Chief Executive's Review

Overview

NEXT has had another good year. Overall sales increased by 7.2% which was close to the top end of guidance we issued in March 2014. However, it was a year of two very different halves. NEXT Brand sales in the first half were exceptionally strong, up +11%, whilst the second half was relatively disappointing and up just +5%.

Growth in underlying profit before tax of £782m was up 12.5%. This figure is flattered by 1.3% as a result of a £9m accounting profit on currency instruments, which is unlikely to recur in the year ahead. Strong cash generation enabled us to buy back 1.4% of the shares outstanding which, along with the effect of buybacks in the previous year, meant that underlying Earnings Per Share (EPS) grew by 14.7%.

For much of the year the Company's share price was above our internal buyback price limit and we were unable to return all surplus cash through share buybacks. As a result, and in keeping with our stated intentions, we returned a further £223m to shareholders through three special dividends of 50 pence each. Ordinary dividends for the full year will increase by 16.3%, to £1.50.

SALES excluding VAT *January 2015
£m
January 2014
£m
NEXT Retail2,348.22,240.5+ 4.8%
NEXT Directory1,540.61,373.9+ 12.1%
NEXT BRAND3,888.83,614.4+ 7.6%
Other139.0143.8
Total Sales excluding VAT4,027.83,758.2+ 7.2%
Statutory Revenue3,999.83,740.0+ 6.9%

* See Group Accounting Policies and Note 1 for Total Sales definition (reflected throughout the Strategic Report) and change in segment sales from previously reported.

PROFIT and EPSJanuary 2015
£m
January 2014
£m
NEXT Retail383.8347.7+ 10.4%
NEXT Directory376.8358.5+ 5.1%
NEXT BRAND760.6706.2+ 7.7%
Other51.516.6
Operating profit812.1722.8+ 12.3%
Net interest(29.9)(27.6)
Profit before tax – underlying782.2695.2+ 12.5%
Exceptional disposal gains12.6
Taxation(159.9)(142.0)
Profit after tax634.9553.2+ 14.8%
EPS – underlying419.8p366.1p+ 14.7%
Ordinary dividends per share150.0p129.0p+ 16.3%

Next plc economics

2014/15 Profit drivers

The table below sets out the main drivers of the Group's Profit and Loss account for the year. This shows how the sales from (1) new Retail space, (2) existing stores and (3) additional online sales added to the Group's profit. It also shows how (4) cost inflation has, once again, been offset by (5) cost savings. Other Group profits and costs, such as NEXT Sourcing, Lipsy, Estates and Treasury added an unusually large profit this year (see Other Trading Businesses and Central Costs).

Profit Year to January 2014£695m
Profit from sales increases/decreases
(1) New Retail space+£13m
(2) Existing stores+ £9m
(3) Additional online sales+£35m
+£57m
Cost increases and savings
(4) Inflation in cost base- £41m
(5) Cost savings+£42m
(6) Other Group profits and costs+£29m
+£30m
Profit Year to January 2015+£782m+12.5%

Review profit

Next's objectives

NEXT'S Operating Objectives

The Company has five operational objectives, as set out in the table below. These aims remain broadly unchanged from those given in this report last year.

Develop the NEXT BrandContinue to focus on delivering better design. In particular focus on improving our buying processes to (1) make better use of the time spent developing long lead time product and (2) respond more powerfully to emerging trends with short lead time product.
Invest in online growthInvest in growth from our online business, through (1) improving UK delivery services, (2) expanding our new branded business, LABEL, and (3) developing the NEXT Brand in overseas markets.
Invest in profitable new spaceOpen profitable new retail space, maintaining the Company's payback and profitability hurdles of 15% net store profit (before central overheads) and payback on net capital invested in 24 months.
Improve serviceContinue to improve the quality of our service provided in our shops, in our call centres, through website systems and our distribution networks.
Control costsControl costs through constantly innovating and developing more efficient ways of operating. This must be done without detracting from the quality of our products and services.

NEXT's Financial Objective

In last year's annual review we refined the Company's core financial objective. Up until that point, our goal had been the delivery of long term, sustainable growth in EPS. However this measure did not take account of the value created by paying out surplus cash as dividends; and this has become much more important as we have increasingly paid special dividends in lieu of share buybacks.

