SPUR CORP. LIMITED INTEGRATED REPORT 2015

Chief financial officer’s report

COMPARABLE OPERATING PROFIT BEFORE INCOME TAX
 10.8%
COMPARABLE HEADLINE EARNINGS PER SHARE
 14.4%
The South African operations delivered solid results, despite pedestrian economic growth, and the group's new acquisitions exceeded our initial expectations.

Spur Corporation delivered another strong performance despite a challenging economic and operating environment. While the results in the UK operation and at Captain DoRegos were disappointing, the group’s expansion into Africa showed good progress and the contribution from Australia resumed its positive trend. The South African operations delivered solid results, despite pedestrian economic growth, and the group’s new acquisitions exceeded our initial expectations.

Restaurant sales increased 12.1% to R6.2 billion (2014: R5.5 billion) due to growth in core brands, the inclusion of The Hussar Grill for 12 months (2014: six months) and RocoMamas for four months. Sales from existing restaurants increased 7.8%, a satisfactory result in a difficult trading environment.

Group revenue grew by 3.7% to R760.1 million (2014: R732.6 million) and group profit before income tax increased by 1.8% to R205.4 million (2014: R201.9 million).

Group operating profit before finance income did not achieve the target of R215.0 million, primarily due to the IFRS2 share-based payment expense of R33.0 million relating to the GPI B-BBEE transaction concluded during the year.

Comparability of group profit before income tax and headline earnings per share is distorted by a number of one-off and exceptional items that are reconciled in the tables here and here in this section. Adjusting for these one-off and exceptional items, comparable profit before income tax increased by 10.8%, comparable profit before finance income increased by 9.4% and comparable headline earnings per share increased by 14.3%.

The target of 15% growth in comparable profit before finance income was not achieved largely as a result of the disappointing performance in the UK region.

Operating margin and return on equity were negatively impacted by the share-based payment expense relating to the GPI B-BBEE transaction.

In addition, the decline in the operating margin in recent years is attributable to the inclusion of the Captain DoRegos depot from March 2012, and the increased number of company-owned restaurants in the UK and Australia which operate at substantially lower margins than the franchise businesses. The Captain DoRegos depot was closed in November 2013, the three remaining company-owned restaurants in Australia were disposed of during the year and a company-owned restaurant in the UK was closed in February 2015. All of these factors should have a favourable impact on the group’s operating margin in the year ahead.

The return on equity is further negatively impacted in the current year by the issue of additional shares to GPI. In addition, a weakening rand increases the local currency equivalent asset base of the group’s international operations, and the returns on those assets are relatively low (or loss making in the case of the UK), which has a double negative impact on the return on equity. Assuming that the rand stabilises, it is anticipated that return on equity will improve by a reasonable margin in the year ahead.

Comparable operating profit reconciliation

The table below reconciles profit before income tax to comparable profit before income tax. The table shows key items included in the calculation of profit and is not intended to indicate sustainable or maintainable profit.

  2015 
R’000 
2014 
R’000 

change 
Profit before income tax 205 421  201 871  1.8 
Acquisition-related costs 233  1 620   
Captain DoRegos distribution centre closing costs –  1 326   
Foreign exchange loss/(gain) 21  (2 616)  
GPI B-BBEE transaction 19 554  –   
Impairment and associated losses 14 959  5 974   
International structure and tax query costs 1 310  2 169   
Loss on disposal of subsidiary 4 674  – 
Profit on disposal of subsidiaries (4 954) (2 154)  
Release of non-controlling interest shareholder loan (5 173) –   
RocoMamas contingent consideration 3 681  –   
Share appreciation rights cost (net of related hedge) 4 941  10 195   
Share appreciation rights cost (actual net cost amortised on straight-line basis) (7 768) (6 073)  
Spur Foundation (1 761) (122)  
Comparable profit before income tax 235 138  212 190  10.8 
Net finance income (excluding impact of GPI B-BBEE transaction) (10 912) (7 251)  
Comparable profit before finance income 224 226  204 939  9.4 

