Ocado Group plc (OCDO) Earnings Call Transcript & Summary

Well, good afternoon, everyone, and a very warm welcome to you all to Ocado's 2020 Accounting Seminar. This has become something of an annual event. In 2018, we introduced segmental reporting to give you a very good sense of the profitability of the retail business of Ocado Solutions. In 2019, we updated you on the impact of IFRS 15. And in 2020, we are updating you on IFRS 16, plus additional segmental disclosure and a fresh and up-to-date set of KPIs. We're also taking this opportunity to explain in a bit more detail the revenue cost and capital investment profile of a new CFC. The fact that this seminar has become an annual event is illustrative, not only of the pace of change in accounting standards, but in the shape and direction of Ocado Group. As we grow, we are endeavoring to ensure that you have the best possible understanding of the financial moving parts of Ocado, taking into account commercial sensitivities, of course. We hope that you find this session rewarding. What's going to happen is that I'm going to hand over in a moment to Duncan. He'll talk you through the various slides, which you will find on our newly relaunched website. If you haven't seen that, please have a look, tell me what you think. Then, we're going to go to questions. I would just stress, because there will be hundreds of people on the webcast, if you wouldn't mind using the microphone to ask the question. It is a small room, but the people on the webcast will only hear your questions if you use a microphone. So with that having been said, Duncan, over to you.