So we restated our objective as the delivery of long term, sustainable growth in Total Shareholder Returns (TSR). We define TSR as growth in Earnings per Share added to the total dividend yield. Taking dividends as a percentage of our share price at the beginning of our financial year (February 2014) our TSR is set out in the table below:

Total Shareholder Returns
Growth in underlying EPS+14.7%
Special Dividend Yield* 150p+2.3%
Ordinary Dividend Yield* 150p+2.3%
Total Shareholder Returns*+19.3%

*Based on £63.45, being the average share price for the first month of the financial year (i.e. to 25 February 2014)

The inclusion of growth in EPS in Total Shareholder Returns is grounded in the belief that, over time, share price growth will follow growth in EPS. The graph below shows how our share price has tracked EPS over the last 16 years.

The graph also demonstrates that our shares now enjoy a rating well above their historical average. It is important to point out that the high rating means that the deployment of surplus cash, as special dividends or share buybacks, will provide lower returns for shareholders than if the shares were at a lower rating.

EPS

The Company maintains its 8% Equivalent Rate of Return (pre-tax) investment hurdle for share buybacks. At the mid-point of guidance issued in this report, our share price limit is £68.27.

Product and the next brand

Over the course of the year we have focused on improving the design content of our ranges. We believe the investment in time, effort and resources has been worthwhile. Unusually, our ranges in Spring and Summer 2014 were successful across all of our five product divisions (Womenswear Clothing, Women's Shoes and Accessories, Menswear, Childrenswear and Home). The focus on design continues in the year ahead with further investment in our fabric and print resources.

We also aim to develop and improve our buying processes. Traditionally, NEXT has begun to develop design themes eight months before the launch of a season. We will continue to work this way but believe that we can make much better use of the intervening time to improve our fabrics, design details, prints, trims, shapes and prices on long lead-time product.

In addition to our more traditional buying cycle, we also develop a small amount of product much closer to the season, using shorter lead time territories and quicker response suppliers. This approach to buying is newer and less comfortable for NEXT, and requires a different mind-set to our traditional techniques. We aim to build on the success we have had with shorter lead-time product and make more of this buying method going forward.

Retail

Total Retail sales were 4.8% ahead of last year, of which new space contributed 3.4%.

Retail space expansion

Space added in the year

Trading space increased by 330,000 square feet to 7.4 million square feet. Store numbers remained broadly the same, with the increase from new stores being offset by the closure of smaller, less profitable stores.

Store NumbersSq. Ft.
(000's)
January 20145417,045
New stores, including re-sites (9)+20+439
Closures- 22- 181
Extensions (7)+70
January 20155397,373+4.7%

Returns on Capital and Profitability

Profitability of stores opened in the last 12 months is forecast to average 20% and payback on the net capital invested is expected to be 20 months. Both figures are within Company investment hurdles of 15% store profitability and 24 months capital payback. The table below sets out the profitability and returns of new space, broken down into Fashion and Home.

New spaceSales vs
target
Forecast profitabilityForecast
payback
Fashion+9%20%19 months
Large Home format+13%20%21 months
Total+10%20%20 months

Aspirational Out-of-Town Architecture

An unusually large percentage, 75%, of new space was large format Home and Fashion stores. These side-by-side stores give the Company the opportunity to re-define the way we trade out of town, investing in the architecture of our buildings and the quality of shop-fit. We have radically changed the appearance of existing retail park buildings, adding glass frontages, light-wells, and improved facades. We have also built two stores from the ground up (Hedge End and Maidstone), and these have enabled us to create beautiful and iconic buildings. Over the next three years we hope, subject to planning, to open at least eight more of these bespoke new stores.

Next Maidstone

Maidstone – Opened November 2014

Retail Space – Pipeline to 2017

We continue to look for opportunities to profitably increase UK selling space. For the coming year we expect to add 350,000 square feet (net of closures). Looking further ahead into 2016 and 2017 our pipeline is less certain, but we believe that we will add around 350,000 square feet of net trading space in each of these two years.

Next High-Wycombe

High Wycombe – Under construction February 2015

The long view – retail portfolio economics & lease terms

Since the beginning of the credit crunch in 2008, sales in our existing stores have moved backwards in almost every season. The combined effect of a weak economy and growth in online sales has meant that same-store growth has been hard to achieve across the sector. Despite this, the profitability of our store portfolio remains extremely healthy. The reason for this apparent contradiction is that the active expansion and relocation of our portfolio has allowed us to manage the economics of our retail portfolio to reflect the current retail environment.

