Review of operations Both core businesses reaped the beneï¬t

08/Review of operations

Boots Group PLC Annual Review and Summary Financial Statement 2003

Review of operationsBoth core businesses reaped the benefit of increased investment. Boots TheChemists increased market share in keyareas and had its best Christmas for adecade. Boots Healthcare International’sfour-year growth strategy delivered thepromised boost to sales and profits ahead of schedule. Meanwhile Wellbeing Servicesand Boots Retail International cut out lesspromising activities to focus on those withgreatest potential for profitable growth.

No7Gay Geranium lip colour, one ofthe original shades sold in 1935,is still sold today



Boots The ChemistsSales £m 4,284.4Increase % 5.2Profit £m (before exceptionals) 568.6Decrease % (6.0)Sales split £mHealth 1,716.4Beauty & Toiletries 1,891.9Other 676.1

Boots the Chemists showed strongsales growth in the year, particularlyin the second half. The business heldor grew market share by value in allcounter health and beauty categories.The Christmas trading performancewas the best for a decade, and thedecline in transaction numbers wasstemmed. Our prices in commoditytoiletries and healthcare becamemore competitive, in part passingon the benefits of better buying and cost efficiencies. This, togetherwith investment in store refits andhigher pension costs, resulted in afall in operating profit to £568.6m(before exceptionals).

Strategy BTC’s customer appeal is founded on the trust and heritage of the Boots brand, broad choice ofown brand and proprietary products,innovative new product developmentand expert service and advice. We arefocused on the health and beautymarkets and are confident of growingwith them. We will maintain our

2m people in the UKhave usedMediterraneanBody Butter

secondsOver the past yearsomeone sprayed Boots Hayfever ReliefNasal Spray every2 seconds on average

22m



leadership position through innovation,continued development of our storeportfolio, understanding of consumerneeds reinforced by analysis ofAdvantage Card data, and clear valuepositioning supported by tight controlof operating costs.

Trading Sales rose 5.2% over the year(4.8% like for like). The increase wasstronger in the second half than in thefirst, and growth over the Christmasperiod was the best for ten years – thirdquarter sales were 8.1% up on theprevious year.

Healthcare sales rose by 5.1%, ledby our prescriptions business. Beauty & Toiletries grew by 6.8%, with aparticularly strong performance fromcosmetics and fragrance. Sales in othercategories, including baby, food, photo,seasonal and Digital Wellbeing, grew by1.3%, driven by our enhanced Christmasrange and a strong performance inbaby products.

We held market share in all counterhealth and beauty categories withimprovements in cosmetics (where wesaw particularly strong sales growth),baby and over the counter (OTC)healthcare. Market share in toiletrieswas maintained and we saw a slightdecline in our dispensing market share.

The number of transactions wasslightly down for the year as a whole,but the long term decline stabilised in mid-year. The Advantage Card was a

key driver. Since relaunching it last year,we have issued a million new cards.

Operating profit was affected by investment in stores, keenerpromotions and increased pensioncharges. Underlying margins weredown by about 1.1 percentage points,due largely to pricing, promotions and a slightly adverse change in thesales mix, partially offset by savings in the cost of goods.

Health The regulation of the pharmacymarket is under review by theDepartment of Trade and Industry (DTI).At the time of writing it is unclear whatthe outcome of the review will be,however the DTI are known not tofavour total deregulation. We believethat some degree of regulation isnecessary to secure convenient accessto community pharmacy for all. We are keen to work with all therelevant authorities to ensure that any changes to the current regulationsdeliver an enhanced service, offer wide access to convenient communitypharmacies, and play a fuller role in the nation’s primary health care.

During the year, although we increasedthe number of prescriptions dispensed,we saw a slight decline in market sharebecause the pattern of prescribingchanged to favour older people.

We began a substantial investmentprogramme in our pharmacy operations,installing more carousel style dispensing

units which speed-up customer serviceand let pharmacists spend more timeconsulting with patients. We have beguna programme to double the number byMarch 2004. We also began to introduceour new pharmacy system, SmartScript,which will further enhance customerservice and give us more detailedinformation on our dispensing business.

Since the abolition of Resale PriceMaintenance on OTC medicines we havegained market share on the back of anattractive programme of promotions.

Beauty & Toiletries Sales grew stronglythroughout the year but particularlyover Christmas which saw an increaseof over 10% overall and sales of beautygifts up almost 40%. Sales of premiumcosmetics grew by over 15% increasingmarket share by 1.5% in the year. Wenow sell them in 125 stores and we arethe leading UK retailer of a number of major cosmetic brands.