Thanks, David, and good afternoon, everyone. David's already covered the agenda. So I'll get straight into the meat of the presentation. To IFRS 16, as this is a topic well understood by some, given the impact that it's already had on the retail sector, I'll be brief. We've taken the decision to adopt IFRS 16, the year just finished, slightly earlier other than required. As you know, this standard brings on balance sheet, those leases that were previously treated as operating leases and so on operating expense. The results of the change for Ocado with leases that, on average, less than half their way through their life is no impact to cash flows, but an increase in EBITDA with a greater increase in interest and depreciation. So overall, a reduction in profit. The impact for the 2018 financial year was to bring GBP 206 million of operating leases onto the balance sheet, to increase EBITDA by GBP 23 million, but to increase loss before tax by GBP 6 million. We will present 2019 full year numbers under IFRS 16, and we'll explain the impact of this standard in those results. You can expect similar EBITDA and PBT changes. Now on to the change to segmental reporting with an explanation of why the change and what are the new segments. Our joint venture with M&S is now in place. The management team is formed, our relationship with M&S is good. There's much to do, particularly planning the transition from the Waitrose range to M&S for the beginning of September. We'll cover progress and talk more about this at our full year results presentation next month. But for segmental reporting, now that we have formal arrangements in place, Ocado Group and M&S want to be able to talk about the performance of this business as a stand-alone entity. As a result, Ocado Group central costs can no longer be allocated to the retail segment on a proportionate basis as was previously the case, but a charge based on the written agreements with Ocado Retail. Equally, the services provided by Ocado Group and now on an arm's length, in a commercial basis. We at Ocado also want to help provide a better understanding of our solutions business, and so intend to separate the U.K. operations from our international agreements. The services provided are slightly different, and the maturities are different. This will result in increased disclosure as we plan to move from 3 segments to 4. So onto these into a bit more detail. Retail, which used to include the operational EBITDA performance and both direct and allocated central costs will now reflect the joint venture arrangements. Without the technology and engineering costs for the platform, but with the solutions and logistics contracts that are now in place. As a result, EBITDA will be lower, reflecting these fees, although note that this also results in lower capital costs for the joint venture. The Solutions, which included the solutions and logistics service contracts for Morrisons, together with International Solutions contracts and allocated central costs, we now intend to split into U.K. Solutions and Logistics and International Solutions. U.K. Solutions and Logistics will include the fees and direct costs from both Ocado Retail and Morrisons, whereas International Solutions will only include those fees and costs associated with the International Solutions partnerships. Together, these segments will incur nearly all of the central costs associated with developing our platform. Note that the U.K. Solutions and Logistics segment will have strong positive EBITDA, whilst given the early stage of international and a lack of any material revenue being reported, International Solutions will be negative in the near term. We will continue to report an Other segment, which includes the EBITDA resulting from the accounting impacts of MHE JV Co setup and Board and management incentives. Note that it will now include the venture's EBITDA impact, which are not currently material. But 2018 and 2019 only, the Other segment will also include the Fabled business, sold earlier this year. This slide shows the 2018 financial results represented for the new segments. Note that Fabled was a GBP 4 million EBITDA loss included in Other on this slide. For those of you who are quick and adding across each row and not getting the total, you will find in the appendix, a slide with an additional column of eliminations. Now let's look at some of the plan -- changes we plan to disclose. But first, let's look at the profile of International CFCs. We're confident that arrangements -- our arrangements with our 7 existing international partners will be successful for our partners and ourselves, as we see continued channel shift, and we both benefit from using the platform that we've built over the last 20 years. We expect to develop more CFCs with existing and new clients. For Ocado, we expect that we'll have consistent and attractive returns from each CFC. Now today, I do not plan to share any new information on the level of fees or the expected costs of operation. I believe the market has a reasonable understanding of our expectations. What this slide shows is what I believe is well understood by the market. This is for a hypothetical standard CFC, but not the first built in for any -- in a market for any given partner. For fees, with the chart, excluding any sign-on fee, we received cash fees in the 2 years prior to opening, dependent primarily on the potential mature capacity of the facility. Post opening, assuming in this case a 3-year ramp to maturity, we will receive cash fees for capacity provided. On the lower graph, we would incur capital costs prior to opening to install all of the fixed elements of the facility, notably the base infrastructure like the grid, and a proportion of the modular capital, notably the bots and the peripherals. Capital costs continue post initial launch as we add additional bots and peripherals to provide more capacity to our partners. Back to the upper graph, we would start incurring the operating costs, some prelaunch, primarily for on-site maintenance, cloud and other support costs. These would grow as capacity utilized grows. As indicated previously, for a standard and oversized facility, this will result in peak cumulative cash outflow of around GBP 30 million with positive ongoing cash flows afterward. We expect an attractive NPV. Now it's worth highlighting a couple of points for the 2020 financial year. First, this slide obviously excludes any signing-on fees for new clients, which will increase cash but have no revenue impact as only recognized once operations commence. Second, as the Casino and Sobeys CFCs are due to open during the first half, do not assume a full year of fees and, of course, do not assume that they'll open at full capacity. Finally, note that these 2 facilities are our first overseas sites ever to open. We plan to operate them initially with a higher cost to ensure a smooth possible launch and early ramp. To give you an example of this, we're planning to have more engineers on-site in Toronto for Sobeys than we would expect when the capacity is operating -- the facility is operating at full capacity. This is the first of 22 CFCs in North America of Andover-size capacity that our clients have indicated they want, and we expect this number to grow. As such, we'll use this first facility, partly as a training ground for engineers and their management so that we're best placed to grow our capabilities rapidly. We think this will enable us to more quickly identify efficiency gains that will help future launches. Now on to disclosure post the completion of the JV. The center of gravity of the group has moved, and we're increasing the financial disclosure by adding an additional segment. We plan to reduce the number of formal KPIs for our retail business, but to increase for Solutions to reflect this change in center of gravity. We will, however, continue to provide the additional narrative disclosure to allow you to maintain your understanding of our business. So what does this mean? For retail, we currently have a large number of formal KPIs, which we report on, on top of revenue cost and EBITDA information that we disclose by segment. We will reduce the formal KPIs to mature CFC UPH, drops per van per week and active customer base. The UPH metric will evolve once Erith and other newer generation facilities get to sufficient scale and maturity to include it. We will continue to provide narrative information for the other KPIs. As an example, you should expect to find all of these referred to in our full year results announcement. The Solutions will disclose the number of deals signed and cash fees and have given indication on the CFC size in all cases. From 2021, we intend to provide a new formal KPI, the live CFC total capacity for all our clients, probably in Ocado equivalent orders. We will also consider a cost-to-serve measure once this is a meaningful indicator of the long-term economics of our platform. So this ends the formal part of the presentation. We are now happy to take your questions with a microphone at the back.

It's Andrew Porteous from HSBC. A couple for me. Can you give us an idea of how the depreciation and amortization splits in the retail JV in the U.K. Solutions bit, just to see what's below the EBITDA level? I know you've kept a lot of the assets, I think, in stubs amount.

