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Business and Trading Update 2013

04 February 2013

Edcon would like to update investors on a number of recent developments in our business.

  • Investment in strategic initiatives starting to show traction
  • Preliminary results for 13-week ended 29 December 2012: Headline results down for the quarter
  • Tax settlement agreed with the South African Revenue Service with no near-term cash impact
  • Commitment letters signed for approximately R4 billion senior secured term loan facility to refinance short term maturities
  • Background

    In particular, we would like to describe our progress on certain of our key strategic initiatives and provide investors with details on our recent tax settlement with the South African Revenue Service ("SARS"). In addition, we are providing investors with certain preliminary financial results for the 13-week period ended 29 December 2012. We expect to publish Edcon's interim financial statements and quarterly report as at and for the 13-week and 39-week periods ended 29 December 2012 on or about 21 February 2013. 

    Update on Strategic Initiatives

    Edcon would like to provide more detail on the strategic and operational initiatives it has started implementing, and intends to implement further, in order to meet the following four key objectives:

    • deliver growth on a same-store basis;
    • deliver growth through the increase of our footprint;
    • improve our margins; and
    • increase sales through our private label store card programme.

    Delivering growth on a same-store basis 

    We have recently initiated the process of refurbishing and improving the assortments and selection of key merchandise in 72 of the leading Edgars stores, with positive results so far.  We invested approximately R65 million in the first phase of this project, which we initiated in May 2012 and completed in November 2012. Our sales in these 72 stores were adversely affected during the time they were being refurbished but exhibited growth with respect to the merchandise categories covered by our merchandising initiative of approximately 6 percentage points higher than the remainder of our Edgars stores since completion. We plan to implement the second phase of this project, which includes rolling out "stores-in-store" devoted to international brands such as Topshop, from April to August 2013 across the same 72 stores. Total investment for this second phase is budgeted at approximately R300 million. 

    We have implemented a new merchandising strategy in our Discount division, and more recently in our Edgars division, aiming to provide "fashion-right" offerings within our private label, with a focus on key value items in our Discount division. We believe this strategy resulted in the increased market share of our Discount division in ladieswear.

    Approximately 8.8 million of our customers are now members of our "Thank U" loyalty programme, which will give us the opportunity to promote our offerings through selective direct marketing, which we expect should have a positive impact on our results. We are required to record a provision equal to approximately 1% of our sales made under our "Thank U" loyalty programme, which has a one-off impact on our revenues for period-to-period comparability purposes.

    Delivering growth through the increase of our footprint

    We plan to continue our disciplined investment programme, targeting on a long-term basis an average annual square metre growth of over 5%. Despite the impact of our store rationalisation programme, we have increased the total number of our stores over the past six years, from 909 stores at the beginning of fiscal year 2007 to 1,218 stores at 29 December 2012. We plan to grow our offering by: (i) adding space to our existing stores, mainly to broaden our offering through the opening of stores- in-stores; (ii) continuing to add new stores with a focus on our speciality offerings such as Legit, Edgars Active and Edgars Shoe Gallery; and (iii) promoting our mono-brand offerings, such as Topshop. We also intend to consider opportunities and selectively expand our presence in the rest of Africa, where we have recorded positive results so far. 

    We plan to enhance operating margins by continuing to: (i) improve our retail price management; (ii) leverage our sourcing capabilities and input price management while reducing markdowns; (iii) optimise our store operations to improve merchandise availability and effectively organise promotional schemes; and (iv) improve the efficiency of our support functions.

    We have extended our quality assurance and control functions to China and Bangladesh, closer to certain of our suppliers, to reduce our dependence on, and the costs associated with, intermediaries. The amount of our purchasing done directly with the suppliers has increased meaningfully for winter 2013. We have also increased the number of South African and regional suppliers in support of our "quick response" strategy. The amount of product ordered from South African and regional suppliers more than doubled between summer 2011 and summer 2012. Quick response allows stock to be ordered in smaller, more customised orders, thereby allowing testing of merchandise. This approach reduces fashion risk and the amount of markdowns required based on a demand forecasting system. 

    Store optimisation initiatives, substantially rolled out in our Discount division but just beginning within the Edgars division, have contributed to productivity and the stabilisation of store costs.

    Increasing sales through our private label store card programme

    We expect the recent sale of our receivables to, and our new strategic relationship with, Absa will allow us to better focus on our core retail operations. It will also improve our working capital by changing our business to a cash business. We expect that this ready access to credit will continue to draw customers to our stores and help us to grow our customer base.

    Trading update

    Total retail sales for 13-week ended 29 December 2012 are expected to be between R8,300 million and R8,375 million, compared to R8,386 million for 13-week ended 31 December 2011, a slight decrease primarily due to the trading performance from the Discount division as well as the impact of new initiatives in the Edgars division. Gross profit margin is expected to be higher due to improved margins in the Discount division, while Edgars divisional margin is expected to remain stable when compared to 13-week ended 31 December 2011. On a same-store basis, retail sales are expected to be lower by 3.4% to 3.5% over the period, primarily due to the trading performance of the Discount division.