Item 2015  2014 
Acquisition- related costs Legal, due diligence and consulting costs of R0.233 million were incurred in the acquisition of the RocoMamas franchise business during the year. These costs are required to be expensed in accordance with IFRS. Legal, due diligence and consulting costs of R1.620 million were incurred in the acquisition of The Hussar Grill franchise and retail outlets during the year. These costs are required to be expensed in accordance with IFRS.
Captain DoRegos distribution centre closing costs Rnil Includes retrenchment costs of R0.238 million, the loss on asset sales of R0.329 million, and the increased cost of working (arising on the sale of assets while still operating) of R0.759 million.
Foreign exchange A net loss of R0.021 million, which includes a gain of R1.899 million in realised and unrealised exchange differences and a loss of R1.920 million relating to translation differences of foreign operations (initially taken directly to equity) recycled to profit as the related foreign operations were deregistered or abandoned during the year. A net gain of R2.616 million, which includes a loss of R0.770 million in realised and unrealised exchange differences and a gain of R3.386 million relating to translation differences of foreign operations (initially taken directly to equity) recycled to profit as the related foreign operations were deregistered or abandoned during the year.
GPI B-BBEE transaction A net cost of R19.554 million which comprises an IFRS 2 share-based payment expense of R32.957 million, transaction costs of R0.301 million and an estimate of dividend and interest income of R13.704 million arising from the transaction. Rnil
Impairment and associated losses R13.905 million relates to the impairment of the Captain DoRegos trademark and related intellectual property intangible assets. R1.054 million relates to the impairment of property, plant and equipment of the Cheyenne Spur in the 02 Arena in London (UK). R2.496 million relates to the impairment of property, plant and equipment of the Panarottis in Blacktown (Australia). R1.866 million relates to the impairment of the franchise rights intangible asset and R1.612 million relates to the accelerated amortisation of leasing rights relating to the Mohawk Spur in Wandsworth (UK).
International restructure and tax query costs Professional services costs of R1.310 million associated with defending assessments issued by SARS in respect of the group’s controlled foreign companies and the assessments issued in respect of the group’s 2004-2009 share incentive scheme as detailed in notes 45.1 and 45.2, respectively, of the annual financial statements. Professional services costs of R2.169 million associated with defending assessments issued by SARS in respect of the group’s controlled foreign companies and the implementation of a restructure to facilitate the uninterrupted operation of the group’s international franchise division as detailed in notes 45.1 and 36.1 respectively, of the annual financial statements.  
Loss on disposal of subsidiary The group realised a loss on the disposal of the Silver Spur business in Penrith (Australia) – see note 35.3 of the annual financial statements. Rnil
Profit on disposal of subsidiaries The group realised a profit of R1.506 million on the sale of its 92.7% interest in the Panarottis in Blacktown (Australia) and a profit of 3.448 million on the sale of its 100% interest in the Panarottis in Penrith (Australia) – see note 35.1 and 35.2 respectively of the annual financial statements. The group realised a profit of R2.154 million on the sale of its 80% interest in the Panarottis in Tuggerah (Australia) to the former operating partner of the outlet – see note 35.4 of the annual financial statements.  
Release of non-controlling shareholder loan The group previously recognised a loan payable to the non-controlling shareholder of Larkspur Five Ltd, an entity in which the group held a 70.6% interest. The entity had previously operated the Golden Gate Spur in Gateshead (UK), which ceased trading in October 2013. The company was dissolved on 16 June 2015 and the group was effectively released of its liability to the non-controlling shareholder. Rnil
RocoMamas contingent consideration The purchase consideration for the acquisition of RocoMamas is determined as five times RocoMamas’ profit before income tax in the third year following the date of acquisition. IFRS requires a liability to be recognised at fair value for this contingent consideration. Any change in the fair value is recognised in profit. The change in fair value for the period from 1 March 2015 to the reporting date amounted to R3.681 million. Rnil
Share appreciation rights cost (net of related hedge) (long-term share-linked employee retention scheme) Comprises a share-based payment expense of R19.735 million, net of a gain on the related hedging instrument of R14.794 million – see notes 23 and 17 respectively of the annual financial statements. Comprises a share-based payment expense of R28.117 million, net of a gain on the related hedging instrument of R17.922 million – see notes 23 and 17 of the annual financial statements.  
Share appreciation rights cost (long-term share-linked employee retention scheme) (actual net cost amortised on straight-line basis) The vagaries of the IFRS treatment of the share appreciation rights and related hedging instruments create significant volatility in earnings. The purpose of the hedge is to fix the cost of the scheme at the commencement of each tranche of rights. The economic cost to the group of the scheme, should it be amortised on a straight-line basis over the vesting period of each tranche, amounts to R7.768 million for the year. The vagaries of the IFRS treatment of the share appreciation rights and related hedging instruments create significant volatility in earnings. The purpose of the hedge is to fix the cost of the scheme at the commencement of each tranche of rights. The economic cost to the group of the scheme, should it be amortised on a straight-line basis over the vesting period of each tranche, amounts to R6.073 million for the year.
Spur Foundation Profit of R1.761 million. While the Spur Foundation is required to be consolidated in terms of IFRS, the full profit/loss is attributable to non-controlling interest. Profit of R0.122 million. While the Spur Foundation is required to be consolidated in terms of IFRS, the full profit/loss is attributable to non-controlling interest.

