Chief Financial Officer’s Report

Chief Financial Officer – Mark Kathan

This report is intended to provide a high level overview of the financial performance of the AECI Group for the year ended 31 December 2011. The Report should be read in conjunction with the consolidated Annual Financial Statements.

FINANCIAL PERFORMANCE

OVERVIEW

The Group delivered most pleasing results for the year with profit from operations and headline earnings per share (“HEPS”) increasing by 24% and 25% respectively. The growth was made possible by improved performances in all of our operating segments and was particularly gratifying given a very challenging trading environment in which commodity prices were rising and the rand remained at strong levels against the US dollar for most of the year. Performances improved strongly in the last quarter of the year when there was a sharp and significant decline in the rand exchange rate within a short period. The Group was able to respond quickly, thereby enhancing its results for 2011.

Revenue for the year was R13 397 million, a 16% increase year-on-year. Volumes grew by 7%. Profit from operations increased to R1 316 million from R1 062 million in 2010 and EBITDA improved by 26% to R1 746 million from R1 385 million in the prior year.

The results included the positive effects of a net translation gain of R77 million, of which R35 million related to the realisation of an amount of foreign cash which was repatriated. Costs were well controlled and margins maintained or improved to deliver higher revenue despite increased energy costs, higher depreciation from the Group’s capital expansion programme and the effects of nitrates shortages.

Profit after tax increased by 31% to R838 million. Interest expense increased by R61 million as a result of lower capitalisation of interest into projects, with R17 million capitalised in 2011 compared to R93 million in 2010. The Group’s effective tax rate was 27%, due mainly to a proportion of the profits being earned in territories with lower tax rates. It is likely that the Group’s overall tax rate will be slightly lower in future as secondary tax on companies in South Africa is replaced by dividends tax, whereby dividends will be taxed in the hands of shareholders.

SEGMENT OPERATING PROFIT (RM)

POST-RETIREMENT MEDICAL AID

The Group’s post-retirement medical aid obligation is valued annually and adjusted in line with the revised valuation. There are a number of assumptions in valuing this long-term obligation and the charges are all recognised in the Income Statement. The 2010 charge of R168 million was largely the result of a number of additional pensioners being included. In 2011 the charge was R87 million even though the net discount rate used in the valuation was decreased from 1,75% to 1,25%. The net discount rate is the difference between the long-term interest rate used to discount the obligation to present value and the expected long-term inflation rate used for healthcare costs. This rate should be relatively stable over time and 1,25% is seen as an appropriate rate for the foreseeable future. For more details on this obligation, see note 15 and note 30 of the Annual Financial Statements.

IAS 19 is the Standard which governs the accounting for employee benefits. This Standard was revised in 2011 and becomes effective from 1 January 2013. One of the key changes in IAS 19 is that actuarial gains or losses determined in the annual valuation including changes in any of the underlying assumptions will be recognised in Other Comprehensive Income. This change should result in less volatility in the Income Statement but will not be adopted by the Group before 1 January 2013.

NET DEFINED BENEFIT OBLIGATION (RM)

EMPLOYER SURPLUS ACCOUNTS

The Company has employer surplus accounts with the Group’s defined-benefit Pension Funds as described in note 5 . The Company earns a proportionate share of the returns of the Funds and utilises the surplus to fund contribution shortfalls calculated actuarially with reference to the benefits granted compared to the contributions received from the Group and its employees, without considering the assets and returns earned by the Funds. In 2011 a surplus apportionment was made in three of the funds to members and the Company in equal shares, resulting in the Company receiving further allocations of R49 million. Allocations are recognised as income and included in the Income Statement, which have been disclosed separately.

EARNINGS PER SHARE

As already outlined HEPS increased by 25%, to 720 cents and earnings per share (“EPS”) increased by 30% to 724 cents. EPS in 2010 were affected by a number of non-headline non-recurring transactions which negatively impacted on earnings for the prior year. Note 24 provides more detail in respect of the per share data. The 2011 earnings are indicative of the operating result and were not affected significantly by unusual or once-off items.

