Chief Executive Officer's
letter to stakeholders

Italtile's ESG journey to sustainable value creation

Dear stakeholder

The reports in this section provide insight into our approach and commitment to environment, social and governance ("ESG")imperatives and sustainable value creation – and to the journey we are undertaking to improve our efforts in this regard.

We recognise that it is logical that companies with high ESG scores show stronger growth, are perceived better by stakeholders and are better equipped to thrive over the long term, based on the premise that issues such as bad governance or environmental problems damage profitability.

Increasingly frequently in the listed environment, shareholders identify ESG credentials as having an impact on their decision to invest in companies. Furthermore, ESG awareness continues to grow among consumers who prefer to associate with brands that have admirable reputations and align their words with their actions. In an Old Mutual Morningstar survey*, 95% of millennials affirmed that they are interested in sustainable investments and 90% want their investments tailored to match their values. If one considers that the baby boomer generation is expected to transfer US$30 trillion in wealth* to these young prospective investors over the forthcoming decades, the significance is clear.

Notwithstanding the global shift in awareness, sustainable value creation is not a new concept to our business.

Founded over 51 years ago, Italtile is a Proudly South African company, with deep roots in this country. We are mindful that this long-standing heritage is testament to the contribution of the people we employ across the Group – and to our key stakeholders and the natural environment we operate in – who support the continued growth of Italtile. In this context, we are cognisant of our duty to responsibly advance the sustainability of our business and our surrounding communities.

In Our business at a glance, the Chairman outlines the Board's focus on ESG sustainability, through transformation, creating jobs and contributing to local communities and by conducting our operations in an ethical and responsible manner to continue to reduce our carbon footprint and enhance the natural environment. The Chairman also discusses our investment in dovetailing our innovation strategy with our sustainability strategy, illustrating how ESG data is incorporated into our investment decision-making processes.

* https://moneymarketing.co.za, 6 July 2020

COMMITMENT TO KEY UNITED NATIONS SUSTAINABLE DEVELOPMENT GOALS

Our core values are partnership, empowerment, fairness, human dignity, integrity, excellence, honesty and servant leadership. These values underpin our approach to sustainability and are supported by rigorous ethics, sound governance and robust risk management processes and structures.

Our efforts to address environmental, social and governance challenges and contribute to transformation in our business align with the United Nations' Sustainable Development Goals ("SDGs") to promote sustainability by eliminating extreme poverty, protecting the planet and ensuring prosperity for all. We recognise these SDGs as being of vital importance to driving economic growth, addressing social and economic instability and promoting short, medium and long-term sustainability.

Although not a signatory to the UN Global Compact, we have identified the following SDGs to which we believe we can contribute the most and on which we can have the most impact. Our contribution to these SDGs is largely determined by the evolving landscape in our operating markets, as well as the interests and issues raised by our stakeholders.



UN SDG                    
Goal       Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all.     Build resilient infrastructure, promote inclusive and sustainable industrialisation and foster innovation.     Ensure sustainable consumption and production patterns.     Take urgent action to combat climate change and its impacts by regulating emissions and promoting developments in renewable energy.     Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification and halt and reverse land degradation and halt biodiversity loss.
 

COMMUNICATING OUR ESG MESSAGES

During the year under review, we continued to implement our well-established open-door policy in terms of our key stakeholders, including regular engagements with our top 25 local and international institutional and private shareholders, as well as prospective investors and other interested parties.

The following commentary outlines the key areas of interest and concern expressed by these groups. I have confined the content to the most frequently asked questions and compartmentalised the information under the following categories: environment, social and governance.

In addition, given the material impact of the COVID-19 pandemic on our business and trading markets in the fourth quarter of the review period, I have included a dedicated section dealing with the concerns and queries raised in this regard, which I trust will provide comfort to stakeholders.

ENVIRONMENT
Environmental report
Property investment portfolio report

What are the different ways that the Company emits greenhouse gases ("GHGs")? Does the Group measure its carbon footprint? Are there targets in place?

Ceramic Industries, in which we have a 95% stake, uses natural gas to evaporate water from ceramic slips and pressed tiles as well as to fire ceramic tiles and sanitaryware. GHGs are indirectly emitted through consumption of electricity in the production process and diesel in transportation to deliver product. Through sustained investment in innovative technology and processes, our factories are amongst the most energy efficient in the world. The Environmental report provides further in-depth detail.

Does the Group have plans to reduce emissions and manage exposure to climate risks (and, if so, what are they)?