In the seven years since 2008 NEXT has increased its net trading space from 5.2 million square feet to 7.4 million square feet. Of the 539 stores we trade in today, almost half are either new or have been significantly extended. Those stores represent 60% of our current trading space. The table below shows the changes to store numbers and square footage since 2008.

Store
Numbers
Sq. Ft.
January 20085025.2m
New stores, including re-sites (63)1792.6m
Closures- 142- 0.8m
Extensions (82) gross 1.8m sq.ft.0.4m
January 20155397.4m

Long Term Profitability Comparisons

The table below gives key measures of performance since 2008. It shows how the 26% fall in sales per square foot have not resulted in the proportionate increase that might be expected in rent, rates, depreciation and branch wages.

In fact, store profitability (before central overheads) has moved forward in the period. This is because savings achieved through more effective Sale stock clearance, lower shrinkage and management of other branch costs have more than offset any increases in rents and rates. Wages have reduced as a percentage of sales, because productivity improvements have more than compensated for the dis-economies of lower sales per square foot and inflationary wage increases.

The table below shows key branch costs as a percentage of VAT inclusive sales in 2008 and 2015.

Store Variables2007/82014/15
Sales per square foot£491/sq. ft.£365/sq. ft.
Wages11.3%10.9%
Rent5.5%6.5%
Rates2.2%3.0%
Depreciation3.1%3.2%
Markdown, obsolescence & shrinkage8.7%5.0%
Net Branch Profitability21.4%23.7%

Current Profitability Profile

As a result of the active management of our store portfolio, the vast majority of our stores make a healthy profit, with 97% of our space delivering a net branch profit of more than 10%. The table below sets out the percentage of our turnover within stores of different levels of profitability.

Mainline store profitabilityPercentage of turnover
>20%
>15%
>10%
>5%
>0%
81%
94%
97%
99%
99.7%

Lease Terms

Over the last ten years we have seen a move away from long lease terms. We are currently only entering into leases of more than 10 years in situations where (1) we believe that the trading location is very unlikely to deteriorate within 20 years, (2) landlords are making a very substantial investment in a new trading location or (3) we are swapping out of an existing store with a significant number of unexpired years on the lease.

The graph below shows the remaining lease commitment in years by percentage of our portfolio (by rental value). This shows that in 2008 approximately 50% of our store leases would have expired in just over ten years' time. Today 50% of our leases will expire in just six years' time.

Rental value

Retail service

At the beginning of last year we set ourselves the objective of improving our customer service across the Group. Our starting point was a rather disappointing set of customer surveys conducted in June 2013. We re-defined what we meant by great service, focusing on serving our customers in the way they want to be served, not on traditional retail salesmanship designed to maximise short term sales.

Over the last eighteen months we have:

  • Overhauled our recruitment process, focusing on attitude rather than experience
  • Increased our lowest wage rates by 6%
  • Introduced new service training
  • Changed our store staff bonus scheme to be awarded on the basis of service, rather than sales
  • Re-allocated contract hours throughout the day to achieve better service at peak times
  • Increased the average contract hours worked per member of staff. (Any consequent reduction in head count has been achieved through natural wastage and without any redundancies)
  • Introduced a shift market-place to allow staff to offer up, swap and accept additional shifts
  • Changed our staff appraisal and performance management systems

We believe that all the above changes have had a significant and positive effect on the levels of service we provide in our stores. The two charts below are taken from an independent survey which assesses the number of customers rating service as "Very Good" or "Outstanding", both in our own stores and in other major competitors. As can be seen, we have achieved a marked improvement but still have some way to go to get to best in class.

June 2013: Customer rating Very Good/Outstanding

Customer rating

November 2014: Customer rating Very Good/Outstanding

Customer rating

Retail profit analysis

Full year operating margin improved by 0.8% to 16.3%. The table below sets out significant margin movements by major heads of costs.

