Harvey Norman Holdings Limited

A.C.N. 003 237 545

A1 RICHMOND ROAD

HOMEBUSH WEST N.S.W. 2140

LOCKED BAG 2

SILVERWATER DC, N.S.W 1811

Telephone: (02) 9201 6111

Facsimile: (02) 9201 6250

29 October 2018

Australian Securities Exchange Limited Exchange Centre 20 Bridge Street SYDNEY NSW 2000 Dear Sirs

Response by HVN to Australian Shareholders Association Questions

The Company encloses a copy of correspondence sent, or shortly to be sent, to the Australian

Shareholders Association.

Yours faithfully

Harvey Norman Holdings Limited

Chris Mentis

Company Secretary

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29 October 2018

Ms Pamela Murray-Jones

Monitor

Australian Shareholders' Association

227 Elizabeth Street

Sydney NSW 2000

By Email: pamela@strategycoaching.com.au

Dear Ms Murray-Jones

Harvey Norman Holdings Limited (Company) Australian Shareholders' Association (ASA)

Annual Report of the Company for the financial year ended 30 June 2018 (Annual Report)

We refer to: 1. the upcoming annual general meeting for the Company scheduled to occur on 27

November 2018 (AGM); and 2. your email dated 23 October 2018, to Graham Paton, Chairman of the Audit Committee of the

Company, which attached a document headed Harvey Norman Holdings Limited Questions for Meeting Thursday 25 October 2018 (Questions Document) and a document headed Part C: Executive Remuneration (ASA Position Document). A copy of the Questions Document and ASA Position Document are enclosed for your information.

Thank you for your correspondence. The ASA has made a number of comments and posed questions in the Questions Document.

We have set out, verbatim, in italics, the questions posed by you to the Company in the Questions Document and respond below, adopting the same paragraph numbers, and headings, as you have used in the Questions Document. The Company will not provide any selective preferential briefing to you, and in particular will not disclose to you any price-sensitive information about the Company and the affairs of the Company, which has not been previously disclosed to the ASX. Financial Performance 1. Could you please confirm the accuracy of the following table:

(As at FYE) 2018 2017 2016 2015

NPAT ($m) 375.38 452.9 351.3 268.9

UPAT($m) 377.03 448.9 348.6 268.1

Share Price ($) $3.26 $3.85 $4.61 $4.50

Dividend (cents) 24 26 30 20

TSR (%) (9.0) (11.49) 8.09 60.16

EPS (cents) 34.96 40.35 31.36 24.51

CEO total remuneration, actual ($m) 3.58 3.41 3.08 2.93

The table is inaccurate.

HARVEY NORMAN HOLDINGS LIMITED A.C.N 003 237 545

A1 RICHMOND ROAD

HOMEBUSH WEST, N.S.W 2140 LOCKED BAG 2

SILVERWATER DC, NSW 1811 AUSTRALIA

Telephone: (02) 9201 6111 Facsimile: (02) 9201 6250

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The following information has been disclosed in the Annual Reports of the Company.

(As at FYE) 2018 2017 2016 2015

NPAT ($m) 375.38 448.98 348.61 268.10

UPAT($m) 377.03 377.42 316.64 261.84

Dividend (cents) 30.0 26.0 30.0 20.0

EPS (cents) 33.71 40.35 31.36 24.51

CEO total remuneration, actual ($m) 3.13 3.34 3.08 2.93

2. There have been 2 years of losses in Other Non-Franchised Retail and Other Segments.

* What has been the total loans to KEH over the years?

* How much has been written off?

The financial results of the KEH Partnership Pty Limited (KEH) form part of the Other Non-Franchised

Retail Segment.

We refer you to page 97 of the 2018 Annual Report

* What is the likelihood of further impairments?

The Company does not make forward looking statements. The Company strictly complies with the law in

relation to financial reporting.

(i) Impairment of non-trade receivables from the KEH Partnership retail joint venture: The consolidated entity, through a wholly-owned subsidiary, has a 50% interest in KEH Partnership Pty Limited,

a retail joint venture in Australia. The primary business of the KEH Partnership retail joint venture is the retail

sale of school apparel and educational goods through the brand name of The School Locker. The ‘Big Buys by

Harvey Norman®‘ division of the KEH Partnership was closed during the second half of the 2018 financial year.

As at 30 June 2018, the consolidated entity had a commercial loan receivable from the KEH Partnership retail

joint venture totalling $60.96 million in respect of the amounts advanced to The School Locker business to assist

with working capital requirements (2017: $38.68 million). The amounts previously advanced to the Big Buys by

Harvey Norman® business were either repaid or written off in full upon closure of that business and was nil as at

30 June 2018 (2017: $34.92 million). As at 30 June 2018, the total balance of the provision for doubtful debts

relating to the non-trade receivable from The School Locker business of the KEH Partnership joint venture was

$20.82 million (2017: $9.96 million). The provision for doubtful debts previously raised for The Big Buys

business was fully utilised upon closure (2017: $24.97 million).

