Ocado Group plc

Stuart Rose - Chairman Tim Steiner - CEO Duncan Tatton-Brown - CFO David Shriver - Communications Director

Bruno Monteyne - Bernstein Andrew Gwynn - Exane Stewart McGuire - Credit Suisse Rob Joyce - Goldman Sachs James Lockyer - Peel Hunt Nick Coulter - Citi Mark Hiley - The Analyst Charles Allen - Bloomberg Intelligence Dusan Milosavljevic - Berenberg

Good morning, everyone. I’m Stuart Rose, and I’m Chairman of Ocado.

I was only thinking to myself and saying to Duncan down there this is what happens when you join the FTSE 100, isn’t it Tim? We get the biggest screen and the bigger auditorium.

So, welcome to everybody this morning and welcome to our 2018 interim results presentation. Some of you may remember that when we last met six months ago, I talked about the unprecedented number of options that we have now to grow our business, or we had at the time to grow our business.

And I said at the time that Tim and Duncan and Luke and the rest of the team had their wholehearted support of the Board to turn this business into a well-resourced, resilient business, which could fulfill the growth opportunities that we thought it had. And I’m really happy to say that since we last met, we’ve now done a deal with ICA or we did that deal last time we spoke; we’ve done a deal with Kroger.

And we believe that further growth opportunities are there for us to come. As of today our platform will power the online grocery business for seven of the world’s most innovative and forward looking retailers.

We have a deal with -- we’ve obviously got Ocado, we had our deal with Morrisons for some time now; we’ve got Bon Preu; we’ve got Groupe Casino; we’ve got Sobeys; we’ve got the ICA Group; and as I just said at the beginning, we’ve got now Krogers. And I believe that there will be other smart retailers who will follow us into the future.

Just as encouraging is the fact that the business is now rapidly building its capacity to deliver successful outcomes for our customers and partners. And you’re going to hear from Tim, you’re going to hear from Duncan about what we’re doing about that, shortly.

This involves amongst other things of writing code faster, bringing new capacity online, improving our fulfillment solutions and building the capability of the Ocado Solutions team. Ocado today is offering its UK customers a better experience never before within the domestic market.

It’s enhancing its market leading opportunities and it’s beginning to industrialize the processes and growing in terms of scale and in terms of pace. And we are taking real advantage now and enabling other retailers to take real advantage of the significant channel shift that’s now taking place in the retail industry.

This has been talked about for long time but I believe this is really now happening. And I was in the States four days last week with six or seven retailers in four different cities including Canada and everyone is talking about what is going to go on now in terms of technology and fulfillment solutions for retail in groceries of the future.

So, it’s very exciting times. Very exciting times to be part of Ocado story; I am delighted to be part of it.

But I’m only the small part. The big part is Tim and Duncan, the team behind this.

So, I’m now going to hand you over to Tim. Thank you.

I’m going to talk very briefly about the opportunities ahead and then I’m going to handover to Duncan before coming back on stage. As we’ve mentioned before, our virtuous cycle drives the Group.

For many years now and on an increasing and ongoing basis, we’re making significant investments, investments in innovation to create the best platform to change the way the world shops. We’re driving efficiency in our operations, unrivaled efficiency and creating the best customer propositions, and that drives growth and the growth drives profitability which will drive investment.

And all of it is underpinned by our proprietary technology, and the cycle is just moving faster for us. So before I talk about in more detail, I’m going to invite Duncan to come up and take you through the last six months’ numbers.

Thanks, Tim, and good morning, everyone. So, before Tim takes you through some of the plans and our progress, I want to talk you through the financial results we announced this morning.

The key headlines are that we continued to deliver market leading growth and further improvements in efficiency with the new CFCs poised to fuel the next leap forward. We have invested heavily in CFCs and technology as a driver of growth for both our Retail and Solutions businesses, and with the Solutions team and prospects growing all the time.

Finally, we are well funded to deliver on our growth plans and our current commitments. So, the financial summary.

We’ve continued to grow revenues strongly in the first half with our Retail business up 11.7%, well ahead of both the total and the online grocery markets. Revenue growth was even stronger in Solutions.

This primarily reflects the revenues from our arrangements with Morrisons but does include some modest revenue from our new international solutions partners. I will talk a little later about accounting for these deals.

Overall, our revenue was up 12.1%, just shy of £800 million. On EBITDA, the story is different for each segment.