Within our own brands No7continued to perform strongly with sales up 14% following the launches of Intelligent Colour Foundation and the Skincare Vitamins range. The pre-Mothers’ Day week was the biggest in the brand’s history.

Toiletries grew in line with themarket supported by a combination of innovation and promotion. New ownbrand ranges included MediterraneanEssentials and fcuk® branded toiletriesfor women.

131,218 litresof ch

ildren

’s m

ulti-vitam

in syrup are sold

each

year in 200m

l bottles

214All the bottles of Soltan sold last year would reach 214 miles,from Nottingham to Dublin

miles

131,218



Boots is also the partner of choice for launching and promoting newproprietary products, and last year we continued to emphasise this area.Boots led the launch of the new GilletteMach III Turbo blades in Januaryattracting immediate share of 60%.Some four months later we continued to sell more than our expected share.During the year we ran strong promotionsin the toiletries category including 99 pence price points, and weresuccessful in maintaining market share.

In sun preparations sales were upover 14% and we gained 4% of marketshare, helped by the strong performanceof the St Tropez self tan range.

Other Sales grew by 1.3% reversingthe trend of the last two years.

Baby had a good year, with sales up4.7%. We are supporting this categorywith stronger promotions because they are very effective in raising overallfootfall. As a further boost we havedeveloped the mini mode childrenswearrange in conjunction with Adams.Launched in February, it is makingencouraging progress.

Food sales showed no growth overthe last year and we saw a decline insales in London affected by increasedcompetition and the downturn intourism. We relaunched our sandwichpackaging in May 2003 to enhancecustomer perceptions of our range.

Photo sales were down 7.6% in arapidly declining market, reflectingcustomers switching to digitalphotography and the associatedreduction in spending on films andsimilar products. In response we arebroadening our range of digital cameras and installing instoretechnology to produce photo qualityprints from digital memory cards.

Growth in sales of seasonalmerchandise was due largely to anenhanced range of Christmas lines. The inclusion of a broader assortment of products is valued by our customersand helps us to become a destinationshop at Christmas. We intend to placemore emphasis on seasonal lines in the future – for example, broadeningour range of summer related productssuch as swimwear to sell alongside sun preparations.

During the year we brought thewellbeing.com website in-house andrenamed it boots.com.

Total online sales grew 120% in the year, and average order value grew 17% as customers became moreconfident online shoppers. In November2002 independent research reported arecord 592,000 unique visitors, makingit the UK’s tenth busiest retail website.

Products Product innovation played an important role in the year’s salesgrowth. No7 had the best sales in its

2,410 packs ofIntelligent ColourFoundation aresold every day

2,4106,750 No7UltimateVolumisingMascara were sold every week last year6,750



grown the volume sales of our everydayvalue products by bringing themtogether under the Boots Essentialsbrand, which has won an award for itspackaging design. Essentials now coversall major toiletry categories – washingand bathing, haircare and men’s.

Store development In addition to ourstore reinvigoration programme, weundertook other schemes including therefitting of our Victoria Centre,Nottingham store. Although wereduced the product sales area by 22%,we increased weekly takings by£35,000 per week, representing a salesintensity increase of almost 40%.

Over the next 12 months we willaccelerate our store developmentprogramme. We have restarted ouredge of town programme and aim toopen 20 more stores by April 2004. In addition, we will undertake manyprojects within our existing portfolio of high street stores. To respond toevolving customer shopping patternsthese will be a combination of openingnew stores, space changes andclosures. Taken together, these changesrepresent a significant increase in ourdevelopment programme to enhancethe quality of our store portfolio.

history, with Intelligent ColourFoundation proving to be its mostsuccessful product launch ever. Thisinnovative foundation is a uniquesilicone gel/pigment blend whichpromises to match the skin tones of allwomen with just three shades. Saleshave exceeded forecast by almost 40%.Other No7 debuts included the relaunchof DailyV Skincare, which isoutperforming the old range by 34%.

The most successful addition to the17 range was Fat Lash, a volumisingmascara in an innovative tube packformat which achieved excellent sales in its first six months. Over a third ofbuyers are new to the 17 brand.

We continued to extend the popularBotanics range. Its Face Renewal Creamwas named best anti-ageing cream byM magazine. And the simple idea ofbundling miniature packs of Botanicsproducts into themed kits – such as theFacial Pamper Kit and Weekend PamperKit – has been a great success inintroducing new customers to the brand.

The new Mediterranean rangeproved a good example of turningconsumer insights into popularproducts. It capitalises on the popularappeal of Mediterranean diets andlifestyle to create innovative toiletries thatalready have annual sales of over £4m.