During the 2018 financial year, an impairment assessment was conducted resulting in the recognition of an

expense of $16.92 million (2017: $18.41 million), with $6.06 million relating to the Big Buys by Harvey Norman®

business and $10.86 million relating to The School Locker business.

As at 30 June 2018, the present value of future cash flows of The School Locker business was assessed for a

five-year period, based on financial budgets and assets held as security. The effective interest rate of 7.5% was

applied to the cash flow projections. Cash flow projections were limited to five years. Each of the key

assumptions in the impairment assessment were subject to significant accounting estimates and assumptions

including the future trading performance of the retail joint venture. Judgement was made based on these

accounting estimates and assumptions to assess the recoverable amount of the non-trade receivables as at

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* What is the total of the loans made to the mining camp joint venture?

* How much has been written off?

The results of the mining camp joint venture do not form part of the Other Non-Franchised Retail Segment

and Other Segments. Any profits or losses attributable to the mining camp joint ventures are reported

within the Property Segment.

We refer you to page 97 of the 2018 Annual Report.

The consolidated entity has made commercial advances to the mining camp joint ventures totalling $37.63

million (2017: $31.15 million) in aggregate as at 30 June 2018. The recoverable amount of non-trade

receivables advanced to the mining camp joint ventures was assessed during the year. No impairment

loss was recognised in the current year (2017: $0.43 million) to reduce the carrying amount of the non-

trade receivable to recoverable amount. The total balance of the provision for doubtful debts as at 30 June

2018 relating to non-trade receivables from the mining camp joint ventures was $13.23 million (2017:

$13.23 million).

The recoverable amount for these non-trade receivables have been determined based on the present

value of estimated cash flow projections as at 30 June 2018 for a five-year period, based on financial

budgets and the assets held as security. The effective interest rate applied to the cash flow projections

was 7.5%. Cash flow projections were limited to five years due to the inherent risks associated with the

mining industry.

Each of the key assumptions in the impairment assessment were subject to significant accounting

estimates and assumptions about future economic conditions and its impact on the ongoing trading

performance of the mining camp joint ventures and the possible commencement of future projects which

are currently out to tender. Judgement has been made, based on available information and these

accounting estimates and assumptions, to each of these variables to assess the recoverable amount of the

non-trade receivables as at balance date.

* What is the likelihood of further impairments on this venture?

The Company does not make forward looking statements. The Company strictly complies with the law in

relation to financial reporting.

* Can you provide me with some further understanding of the total investment in Byron Bay and

return and losses to date?

The company has no obligation to make a separate disclosure in respect of the investment in the Byron

at Bay Resort, Spa & Conference Centre.

We refer you to the following parts of the 2018 Annual Report.

i) Page 55

By a contract for sale dated 15 May 2002, a company (of which Gerald Harvey was a director) acting in its capacity as trustee of a trust, as to a one-half share as tenant in common (the “GH entity”), and a subsidiary of Harvey Norman Holdings Limited, as to a one-half share as tenant in common, purchased the Byron at Byron Resort, Spa and Conference Centre (the “Byron Bay JV”). In the financial statements of the consolidated entity, the day-to-day management of this entity has been accounted for as a joint venture as disclosed in Note 37 to the financial statements. This transaction was executed under terms and conditions no more favourable than those which it is reasonable to expect would have applied if the transaction was at arm’s length. No capital distribution was received by each of the GH entity and a subsidiary of Harvey Norman Holdings Limited (2017: $0.30 million). A subsidiary of Harvey Norman Holdings Limited held a conference at The Byron at Byron Resort and paid the Byron Bay JV conference fees amounting to $0.12 million for the year ended 30 June 2018 (2017: $0.11 million).

(ii) Impairment of the non-trade receivables from mining camp joint ventures:

(vi) The Byron at Byron Resort, Spa and Conference Centre For

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ii) Page 128

CONSOLIDATED

Investment Share of Profit Before Tax

June 2018 $000

June 2017 $000

June 2018 $000

June 2017 $000

Total joint venture entities accounted for using equity method 4,497 26,355 5,792 5,200

Name and Principal Activities Ownership Interest Contribution to Profit / (Loss) Before Tax

June 2018

%

June 2017

%

June 2018 $000

June 2017 $000

Noarlunga (Shopping complex) 50% 50% 1,573 1,591

Perth City West (Shopping complex) 50% 50% 3,806 4,023

Warrawong King St (a) (Shopping complex) 62.5% 62.5% 1,100 1,081

Byron Bay (Residential/convention development) 50% 50% (741) (734)

Byron Bay – 2 (Resort operations) 50% 50% 246 467

Dubbo (Shopping complex) 50% 50% 631 651

Bundaberg (Land held for investment)

50% 50% (234) (3)

Gepps Cross (Shopping complex)

50% 50% 3,075 3,101

QCV (b) (Miners residential complex) 50% 50% 10 (114)

KEH Partnership (Retailer) (c) 50% 50% - -

Coomboona Dairy (d) (Dairy farming) 49.9% 49.9% (4,565) (5,945)

Other 50% - 891 1,082

5,792 5,200

3. I notice a significant rise in trade debt receivables 90+ days (p96) from $57,368,000 to

$105,794,000. This seems highly unusual. Could you provide further detail and explanation.