Ceramic Industries consistently re-invests in the latest technology that is more efficient, reduces waste and minimises consumption. Our Betta sanitaryware plant in South Africa and our Centaurus plant in Australia both utilise 1 MW solar power plants to offset consumption currently supplied by electricity generated from gas or coal consumption. A 3 MW solar installation is planned for our Vereeniging site by the end of 2021, which will reduce reliance on non-renewable energy and generate up to 25% of energy requirements (at peak generation in the day) on the site. We will also continue to roll out solar installations to a number of our stores. The environmental and property portfolio reports of this document provide further in-depth detail.

What natural resources does the Company consume, extract, degrade, toxify or otherwise harm (and to what extent)?

Ceramic Industries' operations consume natural gas (3,6 million GJ per annum). We extract clays, feldspars and granites, which are beneficiated to form inert ceramic tiles and sanitaryware (570 000 tons per annum). We consume 27 000 tons of glaze per year in the production of ceramic tiles and sanitaryware. We also form PMMA and ABS sheets into bathtubs, which we reinforce with fibreglass and resins (2 550 tons).

Ceramic Industries conducts mining activities in open cast quarries that supply clay for the manufacturing process. Concurrent rehabilitation is practised to ensure minimum disturbed environment at any time. When the quarries reach the end of their useful life, the Company completes rehabilitation measures to restore the site to a safe and natural state.

Ezee Tiles production processes consume 185 000 MT of silica sand per annum; 2 800 MTs of dolomite/calcium carbonate per annum and 1 800 000 L of water per annum. The business does not create any harmful toxins.

Outside of climate risks, does the Company have an environmental risk reduction plan (and, if so, what is the plan)?

The Group's sustainability agenda is promoted through the use of cost-effective, energy efficient practices in the construction of new buildings and the renovation of older buildings. Optimal use of natural light, solar technology, new-generation efficient lighting, water-saving taps, rain water harvesting and environmentally sensitive building materials is prioritised. Our factories at Ceramic Industries use the latest technology in their operations and rank among the most energy efficient in the world. The Environmental report provides more detail in terms of our plan to reduce the Group's carbon footprint, including reducing consumption of water and energy and improving waste management.

SOCIAL
HR and Training report
Support for communities report

Does the Group measure employee turnover and what is the three-year trend?

Yes, employee turnover is measured on an annual basis. The three-year trend is: 2018: 7,6%; 2019: 9,3% and 2020: ??%. Assuming up, we can say "The reduced headcount is performance-related and a result of an ongoing productivity drive in the business to optimise the returns on all resources and assets."

Does the Group measure employee satisfaction and what is the three-year trend?

An independent evaluation is conducted annually to assess the quality of engagement with our employees. The score has consistently improved over the past three years, from 73% and 74% in the two prior years, to 77% in the current year, our best score to date.

Has the Group made significant investment in its human resources over the review period?

Investment in training and development as a percentage of costs to the business is significant. Over the past year R15,6 million was incurred on various training initiatives.

What strategies does the Group employ to attract, retain and promote qualified talent?

The Group pays well above the prescribed minimum wage and our salary scale complies with all relevant legislation. Our remuneration philosophy is governed by the principles of equity, fairness and affordability, ensuring alignment between management and shareholder requirements.

In addition, the Group's share schemes (including a broadbased scheme for all levels of staff) is designed to incentivise employees to participate in the growth and profitability of the business.

Our policy is to attract the best calibre of people by being the employer of choice in our industry through ensuring our employees are appropriately remunerated, incentivised through profit share and partnerships, and equipped through training and skills development to perform their jobs.

Refer to Review of operations and the Remuneration committee report for futher details.

What are the Group's policies related to discrimination, harassment, healthy working conditions and fair wages?

We practise zero-tolerance of discrimination and harassment in the workplace. In 2018, we introduced diversity, equity and inclusion workshops to the business, the purpose of which is to entrench the culture of inclusion by acknowledging differences and equipping diverse employees to build better relationships.

Our working conditions comply with the Occupational Health and Safety Act No 85 of 1993 and other relevant legislation, regulations and codes of practice in South Africa and other jurisdictions in which we operate. We conduct regular health and safety audits across all retail stores and supply chain businesses. The most recent audits conducted during the current year continued to yield improved results, achieved through various training and monitoring initiatives.

In terms of fair wages, we pay well above the prescribed minimum wage and our salary scale complies with all relevant legislation. Our remuneration philosophy is governed by the principles of equity, fairness and affordability, ensuring alignment between management and shareholder requirements.

In terms of Ceramic Industries, all of the South African factories undergo the Sedex Member Ethical Trade Audit ("SMETA") — a global accreditation. The SMETA audit process comprises four pillars: labour standards; health and safety; business ethics and the environment.