FINANCIAL POSITION

The Group’s non-current assets remained at similar levels to those for 2010, with the capital expansion programme reaching its conclusion. However, the reasonably moderate increase that did occur was the result of acquisitions made in 2011. The assets acquired included plant and equipment, intangible assets and working capital.

The working capital acquired contributed to the Group’s working capital ratio being significantly higher at the end of 2011 than at the end of 2010. The measure we use is the percentage of net working capital to revenue and our target range is between 16% and 18%. In 2010 working capital was at 15%. At the end of 2011 it was 17,7%, still within our target range. An impacting factor, in addition to working capital acquired through business combinations, was the sharp decline of the rand to R8,15 against the US dollar in the last quarter of the year. Commodity prices are largely US dollar based and this affects the rand value of purchases and sales, and hence working capital. As the international component of the Group’s business increases these effects will be greater, as will the effects of a longer supply chain to international markets. Management continues to have a strong focus on working capital so as to maintain it at appropriate levels.

Net debt which includes long-term and short-term debt and cash increased by R98 million from 2010, but the Company’s debt to equity percentage declined from 40% to 36%, placing us in an excellent financial position to fund future growth. We have repaid about half of the term debt obtained in 2008 and in 2011 we concluded an agreement for new floating rate debt of R1 000 million for a period of three years. Term debt represented 51% of the Group’s borrowings at end 2011. All loan covenants were met in the year under review. Total debt is approximately R1 100 million below the existing facilities available to us.

BORROWINGS AND GEARING

CASH FLOW

The Group’s operations generated R1 883 million in 2011. These funds were utilised to pay interest, tax and dividends, as well as financing the increase in working capital. Interest paid for the year was R253 million and was slightly lower than in 2010 in an environment of stable interest rates. Tax increased in line with the Group’s improved profitability and dividends paid increased by 62% to R237 million during the year in line with the higher earnings. Cash flow from operating activities was R425 million for the year, down from R984 million in 2010. It should be borne in mind that working capital levels at the end of 2010 were similar to those at the end of 2009.

Investments included R475 million for property, plant and equipment, with R182 million in respect of capital mainly related to the final stages of our R2 000 million strategic investment programme which commenced in 2007; investment property and intangible assets; and R173 million for the acquisition of new businesses and subsidiaries. These investments were funded mainly by increased long-term debt. The Statements of Cash Flows and the associated Notes to the Statements of Cash Flows provide further details.

ACQUISITIONS

The Group concluded a number of acquisitions during 2011 after a period of consolidation in 2009 and 2010. These acquisitions are the first business combinations by the Group since the introduction of the revised IFRS 3. The Group acquired businesses and subsidiaries with a combined purchase price of R180 million which included R49 million to acquire the non-controlling interest in Cobito and contingent consideration calculated and provided for as a liability of R7 million. Details of the consideration, assets and liabilities of the acquisitions can be found in note 33.

The Group acquired the remaining 20% of Cobito, which has performed well since it was acquired in 2008. The original acquisition was accounted for prior to the effective date of the prospective application of IFRS 3. The transaction represents the acquisition of the non-controlling interest and is accounted for as a transaction between shareholders and not as a business combination.

The agricultural chemical distribution business of Qwemico Distributors was acquired in March 2011 and incorporated into Nulandis. This acquisition has enhanced Nulandis’ distribution network in the northern regions of South Africa and has resulted in revenue growth in that business.

Crest Chemicals acquired the business of Croxton Chemicals and this company’s investment in Protank, thereby adding bulk caustic soda supply to Crest Chemicals’ range of products. The transaction involved the acquisition of storage tank facilities, which were recognised at fair value, and a beneficial supply chain arrangement which was recognised as an indefinite life intangible asset with reference to IFRS 3 and IAS 38.

The Group also acquired the chemical toll manufacturing business of T&C Chemicals, with water treatment technologies incorporated into ImproChem and the manufacturing facility combined with Chemisphere Technologies (formerly SA Paper Chemicals). Another acquisition was the business of Instavet, which has been added to the Chemfit portfolio. Instavet supplies medicated feed additives, diagnostic equipment and vaccines to the livestock industry.