There was no rise in trade debts receivables in the amount you have described. There was a rise in

non-trade debt receivables.

We refer you to the following parts of 2018 Annual Report:

i) Page 96

Non-trade debts receivable are generally interest-bearing and are normally payable at call. The aggregate balance of

current and non-current non-trade debts receivable as at 30 June 2018 was $211.96 million (2017: $144.43 million) as

follows:

$43.16 million of the non-trade debts receivable balance as at 30 June 2018 (2017: $38.76 million) are neither past due nor impaired. It is expected that these balances will be collected by the consolidated entity on, or prior to, the due date.

$105.79 million of the non-trade debts receivable balance as at 30 June 2018 (2017: $57.37 million) are past due but not impaired. These receivables are subject to regular monitoring and periodic impairment testing to ensure that they are recoverable.

$63.01 million of the non-trade debts receivable balance as at 30 June 2018 (2017: $48.31 million) are past due and impaired and a provision for doubtful debts has been raised in full.

(e) Non-trade debts receivable and provision for doubtful debts

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At 30 June, the ageing analysis of non-trade debts receivable is as follows:

Past due but not impaired

Past due and impaired

Neither past due nor

impaired

31-60 Days

61-90 Days

+90 Days

31-60 Days

61-90 Days

+90 Days

Total

2018 ($000) 43,158 - - 105,794 - - 63,008 211,960

2017 ($000) 38,759 - - 57,368 - - 48,305 144,432

ii) Page 98

iii) Page 21

The total indebtedness of CHPL to its creditors NCF and the HN JV Entity, both wholly-owned subsidiaries of Harvey

Norman Holdings Limited, as at 30 June 2018 amounted to $74.99 million as follows:

first-ranking secured creditor (NAB): the total value of commercial loans granted to the Coomboona JV by NCF of $36.28 million; and

second-ranking secured creditor (HN JV Entity): the total value of commercial loans granted to the Coomboona JV by the HN JV Entity of $38.71 million, repayable on demand.

The recoverable amount of the indebtedness of CHPL to NCF and the HN JV Entity, totalling $74.99 million in

aggregate, was assessed as at 30 June 2018. An impairment loss of $28.78 million was recognised in June 2018 to

reduce the carrying amount of the Coomboona JV non-trade receivables to its recoverable amount. Each of the key

assumptions in the impairment assessment is subject to judgement regarding the estimated shortfall in the

repayment of the loans advanced by NCF and the HN JV Entity to CHPL.

Combined, the Coomboona JV equity-accounted trading losses of $4.57 million, the impairment of the Coomboona JV investment in December 2017 of $20.67 million and the estimated impairment loss for the shortfall in the recoverability of funds advanced by NCF and the HN JV Entity of $28.78 million, totalled $54.01 million and was recognised as losses in the income statement for the 2018 financial year.

4. Could you explain why franchise fees are lower despite the increase in franchise sales?

5. Why have the results for the second half of the year been softer and how is the first half of

2019 shaping up?

We refer you to Page 23 of the 2018 Annual Report.

The Franchising Operations Margin (%)

The franchising operations segment result decreased by $21.99 million, or 7.2%, to $282.54 million in the 2018

financial year from $304.53 million in the previous year. This was a solid result particularly as it was on the back

of a strong 13.6% growth in the 2017 financial year and the massive 34% increase in the 2016 financial year. The

result generated by the franchising operations segment represented 53% of the total consolidated profit before tax

result for the 2018 financial year.

Revenue in this segment reduced by $7.64 million, or 0.8%, to $932.67 million primarily due to a decrease in

franchise fee income of 1.8%, or $14.41 million, to $768.45 million in the 2018 financial year from $782.86 million

in the previous year. Tactical support payments to protect, enhance and promote the brand increased by $10.50

million, or 16.3%, to $74.98 million for the year ended 30 June 2018, up from $64.48 million in the previous year.

Higher tactical support payments were required during the year to assist franchisees to better compete in their

respective markets. This increase was inclusive of $7.80 million in tactical support payments to assist a B2B

(iii) Impairment of the non-trade receivables from Coomboona joint ventures:

The total indebtedness of the Coomboona joint venture to the consolidated entity amounted to $74.99 million as at

30 June 2018 (2017: $9.86 million). An impairment assessment was conducted resulting in the recognition of an

impairment expense of $28.78 million (2017: nil) to reduce the carrying amount of the Coomboona joint venture non-

trade receivable to its recoverable amount.

The recoverable amount has been determined based on the estimated fair value of the securities granted by

Coomboona Holdings Pty Limited (CHPL) and subsidiaries of CHPL.

