AO World plc (81A.DU) Earnings Call Transcript & Summary

Okay. Well, good morning, and thanks for joining us today back here at our London creative center where we really do bring our products to life. So since we were last here in November, we've issued a number of trading statements. So we expect today to hopefully be relatively short and reassuringly boring. I'm going to give you some color and context to the financial year that ended in March, and then Mark is going to take you through the numbers. And then, obviously, we will both take your questions. So as we began the last financial year, it was abundantly clear that a further period of macroeconomic uncertainty lay ahead. U.K. consumers and companies were and obviously still are suffering the economic aftermath of 3 major shocks in a very short period of time. Those being Brexit, COVID and the economic consequences of war in Ukraine. Inevitably, this did and still does put a squeeze on consumer spending as people have grappled with inflation across a whole range of household costs. Now AO clearly isn't completely immune from these pressures. So we took the view that we were sailing into an economic storm. So we've prepared for it by batting down the hatches and lowering the sales ready for, frankly, whatever came. And in other words, we did what we've always done. We focused on our core strengths and we took swift and decisive action whilst continuing to focus on being amazing for our customers. Our top priority was to prepare to trade our way successfully and resiliently through whatever economic climate prevailed. And as we've done in previous downturns, we emerged leaner, stronger and more trusted than ever. The core thrust was to pivot the business firmly towards cash and profit generation. Now our deep understanding of the dynamics and drivers that underpin our operations, made it relatively straightforward to identify both the opportunities and the challenges that we needed to tackle all at AO speed. Our core U.K. business has always been strong, profitable and cash generative, providing those with a fantastic platform from which we've explored many new opportunities for growth over the last 23 years. And as part of our plan, we also undertook a successful capital raise to strengthen our balance sheet, making sure that we were secure as we navigated the choppy waters ahead. And as Mark will explain shortly, our cash position continued to improve through the second half of the year as our actions to improve profitability gain traction. With these macroeconomic clouds on the horizon, the lens that we decided to look through was to only continue with operations where we have a clear line of sight to profitability and cash generation. And that perspective then informed our decision around -- our decisions around several initiatives, and those are pretty well documented. Now over the last 23 years, we have been an entrepreneurial business with a huge ambition without fear of trying new things. But there is a time and a climate for everything. And the last 12 months required rigor and real discipline to deliver the reset that we now have. It's rare that you know instantly whether a new venture is going to succeed on exactly how. It takes time, patience, conviction, intuition, reinvention, and frankly, actually some humility to admit when you may be wrong. But for the avoidance of doubt, we are still an entrepreneurial business with huge ambition that is not afraid to try new things at the right time. Our decision-making process took us back to our fundamentals and made us carefully consider what drives our flywheel and conversely, what adds grit to the AO machine. We also simplified aspects of our operations. We consolidated several teams and realized more of the value that we deliver for customers. We rationalized relevant ranges, and we raised the bar of what we are willing to accept through our supply chains. Inevitably, the cumulative effect has been to reduce sales as was planned, and Mark will cover that in more detail shortly. But I believe that the best businesses are often defined by what they decide not to do rather than always chasing every single opportunity. Rationalization and simplification also meant that we needed fewer people. Consequently, we've had to say goodbye to a good number of AOers over the past 12 months which is never an easy decision, but I'm clear that it was both right and necessary. And whilst the economic element of these choices may have been relatively straightforward, of course, the human element is always much harder. During the 3-year COVID period, over 5 million new customers experienced the AO Way. And whilst we don't have any intention of releasing any detailed data about this for obvious commercially sensitive reasons, one snippet that I will give you is that the cohort acquired during COVID currently performs better and is more valuable than the pre-COVID cohort. But frankly, that's not rocket science. Because our business is bigger, our brand awareness is better and our performance is and always has been consistently excellent. From a market perspective, the COVID period saw a big step-up and then a step back. Demand was brought forward and product usage was also increased. Overall, the market is now normalizing with online penetration comfortably above 50% compared with around 40% pre-COVID when stores were the dominant channel for customers. I've always found that customers are incredibly loyal or intransigent until they find a better way. As those of you and there's enough of you to remember fax machines with those curly bits of paper will know. And our expectation is that the migration to online will just progressively continue over time as it has for 22 of the last 23 years as more customers realize that online is simply a better way to shop the category. And while some post-COVID disruption remains in global supply chains, and it does make certain aspects of forecasting difficult, we as a business now consider the COVID period to be concluded and its lasting impact to be entrenched. Since our launch back in 2000, we've been investing in our relationships with our supplier partners and the depth of trust that we've required to navigate this hugely unpredictable trading period has proved to be invaluable. And I'd like to thank them very publicly for all their support. And I'd also like to thank all AOers for their continued support and commitment during a journey that has required many leaps of faith over the last year. I'm always really proud of how they rise to the challenges and how they protect our culture in both difficult times as well as good, something which is ultimately at the heart of our ability to deliver brilliantly for customers. Looking forward, our priority now is to continue the progress that we've made with our pivot to profitable growth and cash generation by focusing on brilliant execution and investing to deepen our relationships with customers whilst, of course, growing our brand awareness and our share of wallet with those customers. Our strategy will always be centered around our obsession with customers and treating them like our brands. We now have over 400,000 Trustpilot reviews. And I'm really looking forward to continuing to build our brand over the years ahead around being the most trusted electricals retailer in the U.K. This obsession is a moat around our business and makes repeating what we do and the way that we do it even more difficult for competitors to replicate at scale. Meaning that its value to our customers only increases with time. This is true across a whole host of areas from culture, customer service, loyalty, brand relationships right through to our B2B partnerships. Through FY '24, having embedded the changes from our pivot year, our focus will move back to profitable and cash-generative growth through disciplined investment at the right pace and at the right time, and will drive our structural advantage of having an extremely well invested, more efficient model with better unit economics built for the future, not the past, leveraging our scale centered around trust and excellence. And I'll return to this in more detail later, once Mark has taken you through the numbers. But for now, I'll hand you over to Mark.