Innovation and style are part of thewhole Boots brand offer, not confinedto our premium products. We have

5Clearasil total controlprovides products for the five most importantneeds of young skin: shine reduction,moisturisation, blemishcontrol, sun protectionand evenness of skin tone

Boots Healthcare InternationalSales £m 460.4Increase % 13.0Profit £m (before exceptionals) 70.1Increase % 5.1Core brand sales £mincrease%*Nurofen 117.8 21.7Strepsils 77.8 7.7Clearasil 86.9 14.4Dermacosmetics 61.5 10.0

*at comparable exchange rates

In February 2002 Boots HealthcareInternational (BHI) announced afour-year plan to step-upinvestment in marketing and newproduct development, to deliver anew strategy of building majorinternational consumer healthcarebrands. A pause in profit growthwas predicted for 2002/03 while weregenerated organic sales growththrough the increased brandinvestment. Nevertheless, we havedelivered sales growth of 12.3% atcomparable exchange rates anddelivered a 5% rise in operatingprofit.

Strategy BHI aims to become a top tenglobal player in OTC healthcare. Weaim to achieve this by developing six toeight leading consumer healthcarebrands. We are driving brand innovationto capture a top three leadership position

needs



in our three core OTC categories ofanalgesics (Nurofen), cough/cold(Strepsils) and skincare (Clearasil), whilealso developing new brands. To fulfilour aspirations more rapidly, we willalso seek to acquire brands to whichwe can apply our brand rejuvenationand development capabilities.

We are aiming to accelerate organicgrowth through increased marketingand new product developmentexpenditure. We will have greater focuson both our development pipeline andin-market execution. In 2002/03, overhalf our organic growth was generatedfrom products launched during the year.

The year’s largest product launchwas a major extension of the Clearasilbrand, Clearasil total control, targetingthe high-value ‘young skincare’ market.We also broadened the Nurofen brandby launching indication-specificproducts for conditions such asmenstrual pain. These projects werebrought from marketing concept tolaunch within 14 months.

We remain on track to deliver thefinancial projections we communicatedto the City in February 2002. However, toreach our goal of being a top ten playermore rapidly we intend to supplementorganic growth with acquisition.

Results Sales of £460.4m representedtop line growth of 13% (12.3% at comparable exchange rates). Profit of £70.1m was 5.1% ahead

of the previous year.In line with the growth plan, brand

investment (including brand marketingand new product developmentexpenditure) increased by £27.3m,moving from 25.1% to 28.3% of sales.Brand marketing expenditure rose by26%, while new product developmentspend was up 42% to rebuild the three-year product innovation pipeline.

Operating margin of 15.2% reflectedeffective control of operating costs,which fell as a percentage of sales by1.5 percentage points, and cost of goods,which fell by 0.6 percentage points.

Our research and developmentprogramme made significant progressin developing products that will continueto build our brands and take us intonew therapy areas. Clinical trials haveprogressed well.

Organisational change is focused on four goals; breakthrough brandinnovation, streamlined decisionmaking, building high performanceteams, and clear leadership.

Analgesics Sales of Nurofen grew21.7% at comparable exchange rates,driven by strong performances in theUK, Australia and Eastern Europe.

Growth was driven by newproducts, new packaging such ashandbag packs to offer convenience,and quality new advertising. Keylaunches were Nurofen for ChildrenSingles, and Nurofen Recovery in the

120Strep

sils are sold in

120 coun

triesarou

nd

the w

orld

All the packs of Nurofen sold each year in the UK, stackedend to end, would be 800 times higher thanMount Everest

800



UK, and Nurofen Menstrual in Poland.Nurofen Plus strong painkillers led us to pharmacy market leadership in Australia. The continuing success of Nurofen for Children is growing our share of the children’s market inseveral parts of Europe.

Cough & Cold Strepsils’ worldwidegrowth was 7.7% at comparableexchange rates. The roll-out of Strepfenbenefited from the wide distribution of Strepsils internationally. We also had early signs of success with our entry into the cough segment in Asia,extending the brand beyond sore throats.

Skincare Overall sales of core skincareproducts grew 12.6% at comparableexchange rates, led by strong progressin revitalising Clearasil.

Clearasil sales grew 14.4%, advancingstrongly in the US, UK and Australia.

Growth has been accelerating, from4% in the first half to 26% in thesecond, backed by new TV advertisingand extensions of the base range intobody wash, cleansing wipes, overnighttreatment gel and sensitive face wash.We have switched the brand fromdecline to growth in all major markets(except Germany and France) andexpect stronger growth this year fromthese markets as investment increases.