Each of the key assumptions in the impairment assessment was subject to significant accounting estimates and

assumptions regarding the estimated shortfall in the repayment of the loans advanced by the consolidated entity to

the Coomboona joint venture. Refer to further information provided on Page 21 regarding the Other Segment.

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franchisee with a restructure in Q4 of the 2018 financial year. Excluding the restructure of the B2B franchisee,

tactical support would have been $67.17 million, a minimal increase of $2.70 million or 4.2% from the previous

year. Other costs to operate the franchising operations segment, including interest and depreciation costs, have

also increased during the year contributing to the reduction in the profitability of the franchising operations

segment for the 2018 financial year.

The franchising operations margin reduced from 5.42% in the 2017 financial year to 4.90% in the 2018 financial

year, a reduction of 52 basis points. If the tactical support payments relating to the B2B franchisee were excluded

from the calculation, the franchising operations margin would have been 5.04% for the year ended 30 June 2018.

As the below table demonstrates, this reduction was predominantly in the last 6 months of the 2018 financial year.

For the December 2017 half, the franchising operations segment result decreased by $4.91 million, or 2.9%, from

the December 2016 half. The franchising operations margin was 5.57% for the December 2017 half, compared to

6.01% for the December 2016 half, a reduction of 44 basis points. The franchising operations segment result

reduced further in the second half of the year, with a reduction of $17.08 million, or 12.9%, in the June 2018 half

relative to the June 2017 half. This resulted in a franchising operations margin of 4.18% for June 2018 half,

compared to 4.81% for the June 2017 half, a reduction of 63 basis points.

The deterioration in the second half result and margin can primarily be attributed to:

a reduction in franchise fees by $15.83 million, or 4.4%, for the 2nd half of the year (1st half was actually higher

by $1.42 million); and

an increase in tactical support by $7.67 million, or 21.5%, for the 2nd half of the year, mainly relating to the

tactical support provided to the B2B franchisee in Q4 (tactical support for the 1st half was up by $2.83 million).

The Company does not make forward looking statements. The Company strictly complies with the

law in relation to financial reporting.

Strategy and Risk

1. The annual Report notes that the Board is “retail savvy”.

There is no reference in the Annual Report to the term “retail savvy”. There is reference to the term “business savvy”. We refer you to Page 61 of the 2018 Annual Report.

Board Structure and Composition

The relevant factors in determining the suitability of a board member are integrity, business savvy, an owner-oriented

attitude and a deep genuine interest in the business of the consolidated entity.

In applying these principles to the consolidated entity:

a. Business savvy requires a deep understanding of one or more of the sectors of retail, property, franchising and digital.

b. Integrity requires a level of fundamental honesty, candour and frankness in dealing with colleagues, regulators and other third parties. Integrity necessarily requires a director to bring an open mind and independent judgment to the discussion of any matter of concern to the Board.

c. An owner orientation or perspective of an owner requires the individual to either have:

i. "skin in the game" by holding, controlling or benefitting from a significant parcel of shares where the financial interests of the director are aligned with the long term beneficial interest of shareholders; or

ii. a perspective of advising owners of businesses and understanding that wealth generation is derived from the building of business interests that create long term sustainable value.

Directors with an owner orientation retain an open mind to consider diverse views but are not strictly beholden to the whims of fashionable thinking and are able to form their own views as to what constitutes best practice in corporate governance.

d. Interest in and time to do the job means:

i. the person has an executive role, meaning that the person's career is based on job performance at the company; or

ii. the individual has a limited number of outside interests (i.e. the person is not a professional non-executive director),

but in both cases the individual has an independence of mind and outlook. Applying these criteria to the current Board, the Board is satisfied that each Director brings to the Board the necessary skills and attributes specified.

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1. [Continued] Why then has the board decided to stray from its core area of competency into other strategic ventures where it appears to have little experience? Has the increase in risk of doing this been considered and if so, what contingencies have been put in place to reduce the risk?

2. What is the process of risk assessment undertaken by the Board when considering investments?

We refer you to Page 63 of the 2018 Annual Report under the heading of Risk

The identification and effective management of risk, including calculated risk-taking is viewed as an essential part of

the approach of the Company to creating long-term shareholder value.

The Board determines the risk profile of the Company and is responsible for overseeing and approving risk

management strategy and policies, internal compliance and internal control. The Board has established a separate

Risk Committee, to assist the Board, and has appointed a Chief Risk Officer to collate, monitor, evaluate and report

material risks to the Board.

The Board recognises the CGC's recommendation that the chair should be an independent director and that the Risk

Committee should consist of a majority of independent directors. The Board considers that the frequent reporting to

the Audit Committee by both the chairman of the Risk Committee and the Chief Risk Officer (the latter as providing

private reports to the Audit Committee) provides an adequate and appropriate level of involvement by the independent

directors in the risk management function.