Thanks, John, and good morning, everyone. So I'm going to run through the financial results for the year, which will obviously include the output of the strategic pivot that we took and the challenges that we've navigated through on that journey. We've previously discussed how the decisions made as part of our pivot have negatively impacted revenue. This, along with a weaker consumer market has resulted in a year-on-year drop, which is as we anticipated. We have removed non-core channels and loss-making sales. So very few products now have negative unit economics on a fully costed SKU P&L basis, and the corresponding margin drag has been removed. In August 2022, we removed free delivery slots for customers, acknowledging that deliveries are not, in fact, cost free and to offset the growing inflationary pressures impacting our cost to deliver. We continue to leverage our expertise in complex two-man delivery where it adds incremental profitability. And you can see revenue growth here this year. As we come out of COVID, the overall electrical market is down about GBP 1 billion year-on-year, of which nearly GBP 300 million is in our largest category of MDA and the AV market is also down nearly 10%. We've seen a shift in MDA sales to off-line in the year by around 6%. Our market share in MDA remains strong, and we've got about 16% share of the total market. Our repeat customer base continues to perform well. Our strategy to invest in brand with our most trusted message should continue to drive this customer base, and they will repeat and underpin our revenue in the future. Looking forward to FY '24, we expect revenue to be reasonably flat year-on-year, but not a decline in the first quarter until we annualize the strategic pivot made in the previous year. We've made a step change in gross margin in FY '23. The introduction of delivery charges has acted to offset the growing cost of delivery. In addition, we've accelerated our pricing structure development, particularly in non-MDA categories that have been in an investment and growth phase over the last few years and have caused us some margin drag. MDA mix has increased in the year as a result of those decisions, which has further contributed to the margin growth. Product protection plan valuation has remained steady, and we've seen no significant change in either acquisition or cancellation rates. The mobile network operators increased their prices in line with RPI in April '23. The consequential benefit in AO's commissions were consistent right across the market. And these were primarily invested either in proposition or in acquisition channels. We are optimizing our physical logistics network for current levels of sales and maximizing the return on warehousing and logistic capabilities. This has had an impact both here and in our warehousing line. We've continued to invest in acquisition, marketing and brand. But we no longer chase sales into negative margins on a fully costed SKU P&L basis. We've seen a reduction in warehouse labor in line with the decrease in revenue and have reduced our physical footprint by about 160,000 square feet in the year and we have sublet further 305,000, which does give us the optionality for future growth. The reduction in staff, which we've spoken about previously didn't really impact the P&L until H2. It clearly runs forward on a full year basis into FY '24. The compounding benefit of the staff reduction is also a reduction in our office space requirement and we've closed offices in Thatcham, Manchester and in Bolton. In the next financial year, we expect our warehouse cost to be materially flat. We'll look to invest further, though, in marketing and brand spend and getting our most trusted message out there. I feel like there is further for us to go in overhead reduction as we continue to simplify the business, drive efficiencies and be more joined up than ever. Marketing costs are broadly split into 2 categories. Those that have a fixed cash cost and that things like brand, and those that have a more direct cost, for example, acquisition costs with Google. However, that being said, I would broadly expect marketing costs to remain a flat percentage of sales into FY '24, and we will increase our brand cash investment this year. I'd expect the cash costs of both other admin and warehousing to increase slightly as we grow. And we anticipate that this should drive real leverage through the P&L in the medium term as increases in revenue give us the ability to grow profits at a faster rate than sales. And we can look at the percentage graph for FY '21 for the impact that those increased sales can have. And if we were to repeat those levels of sales, I would expect the output to be significantly better than it was during the COVID period. So since IFRS 16 made a mockery of EBITDA, we have now moved our headline profit measure to adjusted PBT. We've talked through the revenue and cost lines, and this is the output. You can see the changes we have implemented have significantly improved performance from H1 to H2, obviously, bearing in mind the usual seasonality effect that we have. The exceptional costs in the year of GBP 4.5 million are largely the termination costs relating to people and offices and a small amount of software impairment. We've done a good job in exiting a number of property leases in the year with very, very minimal impact. We have a continued focus on an efficient working capital model. Inventory levels have fallen, but our stock days have returned to a more normalized position, and it is our intention to continue to invest in availability for customers. Debtors and contract assets are pretty flat year-on-year. Looking at this slide, it's worth pausing on the impact of the pivot on payables. The graph on the right shows an outflow in creditors of nearly GBP 150 million over 2 years, and that's as we took GBP 500 million of sales out of our run rate. This required very careful management and financial discipline. I think few businesses would have survived that transition. And there really is no point having the operation being a complete success if the patient is left dead on the table. And these stats bring to life the scale of the reset and the leader efficient business we now have ready for growth. The working capital outflows have now normalized as our revenue has stabilized, and so we don't expect any material changes in working capital this year. As we move back to growth, there will, however, be an obvious cash benefit. CapEx is expected to be around GBP 4 million this year, which includes a couple of million in recycling and the remainder being our usual low run rate. The RCF was extended to April 26, with great support from HSBC, NatWest and Barclays. Total liquidity has improved in the period by GBP 39 million, which coincidentally is the value of the share placing. This does help somewhat hide the work done on profitability and working capital, which has been concealed by the output of the pivot. For the year ended March '24, we expect revenue to be between flat and minus 5% of which we expect to see double-digit decline in the first quarter until we annualize the strategic pivot. We expect to exit the year driving profitable top line growth. To remind you, our previous medium-term guidance was adjusted EBITDA margins of over 5%, continued focus on improving cash generation and double-digit revenue growth. Now that we've changed PBT, 5% EBITDA is the equivalent of 2.5% PBT and we would expect to deliver at least that in FY '24. So for that, I would like to reiterate our medium-term guidance. I'd also like to take the opportunity to add my appreciation to John for the hard work, focus and commitment of our people in delivering the pivot this year. Thanks, everyone.