As expected, our Retail EBITDA grew slightly to £45.5 million; the low revenue growth, largely due to the additional cost of Andover. Solutions EBITDA was a loss of £2 million with modest growth from our arrangements with Morrisons and some international revenues, offset by significant further investments to deliver the huge opportunities that we’ve already announced and our expectation of further deals to come.

Our Other segment includes the accounting impact of MHE JVCo and the Board and management incentive scheme costs. A word on these costs.

As we’ve highlighted in our release, at current share prices, we expect in 2019, about £9 million of additional costs, of which about £4 million has already been taken. The biggest but not sole driver of this is the cost associated with our growth incentive plan which rewards some key management if the share price outperforms over a five-year period the FTSE 100 by 20% per annum to achieve maximum payout.

Overall, EBITDA therefore fell to £38.9 million. Net interest costs were up to £6.2 million as despite the positive cash position we incurred additional costs from our bond issued partway through last year.

Depreciation costs increased to £41.7 million with the biggest increase due to the commencement of depreciation of our new front end software platform which started depreciating following its first use with the launch of Morrisons’ store-pick. As a result, we reported a loss of £9 million in the first half and would expect to report further losses in the second.

Here I split out the Retail and Solutions EBITDA in a bit more detail, showing admin costs for each segment. I will cover Retail operating contribution in further detail later.

So, I will focus Solutions. Revenue grew 16.8% on the prior year with operating contribution faster up by over 40%.

Note that revenue includes Morrisons’ income from both recharges of costs effectively -- with effectively low margins and fee income. It also includes a modest amount from our international solutions deals.

As these clients are not yet operational, they do not incur significant operational costs. Admin costs including the P&L costs associated with the investments in the platform were up 65% for solutions.

Tim will give some more explanations of the types of investments we’re making later. For our Retail segment, they also grew but at much lower rate, up 11.8%, just ahead of revenue growth.

So onto Retail performance. Retail revenue was up 11.7% on the year, with total order growth slightly ahead at 11.9%.

Hypermarket baskets were slightly down as we continued to see a bigger mix of mobile orders offsetting some price inflation. The 11.9% growth in orders was an increase in average order volumes of 31,000 orders per week.

Andover provided most of this extra capacity, but we continued to push more orders through our mature CFCs, which have been operating at their maximums, limiting our ability to grow faster and reducing their efficiencies. As a result, mature CFC efficiency fell slightly to 163 UPH.

Dordon continued to be the most efficient, regularly above 180 UPH. We expect UPH to improve further, primarily from the benefits of our new CFCs once they’re operating at sufficient levels of maturity.

Encouragingly, Andover UPH is ahead of plan and we’re now seeing some shifts where its UPH exceeds Hatfield’s average. We would also expect some benefits in our mature CFCs as we ramp Erith and Andover, and so reduce somewhat the pressure of operating at maximum capacity.

Our delivery efficiency is measured by drops per van per week improved by 5.3% to 189, and it’s notable that this is just below our long-term target of 190, a target which we set only two years ago. It looks like we’ll have to set a new target soon.

Wastage cost remains at industry-leading levels. This includes the cost of selling the products at a discount to customers, to staff or donating to worthy causes.

The actual product that is wasted and ends up in landfill is 0.02%. Even so, we’re still looking at ways to reduce this further to ensure that we have a sustainable a business as possible.

So, as promised, I wanted to come back to Retail operating contribution. Gross margin fell by 80 basis points.

The market remains tough and we matched moves by our supply partner Waitrose. We also saw increased customer compensation in the first quarter, largely as a result of the severe weather conditions.

Clearly, an impact, we would not expect to repeat regularly. However, being working hard to find ways for our suppliers to increase their sales with us, and this helped us grow our supplier income by 50 basis points, offsetting much of this margin decline.

Trunking and delivery costs were lower due to the improved efficiency as we continued to grow our customer density. The biggest cost movement was for CFC costs.

As I covered previously, operational efficiency was marginally worse in our mature CFCs as they operate at effectively maximum capacity. But the biggest impact was from Andover for three main reasons.

First, there were higher fixed costs from the facility being formally open for the whole of the period, unlike the previous year; second, despite rapid improvements, UPH Andover, on average, was still below the average of our other CFCs; and finally, engineering costs at Andover were much higher than our existing CFCs. We’ve invested heavily in engineering resource to build our capabilities and to make improvements in reliability and the longer term cost of maintenance.