Net operating margin on total sales last year15.5%
Bought-in gross marginUnderlying gross margin improved by +0.3% due to a planned increase in Home furniture. In addition, we were able to buy currency at slightly better rates than initially anticipated, resulting in a margin gain of +0.2%.+0.5%
Higher markdownRetail stock for Sale was up 13% and markdown sales were up 8.5%. Margin reduced as a result of markdown sales growing faster than full price sales and lower Sale clearance rates.- 0.4%
Decrease in occupancy costsThis improvement was due to (1) store asset write-offs in the prior year +0.5%, (2) lower depreciation due to fully depreciated assets +0.3% and (3) leverage of fixed costs from strong first half sales +0.3%.+1.1%
Store payrollIncreased rates of pay would have cost -0.6% but were partially offset by in-store productivity initiatives.- 0.3%
Central overheadsInvestment in IT infrastructure.- 0.1%
Net operating margin on total sales this year16.3%

Directory

Directory sales and customer base

Directory sales were 12.1% ahead of last year. Sales in the UK grew by 8.2% and overseas online sales increased by 61%. The table below shows the contribution to total Directory growth made by our UK and Overseas businesses. The UK has been broken down to show the contribution made by our brands business, LABEL.

Contribution to
sales growth
UK NEXT5.7%
UK LABEL1.9%
UK Total7.6%
Overseas4.5%
Total sales growth12.1%

Active customers increased by 11.3% to 4.1 million. The table below sets out the growth in our UK and Overseas customer base. Most of our new customers in the UK have chosen to pay on order with a debit or credit card (Cash customers).

Average customers ('000s)Jan
2015
Jan
2014
Change% Change
UK credit account2,7242,798- 74- 2.6%
UK cash899633+266+42.0%
Total UK3,6233,431+192
Overseas495268+227+85.0%
Total active customers4,1183,699+419+11.3%

Directory development – uk

We have developed the UK business through improving our delivery service, improving the levels of customer service, and increasing the frequency of our publications.

Delivery Service

During the year we extended the ordering window for deliveries to stores. From October store orders could be placed until midnight for next day delivery. This service provided the ground work for the much harder exercise of extending our window for deliveries to home, we have recently extended our cut-off to 11pm and hope to extend to midnight by August. Currently we take around 9% of our orders between 10pm and midnight.

NEXT Directory Customer Service

We have made some progress in improving customer service in our call centres. We have taken many of the lessons learnt from Retail and used them to change our recruitment methods, training courses, staff bonus schemes and appraisal methods.

Enquiry levels and complaints have fallen. However, we still feel we have a long way to go to get to the levels of service we would like. In particular we need to ensure that more enquiries are dealt with first time. Of course, much of the effort is about preventing mistakes in the first place. To that extent, our warehouses and distribution network can contribute more to preventing repeat enquiries than our call centres.

We also aim to improve the functionality of our website, with particular emphasis on:

  • Improvements to payment processing and account management screens
  • Re-launch of our iPad and iPhone Apps in addition to a redesign of our mobile site (m.next.uk)
  • Improvements to the operation of specialist Home product web pages where clothing search and selection methods are inappropriate (e.g. dining chairs, tables, fitted wardrobes and beds)

Publications

In 2013 we experimented with a number of small "New In" publications. These are now published at six week intervals between the launch our four big hardback Spring, Summer, Autumn and Winter catalogues.

During the year we increased the size and extended the distribution of these publications. In the year ahead we will add one further small new publication in May to offer High Summer and holiday product.

Focus on next directory credit business

Over the last few years, NEXT Directory has made the transition from Catalogue to Online. In doing so, we have made it easy for new customers to trade using a debit card or credit card (we refer to these customers as "Cash" as opposed to "Credit" customers). This has dramatically increased the reach of the NEXT Directory and we now have 900,000 active Cash customers. However, this has meant that, over the last few years, our Credit customer growth has slowed and this year it has declined by -2.6%. The graph below shows the growth in total Directory sales relative to our Credit customer base, the figures are indexed to 2007. The dotted line shows the growth in Credit sales in the same period.

Total Directory Sales

Effect on Profitability

Net interest income accounts for 8% of the 25.4% net margin made on Credit sales. However, the difference in the profitability of our Cash customers is not as great as might first be expected. Our Cash business experiences much lower returns and marketing costs, boosting the profitability of Directory Cash sales to 23%, and narrowing the difference to 2.4%.