Yes. So the majority of historic capital has stayed in Ocado Group and the commercial arrangements that we put in place at the time of the joint venture meant that rather than transfer assets and actually suffer a -- some cost of transferring those assets, we've -- we agreed a commercial deal where we'll recover the cost of those assets over time, so there's a capital recharge. But actually, the assets will stay with Ocado Group, although they're, in many cases, the exclusive use of Ocado Retail; therefore, the depreciation effectively sits with the Ocado Group. Ocado Retail going forward, for new facilities, will spend the building CapEx itself; therefore, it will sit on its own balance sheet and it will depreciate on its own balance sheet. So unfortunately, it's a bit of both, but more to Ocado Retail in future. Remembering saying the same thing, as I said earlier, which is Ocado Retail doesn't have to pay the capital costs for mechanical handling equipment. It pays a fee, which covers that capital costs and its ongoing maintenance and its ongoing development.

And secondly, just on the International Solutions. Can you give us an idea of the drag from sort of start-up facilities in 2020?

Just quick math -- quick numbers, if you assume an Andover-size facility, let's round up a bit and call it $500 million because we're talking North America. We've always talked about engineering costs in our mature facilities of about 1% of sales. To say fully ramped, that's $5 million. What I said in my speech, assume Sobeys goes with a bit more than that for launch, so its run rate will be a little bit higher, but it won't be using 100% capacity. But you can see in that 1 CFC, it's a couple of million rather than more than that, and there's a little bit of start-up costs. So there's some costs prior to opening you saw. So -- but for single CF, it is quite modest. Obviously, there's Sobeys and casino, so it's slightly bigger than that.

And then is there a technical drag in 2020 from the CFCs that are in development phase and your -- where the cash fees you're getting in, but you can't tuck into the P&L yet?

Yes. So every other CFC that we're developing, where we're getting paid fees in terms of those CFC fees, we're not recognizing new revenue, but cash terms, that's fine. The majority of the costs, as you saw actually from those charts -- as you saw from those charts, are in capital, anyways. So there's not too much of a drag on a CFC-by-CFC basis in 2020. That's a different point from continuing to invest in our platform to develop a number of features that our clients want, and we think they'll want to know. Perhaps more on that, though, on overall platform investment wherein you can ask Tim when we talk about it at the full year result.

Rob Joyce, Goldman Sachs. So just a follow-on from Andrew's question. So initial year, we're thinking an extra $5 million cost per CFC in terms of versus where there might be maturity as they ramp? Is that sort the way you just...

No, because if you were to take a full year from opening, I'm saying it's more than you might expect at capacity. Well, sorry, to a certain extent, Robert, depends how much you already assumed. Yes?

Yes.

Yes. And it will be different for each of you, depending on what you've assumed for a part-year mature facility. But on a -- so if you assumed $1 million, it might be $5 million because it maybe -- it should be $6 million for full year. But even then, we're talking 2020, so we're only talking part-year. So it's not that scale per CFC in 2020, and you've got to focus on thus full year versus 2020.

Okay. And then the allocation on IFRS 16. I think we've got the numbers pre-IFRS 16 historically, should we assume most of the IFRS 16 costs sit in the group and not the JV, given where the assets are?

Yes. So the majority of the IFRS 16 adjustment, as it were from an EBITDA perspective, you'll see in U.K. Solutions because that's where the leases are.

Yes, perfect. And just -- but the retail business will be fully consolidated, so cash flow wise, the only impact of retail would be to see it coming out of any dividend line?

IFRS 16 has no impact on cash across the group or segments.

But just in terms of reporting, I mean, this retail group will be fully consolidated in the cash flow statement?

Yes, yes.

Simon Bowler from Numis. Just a couple of questions around the hypothetical standard CFC chart wise. So first one, you mentioned that's kind of not a first CFC in a region, a hypothetical one. And within that same bit, you mentioned the GBP 50 million kind of peak cash outflow...

GBP 30 million, really.

Sorry?

I think you said GBP 50 million. I said GBP 30 million.

Yes, yes, sorry. And so is the message there that GBP 30 million is for a nonfirst in a region and for the first in the region will be somewhat higher than that, partly for the fees that we mentioned?

Yes. But again, if I go back to Rob's question, he was looking at a full year basis. If you had assumed $1 million, and I'm saying, maybe, it was $6 million, versus your assumptions, it might be significant. We've never been assuming that. So for us, it's slightly more, but don't assume that same EBITDA difference versus whatever you've modeled versus our internal we'd assumed in the GBP 30 million and now it's slightly higher. So yes, slightly higher than GBP 30 million, but not the same extent as the difference in perhaps the modeling.