We’re making good progress. And as we announced this morning, engineering cost per order fell by approximately two thirds during the half.

Overall, with improvements in engineering cost per order and as we continue to grow capacity and efficiency, we believe our retail profitability will grow over the second half. We spent £102 million of CapEx in the first half with less than £10 million on maintenance type expenditure, primarily in mature CFCs and for delivery vehicles.

We spent £54 million on new CFCs with the initial build at Erith and some expansion at Andover. The majority of the balance was on further development of our technology and fulfillment solutions.

Our guidance for the full year is unchanged and we still expect to incur around £210 million of CapEx with the majority of international solutions requirement coming in future years. Our cash position is strong.

We ended last year with £150 million of cash and we had two equity issues since then with underlying cash outflows of £26 million. So with our undrawn RCF, we have in total nearly £550 million of headroom, giving us sufficient funds to keep growing our UK capacity, improving our platform, and meeting the current needs of our Solutions clients.

Now, before I finish, I wanted to give some guidance to help you model Ocado Solutions. I know there is much you’d like guidance on which for commercial reasons I can’t help you with.

And at this stage, we don’t want to get into giving any specific targets on the potential CFC commitments. But what I can do is help you understand some of the accounting.

First, I’ll repeat some of the expected cash flows for typical CFC deals. We would expect the one-off signing fee payable immediately and then CFC preparation fees which reflect the ultimate size of the committed capacity.

This fee is typically paid over the two years following signing. Finally, there are ongoing fees for the use of capacity, which start being paid once the CFC launches and would scale as the amount of committed capacity grows.

So, how do we expect to account for these? As you’re aware, we’ll be moving soon to a new accounting standard for revenue recognition, IFRS 15.

We’ve not considered the impact of this standard on our Retail business but they’re not expected to be significant, nor have we considered our existing arrangements with Morrisons. But it makes sense to start using the principles of IFRS 15 when considering the revenue accounting for our new international solutions partners.

The revenue for the signing on a CFC preparation fees will be recognized partially to cover the cost that we incurred prior to launch, notably some of the implementation cost. The balance of these fees will be phased over a longer period, typically five to seven years.

For ongoing capacity fees, this is much simpler and these will be recognized as earned. The consequence of this is that we will recognize in early years less revenue than we receive in cash.

So, you’ll see a positive working capital movement in our cash flows. Anyway, enough on the accounting.

We have another half of market leading growth, our platform is becoming more efficient, our new fulfillment solution is scaling and improving, and our prospects ahead for solutions are very encouraging. So I’ll now hand back to Tim, who could take you through what we’re doing to take advantage of these opportunities.

Thanks, Duncan. I’m just going to read what we said at the year-end and just focus on that for a moment.

Now is the time to take advantage of our growth opportunities. We will invest to ramp up our new solution in both Erith and Andover and to have the right resources in place to meet growing demand for the Ocado Solutions offer.

We believe that taking advantage of these international opportunities now will make our virtuous cycle turn faster in the years ahead and we expect that to translate into higher returns on capital. We said that on the back of having signed up Groupe Casino in November and having signed up Sobeys at the start of the New Year.

But what we have done since then bringing ICA into the fold and then Kroger, Kroger in particular is a game changer. And it exceeded even our expectations of what we were going to sign up.

And so, as a Group now, we need to go faster. So, what does going faster mean in practice?

We need to write code faster. We need to bring new capacity online faster.

We need to build Ocado Solutions capabilities faster. We need to improve our fulfillment solutions faster.

And we need to innovate for the future faster. The reason that we need to go faster is that we are going to roll out more facilities faster than we have envisaged.

We are going to have tens of thousands of our robots live faster than we had envisaged. And so, we need to improve at an increasing pace.

So, writing code faster. Interestingly, we had one of the Big Four come in and do a review of our IT, our technology and engineering area recently.

They wrote Ocado as one of the best in Europe for agile code writing. We write good code.

We have been writing good code for quite a period of time now but we want to go faster. Even Greg Clark, the Business Secretary, is mentioning us alongside people like Amazon and Rolls Royce in terms of our talent in AI.

But, what are we doing to go faster? When we signed the Morrisons deal, our first platform customer in the summer of 2013 that went live in the beginning of 2014, we had under 300 people in Ocado Technology.