What environmental, social and other ethical standards does the Company require of its various counterparties?

The Group has adopted a formal code of business and ethics and we strive to ensure our business partners share the same philosophy in terms of ESG matters.

Does the Group implement a CSI programme?

The Group's CSI programme is conducted by the Italtile and Ceramic Foundation, as well as through our retail brands. Our franchisees also participate in local community initiatives at their own discretion. The Supporting our communities report of this document outlines the Group's support for our communities through charitable activities conducted during the review period.

What is the Company's approach to maintaining positive customer relationships and brand reputation?

Management is extremely mindful of retaining the loyalty and goodwill of our customers. The Group operates call-in and online support and conducts a range of measures to evaluate customer satisfaction sentiment, including Mystery Shoppers, in-store surveys, Net Promoter Score and an independent brand health monitor.

How healthy is the relationship between the Group and the franchise network and how does the Group engage with and support franchisees?

The management team engages with franchisees on a regular and frequent basis through franchisee forums; personal contact; call-in and online support; regular store visits and annual brand conferences. We regard our franchisees as valued partners and the low franchisee churn is a clear reflection of the good relationship with them.

GOVERNANCE
Remuneration report

REMUNERATION

Is the CEO's compensation linked to the Group's performance and if so, what are the linked KPIs?

Remuneration is linked to Company performance and based on a specific formula, including operational performance metrics. Compensation includes a cash bonus element and shares. The Remuneration report provides extensive detail.

Are the other executive managers also subject to performance-related KPIs?

Yes. All managers in the business are assessed and compensated according to pre-determined KPIs, which are aligned to Group goals. Across the management team, including the CEO, performance against KPIs is rated on a scale: superior achieve (exceeded target), achieve (achieved target) and underachieve (failed to meet target).

How are management incentives designed to prioritise long-term value creation?

The Group's remuneration policy subscribes to the King IV recommendations and principles, including:

  • incentive-based results are linked to achieving demanding performance conditions consistent with shareholder interest over the short, medium and long term; and
  • performance measures and targets for incentive plans are structured to operate efficiently throughout the business cycle and support the business strategy.

The Group's incentive schemes are designed to encourage and reward delivery of its strategic priorities over the short, medium and long-term. The short-term incentive focuses on achieving business targets in that financial year, while the long-term incentive closely aligns the interests of executives with shareholders over the longer term. The long-term incentive encourages directors and prescribed officers to build a shareholding in the Company, which sustains ongoing performance and the creation of shareholder value. Given the Group's philosophy of partnership, greater weighting is applied to long-term incentives. Refer to the Remuneration Committee Report for detailed information regarding management compensation.

Does the compensation of any manager depend on any ESG-related KPIs?

ESG-related criteria have been added to the performance scorecard of the CEO and all executive management with effect from FY2021.

BOARD

What are the Board's long-term financial and strategic targets for the Company?

Sustainable, responsible growth in the interests of all stakeholders. Continued growth in headline earnings per share.

RISK MANAGEMENT

Is there a management succession plan?

There is a detailed succession plan in place for the Chairman, CEO and key individuals within the organisation.

Does the Company have a whistle-blower policy?

The Group makes use of a whistle-blowing line managed by independent third parties. Details of matters reported are forwarded directly to the Chairman of the Audit and Risk Committee, Executive Directors and Internal Audit in the case of Italtile and to the CEO in the case of Ceramic Industries. All reports are actioned by management.

Is there a process for approving Company transactions with related parties?

All products are supplied on an arm's length basis to related parties. There is a Chinese wall in place regarding customer information between Italtile and Ceramic Industries. This was a condition of the Competition Tribunal when they approved the deal for Italtile to acquire Ceramic Industries.

Is there a process by which a minority shareholder can get a proposal on the voting agenda?

A submission may be made in writing to the Board at any time.

What is the Company's strategy for managing reputational and business risk?

The Group's flat organisational structure ensures that significant issues of reputational business risk are rapidly escalated from management level to the appropriate Board Committees. The CEO, supported by the relevant Board members and communication team, is responsible for implementing the strategies and managing issues and crises.

COVID-19 PANDEMIC AND BUSINESS SUSTAINABILITY

In order to curb the spread of the COVID-19 pandemic, the governments in our respective trading jurisdictions, being South Africa, the rest of Africa, and Australia, issued directives commencing March 2020 to lock down business activities, including retail and manufacturing operations, for varying lengths of time. The implications of these measures on our business were material, specifically on the results reported for the fourth quarter of FY2020, commencing 1 April and concluding on 30 June 2020. It is therefore appropriate for me to address the key issues which arose relating to the impact on the business up to the conclusion of the reporting period and the projected impact on the business in the future.