In addition, ImproChem concluded a distribution agreement with GE Betz, a General Electric company, which will leverage ImproChem’s extensive local expertise and GE’s advanced technologies to create greater access to innovative water solutions for customers in Africa.

B-BBEE TRANSACTIONS

During 2011 the Group proposed two B-BBEE transactions, with both transactions being non-adjusting events occurring after the end of the reporting period.

The first transaction, which was approved by shareholders in November 2011 and was concluded in January 2012 with the fulfillment of the suspensive conditions contained in the agreement, was for the purchase of the 25,1% interest held by Kagiso Tiso Holdings (“KTH”) and the AEL Tiso Development Trust in AEL Holdco Limited in exchange for shares in AECI Limited. The transaction gives AECI full control of AEL and allows greater flexibility in managing the operations of AEL while allowing the entire Group to benefit from KTH’s involvement as a long-term B-BBEE partner and strategic investor.

AEL Holdco Limited was already a subsidiary of AECI and as a result the transaction will not be accounted for as a business combination under IFRS 3, but rather as a change in the parent’s ownership interest, with the carrying amounts of the controlling and non-controlling interest adjusted to reflect the changes. The fair value of the transaction is based on the closing AECI share price on the day prior to the listing of the shares, being R83,98 multiplied by the 4 678 667 shares issued. The difference between the fair value being R392,9 million and the carrying amount of the non-controlling interest will be recognised directly in equity and attributed to AECI’s shareholders in accordance with IAS 27.

The second transaction involves an Employee Share Trust (“EST”) and a Community Education and Development Trust (“CST”). The transactions were approved at a General Meeting of shareholders in January 2012 and the shares were allotted to the Trusts in February 2012. The transactions are equity-settled share-based payments and are accounted for in terms of IFRS 2. The CST transaction is recognised in the Income Statement on the grant date as there are no vesting conditions and the EST transaction is recognised over a seven year vesting period.

The CST subscribed for 4 426 604 ordinary shares in the Company, with funding advanced by the Company to the Trust to enable it to acquire the shares. The CST will earn dividends on its shares and these dividends are to be utilised for projects focused on improving education in Black communities in areas where AECI operates or has an interest. The AECI ordinary shares held by the CST will not be included in EPS or HEPS as they are contingently returnable in future and are excluded in terms of IAS 33, but will be included in the diluted per share calculations.

The CST will not be consolidated under the current IAS 27 and the impact of IFRS 10 will be determined during 2012 to assess whether this treatment will change once that Standard becomes effective.

The IFRS 2 cost to be recognised in the first half of 2012 is based on the fair value of the shares. Fair value is determined using an option pricing model with reference to the closing AECI share price on 9 February 2012, which is the grant date of the transaction. The IFRS 2 expense of R138 million will be recognised in the Income Statement with a corresponding credit directly to equity.

The EST subscribed for 10 117 951 newly created B ordinary shares which are a separate class of shares and are unlisted, redeemable, convertible shares of no par value. The shares carry the same voting rights as AECI ordinary shares and are subject to a separate dividend declaration from ordinary shares, subject to the condition that the B ordinary share dividend may not exceed the ordinary share dividend. The B ordinary share dividend is expected to be 10% of the ordinary share dividend.

The EST will allocate shares to eligible employees based on their years of service and to Black managers on a basis linked to their annual remuneration. 10% of the shares will be retained initially in the EST for allocation to future Black employees. The shares vesting in the employees will be subject to a forfeiture profile based on a seven year vesting period and on the circumstances of employees leaving the Group within the 10 year term of the EST. Employees will only be entitled to convert their B ordinary shares to AECI ordinary shares after 10 years.

The EST will be consolidated in the Group Financial Statements in terms of IAS 27 and IFRS 10 when it becomes effective. The costs of administering the EST will be included in the Group’s results, but the shares and the dividends thereon will be eliminated in the consolidated accounts. The EST shares will not be included in the number of shares for EPS or HEPS calculations. However, the effects will be included in the corresponding dilution calculations.