In the fourth quarter this growthwas supplemented in the US and UK bythe launch of the Clearasil total control

range, which extends Clearasil from spot control to young skincare.Targeting women aged 16-24, itprovides products for the five mostimportant needs of young skin; shinereduction, moisturisation, blemishcontrol, sun protection and evenness ofskin tone. These have received verypositive trade reaction as we have builtthe distribution pipeline.

In dermacosmetics, total sales roseby 10%. E45 sales benefited from newproduct launches including the E45Junior range. Lutsine continued to growstrongly in Italy and Spain, but in Francesales were disappointing – they willimprove as we benefit from the more unified global platform, further product innovation, and improved in-market execution.

Opticians & Eyecare, Dentalcare and Wellbeing ServicesSales £m 262.5Increase % 13.6Operating loss £m (28.6)Increase % 13.6

During the year we decided to close our Wellbeing Serviceswhile retaining Dentalcare andFootcare. The Opticians & Eyecare business continues torebuild profits in its core market.The exceptional costs of closingWellbeing Services were £34.5m.

Opticians & Eyecare The UK optical market is a mature one – highlycompetitive and growing at only 2-3%a year. Our strategy is to achieve modestsales growth and stable market share,while controlling costs tightly to enhanceprofits. After a period of movingupmarket we are returning to a broadappeal, in keeping with the overallBoots brand.

Sales for our core business grew 7% in the first half, but were weak in the second , with a year on yeardecline of 1% bringing growth for the full year to 3% – roughly in line with the market. Tight cost control held profits level at £9.6m.

LASIK sales grew 84% increasingour market share from 15% to 18%.We opened four new clinics during theyear – at Bluewater, Bristol, Glasgowand Nottingham making a total of nine.The business made a trading loss largely due to higher marketing costs in a more competitive market. We arenow integrating LASIK more closelywith the core Opticians business toreduce costs and increase cross-referral.

Dentalcare While we have closed ourWellbeing Services we have decided toretain our Dentalcare business. Privatedentistry is a £2bn market in the UK and may have the potential for Boots to develop a profitable business model.Sales rose 64% to £21.8m and weincreased the number of registered

1.4mL

ast year Boots O

ptician

s carried

out m

ore than

1.4m

eye examin

ations

1.5mBoots Dentalcareconducted 50,000initial new patientexaminations last year – that’s around1.5m teeth



patients by 75% to 175,000. Thebusiness is growing well, but we wantto shorten the time it takes to bring new practices to profitability.

We have changed the model,moving into line with standard industrypractice by transferring our dentists toself-employed status. This will make iteasier to recruit and incentivise dentistswhile making the professional staff costbase more flexible. We believe this willshorten the period to breakeven.

Footcare continues to operate from 44 locations, in association with dental practices.

Insurance Services Health and travelcover is a small but profitable business.Sales and profits were in line with theprevious year.

Boots Retail International Sales £m 37.0Decrease % (8.2)Loss £m (22.3)Increase % 7.5

We have found that there issignificant demand for Boots own brand and exclusive products in some overseas markets. We willmeet this demand through the use of a low cost export model with retail partners who host Bootsbrand implants in their stores.

Strategy BRI has 66 stores and 106implants, almost all in South East Asia.Our strategy is now based on exportsales through low cost, low riskimplants selling a select range of about800 Boots own brand and exclusiveproducts through selected hostretailers. This simplified approachenables us to focus on managing theinstore offer, controlling costs andbuilding scale.

Performance Overall sales were in linewith the previous year, in a period ofmajor change involving the closure ofstores and opening of many implants. In Thailand like for like sales grew 7%.The operating loss of £22.3m includes£5.5m for exiting the loss makingEuropean operations and restructuringour business in Asia.

South East Asia A year ago weannounced agreement with Watsons,South East Asia’s leading drugstorechain, to open implants in Taiwan. We now have 54 implants in Watsonsstores. We are now simplifying ourTaiwan operation, growing to around100 implants, closing our Boots storesand shipping direct to Watsons.

In October we launched a similararrangement with Watsons in Hong

Kong, where we now have eight implantsand performance to date is encouraging.

In Thailand, we have had a verysuccessful year in turning the businessaround. Strong like for like sales growthof 7%, margin growth and cost reductionhave significantly improved the resultsof the business.