The effective tax rate was 34% (2014: 32%). The main reason for the increase relates to the share-based payment expense arising from the GPI B-BBEE transaction which is non-deductible. The effective tax rate is greater than the corporate tax rate of 28% in the current year because the impairment recognised in the UK is not tax deductible, the deferred tax adjustment arising on the Captain DoRegos intangible asset impairment is calculated at the effective tax rate attributable to capital gains, and no deferred tax assets are recognised in respect of the tax losses incurred in the UK.

Comparable headline earnings reconciliation

2015 
R’000 
2014 
R’000 

change
 
Headline earnings – as reported 141 511  135 203  4.7 
Acquisition-related costs 233  1 620   
Captain DoRegos distribution centre closing costs –  955   
Foreign exchange (gain)/loss (1 424) 578   
GPI B-BBEE transaction 22 236  –   
Impairment and associated losses –  1 612   
International structure and tax query costs 973  2 119   
Release of non-controlling interest shareholder loan 277  –   
RocoMamas contingent consideration 3 681  –   
Share appreciation rights cost (net of related hedge) 3 558  7 340   
Share appreciation rights cost (actual net cost amortised on straight-line basis) (5 594) (4 373)  
Comparable headline earnings 165 451  145 054  14.1 
Weighted average number of ordinary shares (excluding GPI) (’000) 85 429  85 633  (0.2)
Comparable headline earnings per share (cents) 193.67  169.39  14.3 

Earnings per share decreased 13.5% to 137.7 cents per share (2014: 159.2) and headline earnings per share decreased 3.2% to 152.8 cents per share (2014: 157.9). Headline earnings were impacted by the increased number of shares in issue and the costs and income arising from the GPI B-BBEE transaction. Comparable headline earnings per share increased by 14.3%. Distribution per share increased 9.1% to 132 cents (2014: 121); although, as a consequence of the increase in the number of shares, the gross dividend declared increased by 21.2% to R143.2 million (2014: R118.1 million). The group’s dividend policy remains unchanged at a payout of 75% of headline earnings adjusted for exceptional and one-off items and our intention is to maintain this policy.