The Risk Committee is not comprised of a majority of independent directors and is not chaired by an independent

director. The Risk Committee is comprised of four executive directors, including the CEO and CFO. The Chief Risk

Officer is required to attend all meetings of the Risk Committee to inform and assist members of the Risk Committee to

carry out its functions. The chairman of the Risk Committee and the Chief Risk Officer, both regularly attend meetings

of the Audit Committee to inform members of the Audit Committee of risk matters considered by the Risk Committee.

The chairman of the Risk Committee regularly reports to the Board on matters considered by the Risk Committee.

The Board, in conjunction with the Chief Risk Officer, oversees an annual assessment of the effectiveness of risk

management and control. The tasks of undertaking and assessing risk management are delegated to the Chief Risk

Officer through the CEO, including responsibility for the day to day design and implementation of the risk management

system of the Company. The Chief Risk Officer reports to the Board on the key risks of the Company and the extent to

which the Chief Risk Officer believes these risks are being adequately managed.

The annual assessment has been undertaken for the year ended 30 June 2018. The key business risks identified by

the Board are summarised in the Directors' Report on pages 30 and 31 of this report.

The Chief Risk Officer is required by the Board to carry out risk specific management activities in core areas, including

strategic risk, operational risk, reporting risk and compliance risk. The Chief Risk Officer is then required to assess risk

management and associated internal compliance and control procedures and report to the Board on the efficiency and

effectiveness of these efforts by benchmarking performance substantially in accordance with Australian/New Zealand

Standard for Risk Management (AS/NZS ISO 31000:2009 Risk Management).

The Board has a number of mechanisms in place to ensure that management’s objectives and activities are aligned

with the risks identified by the Board. These include:

a) Board approval of strategic plans designed to meet stakeholders’ needs and manage business risk; and

b) Implementation of Board approved operating plans and budgets and Board monitoring of progress against these budgets, including the establishment and monitoring of financial and non-financial KPIs.

The Board has adopted a comprehensive set of policies and procedures directed towards achieving the recognition

and management of risks relating to:

a) Effectiveness and efficiency in the use of the resources of the Company.

b) Compliance with applicable laws and regulations; and

c) Preparation of reliable published financial information.

Additional details about the Risk Committee, including a copy of its charter, is available on the Governance page of the

website

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Remuneration ASA will be voting undirected proxies against the Remuneration Report since Harvey Norman’s policy does not align to our guidelines for good practice. A copy of these guidelines are attached and I would welcome an opportunity to discuss them. Noted. The Company does not accept your submission. Governance While the Annual Report notes that the company is committed to a high standard of corporate governance aligned to ASX’s Corporate Governance Principles and Recommendations, ASA has some concerns in this area.

Principle 2 states that the board needs to have an appropriate number of independent non-executive directors who can challenge management and hold them to account, and also represent the best interests of the listed entity and its security holders as a whole rather than those of individual security holders or interest groups. We notice that 3 of the directors are up for re-election. None of them can be considered to be independent because of related party transactions (Brown) or more than 12 years on the Board (Harvey and Slack-Smith) bringing their “independence of mind” into question. This means that no director on the Board can be considered to be independent. Why has the Board not taken this opportunity for Board renewal? Does the Board have a succession plan?

The Company does not accept your submission. The position of the Company is set out on Page 61 & page 62 of the 2018 Annual Report under the heading of Board Structure and Composition.

Board diversity is also recognized as important to good governance. Harvey Norman has only one woman on its Board. ASA and AICD both recommend that a Board should consist of 30% women. This would appear more crucial in an industry whose customers are women or the key decision makers. What consideration is the Board giving to addressing the imbalance?

The CEO of the Company is female. We refer you to Page 65 and Page 66 of the 2018 Annual Report, for information in relation to diversity, diversity policies, measurements, workforce gender profile and diversity measures, targets and initiatives.

Principle 6 refers to two-way communication with security holders and recommends a company have an investor relations manager. As a new monitor I found it impossible to find any contact for investor relations. There is no email address nor phone number on the website for investors to contact the company. Can this matter be rectified?

Principle 6.2 recommends an “investor relations program”, not an “investor relations manager”. The Company has an effective “shareholder communications” policy which is described on the Company’s website. The Company Secretary, Mr. Chris Mentis, manages such communications and his contact details are set out in the annual report. The Company Secretary Telephone: 02 9201 6111 Fax: 02 9201 6250 Email: chris.mentis@au.harveynorman.com.au PA: Valerie.salame@au.harveynorman.com

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Thank you again for your questions and comments.

If you have any queries or wish to discuss this letter further, please do not hesitate to contact

Chris Mentis on (02) 9201 6122 or chris.mentis@au.harveynorman.com.au.

Yours faithfully

Chris Mentis

Company Secretary

.

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Harvey Norman Holdings Limited

Questions for Meeting Thursday, 25 October

General Business Overview

Overview of operations and subsidiaries and core competitive advantage?