Supply and support servicesThe simplification of theorganisation has enabled us tointegrate our supply chain, logistics,procurement, IT, manufacturing,properties, engineering andfacilities management activities and our retail buying operation inHong Kong into a single supportorganisation serving all our retailoperations and BHI.

The year’s principal achievements werethe dramatic improvement in on-shelfavailability – without which our salesgrowth would not have been possible –and the outsourcing of IT, which willsave £100m over 10 years.

Supply chain Now that on-shelfavailability is running at acceptablelevels, we can begin to reduce the large distribution inventories that we currently hold around the country.

In June we opened a newautomated single-picking warehouseon our Nottingham site to support our dispensing operations. This nowprovides top-up deliveries to all ourpharmacies every morning. It is thebiggest system of its kind in Europe andhas enabled us to close our Aldershotwarehouse and downsize Heywood,reducing total headcount by 700.

This year we have launched a supplychain transformation programmeinvolving long term structural change, including rationalisation ofmanufacturing. The aim is to deliverbest in class on-shelf availability inparallel with reductions in cost andworking capital.

We are working towards a supplychain that will replenish stores’ stocks of most lines every day – deliveringstraight to the shelf. We will only holdinventory in store stockrooms for thefew lines such as nappies and seasonalitems that need replenishing more thanonce a day. This will deliver significantsavings in store staff time, and reduceinventory. Trials of the new replenishmentsystem begin this year.

Currently there are multiple locationsholding balanced stocks around thecountry. Vehicle capacity utilisation islow because of inherent inefficiencies in the system. We are moving towardscategory-specific warehouses supplyingregional distribution centres which

1/2m BRI sold half a millionlitres of liquid soaplast year



will crossfeed into delivery vehicles for stores. Transport will be betterintegrated, greatly improving vehicleutilisation. On the upstream side, we will also move closer to just-in-timedelivery from suppliers. All thesechanges will use proven technology and should result in better customerservice at much lower cost.

We will also outsource all ourtransport services and the managementof a major Nottingham warehouse.

Manufacturing We have completed a review aimed at simplifying andrationalising production capacity, and inFebruary 2003 we announced proposalsto close our Airdrie manufacturingfacility over the next two years. Savingsfrom the closure will amount to £16m a year. About 1,000 people work at the site and we have declared ourdetermination to minimise the socialimpact of any closure. Closure of Airdriewill allow us to realign productionresources in favour of short-cyclemanufacturing. Until now, big-batchproduction has meant that some linesare made infrequently – resulting in large inventories, exposure toforecasting errors and slow response to changing fashions. The investmentcost of switching to short-cyclemanufacturing will be relatively lowbecause we will be able to adaptexisting equipment, including sometransferred from Airdrie.

Purchasing During the year wereduced purchasing costs by £30m,mainly in buying goods not for resale.We are continuing to make effectiveuse of global internet auctions, savingmoney on purchases ranging from TV advertising to plastic bags.

IT In 2001/02 we reorganised our ITfunction, bringing 14 groups into oneand establishing an integrated businessprocess and information systems blueprintfor the future. In the past year we havemade real progress in the developmentand implementation of that blueprint,Project Backbone, and announcedinvestment of £79m in the coming year.

To support our new IT strategy wehave outsourced our IT operationsunder contracts worth a total of £800m,transferring over 600 staff to IBM andXansa. The result will be annual savingsof £8m immediately, and a total of£100m over the ten-year contract period.

These savings will help to offsetinvestment in new systems and processesthat support the organisational changegoing on across the business. By theend of this year we will have madesubstantial progress in implementingnew finance, human resource, space

and range planning systems, and will be about to begin deploying a new merchandising and supply chain system.

We have installed 2,290 new touch-screen tills in 218 stores as part of thestore reinvigoration programme. Thisyear we will add a further 3,000 newtills in 109 large stores in time for theChristmas season.

We continue to develop theAdvantage Card’s capabilities, upgradingthe instore kiosk system to generatemore personalised offers based onindividual customers’ spending patterns.Very few retailers anywhere are able touse their loyalty cards in this way, andwe are continuing to add enhancements.

Property Our property team has greatlysimplified its processes, to improve theefficiency of its acquisition, constructionand maintenance operations. It is nowclearly focused on servicing the BootsThe Chemists and the disposal of itsinvestment and development portfoliosis almost complete. Last year werealised £61m from disposals, £23m from investment properties and £38m from Halfords sites. The only sites remaining to be sold are the shopping centres at Hastingsand Kendal. The plan is to dispose ofthese in the current financial year.

Review of operations Both core businesses reaped the beneï¬t

Documents

Transcript of Review of operations Both core businesses reaped the beneï¬t