I have focused on the primary areas of interest or concern to our stakeholders.

How and to what extent were your operations affected by the pandemic during the review period?

The Group's results for the year are best analysed in the context of the progression of the pandemic which commenced in March 2020 in our various trading markets.

Total system-wide turnover for the year of R9,3 billion (2019: R10,0 billion) was 7% lower than the prior comparable period. Total retail store turnover declined 3,9% compared to the previous corresponding period, while like-for-like retail store turnover decreased by 6,2%. Prior to the lockdown in South Africa, up to 27 March, retail store sales were up 5,4% year on year. During the lockdown only marginal sales were recorded in April. In May and June following the easing of restrictions, retail sales grew 3% and 11% respectively.

Supply chain sales decreased by 6,1% compared to the previous corresponding period. Prior to the lockdown, sales had decreased 1,4% year on year.

Manufacturing sales for the review period declined by 8,8% compared to the previous corresponding period; prior to the lockdown, sales were flat year on year.

Encouragingly, retail sales growth of 14% and 17% were recorded in July and August 2020 respectively, exceeding our expectations. There is, however, significant uncertainty regarding the sustainability of this strong growth given the economy's weak fundamentals. It is difficult at this point to ascertain to what extent growth is driven by pent-up demand following restrictions and, furthermore, how sustainable the source of disposable income is (our preliminary analysis is that it probably derives from debt payment holidays; funds previously spent on transport and leisure activities; retrenchment pay; TERS/other COVID-19 relief funds; and lower interest rates).

The CEO and CFO's reports of this document provide further in-depth detail regarding the Group's performance and results for the period.

Have you breached, or might you breach, any covenants as a result of the pandemic?

No.

Will raising additional capital be necessary to weather the crisis? And if so, would you raise debt or equity?

The Group negotiated a short-term contingency facility prior to the lockdown, which has not been utilised.

Has the pandemic impacted on the Group's debtors' book?

There has been no material impact on the debtors' book, which remains healthy.

In response to the pandemic, have you:

reduced or delayed any investment spending plans and if so where?

We postponed an upgrade to one of our factories and delayed some new store openings. Subsequent to year end, and given strong cash reserves, we have reinstated the roughly R800 million capex programme, which will be implemented over the next 12 to 18 months.

made any changes to executive and Board compensation?

Salary and fee sacrifices were made by the Chairman, CEO, prescribed officers, executive and non-executive directors as follows:

  • Chairman and CEO: 35% salary sacrifice for three months;
  • CFO and prescribed officers: 30% salary sacrifice for three months;
  • Other executive management: 25% salary sacrifice for three months; and
  • Non-executive directors: 30% fee sacrifice for three months.

In addition, the standard annual salary and fee increases implemented traditionally on 1 July have been waived.

made any changes to share buy-back plans or the dividend?

The Group continues to buy back shares in line with the 2019 AGM resolution and Board mandate. Over the past 12 months shares valued at R243 million have been bought back. The dividend cover remains at two-and-a-half times and given strong cash reserves, a full-year dividend was paid.

provided extraordinary non-contractual financial flexibility to any customers, suppliers, or business partners?

No.

made any additional coronavirus-related donations (cash, supplies, human resources), or shifted any business operations to fulfil crisis needs to help fight the pandemic?

The Group's Italtile and Ceramic Foundation made a cash donation to the Solidarity Fund and donations of cash, personal protective equipment and food parcels to needy organisations. Our Ezee Tile business, which manufactures adhesives, commenced production of hand and surface sanitisers (compliant with World Health Organization ("WHO") standards) for our stores and other operations.

What is your prognosis for the business in terms of future sustainability?

We have clear strategies in place to continue to optimise on improvements made in the business to extract growth and gain market share.

The Group's cash generating ability, robust cash reserves and engrained disciplines of working capital management and cost leadership will continue to be a significant advantage for the business in the COVID-19 era. There is a strong focus on value thinking and management will continue to aggressively review the Group's cost base and return on assets and resources.

The safety of our customers, employees and neighbouring communities is a key priority for the Group and extensive measures are, and will remain, in place in our stores and factories to ensure operational health and safety protocols comply with prescribed government regulations to curb the spread of the virus. We will continue to practice zero tolerance on non-compliance.

  

The reports which follow elaborate on our journey to sustainable value creation, and include:

> the environment in which we operate;

> material issues, risks and opportunities;

> our stakeholders;

> transformation;

> our people;

> supporting our communities;

> environment; and

> corporate governance.