Financial Performance

1. Could you please confirm the accuracy of the following table?

(As at FYE) 2018 2017 2016 2015

NPAT ($m) 375.38 452.9 351.3 268.9

UPAT ($m) 377.03 448.9 348.6 268.1

Share price ($) $3.26 $3.85 $4.61 $4.50

Dividend (cents) 24 26 30 20

TSR (%) (9.0) (11.49) 8.09 60.16

EPS (cents) 34.96 40.35 31.36 24.51

CEO total remuneration, actual

($m)

3.58 3.41 3.08 2.93

2. There have been 2 years of losses in Other Non-Franchised Retail and Other Segments.

What has ben the total loans to KEH over the years?

How much has been written off?

What is the likelihood of further impairments?

What is the total of the loans made to the mining camp joint venture?

How much has been written off?

What is the likelihood of further impairments on this venture?

Can you provide me with some further understanding of the total investment in Byron Bay

and the return and losses to date?

3. I notice a significant rise in trade debt receivables 90+ days (p96) from $57,368,000 to

$105,794,000. This seems highly unusual. Could you provide further detail and explanation.

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4. Could you explain why franchise fees are lower despite the increase in franchise sales?

5. Why have the results for the second half of the year been softer and how is the first half of

2019 shaping up?

Strategy and Risk

1. The Annual Report notes that the Board is “retail savvy”. Why then has the Board decided to

stray from its core area of competency into other strategic ventures where it appears to

have little experience? Has the increase in risk of doing this been considered and if so, what

contingencies have been put in place to reduce the risk?

2. What is the process of risk assessment undertaken by the Board when considering

investments?

Remuneration

ASA will be voting undirected proxies against the Remuneration Report since Harvey Norman’s

policy does not align to our guidelines for good practice. A copy of these guidelines are attached and

I would welcome an opportunity to discuss them.

Governance

While the Annual Report notes that the company is committed to a high standard of corporate

governance aligned to ASX’s Corporate Governance Principles and Recommendations, ASA has some

concerns in this area.

Principle 2 states that The board needs to have an appropriate number of independent non-

executive directors who can challenge management and hold them to account, and also

represent the best interests of the listed entity and its security holders as a whole rather than

those of individual security holders or interest groups. We notice that 3 of the directors are

up for re-election. None of them can be considered to be independent because of related

party transactions (Brown) or more than 12 years on the Board (Harvey and Slack-Smith)

bringing their “independence of mind” into question. This means that no director on the

Board can be considered to be independent.

Why has the Board not taken this opportunity for Board renewal? Does the Board have a

succession plan?

Board diversity is also recognised as important to good governance. Harvey Norman has

only one woman on its Board. ASA and AICD both recommend that a Board should consist of

30% women. This would appear more crucial in an industry whose customers are women or

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the key decision makers. What consideration is the Board giving to addressing the

imbalance?

Principle 6 refers to two-way communication with security holders and recommends a

company have an investor relations manager. As a new monitor I found it impossible to find

any contact for investor relations. There is no email address nor phone number on the

website for investors to contact the company. Can this matter be rectified?

________________________________________

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11 

PART C:  EXECUTIVE REMUNERATION 

 

32. Presentation of remuneration report 

First and foremost, a remuneration report should be readable, transparent and understandable for investors, and contain no material omissions.  

33. Long‐term alignment with shareholders 

The most important element of any remuneration structure is to attract and retain superior executive talent which operates  in an environment with  long‐term  financial alignment with shareholders. ASA will expect financial performance, shareholder reward and executive remuneration to have a logical relationship. 

34. CEO remuneration 

The CEO should have the largest component of at risk pay amongst the key management personnel.  Salaries may rise with market capitalisation, but the financial performance, size, competitiveness and complexity of a company’s operations should be a key determinant.  

ASA requires that at least 50% of a CEO’s total potential pay should be genuinely at risk, primarily through the LTI. The maximum potential STI opportunity should not exceed the CEO’s fixed remuneration. Bonuses should only accrue if there has been financial out‐performance. The CEO’s actual take home remuneration as well as the maximum opportunity for each component of the CEO’s total remuneration should be clearly disclosed. Companies should also publish a ratio of the CEO’s actual remuneration against the Adult Average Weekly Total Earnings, as published by the Australian Bureau of Statistics. 

The overall balance of an executive package will differ from company to company and ASA monitors take into account company specific arrangements when preparing our voting intentions. 

35. Short term incentive payments 

A majority of STIs should be based on quantifiable performance metrics. Where non‐financial hurdles are used, no STIs should be paid unless a financial gateway is met. 

ASA expects clear disclosure of the performance hurdles and the weightings applied for each key executive. The remuneration report should set out individual outcomes for the year as measured against each metric and  explain  any  board  discretions  applied,  so  that  shareholders  are  able  to  understand  the  reasons  for payments made. For the CEO and other executive KMP, at least 50% of any STI award, if available, should be paid in equity with a minimum 12 month holding lock. Up to 50% can be paid as cash.  

36. Long term incentive payments 

From the shareholder’s point of view the LTI is the most important component of any remuneration package, even though  international research has shown that executives prefer to receive fixed cash payments and value these more highly than the various accounting treatments of LTI schemes. 