Yes. Okay. Fine. And then secondly, how much would you discourage us to get a ruler out and try and look at the scales of the various bars on that chart and extrapolate bits and pieces? And are the scales for the top and the bottom bars equivalent?

I thought some of you would want to do that. I'm sure you will do that whatever I say. Look, these are indicatively the right shape, but they are actually 2 graphs put together and the scales aren't exactly the same, but indicatively, they're right profile. But if somebody comes back and says, "I measured it, whether one says it's x.x%, then that's spurious accuracy, let me assure you.

Marcus Diebel from JPMorgan. Maybe also in the same direction, I think some of us do extrapolate. How do we sort of think about the cash fees? If you give more disclosures, so the first one being able to come in, are they entirely different between the different context? Or should we just argue this is more or less going in the same direction? I'm just thinking, just -- I'd love to hear what I would do with knowing the first cash fees coming in, how I then basically get any indication where things might go with more contracts in other regions. So basically, bottom line is, are there major differences in terms of the amounts of cash fees that you're getting?

And on a client-by-client basis, in terms of the aggregate fees over the life of a project and the -- break that down into effectively 3 different fees, remember, we get a fee for signing on, we get a fee for each CFC in the 2 years prior to opening, and then we get capacity fees going forward. Both the total and the split is all roughly similar. They're not all exactly the same, but they're all roughly similar. There was some trade-offs, but broadly, for modeling purposes, just assume they're the same in all the plans.

Nick Coulter from Citi. If I may just on the U.K. Solutions column, in the -- representing FY '18, could you qualitatively give us some color as to what's in that GBP 541 million? And I've probably got a follow-up on that.

In terms of the GBP 541 million revenue. So when you think about it, when Ocado Group incurs a payroll cost by employing a driver or we call them customer service team manager. So that cost is in the revenue because it is -- for the entity, it is actually a fee that you charge.

As it has been.

Yes. So it's the cost you incur. It's then the management fees you go on top of that, i.e., typically, 4% of the costs that we could incur on behalf of Ocado Retail and on behalf of Morrisons. And then on top of that, its fees, which is Morrisons' fees, both the original deal and subsequent deals, and the new fees that are now in place post the formation of the joint venture.

So I guess the -- I guess the chart you haven't shown is what a pro forma would be if you add the M&S deal running at that point in time as you did on the announcement of the deal.

But if you actually go back to the prospectus, you'll find that same GBP 30.1 million EBITDA. So these are the same as we put in the prospectus.

But that's a net figure, isn't it, that here, you're grossing up between revenue and costs?

If we had disclosed in the prospectus, this level of detail, it will be the same as it was in the -- this is the same as it would have been in the prospectus. We didn't give you that level of detail because we didn't give you that column in the prospectus. All we gave you is the first column in the prospectus. So there's no change in the way it's presented as it were, as that is the stand-alone entity with the contractual arrangements that are in place at the time. Of course, the time for 2018, that doesn't reflect new sourcing arrangements that will be in place with M&S. This is only the Ocado Group change.

Okay. And then -- can you then talk more about the recharges from the group into M&S? Obviously, it sounds like you're probably on a phased runoff in terms of providing services to the JV and obviously, charging items in.

Yes. And there's no sort of, as it were, change from this going forward, apart from the specific one, of course, which is this doesn't assume that we're sourcing from M&S, which will be happening from September, and the commercial terms of that were disclosed at the time and they are from an Ocado Group perspective and an Ocado Retail perspective, better than they are to Waitrose. And of course, we benefit from all of M&S' sourcing strength as well. Others, some in the room, can probably talk to you about the benefits of M&S of having the extra volume and the information thing. So we think this works for us all.

That's the GBP 15 million?

Yes. So that's not -- because this is only representing 2018.

And then perhaps on that basis, being the disclosure here, you've given a couple of x columns, but the disclosure in the Ocado Retail JV has come down quite markedly. Why aren't you giving some sort of guidance on capacity or orders?

Nick, I don't think it's come down quite markedly. You'll get -- you've got, in the simplified column, you don't have the CFO reporting this.