Thanks, Mark. So no doubt, a big question that everyone is going to have is how we're going to grow given the impact that growth now has on this business that we've got. Well, there are several answers to that question, all of which ultimately center around our brand growth, our customer numbers and the sheer quality of our execution at scale. As I said earlier, AO is the U.K.'s most trusted electricals retailer. And what makes that true lies in how we do it, not what we do. To understand that properly, you need to experience it ergo, you need to shop with us because people forget what you tell them, but they remember how you made them feel. And our frequency of purchase cycle is not that of grocery or Amazon. And therefore, it takes time for the value of this to be realized. And over the last 3 years, we have impressed over 5 million new customers. And it's important context when you think that it took us 18 years to impress the first 5 million customers. So I'm sure you can work out that we think there's real value in the behavior of our newer customers in the coming months and years. There is an intrinsic value as well to just being bigger than we were pre-Covid in just so many ways. And these principles are as true in our B2B business as they are in our retail business, albeit inertia to change is higher and the available number of customers is lower. But once won, they really are actually our most valuable customers. Five years ago, we had no focus at all on a B2B business. And today, we have a B2B business worth over GBP 100 million in sales. And more importantly, all of the learnings and therefore, the playbook of how to grow it importantly, in the right way. As you might expect, we have lots of other initiatives on top of these to improve the shopping experience and to cement our relationships with customers and to drive ever more share of wallet from that base as well as, of course, appealing to new customers so that they too can experience and therefore, feel why buying electricals the AO way is just, well, fundamentally better. Cost out and simplification were cornerstones clearly of the pivot. But as you might expect me to say, I am equally clear that we will not cut our way to success. And as Mark mentioned, we will continue to invest in our brands throughout the year, and we will do going forward as well. The output of that in the year was that spontaneous brand awareness has improved by 35%. And this is as important for new customers as it is for existing ones. And frankly, it's just more fuel for our flywheel because increased brand awareness, well, improved just about virtually every other metric in the business. So in summary, we're in good shape. Our trading is in line with our expectations for the current year, and we are beginning to prepare our sales again for our medium-term outlook, and we're looking forward to the next few years with a shipping forecast that's well set reasonably fair. And so with that, we'll take some questions, just one piece of housekeeping. If you can -- before asking the question, if you can get hold of one of the roving mics that are hovering on either side so that our U.S. investor base can hear the questions as well as the answers.