Since 2004, ASA has opposed many remuneration reports citing, amongst other factors, the lack of an LTI performance period which extends to at least four years, but preferably five years. We continue to hold to this position and note LTIs should require behaviour  that  is measured cumulatively or on average over a number of years. 

ASA will  continue  to  take  into  account  performance  periods  together  with  actual  performance  hurdles. Where a combined incentive plan is in place, and the number of shares or performance rights are determined by the company’s performance over a one‐year period with no further performance hurdles to be met before vesting over a subsequent period of years, ASA is of the opinion that it is not a true LTI. An LTI requires hurdles to be met on average or cumulatively over a period of a number of years, preferably a minimum of four. The 

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mere awarding of shares or converting performance rights to shares over a period of time with no hurdles is simply a retention scheme. 

37. Retesting of incentives 

The ASA is generally opposed to “re‐testing” of at risk executive incentive schemes which fall short of performance hurdles over the performance period, which should be at least four years. Where there is retesting, it should only be for one year and require all performance hurdles over the extended period to be met, including making up any shortfall in previous years.  

38. Relative TSR, negative TSR and absolute TSR 

ASA requires companies to have at least two hurdles for an LTI scheme and one of them should always be based on Total Shareholder Return (TSR) which reflects share price performance plus dividends paid over the performance period of at least 4 years.  There should be no out‐performance bonuses paid if TSR is negative in nominal terms whether relative TSR or absolute TSR is the measure, ASA will support LTI schemes with appropriate positive  absolute TSR hurdles. As an example, vesting could commence with 10% compounding annual TSR over a 4 or 5 year performance period and provide 100% vesting  if annual compounding TSR exceeds 20%. However, any absolute TSR measure should only apply to a maximum of 50% of the LTI award. 

39. Comparator groups and benchmarks for relative TSR measurement 

When measuring relative TSR, the ASA requires comparator companies from similar industries or a specific index such as Financial Services or Resources. Any comparator group should  include key competitors and preferably at  least  five  companies,  including  relevant  companies  listed on  foreign exchanges. Companies should  show  graphically  the  company’s  TSR  performance  as  against  the  comparator  group(s)  in  the remuneration report. 

40. Vesting of equity grants on out‐performance 

The ASA has long maintained that LTI awards based on a relative TSR hurdle should not commence unless performance is above the 50th percentile of the peer group over a minimum 4 year period.  Our preferred position  is 30% vesting at  the 51st percentile, rising with a sliding scale of 2% vesting for each additional percentile such that only CEOs who exceed the 85th percentile will receive 100% of the potential award. Cliff vesting structures should be avoided as they are less likely to encourage out‐performance. 

41. Dividends on performance rights 

Dividends must not accrue on unvested shares for either an STI or an LTI. Dividends can accrue on fully vested, but deferred, equity from an STI award. Similarly, once an LTI has irrevocably vested, the executive can accrue the benefit  of  any  dividends paid  even  if  there  is  a  holding  lock. ASA  requires  the  cash payment  of  any dividend benefit to be deferred or locked up until the vested share is also unconditionally available to the executive. 

42. On‐market purchases vs newly issued equity 

ASA prefers that companies purchase shares on‐market when incentive schemes vest, as this would prevent the dilution to shareholders that would occur if the company were to issue shares. If shares are to be issued, ASA prefers that those shares be included in the 15% cap on selective placements. 

43. Opposition to underlying earnings as a performance metric 

Where earnings per share (EPS) is a performance metric/hurdle for a CEO’s incentive plan, ASA requires calculation of EPS to be based on statutory profit, rather than any form of “underlying” or “normalised” profit measure. Shareholders lose real money with write‐downs, restructuring costs and other one‐off items, so these should not be excluded from any bonus calculation.  

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44. Other LTI performance hurdles 

Return on assets (ROA) is a measure which may be suitable for some companies, such as banks. However it needs to be assessed by consideration of other risk ratios, such as those for credit,  interest rate margins, liquidity, foreign exchange and off balance sheet exposures. 

Return on capital employed (ROCE) is a measure which is suitable for some sectors such as real estate trusts or  for  divisional  executives  in  conglomerate  structures,  but  the  composition  of  the  return  if  it  includes revaluations from equity accounted investments should be adjusted to reflect that such revaluations may not be realised. 

A return on equity (ROE) target can be appropriate where it can be demonstrated that the target hasn’t been achieved by excessive gearing, or by a capital restructuring (i.e. share buyback). If this measure is chosen it should be absolute, not relative, in view of the many different capital structures across companies. 

Cash generation is often the best sign of business success so an appropriate cash flow metric may also be used. 

Non‐financial metrics in an LTI scheme should be limited to a small proportion of the award. ASA requires these to be focused on the STI. However, if companies do not have an STI scheme it is acceptable for some non‐financial measures such as defined market  share,  customer satisfaction,  safety, diversity, production numbers, unit costs, minerals resources, ore reserves, succession planning and the like to be included in the  LTI metrics.  