In the second half of this year, we are aiming to add 200 to 300 more software engineers. So, we are aiming to add as many people as we had in our business when we signed our first client.

We are over 1,000 people. We are growing in all five of our tech offices.

We have put in place a new leadership structure for Ocado Technology. Our Group CTO, Paul Clarke is now taking on a new role as our Group CTO but focusing on what we need to be doing in the next three to five years -- sorry, from three to five years, from five to 10 years and 10 to 20 years.

He is not focusing on the engineering that we need to deliver for our Solutions clients today. He is making sure that we are relevant in five years time and relevant in 10 years time, and that we are staying ahead of the curve.

And he is focusing on the medium to long term future. We brought back into technology James Matthews.

Some of you may have met James before. He started off as a computer scientist in our technology area.

He left us and went to HCS to get his MBA. He rejoined us and now has been running our general merchandise business for several years now.

He is very focused on execution and he is now managing the Ocado Engineering in Ocado Technology as the CEO of Ocado Technology to drive the delivery of our software, delivering well engineered code fast. Good code is code that our customers need when they need it and that is James’ focus.

We have also brought in a new Chief Product Officer. So, we’re having split that original role into three roles today.

Our new Chief Product Officer, Simon Thompson is well known to us. He was our first client.

After a background at Apple, at Honda and lastminute.com, Simon joined Morrisons to help them take that business online. He worked out that we have the best solution in the market, negotiated a deal with us, implemented it and ran it for its first year before going off to be Chief Digital Officer, HSBC.

So, Simon has joined us to run the management of our roadmap. And we’re really, really excited about this new structure, and it’s already in its first few weeks having a significant impact.

We need to bring new capacity online. We’re very pleased with the results in Andover at the moment.

In this half, we doubled the volume there. We’re running Andover around 30,000 orders a week.

That’s half its endgame volumes. We’ve got over 600 robots moving around on the grid today.

That’s just over half of endgame. So, we’re getting just getting just around half of endgame volumes with just over half of endgame robots.

We’ve also turned on Erith. It’s the same solution.

It does have some enhanced components. It’s got a redesigned grid that’s more structurally stiff.

It’s got some improved peripherals. It was delivered on time and on budget.

But more importantly than that is how it’s scaling. In its first three weeks, it reached the same volume that took us 32 weeks to achieve in Andover.

We’ve been explaining this. Every lesson that we learned in Andover, every enhancement we’ve made to the automation of the software to drive Andover’s volume, is instantly transferable to every future site.

And Erith is the first evidence of that. Three weeks to achieve what took us 32 weeks in Andover.

And there is our new site in Erith. As you know, the small building without the circle on it next to the river is Tesco’s largest automated facility.

The key reason we like to point that out is our building is 4 times the size, but we expect to achieve 16 times the volume. We will generate 4 times the sales per square foot as our leading competitor.

But there’s another building in there also circled that in this half year we’ve rolled out our second general merchandise facility just down the road from our new Erith warehouse. We’ve done that because we’ve hit max sales capacity at the first general merchandise facility that was reaching about 7% of our sales last year.

And so, that will give us the capacity to more than double our general merchandise business. We’re building our capability in our Solutions area.

Having brought on Luke in February last year, obviously, we’ve gone through a flurry of deals and we’re building the teams around him. We’ve brought in a new commercial director in Ocado Solutions working for Luke who’s ex-IBM.

We’ve got a very internationally focused team and we’re fluent now in that team in 11 languages, helping us to seek the clients around the world in their mother tongue. We’re building up our relationship management skills and our relationship management team and many of you will remember David Hardiman-Evans, who is our IR for some time who’s now Senior Vice President of our North American operations.

Obviously, we’ve been relatively successful in North America over the last nine months, signing two very large transactions. And we’ve got other people joining that team, both internal and external, and bringing in external experience but also a very deep understanding of Ocado and how we do things.

We’ve been growing the teams that help us to build CFCs. We’ve got a lot more work to do there and we’ve been dramatically increasing the size of the teams that can design warehouses.

And over the last six months, we’ve been designing a lot of warehouse opportunities for ourselves here in the UK to practice our capabilities of designing multiple warehouses simultaneously. We’ve got a lot of experience of proven delivery, still having many members of the team that go back as far as building Hatfield, Dordon, Andover and Erith that will help us to expand out around the globe, leverage the capabilities of some of our partners like Kroger and their project management skills as well as external skills that we’ll leverage from engineering firms to enable us to build dozens of concurrent warehouses around the world.