Effect on Credit Sales

Interestingly, the decline in Credit customers has not yet been matched by a decline in Credit sales. Growth in sales to our Credit customers is more than compensating for the decline in customer numbers. Interest income has also started to grow slightly faster than Credit sales. We believe that this is because the customers who are leaving are those who are most likely to have been paying down their balance in full.

Both of these effects do not change the underlying reality, that our Credit business is in decline, but they do mean that the decline is likely to be slower than we initially anticipated.

Promoting the Credit Offer

We have not directly promoted our Credit business but will begin to do so over the course of this year. In addition to providing flexible payments, the account also allows customers to try items before they buy them (customers have at least 28 days to return items without incurring interest charges on them). Most Credit account holders are also eligible to get early access to our End of Season online Sale. Whilst it is very unlikely that we will return to our Credit customer base growing in line with Directory's total UK sales, we may be able to take steps to arrest the decline. We will have further information on this subject at the half year.

Developing directory overseas

NEXT's online business continues to do well overseas. Around 85% of Directory's overseas sales come from our own website, the remainder is being sold through local third party home shopping operators.

Over the last three years the emphasis of our work overseas has been on opening new territories, translating our website and accepting local currencies. Much of this work is now done and we will shift our focus to improving our delivery service. This can be achieved either through increasing the speed of distribution from our UK warehouses through 3rd party networks or by distributing from our overseas hub warehouses.

Faster From the UK

We have recently improved our delivery service to Germany and France, offering most of our customers a next day delivery service. Initial sales response has been encouraging and we will look to extend this service to other close European countries.

Local Distribution Hubs

In September 2014 we successfully opened a local hub in Northern Ireland. This has allowed us to offer next day delivery in both Northern Ireland and Eire. We will shortly open a local distribution hub and, later in the year, a call centre in Russia. Total investment in this project is £2.5m. Our current delivery promise in Russia is 8 to 12 days. The new hub will allow us to offer a stated day service, next-day to customers in Moscow and St Petersburg, and between 2–5 days for our other Russian customers.

New Territories – China

The only significant new territory launched last year was China. Sales started slowly but are now exceeding our expectations and we believe that China will shortly be one of our top ten trading territories. We are currently working on a local distribution hub to serve mainland China, Hong Kong, Taiwan and Japan. We hope to be operational within the current year. Our aim is to reduce mainland China lead times for most of our customers from 14 days to 1–2 days.

Sales, Profitability History and Outlook for the year ahead

The table below sets out the last three years' sales, profits and net margins for overseas online. The fourth column gives an estimate of the sales and profitability we are expecting in the year ahead.

£mJanuary
2013
January
2014
January
2015
January
2016(e)
Sales54101163205(e)
Net Profit10183037(e)
Profitability19%18%18%18%(e)

We expect our international online sales to grow by 25% in the year ahead, to around £205m. This rate of growth is significantly lower than last year. This is partly because we have now opened in all our target territories and have limited further opportunities to add local currencies and languages. In addition two of our largest markets, Russia and Ukraine, have both suffered significant currency devaluations. We have had to increase our prices in local currency to maintain profitability in these territories and as a result sales (measured in £ Sterling) are no longer growing. We believe that both countries will return to growth if and when their currencies stabilise. Despite the tough trading environment we remain confident that our Russian distribution hub will be operational with the next two months.

Label

We launched our first LABEL catalogue in March last year. The business was an extension of the small number of third party brands we had been selling through the NEXT Directory. The aim was to offer premium non-competing brands to the 4 million NEXT Directory customer base, leveraging the next day service we are able to offer through our warehouses and distribution networks.

The business has started well and we continue to recruit new, premium brands to the business. Last year we added 34 new major brands to LABEL. In the year ahead we intend to add at least another 30 premium brands. LABEL will publish four catalogues a year with around 400 pages in each. LABEL products can be ordered through a dedicated part of the NEXT website and through LABELONLINE.CO.UK

Sales, Profitability and Outlook

The table below sets out the last three years' sales, profits and net margins for our third party branded business. The fourth column gives an estimate of the sales and profitability we are expecting in the year ahead. Profitability is shown excluding any interest income from those customers who buy items using their Directory account.

£mJanuary
2013
January
2014
January
2015
January
2016(e)
Sales excluding VAT8189110150+ (e)
Profitability*11%19%14%15% (e)

* Profit excluding interest income.