John Stevenson from Peel Hunt. I suppose keeping with growth as a starting point. I mean, can you talk about the performance between sort of MDA and non-MDA categories and then how, obviously, you've got fantastic service proposition in MDA. How do you break into things like sort of laptops where it's been harder to drive share without the runaway marketing? Maybe sort of talk about some of the initiatives you've got thinking about in terms of driving share in newer categories.

Yes. So I'll take that question. So clearly, the -- those newer categories are slightly more discretionary than our core MDA category. But we're seeing it happening. So we don't have any intention to go and blast our way from a marketing perspective into those categories. But we know as we -- we're not releasing the data on this, but we know the cross-pollination of existing customers from one category into another category. All categories cross pollinate other categories. But one of the things that we've done in the year is to consciously take out some of the sales where the unit economics didn't work for us. And we've been working hard in the background to fix the unit economics around that such that we can sell those categories as competitively as we do everything else and do it profitably. And so I would expect the -- some of the rationalizations that we've been doing over the last year to slowly reverse over the next 12 months as well and then compound with a bigger customer base as well. But I don't expect any light switch moment. I expect it to be gradual over time, leveraging a bigger brand that more people are aware of, double the people have now transacted with and trust and are more comfortable to return.

And then just on in terms of the CRM, I don't know how you see the rate your CRM currently in terms of the ability to get [indiscernible] actually to come to you first to stay within the network.

So I'm always harsh on our own internal scoring. I would probably give us a 6 out of 10 within CRM. And I think there's a lot more upside for us to do. And we can get ever more granular on that and the capabilities and the technology that's enabling us to do that is getting ever better at a rate of knots that we've never seen before. So again, if you look at -- so if you look at things like ChatGPT, for example, and you look at the improvements in processing power and capability of all that of what's happening every 2 to 4 weeks, frankly, that's valuable if you've got a big base to apply it to. If you've only got 10 customers, then it's not that valuable. If you've got 10 million customers and if those 10 million customers really trust you, if those 10 million customers had a brilliant experience with you. So all the fundamentals applying those capabilities to them. We see lots of upside -- exactly what it's all going to be is unclear at the minute. But all the critical fundamentals we've got in place. So we need to go and leverage that. And that's what we're -- one of the key areas that we're focused on.

It's Simon Bowler from Numis. Three from me, I'll kind of go one by one. Can you just kind of explore a little bit more some of your comments on kind of warehousing and space, and there obviously been a lot of work coming out of space and so on. Where are you at the moment versus kind of an ideal position from a real estate perspective?