The beauty of these warehouses is how the software controls them and how it enables us to build multiple one and scale them to their maximum potential without needing to have very, very specific commissioning teams on the site. And also, as I mentioned before, the product team as well as in Ocado Solutions led by Simon, our former client who will be running the product roadmap and the relationship on all the technology interfaces with our clients.

And in that area we’ve brought in expertise not only from IBM, but from Apple and from Google as well. So, we need to carry on innovating because we’re not content just to sit and sell the solution that we have today.

Sorry. You’re right.

I missed one. Thank you.

So, also we are improving our fulfillment solution and this is really critical, as I mentioned before, because we’re going to roll more of this out faster than even we anticipated. The good news is that in the half we started to take delivery of our second generation bots.

These bots are intended to run to the same physics model as the previous generation, but they’re intended to bring down the long-term cost of ownership, the combination of capital and running cost. Now, when we’re developing bots at the moment, think about how a company like Apple might develop an iPhone.

You have concurrent teams developing new generations because the development cycle is longer than the period of time in which you want to roll out a new product. So, whist we’ve been developing the second generation robot that we are now taking delivery of, there is the majority of the fleet in Erith going forward, we are also developing the third generation robot.

And we’re currently testing subsystems of that third generation which is a robot that we will roll out to the majority of our international customers. To give you an idea of kind of scale of change, generation 2 has about 25% new components compared to generation 1.

Already it’s proving hugely valuable to us in terms of some benefits in its engineering ownership cost, so we can change components on it 80% faster than on its predecessor. Generation 3, the next robot is built on 75% new components versus generation 2, so a significant change.

We’ve dramatically increased our testing capabilities in order to build that new robot. A year ago, we had one test grid in our test facility in Hatfield that we ran 10 hours a day five days a week.

During the half, we’ve moved into a new facility next door that’s over three times the size. We’ve now got six test grids on that.

We are running them 24/7, giving us a significant increase in our capabilities to design, engineer, and prove the new hardware. Today, before we make a software change to the fleet running in Andover, it will -- that software will have been through over a 1,000 bot hours of testing in our test facilities, something that we weren’t capable of doing beforehand.

The aim here is increased reliability, increased efficiency, manufacturability, serviceability and throughput, and at the same time, decreased capital costs. And we really are making significant progress.

The engineering cost on our fleet in Andover is reducing dramatically. In the half, our engineering cost per order reduced 66% from the start of the half to the end of the half.

So, the trends are all very positive. As I said before, when I flipped two slides, we need to focus not just on what we have to do today but we have to make sure that we innovate for the future.

And so, that’s not just around our current operations. So, we are continuing to innovate there with things like robotic picking, AGVs and other innovations that will drive towards lifestyle facilities in the future.

Increasing efficiency for our customers, driving variability to make better price offers to their customers to drive market share. But we are also scaling into other areas of food distribution.

And you would have noticed from the announcement from Kroger that they will be using our facility to do some store-based replenishment as well. It’s worth remembering that the global food distribution market per year is about £5 trillion.

And something like 30% of that £1.5 trillion a year is spent by food retailers and distributors getting product from suppliers to customers. So, there’s a very big market out there in food.

But we are also exploring other applications where our skills of moving things could be just as useful as they are in the food market. So, we are spending money developing robotic picking and we have our first robotic picking cell in Andover, currently not being used as part of the live production but there to show our clients how it works.

We are exploring opportunities in immediacy, so we can address more of the spending in this market and in the global market. We have now filed over 300 patent applications on our innovation.

We have had over 50 of them granted. So, we are making it harder for people to come up behind us and copy what we do.

And we are working on a number of applications outside of retail. There are no guarantees that all of them will be successful but our aspirations here are huge.

So, in the second half of this year, our priorities are to bed down our organization and our enhanced capabilities to ensure that we can do what we’ve promised to do very successfully. We need to ramp up our new facilities even further, both Andover and Erith, which will allow us to grow our Retail business but also to prove our Solutions.

The early stage implementation of our current partnerships is very important and we are building a facility at the moment in Paris with Groupe Casino, and we’ll start building more facilities around the world. As I mentioned earlier, we need to write more code faster, finalize our service agreements with Kroger and continue to build the pipeline of potential Ocado Solutions partners.