Profitability in the year just ended was lower than the previous year, partly as a result of more partner brands switching to trade with LABEL on a commission basis. This means we take a commission on sales rather than purchase wholesale. The commission model is less profitable for us, but gives partner brands far more freedom to manage the ranges they sell through LABEL and allows us to draw on their selection expertise. Our experience so far is that brands which switch to trading on commission can dramatically increase their sales.

Label screenshot
Label catalogue

Directory profit analysis

Operating margin reduced by 1.6% to 24.5%. The table below sets out significant margin movements by major heads of costs.

Net operating margin last year26.1%
Bought-in gross marginUnderlying gross margin improved by +0.3% due to a planned increase in Home furniture margin. In addition, we were able to buy currency at slightly better rates than initially anticipated, resulting in a gain of +0.2%. This has been offset by an increase in Branded and International sales which have lower margins.- 0.1%
MarkdownDirectory stock for Sale increased by more than Sales, up 25%. In addition lower clearance rates have reduced overall margin.- 0.4%
Stock write downsMore stock was damaged whilst in transit. In particular flat pack furniture and items returned via our stores. In addition, we incurred a £0.9m one-off sofa recall cost.- 0.3%
Interest incomeInterest income increased, but at a lower rate than total sales. Interest income was also reduced by a 1% APR reduction made in September 2014.- 0.4%
Bad DebtBad debt costs have reduced, increasing margin.+0.3%
Warehouse & distributionMargins have reduced by -0.6% due to increasing International sales. This has been partially offset by savings in International parcel rates, operational savings and increased use of our store network for customer returns.- 0.3%
Photography & catalogue productionA combination of additional LABEL and New In publications increased print costs faster than sales. In addition, we have incurred creative costs for the Summer 2015 LABEL in 2014.- 0.3%
Central overheadsStart-up costs associated with our Russian hub.- 0.1%
Net operating margin this year24.5%

Cost inflation and cost control

This year we have offset cost increases with cost savings. The tables below outline the main contributors to cost increases and cost savings over the last year. Cost control remains at the heart of the business and we remain determined that cost savings must come through innovation and efficiency rather than any compromise to our product quality or services.

Cost Increases£m
Cost of living awards and other wage related inflation19
Rent, rates & other occupancy costs6
Systems investments (mainly new till systems)5
Additional costs associated with overseas deliveries4
2015/16 LABEL costs incurred and charged in 2014/154
Change in net achieved margin on product (markdown, slippage, gross margin, etc.)3
Total Cost Increases41
Cost Savings£m
Reduction in the cost of senior management and staff incentives12
Non-recurring prior year store asset write-offs12
Fully depreciated store assets no longer incurring a depreciation charge8
Directory distribution efficiencies4
Retail manpower productivity improvements4
Lower bad debt charges2
Total Cost Savings42

In the year ahead we expect cost increases of around £36m. Anticipated wage increases account for £18m of this, the majority of which comes from our annual wage award. We again expect cost increases to be more than offset by cost savings. In NEXT Retail, the profit from new stores should offset lower profits from existing stores. In NEXT Directory, profit from growth in UK sales should exceed that from growth in International sales.

Head Office, Warehouse and Systems Projects

The rapid growth of our Online and Home businesses meant that we commenced an unusual number of big systems, warehousing and Head Office Infrastructure projects in 2014.

These projects will give some operational benefits but are mainly required to facilitate continued growth or replace obsolete systems and buildings. Most systems development costs are revenue costs and written off in the year they are incurred. Hardware and other infrastructure are depreciated over the life of the asset.

The table below sets out the largest projects and their revenue and capital costs for the year ended and estimates for the year ahead. The biggest number is the £20m investment in fitting out a new automated Home Sofa and Furniture warehouse, located next to our existing warehouses in Doncaster. We expect to spend a further £12m on this project in the year to January 2017.

Revenue Cost (£m)Capital Cost (£m)
Project DescriptionLifeJan
2015
Jan
2016(e)
Jan
2015
Jan
2016(e)
Store till, back office and payment systems upgrade2yrs2125
Mainframe upgrade and modernisation2yrs21
International website re-write and convergence with UK2yrs1
Head Office Product, Call Centre and Systems infrastructure2yrs911
Home warehouse expansion3yrs320
Total521436

Other trading businesses

Next sourcing

NEXT Sourcing (NS) continues to provide more than 40% of NEXT Brand stock from our global supplier base, sourcing from 18 countries. It employs 3,600 people in 12 countries, including 2,700 in factories which we own. NS provides the Group with an insight into manufacturing and the relative technical strengths of different parts of the world. Although wholly owned, it operates as a stand-alone business and must compete (without favour) with our other suppliers.