Segmental performance

Revenue

Profit before income tax

Operating margin

2015 
R’000 
2014 
R’000 

change
 
2015 
R’000 
2014 
R’000 

change
 
2015 
R’000 
2014 
R’000 

change
 
Manufacturing and distribution 173 924  176 576  (1.5) 67 083  58 520  14.6  38.6  33.1  5.5 
Spur 217 276  198 498  9.5  194 037  176 552  9.9  89.3  88.9  0.4 
Panarottis 27 575  20 932  31.7  18 904  13 117  44.1  68.6  62.7  5.9 
John Dory’s 16 220  14 271  13.7  9 119  7 736  17.9  56.2  54.2  2.0 
Captain DoRegos 6 077  8 185  (25.8) (11 821) 2 158  (647.8) (194.5) 26.4  (220.9)
The Hussar Grill 2 417  700  245.3  1 298  471  175.6  53.7  67.3  (13.6)
RocoMamas 2 175  –  –  1 386  –  –  63.7  –  – 
The Hussar Grill retail 30 760  14 988  105.2  4 645  2 354  97.3  15.1  15.7  (0.6)
Other segments 58 861  44 958  30.9  327  (160) 304.4       
Unallocated 1 720  1 595  7.8  (81 818) (60 020) (36.3)      
Total South Africa 537 005  480 703  11.7  203 160  200 728  1.2  37.8  41.8  (4.0)
UK 147 657  157 565  (6.3) (4 714) (2 232) (111.2)      
Australia 55 729  79 366  (29.8) 4 488  (157) 2 958.6       
Other segments 19 668  15 002  31.1  10 616  8 829  20.2       
Unallocated –  –  –  (6 496) (4 918) (32.1)      
Total international 223 054  251 933  (11.5) 3 894  1 522  155.8  1.7  0.6  1.1 
Total 760 059  732 636  3.7  207 054  202 250  2.4  27.2  27.6  (0.4)

Revenue declined in the manufacturing and distribution segment owing to the closure of the Captain DoRegos depot in November 2013. The depot’s revenue amounted to R22.7 million in the prior year and the loss before income tax amounted to R1.4 million. The depot operated at a low margin and the exclusion of this business consequently resulted in the significant increase in the operating margin in the current year. Overall segment comparable revenue, which removes the depot from the prior year comparative number, increased by 13.0%. The margin further benefitted from the higher cost of integration (distribution fee) income which effectively realises a 100% margin, as the group’s procurement basket and franchisee participation increases.

Franchise revenue in the Spur, Panarottis and John Dory’s franchise brands increased in line with restaurant turnovers and the margins benefitted from increased revenues and the associated economies of scale.

The Captain DoRegos loss before income tax includes the impairment of the trademark and related intellectual property. Excluding this impairment, the brand actually increased its operating margin to 34.3%. As a consequence of the lower turnovers, cost cutting measures were implemented to “cut our cloth accordingly”.

The Hussar Grill franchise margin declined due to travel and development costs incurred in exploring opportunities to expand the brand nationally.

Other local segments comprise the group’s décor manufacturing, export, radio station, training and call centre businesses. The increase in revenue related largely to the increase in export business driven by store openings internationally. With the exception of the export business, the other businesses are not intended to make significant profits as they are largely support functions to franchisees.

Unallocated South Africa loss before income tax includes:

  • net finance income of R24.4 million (2014: R7.1 million) (which includes interest and preference dividends relating to the GPI B-BBEE transaction in the current year);
  • the impact of the long-term share-linked employee retention scheme;
  • the net income of the Spur Foundation Trust;
  • the share-based payment charge and transaction costs relating to the GPI B-BBEE equity transaction;
  • professional fees related to the acquisition of RocoMamas in the current year and The Hussar Grill in the prior year;
  • the fair value adjustment relating to the RocoMamas contingent consideration liability; and
  • professional advisory fees of R0.5 million relating to defending the tax queries on the group’s international structure and 2004 share incentive scheme in the current year, and the prior year includes costs of R0.4 million relating to a restructure of the group’s international subsidiaries.