No, in the narrative in KPI. Sorry.

But -- wait and see the full year results and see whether you've got any significant change in disclosure, whether we're going to now report every half year, full year, put it in our annual report, they're on a formal KPI page, waste. It's not material, and we'll disclose it if it is material.

No, but I guess, you could argue, it's a distinct advantage of your view of solution and something that is...

You'll expect us to hear us talk about it. But one, we can talk about. The other one, we have to put in the annual report has to be on the KPI page.

Okay. I'll defer my skepticism until your report.

That's what I think you should do it. I promise you'll still be able to understand our business. You can hold me to that.

It's James Lockyer from Peel Hunt. Two questions. Firstly, on the resegment or the segmentation of the Ocado Retail part, where you said that Ocado and M&S wanted a standalone business, so they can report on that now. Can we think of that as an indication of how your partners might -- the opposite side of things from the partner's perspective, is that sort of the profitability they should recognize on their side? It'd be good to understand that first one. And then secondly, on Kroger, the Kroger deal on that sort of indicative chart. I think you talked about you had been looking for more value neutral sort of situations and CapEx lighter in sort of the later deals. So it would be good to understand how that chart might change.

James, 2 good questions. So the first thing to say is, yes, it is indicative, with a bot. It's indicative with a bot because if you think about 2018, the majority of the capacity serving Ocado Retail in 2018 is from the old generation facilities with lower UPH and less efficiency. So that's an important point. Secondly, 2018 is part of a pretty dramatic scaling of capacity with a lot of fixed costs and you should assume any business adding chunks of capacity and the scale that we have done historically, we'll see a tooth edge, a sore edge as you grow. So there'll be -- when you add the capacity, the extra fixed costs will be some diminution, but underlying trend. Those are 2 obvious differences. But no, it is a lower level of EBITDA, but by the way, is -- effectively, there's very little depreciation in that. So that's part of it. Unfortunately, because we don't split our capital by segment, that will be more difficult to fully demonstrate to you, but we'll obviously keep trying to do that. Second point was on the hypothetical standard CFC, how might that change. Have no doubt, internally, we'd like that graph to look quite different and keep asking the question and know that we keep working on it, but I'm not going to commit to further changes. I know some of the things that we're working on, but you'll have to wait and see. So we'll keep working on improving this. And some of the ideas are fabulous, but I just have to leave it there.

Thomas Davies from Berenberg. Just one question on the -- so the cash signing-on fees. Obviously, that's not allocated to revenue. But when the facility goes live, how is that amortized onto the P&L?

So on that chart, you saw the ongoing capacity fees and ongoing capacity fees are effectively annual or monthly or quarterly fees. So assume that they're going to be recognized in revenue as they're received in cash, simplistically. So that's relatively flat. Those only really are talking about initial fees and those are -- I won't get into the tech of accounting, looking at things like contractual life and customer life, sometimes difficult to completely estimate if you have an open-ended contract where you give your customer the right to cancel. But I think, for simplicity for this room, just for the modeling purposes, take us something like an 8- or 10-year basis now because we have a lack of knowledge. I can tell you, personally, I'd expect it to be a lot longer than that. But I can't prove it's a lot longer than that until we've experienced it. But that element is, of course, in 2020 or 2021, the much smaller element of the reported revenue.

Please, can you just explain why you chose those 3 formal KPIs as opposed to any other 3 in the retail business?

Well, I'll just give you a challenge of a scale measure, which might be, well, why do you do customer orders? Why don't you do orders? Or say, why do you do customer base? Why don't you do orders? Problem with orders, and you'll have to keep asking this question about how bigger proportion of your business do you expect Zoom to be. But if I were to ask this room, you -- probably most of you have a completely different basket size for Zoom than you would for ocado.com. So what happens if Zoom grows really fast, then your order growth looks really strong and your basket size starts declining. But continuing to report both of those doesn't tell you anything until you get to the next level of detail. So I know you might say, well, then give us both. But I think, we're pretty good on the disclosure and now giving 4 measures of that, and then we come up with the next concept, is it's 6 measures of that. So we think customer orders is good, but don't -- again, don't worry. If it's material for your understanding of our business, we'll disclose it narratively so that you can understand. And I'm sure you'll be asking questions in the future, what proportion of your orders are from Zoom versus ocado.com. I would expect that, and I'm sure you'll find an answer from us. So that's 1 of the reasons. If you look at some of the others, the 2 other measures, I think, are the clearest indicator outside of the financial measures, of course, of margin, which you're still going to see, and the cost, which you're still going to see, of the underlying cost drivers of our business. If you can see that the biggest cost being delivery, the DPV measure's a good measure of that. The second biggest cost is fulfillment and the UPH measure is the best proxy for that. So we'll disclose both. If you remember, in our annual results, we typically put up a slide that takes you to the retail business with the key profit lines as a percent of sales, expect the same.