NS trades mainly in US Dollars and its sales were up 10% in Dollars. The table below shows sales and profits in Sterling.

£m20152014
Sales (mainly inter-company)600.6571.2+5.1%
Operating margin %6.9%6.0%
Operating profit41.434.1+21.3%

We are forecasting NS profits of £47m for the year ahead, which includes a £3m currency benefit from the stronger Dollar. NEXT Sourcing has made excellent progress controlling costs, and its margins are now approaching historical highs. There is an opportunity for NS to be more competitive and their Board has taken the decision to lower their commission rate by 1% for Spring 2016 stock.

International retail and franchise stores

Our franchise partners operate 188 stores in 37 countries, sales and profits were little changed on the year. We own 13 stores in Central Europe, which made a small profit. We have no plans to open our own stores in new territories. Revenue and profit are set out below. We are budgeting for International Retail to make £10m profit in the year ahead. The anticipated drop in profit is due to the economic difficulties being experienced by our franchise partners in some eastern European countries.

£m20152014
Franchise income71.971.0
Own store sales14.314.6
Total revenue86.285.6+0.7%
Operating profit11.712.1- 2.9%

Lipsy

Lipsy performed well, and profit increased to £5.1m. Lipsy sales are broken down by distribution channel in the table below. Lipsy sells stock directly through its own stores, website, to wholesale customers and to franchise partners. Lipsy also sells stock in 34 units inset into NEXT Retail stores and through the NEXT Directory. Sales made through NEXT Retail and Directory are now reported in those divisions (see Note 1 to the financial statements).

£m20152014
Lipsy.co.uk, standalone stores, franchise and wholesale36.835.3+4%
NEXT Retail12.912.1+7%
NEXT Directory23.315.5+50%
Total Sales73.062.9+16%
Operating Profit5.12.7

Currently, the majority of Lipsy's sales are of Lipsy branded merchandise. Lipsy also sells some other, third party, young fashion brands. These third party branded sales now account for 12% of Lipsy's sales and we anticipate that this participation will increase in the year ahead.

Outlook for Sales and Profits

One of Lipsy's major wholesale customers, Bank, recently went into administration and this customer contributed £1.3m to profit. We believe that some of the lost turnover will be recovered through other channels and the balance of lost profit will be made up for with organic growth. We anticipate that Lipsy profit for the year ahead will be broadly in line with last year.

Central costs and other activities

The table below sets out other Group and non-trading activities. In aggregate these activities contributed £25m to the growth in profit, a far greater difference than we would normally expect from these activities. Of this £25m, the most significant was a £15m swing in unrealised accounting gains/losses on currency hedging instruments.

£m20152014
Property management6.91.8
Central costs(23.4)(30.7)
Unrealised foreign exchange8.9(5.9)
Associates0.92.5
Total(6.7)(32.3)

Property Management

The Property Management profit of £7m includes a £4m one-off profit on sale of a NEXT Retail store lease. In the year ahead we anticipate a similar one-off profit will be achieved from the development of at least one other new store.

Central Costs

The reduction in Central Costs is due primarily to lower share-based employee incentives, in the prior year the rate of share price growth and the provisions required had been particularly high.

Unrealised Foreign Exchange IAS 39

The £9m gain this year compares with a £6m loss in the previous year. This accounting volatility is unhelpful and hard to predict, we are working on the basis of no gain or loss in the year ahead.

Interest and taxation

The interest charge was £30m as forecast and we expect a similar figure for the year ahead.

Our tax rate of 20.4% was unchanged and is commensurate with current headline UK corporation tax rates. We expect our effective tax rate will be no higher than 21% in each of the next two years.

Exceptional disposal gains

During the year we sold our investment in Cotton Traders for £15m, which was £11m above book value. We also released £2m of other prior year disposal provisions.

Balance sheet and ordinary dividends

The balance sheet remains strong. Net debt at the end of the year was virtually unchanged at £515m. During the coming year net debt is expected to move between a minimum of £500m and a maximum of £750m, and is expected to finish at around the same level as it started. Our bonds and committed bank facilities of £1,088m remain unchanged, as set out below.