The UK segment comprises the franchise business and company-owned outlets. The Golden Gate Spur in Gateshead and Mohawk Spur in Wandsworth ceased trading in October 2013 and February 2015 respectively, which accounts for part of the reduction in revenue. The two outlets contributed revenue of R8.5 million for the year (2014: 18.5 million). The loss for the year includes the impairment loss on the Cheyenne Spur in the O2 Arena and the gain on the release of the non-controlling shareholder's loan in Larkspur Five Ltd on dissolution of the entity. The prior year includes an impairment of franchise rights and the accelerated amortisation of leasing rights relating to Mohawk Spur. Excluding these exceptional and one-off items, as outlined in the table above, the region contributed a trading loss for the year of R8.7 million (2014: R1.3 million profit).

The Australia segment comprises the franchise business and company-owned outlets. The Panarottis in Blacktown was sold with effect from 15 November 2014 and the Silver Spur and Panarottis outlets in Perth were sold with effect from 31 March 2015. The Panarottis in Tuggerah was disposed of on 1 January 2014. Consequently, the region now operates on a fully franchised model. Revenue related to these company-owned outlets amounted to R49.3 million (2014: R76.0 million). Excluding the exceptional and one off items relating to the impairment and disposal of these outlets outlined in the comparable profit table above, the region returned a profit of R4.3 million relative to R0.3 million in the prior year, which is a positive indication of a sustained turnaround.

Revenue from other international segments, comprising largely the African operations, increased in line with improved trading in the region. The margin contraction is due to the significant increase in travel costs related to developing and expanding the group’s footprint on the continent.

Unallocated international loss before income tax includes foreign exchange gains/losses and professional advisory costs of R0.8 million (2014: R1.7 million) relating to the group’s international restructure and related tax matters, as outlined in the comparable profit table above.

  2011 
2012 
2013 
2014 
2015 
Local franchise operating profit margin          
Manufacturing and distribution 45.5  39.0  27.9  33.1  38.6 
Spur 86.6  87.8  88.5  88.9  89.3 
Panarottis 59.3  60.7  59.2  62.7  68.6 
John Dory’s 46.4  52.5  56.6  54.2  56.2 
Captain DoRegos –  37.1  41.8  26.4  (194.5)
The Hussar Grill –  –  –  67.3  53.7 
RocoMamas –  –  –  –  63.7 

Financial position

Group total assets increased to R1.1 billion from R738.0 million in 2014 due to the increase in cash of R222.3 million and increase in investments (comprising preference shares) of R72.3 million relating to the GPI B-BBEE transaction, and an increase in intangible assets and goodwill relating to the acquisition of RocoMamas of R49.6 million (of which only R2.0 million has been settled in cash).

Total loans receivable increased by R109.2 million. In addition to the GPI preference shares, with a carrying value at the reporting date of R76.7 million, the increase is attributable to the aggregate receivables of R14.4 million arising from the disposal of the Australian company-owned outlets, and an additional loan of R10.0 million advanced to Braviz Fine Foods as bridging finance to fund working capital during the start-up stage of operations.

A contingent consideration liability, measured at fair value of R47.3 million, has been recognised in relation to the acquisition of the RocoMamas business. The purchase consideration is determined as five times the profit before income tax of the business for the 12 month period ending 28 February 2018, with an initial payment of R2.0 million on the acquisition date of 1 March 2015. Interim payments (or refunds, as the case may be) will be made on the first and second anniversary dates of the acquisition date calculated as five times the profit before income tax of each anniversary period less any previous payments made. The total purchase consideration over the three-year period is estimated at R70.8 million, the present value of which amounted to R45.7 million at acquisition date.

During the year, the group acquired an additional 361 273 treasury shares at an aggregate cost of R11.4 million. The group intends continuing to repurchase shares in the year ahead. The group’s financial position remains ungeared with no formal external borrowings.

Cash generated from operations increased 3.6% to R209.9 million (2014: R202.6 million). Working capital increased by R12.9 million, largely attributable to the timing of promotional marketing activities and the related receivables from franchisees.

  2015 
R’000 
2014 
R’000 
Capital expenditure    
Maintenance 12 074  9 298 
Expansion 18 711  784 
Total 30 785  10 082 

Capital expansion in the current year includes R8.2 million for land and R5.1 million for buildings as the group has outgrown its office in Century City in Cape Town. The total contract value for the construction of the additional administrative building is R39.0 million. A further R5.4 million relates to the fit out of the pilot Spur RBW in Corby (UK). Maintenance capital expenditure is anticipated to remain consistent in the year ahead.