We're pretty ideal at the minute. I think it's fair to say on the footprint that we've got. And so all of our primary warehousing is centered in the crew area. And so we took an extra 305,000 square feet because it was there and it was built and it was available. And so we've kept that, as Mark said, for optionality. If we wanted to get out of that, we could have gotten out of it. So we've kept that for optionality and offset the cost price of letting it. But now we're materially where we need to be from a footprint perspective. What we've been working really hard on is the throughput. So storage versus throughput. And so we've got a lot of headroom of sales that we can now drive on throughput through that operation without -- it's not a linear relationship with sales now and warehousing footprint.

Okay. Second 1 is just on the B2B business that you kind of briefly mentioned within there anything around kind of specific plans to grow that or how are you thinking about that part of the business?

Yes, we're continuing to grow it. It sits across different segments. So we've got insurance as a segment, for example, we've got things like landlords and letting agents. Small landlords and letting agents is a big piece of work and service and on time, in time slot delivery with all the premium installation services. The cost of service to them or poor service is really significant. So they place a real value on that. So again, it takes time to get out. People have been doing certain things the way that they've been doing them for a long time. But what we find is that once people taste the AO way of doing it in that space, they are extremely sticky, extremely sticky and really valuable. And then we've got all the partnerships where -- so for example, if you take somebody like Homebase, where we're the exclusive provider for appliances for whenever Homebase sell a kitchen or frankly when they sell appliances on their own, so we take care of all of that for them. Because there's a good number of whether it's kitchen retailers or businesses that have a business in electricals that are subscale really. And the investments that are required and the relationship and the management and the supply chains, you need to be a volume player to make those work at a standard. So again, we're just leveraging that most trusted in that space. So it's a fire and forget for them. They can just concentrate on selling as many kitchens as possible and forget about that. So the B2B piece sits across different verticals, and we're gradually driving them all. And there have been areas within that, that we've tried, that haven't worked for us. So we spent 2 or 3 years developing a business with housebuilders. So the new builds, whether it's Parrot or Persimmon or Red Rover, whoever it might be, and on the base of it, that was extremely logical, drove our logistics biowheel and all the rest of it, actually, at scale, it didn't. So delivering to a building site and then delivering to Mrs. Bowler and shapes in the -- from the building site through the house was different. We don't have to do a health and safety assessment when we come to your house. We do have to do one when we go on to a building site. So actually, you can't leverage the same fleet. And so actually, what we found was, whilst the headline logic made sense, that there was lots of grit that it was putting into our model. And frankly, then you wait about 3 or 4 months for your cash, and we're used to waiting about 3 or 4 hours for it. So when you actually look at it, we've -- and I think we closed the kind of number what the order book was, but I think it was about GBP 13 million or something like that when we closed that business down within B2B. So we spent a couple of years growing that, building the relationships. But it didn't work for us. And it might have made a couple of points of margin for us, and it might have got to GBP 50 million sales. It would have been the hardest million of profit we would have ever have made. And I just know it would have cost us 1 million quitting grit to get rid of it. And so that's a very good example where go and do something and try it. But if it doesn't work, then take it out.

And then the third one was on that targeted EBITDA, PBT margin with the CapEx and working capital comments that you've made, the business starts throwing off quite a bit of cash at the end of the year just going in a net cash position. How are you thinking about what an ideal or efficient balance sheet looks like on a go-forward basis?

Do you want to take that?

Yes. I mean I think that we've obviously been in a phase of strength in the balance sheet over the last 12 months and I would expect that to continue over the next 12. But then as we move further forward, we should start to generate excess cash that we can look at how we best deploy when we think about our capital allocation policy. But I don't see anything in the -- over the next 12 months on that.

Andy Wade from Jefferies. First one, just thinking about the impact of growth and profitability. I know you touched on this a little bit already, but there's a lot of moving parts in there. If you -- and some of them, Mark sort of went into a bit of detail on, you've got the drag of the lower-margin categories. You've got investment in the brand and actual acquisition of customers, then you want some leverage further down the P&L. How should we be thinking about the overall mix of that? Or would we be expecting a downward pressure on EBITDA over time if you're doing double-digit growth? Could you still get leverage? Where is your thinking?