Hurdles in the LTI scheme should be based on financial metrics only, although non‐financial hurdles in an LTI scheme may be appropriate in exceptional circumstances. In these cases, the hurdles must be measurable, clearly explained and  linked  to  the  company’s  long  term goals. ASA will  generally not  support  incentives which are subject only to a share price hurdle or where options are allocated without a performance hurdle. The hurdles used in the LTI plan should not be the same as hurdles used in the STI plan. 

45. Executive sign‐on benefits 

ASA opposes the payment of sign‐on benefits for newly hired executives. Where negotiations unavoidably require compensation to be paid for foregone incentive payments, these should be fully disclosed when the executive is hired. These should never be paid in cash, but should instead be structured as deferred equity‐based payments that vest upon good performance over the longer term. 

46. Retention payments 

ASA  generally  opposes  the  use  of  retention  payments  or  incentive  awards  which  are  subject  only  to continuing service.  

47. Termination payments 

ASA supports the move to rolling contracts for executive KMP.  We generally oppose termination benefits which  exceed  the  12  months  fixed  pay  Corporations  Act  requirement  which,  in  any  event,  requires shareholder approval. However, we will support payments to executives of vested incentive awards that will place them over the 12 month limit, where we are supportive of the remuneration arrangements. After an initial period of appointment (i.e. two to three years) for a senior executive, notice periods should not exceed six months. If departing executives receive any pro‐rata payments for unvested long term incentive schemes, these should be clearly disclosed as termination benefits. ASA opposes any ex gratia payments to departing executives over and above their contractual entitlements. 

48. Treatment of incentive schemes in takeovers 

ASA has been concerned by past practice which has seen CEOs and other executive KMP greatly enriched through the full vesting of incentive schemes in a takeover or “change of control” event. ASA is opposed to 

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automatic full vesting in these circumstances as it can distort the decision‐making process. We prefer pro‐rata vesting based on past rewards. 

Any early vesting arrangements for key management personnel  in takeover or merger situations must be comprehensively  disclosed  when  the  scheme  is  approved  and  in  the  annual  remuneration  report.    The premature conclusion of the contract for an executive KMP should not see automatic full vesting, but rather a pro‐rata approach taken based on the time remaining, whilst also considering the performance impact of the control transaction. 

ASA  recognises  that  some  board  discretion  is  appropriate  in  determining  the  outcome  of  executive  pay arrangements in change of control transactions.  

49. Calculation and valuation of share grants 

The methodology used to calculate the number of performance rights and options to be issued under an LTI plan needs  to  be  clear  and  easily  understood by  shareholders.  ASA  is  opposed  to  the use of  ‘fair  value’ discounting  methods  to  calculate  the  number  of  performance  rights  to  be  issued,  due  to  the  resulting inflation of the number of rights offered. Our preference is for the number of performance rights issued to be calculated on face value, using the current market value (VWAP). We recognise some companies use a fair value calculation to discount for the value of anticipated dividends paid during the performance period, however ASA prefers companies to provide executives with the value of any dividends that would have been paid on  the shares  (either  in cash or  in additional  shares) on vesting, when  the value of  the dividends  is known.  

50. Acquisition of shares by directors under an incentive scheme 

The ASX  Listing Rules  require  shareholder  approval  for  securities  to be  issued  to directors,  including  the Managing Director and any other executive director, under a share incentive scheme.  The ASA acknowledges  the  Listing  Rules  grant  an  exception  to  this  requirement  where  the  terms  of  the  scheme  permit  such purchases, and the scheme was approved by shareholders within the three years prior to the issue. However, ASA’s position is that companies should seek shareholder approval on an annual basis as it provides greater certainty to shareholders regarding the size and nature of the equity grant being approved. As a matter of good corporate governance, approval should be sought annually even if the company intends to purchase the shares on market. 

51. Loans to executives 

Whilst the move to free equity in bonus schemes has seen a reduction in company‐funded loans to allow executives  to buy shares,  some companies still have such arrangements.   ASA will view company‐funded loans that are non‐recourse, interest free or interest‐forgiving in the face of poor performance as a negative when  considering how  to  vote on  remuneration  reports  and  the  issue of  shares or  rights.   ASA will  also examine other company‐funded loans to executives or employees on similar terms. 

52. Voting in relation to the “two strikes” regime 

If a company receives a first strike with 25% or more of the voted shares against the remuneration report, ASA will undertake engagement with the company to secure improvements the following year.  ASA supports the “two strikes” regime, but regards the decision to vote in favour of a board spill after a second strike to be a serious step only to be taken in extreme circumstances. Calling an EGM to spill an entire board can be a highly  disruptive  event  for  a  company.    ASA  acknowledges  that  the  threat  of  this  happening  has  led  to substantial pay reform in Australia.  ASA’s position regarding a vote on a board spill will be determined by the willingness of a board to accept the need for review and change to remuneration structures. 

 

   

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