£m
2016 bonds213
2021 bonds325
2026 bonds250
Total bonds nominal value788
2019 committed bank facility300
Total debt facilities available1,088

Final ordinary dividend

We have proposed raising our final ordinary dividend to 100p, taking the total ordinary dividend for the year to 150p. The increase of 16% is marginally ahead of growth in underlying EPS, although cover remains at 2.8 times.

Cash generation, share buybacks and special dividends

Cash generation

Over the last year we generated £363m of surplus cash after capex, interest, ordinary dividends and tax. We returned £361m of this to shareholders, through special dividends of £223m and share buybacks of £138m.

We expect to generate around £360m surplus cash in the year ahead and, again, we intend to return this to shareholders. We paid a £74m special dividend in February and have committed to a further £90m which will be paid in May. If our share price remains above our maximum limit for buybacks and our profit expectations remain unchanged, then we intend to pay further quarterly special dividends in August and November this year.

Share buyback limit going forward

We have, on several occasions, set out the criteria by which we would decide the maximum price the Company would pay to buy back shares. We use the concept of Equivalent Rate of Return (ERR). This is the pre-tax return required from an alternative investment, if that investment were to produce the same level of earnings enhancement as the proposed buyback. We set the minimum ERR at 8%, which we consider a reasonable target for a return on equity investments.

For the year to January 2016, the mid-point of our guidance for profit before tax is £810m. On this basis an 8% ERR gives a new upper limit for buybacks of £68.27.

Outlook for 2015

Economic outlook

The economic outlook for the UK consumer looks benign. Low price inflation, an end to real wage decline, healthy credit markets and strong employment all paint a more positive picture than in recent years.

Customer price chart

Sales outlook for next

Although the consumer economy looks benign, we remain very cautious in our sales budgets. Whilst we are happy with most of our current product ranges, we recognise that some collections are not as strong as they were at this point last year. In addition, during the Spring and Summer seasons, we face very tough comparative numbers from last year, when sales were assisted by unusually warm weather. There is a potential upside in the second half as the comparative performance last year weakens, particularly in the third quarter.

We are currently budgeting for full price sales growth for the full year to be up between +1.5% and +5.5%, with the first half expected to be up 0% to 3%, and the second half up 3.5% to 7.5%.

Profit and eps guidance for the year ahead

The table below sets out our guidance for the full year. For the purposes of this guidance, we have assumed that surplus cash of £360m is generated and returned as special dividends rather than buybacks. In reality the choice between buybacks and special dividends will depend on the prevailing share price as explained above. We have expressed the dividend return as a percentage of our average share price during the first month of this financial year.

Guidance EstimatesLower end
of guidance
Upper end
of guidance
Total full price NEXT Brand sales % growth+1.5%+5.5%
Group profit before tax £m£785m£835m
Group profit before tax % growth+0.4%+6.7%
Ordinary dividend yield (based on £72.33 share price)+2.1%+2.1%
Special dividend yield (based on £72.33 share price)+3.3%+3.3%
Total Shareholder Returns+5.8%+12.1%

This guidance is based on 52 weeks for the years ending January 2015 and 2016. This year will actually be the 53 weeks to 30 January 2016. Our Interim accounts will be for the comparable 26 weeks to 25 July 2015.

First Quarter Trading Update

Our next statement will cover the first thirteen weeks of the year, to 25 April 2015, and is provisionally scheduled for Wednesday 29 April 2015.

Conclusion – a tougher year but plenty to do

Whilst the prospective returns detailed above would be very respectable by most standards, they are low by comparison to NEXT's historical performance. However, they are based on realistic sales estimates and we believe that it would be a mistake to be over-optimistic at this stage. Our experience is that starting with prudent sales budgets is the key to coping with lower sales growth. Stock purchases and other costs can then be tailored to get the business through the year in good shape.

Whatever the sales environment in the current year, the Company has plenty of opportunities to lay foundations for future growth. Of these, the most important are: further improvement to our buying techniques, customer service, delivery capabilities, growing our store portfolio, initiating overseas fulfilment operations, and growing our third party branded business through LABEL.

Lord Wolfson signature
Lord Wolfson of Aspley Guise
Chief Executive
19 March 2015