Yes. So I don't see downward pressure at all. So all the things that you talked about, the business is set up to drive operational gearing kind of all stop and that converts to cash. So as we drive growth, that will be disciplined growth and it will be accretive growth. So when you go into new things, whether that's a new product category or a new market or a new segment, not always, but quite often, you'll be in an investment phase for a while. And since IPO, we've been into new product categories with new manufacturers and new ranges and new territories and new sectors. All that heavy lifting for me is done, the vast majority of that. It's not to say we won't try the odd thing, but the vast majority of that heavy lifting is done. So no, so we see ourselves extremely well placed to drive a lot of operational gearing as we go forward.

Very helpful. Something that your competitors talk about a sort of single site warehousing and delivery model. Is that another opportunity for AO? Could you consolidate down to a single site, get rid of some of the outbases and driving another step in profitability?

Okay. So yes, I get this quite a bit. So I'm not going to talk about other people's businesses. I'm going to talk about our business. But the point around our interpretation of what's the right thing to do. And so at the scale that we're at, we need outbases. So our outbases -- so our central warehousing is in Crewe, okay? So GB driving regulation say that you can only drive or work or be on duty for 11 hours a day. So if I'm going to drive a van from Crewe to here and back to Crewe again inside 11 hours, then I'm going to struggle to get many deliveries of that van once I get here. And so that's just a factual reality. And so within those regulations, there is an exemption for if you are doing an installation. And if you look at the dictionary definition of an installation, on Google, it says placing something ready for use. So if I take an example like let's say, furniture, let's say DFS. So let's say, DFS are going to deliver a sofa to the Wade household, and they're going to put it in your lounge. Did they install that? They did put it there ready for use. So we've spoken to the DBSA on this, and they've given us their steer. And their steer is that, that exemption is designed for tradesmen, where somebody will be an electrician, let's say, is going to drive 2 hours to the Wade household. He's going to work all day at your house and then he's going to drive 2 hours home. And so he may then be on duty for 13 hours. We think it's a health and safety issue. And so as the most trusted electrical retailer in the U.K., I don't want our drivers out there driving 16, 17 hours a day. My interpretation of that is that's a health and safety issue. How -- whatever our competitors choose to do, that's up to them. So from our perspective, we observed the GB regulations in the spirit of how they're intended, which is that people shouldn't be driving for more than 11 hours. On that basis, and if that's your cornerstone, if you're going to deliver nationally, then you need outbases. It's as simple as that. And the problem is when you're a small -- if you're a smaller business, those outbases proportionately are more expensive. And so as you get to be a bigger business, the economies of scale actually mean that they make sense anyway economically. But obviously, we've kind of crossed that battlefield, and we are where we are. So from our point of view, and it's a long answer because I get asked the question a lot. We're really happy with the unit economics of our business. We're really happy with doing the right thing as the most trusted retailer and interpreting the spirit of the legislation in the right way, I'm really happy with the way that we run it and the economics that come with it.

Very thorough. And just one last one for me. In terms of customer acquisition, obviously, you are going to recruit customers on an ongoing basis. What are you seeing in terms of the cost of customer acquisition now versus, say, pre-pandemic?

So it's different in different ways. So Mark called out the difference in brand investment and digital channels. So digital channels are more expensive than they were previously. And so our strategy is to reduce our reliance on those digital channels, which, again, when you've got the brand awareness levels that we've now got -- and when you've got 10 million customers in the base. And to John's point, that we can see RM into that base effectively for free, that's an increasing percentage of our mix -- but at the same time, we are investing in above the line advertising to drive direct traffic to the website and lasting brand impact. So our brand message is very firmly the most trusted There'll be some deals adverse in there as well, but we're investing medium term in what the brand stands for, not just the steroidal hit of deals today.

Caroline Gulliver from Stifel. I had some follow-up questions on delivery. It's been nearly a year since you introduced the delivery charge, I think you said it was last August. I had some questions around what changes in customer behavior you've seen as a result of it. Have you noticed more price sensitivity at the low-end, entry-level products versus more premium products? Have you just any other sort of customer behavior changes, I assume you trial different price points. So what sort of thing you've felt from that next year?