Nick Coulter from Citi. Again, apologies. Is it possible just to get a sense of the opening timetable for -- over Purfleet and Bristol? It strikes me that they might come, I think, fast.

They are, and that's a good question. So many CFCs now, I'm starting to search my memory for reminding myself exactly which 1 is when. But Bristol should be first, effectively end of this year or early next year. We've told you, I think, early next year. But of course, if we could get it in ahead of Christmas, then we'll try and do that, to plan for early next year, but we'll try. I think Purfleet is next from memory, and then, I think, Andover is following that. So Purfleet is probably from memory, second half of then 2021. And Andover is the beginning of 2022. But again, you should expect us to try and wherever we can, bring those forward, more likely to bring forward Andover a bit than Purfleet. I've also got in my head, what's next, and the next one and the next one as well. So really, we're looking for the future as well.

So just one follow-up for me, James Lockyer from Peel Hunt. The indicative chart page you had on there. Obviously, your revenue operating costs, CapEx. I was wondering if you could give us an idea of working capital and how that might just get us down to a free cash flow number, if you could?

Yes, because in that slide, we're not operating as a retailer, we're operating as a solutions provider. It's effectively -- the operating costs are mostly cash as they're people or cloud costs. Unfortunately, AWS don't give a 6-month payment terms, though they're effectively cash. The capital isn't with significant working capital terms, and that's not particularly important for us. If you're looking at those, we're more interested in getting the best deal with the best supplier than taking a second best supplier and just getting an extra 30 days payment terms. So they're typically -- they're not exactly cash, but they're relatively modest working capital.

Nick Coulter from Citi. Just on the cash flow, so a quick question. Are you going to give segmental disclosure on the cash flow for the JV, so we can see how that takes through?

That -- when somebody asked me earlier, are we going to 100% consolidate Ocado Retail in the cash flows, there's a slight hesitation in my voice, which is we need to work at how we can explain that to you in a way so you understand the cash flows of the retail business. But when you look at the cash flows of the group, it's explainable because some of those cash flows are within group.

Yes. It's the working capital point. Clearly, you still own half of business that will have a very strong working capital profile.

So clearly, the figure at the end of the day for Ocado Group, the figure at the end of the day for Ocado Retail are what they are. How we best disclose that to you, we're still working on. We've got a few weeks to go before we finalize. So I think that's most of the questions you took the opportunity to ask. Sorry, one last one then.

[ Donald Wakefield ], HSBC. I want to turn to IFRS 16 and wonder if you could tell us a bit about your transition approach, practical experience you took, and whether what you could be disclosing in terms of net debt going forward.

Because we have an existing bond and a small working capital facility, the working capital facility has a clause around accounting changes. Therefore, you look at the covenants on a pre basis is undrawn. So that's, frankly, to a large extent, relatively irrelevant. And if we need to do something that's probably more about what's in the future there. So there's no issue from a covenant perspective on debt. In terms of the detail on the accounting, I think probably what we'll do is take that off-line. Yes, it's, I think, a question quite right if you're asking about Tescos with several billion here, but we are quite modest, so we can pick it up in the detail later. Thank you all for your time. Hopefully, that helps you understand a little bit. I would suggest that you spend some time working on your numbers. And I will just make this point because I think it's a relevant point, for next year, which is pretty close on, for example, our Solutions business, in this room, we've got nearly GBP 70 million EBITDA range. And that close to it, somebody is definitely wrong. We all know forecasts are always wrong. Even my own forecasts are always wrong. But I think there's a bit of work to do. So if you need some help to understand this, talk to me. Probably more likely, talk to the experts, so you can spend time with you, David and [ Chandler ] and I will see you again in a couple of weeks' time. Thank you.