The board has approved an investment of R25.0 million in the construction of company-owned The Hussar Grill restaurants in order to establish the brand in Gauteng, with the first such outlet completed in September 2015. The board has furthermore approved an additional investment of R6.5 million for the relocation of the company-owned The Hussar Grill in Green Point (Cape Town) and the establishment of a company-owned RocoMamas outlet in the existing Green Point site.

In addition, the board has approved a further investment of £750 000 for the rollout of a further three company-owned Spur RBW restaurants in the UK. There is no obligation on the part of the group to proceed with the investment, and any decision in this regard will depend on the success of the Corby pilot.

Tax queries

The South African Revenue Service (“SARS”) has issued the group with additional assessments relating to the group’s offshore controlled foreign companies amounting to R2.0 million. In a separate case, SARS has issued the group with additional assessments totalling R6.6 million, following the disallowance of a deduction claimed in respect of the group’s 2004 share incentive scheme. Both amounts have been settled in cash, objected to and are the subject of alternate dispute resolution (ADR) proceedings.

Subsequent to year end, SARS issued further assessments in the second matter amounting to R15.4 million, which have been objected to. The board, in consultation with its tax advisors, remains confident that it will be able to prove that SARS has erred in disallowing the deductions and, consequently, no liability has been raised in respect of the assessments issued to date. More information on these matters is available in notes 45.1 and 45.2 of the annual financial statements.

Long-term share-linked employee retention scheme

In December 2010, the group implemented a long-term share-linked incentive scheme, in terms of which a maximum of 1.5 million cash-settled share appreciation rights are issued to senior management each year. To mitigate the liquidity risk associated with the share appreciation rights, the board requires that the obligation in respect of these rights is hedged to the extent possible. To hedge the possible cash outflow resulting from the rights, the group has concluded a number of forward purchase transactions. The hedge is only effective if the share price appreciates above the forward price of the contracts.

On the assumption that this is the case, the cost per tranche of rights issued is essentially fixed as the difference between the grant date strike price of the rights issued and the forward price of the contracts. In terms of IFRS, the share appreciation rights liability is fair valued at each reporting date and charged to profit over the vesting period of the rights; while the underlying economic hedging instrument is fair valued at each reporting date, with the full change in fair value immediately recognised in profit. This difference in accounting for the changes in fair values of the rights and hedging contracts creates an accounting mismatch, which is excluded in the comparable profit measures reported above. However, the scheme does have a cost to the group, which is added to the comparable profit measures referred to in the table above. The table below demonstrates the normalised impact of the scheme over the vesting periods of the respective rights.

Grant date Dec 2010  Dec 2011  Dec 2012  Dec 2013  Dec 2014  Total 
Vesting date Dec 2013  Dec 2014  Dec 2015  Dec 2016  Dec 2017   
No. of rights granted (’000) 1 500  1 500  1 500  1 500  1 500   
Grant date strike price (R) 14.62  14.80  21.29  30.38  30.91   
Forward price (R) 17.10  17.76  25.64  37.57  35.94   
Total cost (R’000) 3 720  4 440  6 525  10 785  7 545   
Annualised cost (R’000) 1 240  1 480  2 175  3 595  2 515   
Annualised cost 2014 (R’000) 620  1 480  2 175  1 798  –  6 073 
Annualised cost 2015 (R’000) –  740  2 175  3 595  1 258  7 768 


Outlook

We do not expect the trading environment to improve markedly in the year ahead. However, we believe the group is well positioned to continue its expansion into new markets in Africa and to leverage new store formats and grow its new and existing brands. The group will continue to build on its current base and investigate potential acquisitions to increase vertical integration in the supply chain in order to enhance corporate and franchisee profitability.

Ronel van Dijk
Chief financial officer