The IFRS 2 cost of the transaction will be calculated at fair value from the grant date/s and will be recognised over the vesting period of the transaction. Eligible employees will have a prescribed period within which they can decline their share allocations, failing which they will be deemed to have agreed to the offer of shares. This date will become the grant date and has yet to be determined. The IFRS 2 expense will be recognised in the Income Statement on a straight-line basis over the vesting period with a corresponding credit directly to equity

The full accounting effects as far as they can be determined at this time are detailed in note 34.

TAX CASES

The Group’s disputed tax assessments for Founders Hill Proprietary Limited (“Founders Hill”) attracted media attention in 2011 as the appeal by the SARS to the Supreme Court of Appeal (“SCA”) was heard and adjudicated. The SCA upheld the SARS appeal and confirmed the SARS assessment of the profit from the sale of land in the 2000 and 2001 years of assessment as revenue in nature and subject to income tax. The SCA made note of the fact that AECI had acted on legal advice obtained and had made full disclosure in its tax returns. Founders Hill made an application for leave to appeal the SCA judgement to the Constitutional Court. The application was dismissed with costs. Founders Hill has paid the tax raised on the SARS’ additional assessments of R1 million and has requested the SARS to waive the interest calculated to date on the basis of the findings of the SCA and an agreement by the SARS to suspend the obligation to pay the assessed tax until conclusion of the legal process. There are three other Group companies where similar circumstances exist and assessments have been issued and the three disputes were placed on hold until the legal process in respect of the Founders Hill case had been completed.

There has been significant debate in both academic circles and in the media relating to the decision of the SCA, which has effectively reversed many years of accepted treatment with regard to realisation companies. A number of experienced professionals have openly disagreed with the decision of the SCA and the interpretation of the case presented. The Group still considers the arguments of the taxpayers concerned to have merit and the option of taking the remaining cases to court is still available. The Group has approached the SARS to discuss a resolution for the outstanding matters, given the length of time taken for the finalisation of the Founders Hill matter through the courts.

The Group previously disclosed the assessed tax and calculated interest as a contingent liability as there was a present obligation arising from a past event, but while the outcome of the Founders Hill case was still awaited, the amount of the obligation could not be measured with sufficient reliability. Having considered the outcome of the case and the surrounding debates on the decision, the Group has raised provisions in 2011.

DIVIDENDS AND DIVIDENDS TAX

The Company declared a cash dividend of 179 cents per share on 20 February 2012, taking the total cash dividend for the 2011 year to 257 cents. The final cash dividend for 2010 was 135 cents with a total dividend for the year of 205 cents.

The dividend will be paid on ordinary shares recorded in the books of the Company on 16 April 2012, which will include the 9 105 271 shares issued in terms of the KTH transaction and the CST component of the B-BBEE transaction. The declaration of the dividend prior to 1 April 2012 means that the dividend will be subject to secondary tax on companies at a rate of 10% which is payable by the Company. Due consideration was given to the impending introduction of dividends tax before the dividend was declared. Subsequent to the declaration the rate of dividends tax was announced at 15%.

Shareholders will now be liable to pay dividends tax on all dividends declared and paid to them after 1 April 2012, subject to certain exemptions. The tax is a withholding tax and, with listed shares, a regulated intermediary such as Computershare Investor Services Proprietary Limited will be responsible for withholding and paying the amount due to the SARS while paying the shareholder the net amount. Shareholders will be required to make a declaration and submit documents to the regulated intermediary should they qualify for exemption from or reduction of the dividends tax.

CONCLUSION

The financial position of the Company is sound after a challenging year in which a very pleasing performance was achieved. The AECI Group has positioned itself to facilitate the implementation of its strategies for future growth into new markets and geographies. 2011 was also a year in which the Company established a sound base, through its B-BBEE transactions, for advancement of its empowerment objectives which are fundamental to its growth strategy.

Mark Kathan
Chief Financial Officer

Woodmead, Sandton
30 March 2012