek specials and maintaining a strong marketing presence. The Spur Family Card loyalty programme has demonstrated higher spend per visit, with the average loyalty invoice exceeding the average non-loyalty invoice by 34.8%, and holders visiting our restaurants more frequently. The Panarottis loyalty programme will be rolled out early in the 2015 financial year.

Through the acquisitions of Captain DoRegos and The Hussar Grill, the group has broadened its market presence into lower and higher LSM markets.

International expansion

The group’s strategy is to grow our presence in key countries where there are opportunities, with an emphasis on expanding our presence in territories in which we already trade to capitalise on economies of scale.

While our international expansion has not been without challenges, our restaurants in the UK and Ireland are trading reasonably well and we are pursuing some exciting opportunities. We opened our first hotel test site in the UK in Leicester in December 2013 and initial indications are that the business model is viable. We intend piloting a new Spur RBW (Ribs Burgers Wings) counter service concept in the UK in the new financial year. The lower initial capital outlay and reduced overhead structure of the Spur RBW model could prove to be an attractive franchising opportunity.

We believe our operations in Australia are turning the corner, with a number of locations in the development pipeline on the horizon. We intend to exit from our retail investments in Australia to focus our resources on growing the franchise business. We expect the region to produce solid results in the years ahead.

Opportunities in the rest of Africa offer access to markets with higher growth rates, once local conditions are understood and specific challenges overcome.

We opened new restaurants in Leicester in the UK, Southlands in Western Australia and one each in Namibia, Nigeria, Swaziland, Tanzania and Zambia. We also reopened two of our Botswana outlets with new franchisees.

Sustainable local franchise model

Franchisee profitability is at the core of our business. Without profitable franchisees, the group has no income and potential restaurant owners have no incentive to open one of our restaurants. Franchisees rely on revenue growth and improved efficiencies to overcome rising input costs, many of which are outside their control. We constantly refine our business models to increase operational and financial efficiencies.

Spur also continues to roll out smaller format outlets where a lower volume and lower cost model better suits the target market.

Spur, Panarottis and John Dory’s have applied significant effort in providing family-friendly facilities to attract customers with young families and this will remain a focus in the year ahead.

Sustainable supply of raw materials

The great food served in our restaurants is dependent on a reliable supply of high-quality raw materials. This supply can be disrupted by labour unrest, geographic factors and, over the longer term, trends such as global warming. Our close relationship with our suppliers and distribution partner gives us insight into short-term supply and demand dynamics. We source raw materials from responsible suppliers who use sustainable production methods and we continually evaluate their sustainability and contingency plans.

The acquisition of the share in Braviz Fine Foods strategically aligns the group with a major supplier and helps us better control supply, quality and price of ribs – one of our core products.

Product responsibility

Food safety and food quality are critical concerns for all our restaurants – we know we are only ever as good as our last meal. Social media has extended the word of mouth reach and a bad experience can cause damage to a brand. Therefore, our manufacturing facilities, our suppliers’ manufacturing facilities, and our distribution partner, meet the highest standards of food safety.

Corporate social investment

The Spur Foundation’s motto is ’Nourish, Nurture, Now!’ and this is reflected in the socio-economic development initiatives it supports. These make a meaningful difference to the communities around us, specifically through feeding programmes for children and the provision of basic necessities and amenities. The group also invests in promoting a healthy lifestyle and giving people a ’taste for life’ through its support of numerous sporting and community-focused events. More information on the Spur Foundation can be found here.

Transformation

Business in South Africa has to absorb the ethos of transformation into its organisational DNA to ensure sustainability. Transformation is a journey that is less about meeting regulatory benchmarks and more about creating a company that is a true reflection of South Africa as a community. The group’s externally accredited B-BBEE certification improved to level 6.

The empowerment transaction with Grand Parade Investments Ltd, which was announced at the end of July 2014 and approved by shareholders on 3 October 2014, introduces a strategically aligned business partner that will add value to the group, and a strong empowerment partner.

Skills development

Spur Corporation’s highest overhead and biggest investment is in human capital through salaries, wages and training. We invest in our people because it is good business practice. We are managers of intellectual property and it is through the development of this intellectual property that we facilitate franchisee success. Skills development gives people the opportunity to achieve better personal benchmarks for themselves and the company.

We trained 8 565 corporate and franchisee employees, an increase on the prior year figure of 7 220, across multiple areas of our business. This investment unlocks employee potential, builds self-esteem and offers critical support to our franchisees to help them run sustainable and profitable businesses.

The Spur College of Excellence uplifts franchisee employees with potential from historically disadvantaged backgrounds. Courses are run in Cape Town and Johannesburg and include six months of intensive theoretical and practical training. This year a further 13 franchisee employees graduated. The group’s adult education training programme supported 30 corporate employees in improving their basic English and mathematical literacy, opening new career paths for them and improving their self-confidence.

Environment

The group continues to implement energy efficiency, waste management and other environmental initiatives at its corporate offices and to support franchisees in managing their environmental footprint. The rampant increases in electricity costs have made energy efficiency a key focus in franchisee margin management and environmental impact. The group’s sustainability team offers training courses to corporate and franchisee employees to raise awareness and provide practical tips on environmental sustainability. We monitor franchisee environmental performance through six-monthly reviews in the green operations assessment.

Outlook

As always, our focus in 2015 will be on enhancing value for our shareholders and other stakeholders. Economic pressures locally and abroad are likely to continue to dampen consumer demand in the restaurant sector in the short to medium term. Management is confident that the group will continue to deliver on its growth strategy by targeting organic growth within our existing brands and markets, and pursuing opportunities to expand vertical integration in relation to core products.

Ensuring that the group’s brands remain relevant to consumers in their respective markets will be critical to sustained organic growth, as will an uncompromising approach to operating standards and quality, product innovation, and value for money. In the year ahead, we will also focus on ensuring efficient and optimal resource use to contain costs in an uncertain consumer environment.

The Hussar Grill and Braviz Fine Foods are exciting developments in our long-term strategy and we are looking forward to taking the first steps to entrench these new operations into the group. We will continue to evaluate acquisition opportunities as they arise.

We believe in the long-term rationale for our presence in the lower LSM market through Captain DoRegos. Since we acquired the business, we have endured the ‘short-term pain’ involved in taking the corrective measures necessary to fit the model into the group. The management, operational and financial changes we have implemented position us well to realise the value in the brand in the future.

We are positive about the ongoing growth of the group into Africa. Many of the fields we have ploughed are now starting to show growth. While the consensus outlook for the South African market does not appear particularly positive in the near future, we believe there will still be demand for great food at a reasonable price in an entertaining family environment. We aim to ensure that our brands are at the forefront of offering value as the most attractive places to go. We have a busy year ahead of us.

Thanks

In conclusion, I thank the board for their direction and participation and my co-executive directors for their valuable input. I also thank all senior managers and team players in Spur Corporation and its subsidiaries for their ongoing commitment to company performance and their commitment to the company ethos.

Pierre van Tonder GROUP CHIEF EXECUTIVE OFFICER