    Edgars division retail sales are expected to be between R4,525 million and R4,560 million for 13- week ended 29 December 2012, compared to R4,367 million for 13-week ended 31 December 2011, an increase primarily due to the continued opening of Edgars Active stores and increased promotional activity. However, we expect same-store sales to be lower by 2.1% to 2.2% compared to the prior year period due to temporary disruptions as initiatives were implemented in Edgars stores. Promotional activity had a positive impact on our retail sales.

    Discount division retail sales are expected to be between R3,140 million and R,3,170 million for 13- weeks ended 29 December 2012, a decrease compared to R3,368 million for 13-week ended 31 December 2011. Such decreases are primarily due to delays in stock delivery and lower mobile phone sales, as well as the discontinuation of our Discom brand. Margins continued to improve as the benefits of the change in product mix and improved pricing and sourcing initiatives materialised. We expect same-store sales to be lower by 5.8% to 6.0% over the 13-week ended 29 December 2012 compared to 13-week ended 31 December 2011.

    CNA retail sales are expected to be between R635 million and R645 million for 13-weeks ended 29 December 2012, compared to R651 for 13-week ended 31 December 2011, a decrease primarily due to the continued closure of CNA stores and lower mobile phone sales. Same store retail sales remained generally stable over 13-weeks ended 29 December 2012 as compared to the prior year period.

    We estimate that our Adjusted EBITDA for 13-week ended 29 December 2012, after giving pro forma effect to the sale of R 8.8 billion aggregate amount of receivables under our private label store card programme to Absa, would be 6% to 7% lower than for the 13-week period ended 31 December 2011. 

    This information is based on our internal management accounts that are not fully comparable with our audited consolidated financial statements or unaudited interim condensed consolidated financial statements.  Such information has been prepared by, and is the responsibility of, our management, and has not been audited, reviewed or verified, nor have any procedures been completed by our auditors with respect thereto, and you should not place undue reliance thereon.  It is subject to confirmation in our unaudited interim condensed consolidated financial statements and quarterly report for the 13 weeks ended 29 December 2012. 

    Tax Settlement

    On 31 August 2012, SARS notified us that it was considering the issuance of an income tax assessment primarily in connection with our tax treatment of interest payable on the financing of the acquisition of the Group by Bain Capital. We challenged SARS's position and we believe that we were in compliance with applicable South African tax laws and regulations.  Nevertheless, we perceived it to be beneficial to engage in settlement discussions and we entered into a settlement agreement with SARS in relation to the matters in dispute on 14 December 2012 in order to avoid protracted litigation with SARS.

    The agreement addresses the tax treatment of the issues in dispute for fiscal years since the acquisition of the Group by Bain Capital, being fiscal years 2008 through 2013, as well as future fiscal years. Pursuant to the settlement, no cash outflow in relation to tax payments due will be required until September 2014. However, as a result of the settlement, Edcon is likely to pay income tax earlier than was anticipated prior to the entering into of the settlement. We believe that our cash flows should allow us to satisfy the additional income tax payments that may result from the settlement. 

    The main terms of the settlement agreement are as follows:

    • for fiscal year 2008 through fiscal year 2013, we agreed to reduce our tax losses carry forward by approximately R9.0 billion; 
    • for the period from the beginning of fiscal year 2014 until an initial public offering or an issuance of securities representing 20% or more of the Group's equity (if any), we agreed to limit the deduction for tax purposes of interest payable on our senior secured notes due 2014 and our senior notes due 2015 or any refinancing thereof (the "Acquisition Indebtedness") to 50% of such interest, on an aggregate principal amount of indebtedness of approximately €1.3 billion or the equivalent thereof in rand or U.S. dollars, subject to certain adjustments.  Interest on the portion, if any, of the Acquisition Indebtedness exceeding such cap will not be deductible for tax purposes;
    • for the period following an initial public offering or an issuance of securities representing 20% or more of the Group's equity (if any), we agreed that interest payable on the Acquisition Indebtedness would be fully deductible for tax purposes, up to an aggregate principal amount of indebtedness of approximately €711.1 million or the equivalent thereof in rand or U.S. dollars. Interest on the portion, if any, of the Acquisition Indebtedness exceeding approximately €711.1 million or the equivalent thereof in rand or U.S. dollars will not be deductible for tax purposes; and 
    • for the period from and following fiscal year 2014, interest payable on our subordinated shareholder loan, if any, will not be deductible for tax purposes.

    The settlement is without prejudice to future changes in applicable South African tax legislation and does not relate to any matter other than those in connection with the acquisition of the Group by Bain Capital.                                            

    Funding Update

    We are currently considering refinancing options for our senior secured notes due 2014.

    We intend to use a portion of the R8.8 billion proceeds received to date from the sale of certain receivables under our private label store card programme to Absa to refinance a portion of our near- term maturities. We are in the process of consummating the sale of the remaining R1.2 billion aggregate amount of receivables under our private label store card programme.

    On 3 February 2013, we signed commitment letters for a new rand-denominated senior secured term loan facility for an amount of approximately R4.0 billion to be made available by a syndicate of South African and international banks. The availability of such loan is subject to certain customary conditions, including negotiation of definitive finance documents. There can be no assurance that we will be able to obtain such facility on the agreed terms or at all. We intend to use the proceeds from such loan to refinance a portion of our near-term maturities. In addition, we are considering other opportunities on the international capital and financial markets to refinance our near-term maturities.


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