As you can imagine, we are in discussion with a number of retailers at the moment and the interest levels are very, very high. So, in conclusion, we’re now contracted to power the online grocery businesses of seven of the world’s biggest, best and most innovative retailers.

The Kroger deal was a game changer for us. It’s a partnership that we’re immensely proud of and very excited to be working on the execution of.

We’re building the resources within our business to execute well and at speed. Our fulfillment solution in the last half has made enormous progress, doubling the scale at Andover; having shifts in Andover where our productivity is already exceeding Hatfield, bringing our engineering costs per order down by two-thirds and ramping Erith in three weeks to what took us 32 weeks in Andover.

Our greatest scale will allow more innovation to improve the experience for our customers and our clients and their customers and so we want to keep growing. The market opportunity in grocery and beyond is huge as is our ambition.

Tim, thank you very much. Ladies and gentlemen, we’re going to take questions now.

There is a little thing on your desks. Press the red button.

When you want to talk, you got to press the red button. Otherwise, we won’t to hear you.

For those who are following this on webcast, please ask your questions. I have an iPad.

I will raise your questions for you. So Tim, I invite Duncan onto the stage.

Off you go.

Good morning. Bruno from Bernstein.

Three for me. This Andover ramp up, this simply has been live for a year.

What gives you the confidence that you will achieve those much higher productivity rates than you see today? So how do you see and what gives you really confidence that you will get there?

The second one is engineering costs seem to be a newer part of debate in previous discussions. How big are the engineering costs typically for order today?

Can you quantify the size of that? And the third one is, given that you’re still talking to new partners, given that you’re so busy, are you able to improve the take rate or your commission on future deals or is the next partner going to have to materially pay out before you’re willing to add more capacity for your future pipeline?

So, I think there’s at least three questions there. You might have to remind me as we go through them.

The first one is what gives us the confidence that we can achieve the productivity rates. It was productivity, not scale you were asking, I think.

Look, so, we do a significant amount of simulation before we build any of these buildings, both of the individual components, the modular components, as well as the entire end-to-end solution. And so, we obviously have a lot of experience of running each of the peripherals where we deploy people to do processes.

And then it’s about the machinery obviously giving them the opportunity to do those processes at that speed. And so, we have a high degree of confidence on the back of that and on the back of the success that we’re having in achieving the results that we would hope to have at each stage.

And so, over the last six months, we’ve been actually improving productivity, scale and reducing engineering costs ahead of our plan. So, we’ve got very high levels of confidence.

The second question?

Engineering cost, can you sell, bag it up at order and…

Look, our engineering costs in our traditional and on our older mature facilities runs at between 70 and 80 basis points a year of their total sales throughput. The robotics solution, one would expect out in the endgame to have a slightly higher cost because of the inbuilt UPS effectively the battery component of it but only slightly.

And we’re working our way towards that, seeing very significant and meaningful reductions on our journey.

[Inaudible] right now, and you’re building it down to above your old ones.

We’re not going to get into those specific numbers but it’s coming down in a very satisfactory way.

And I think it’s worth noting as Tim was mentioning, Erith is getting second generation bots. The majority of bots in Andover are first generation.

So, second generations have the opportunity to make further rooms, let alone the third generation.

So, that’s the interesting part is the Andover’s cost of doing this. No facility will ever have as higher cost as Andover ends up with.

And the third question was any new international partner, are you having much more negotiation leverage for your potential right now?

Look, clearly, we’re in a much stronger position in terms of deciding which markets we might want to go into, which partners we might want to work within those markets. I don’t think in the grocery business it will be sensible to say, hay, look, we’ve got a limited -- and we do this in our grocery our business too.

If there is a shortage of something, we don’t double the price of water because we know everyone wants to buy it. You have to limit it some other way.

So, we’re not going to suddenly try and double the price of our solution because too many people want it and we can’t deliver it. We’re going to chose the markets and the people that we want to work with and go after those.

Obviously -- and the ability of a potential counterpart to say that you haven’t signed a deal, so can you do this for me and that for me. That has obviously reduced.

Yes. Good morning.

It’s Andrew Gwynn from Exane. I’ve got three questions because Bruno did.

First question is, when do you the Ocado Solutions EBITDA will be bigger than the Retail EBITDA? When do you think it sort of moves to be the dominant part of the P&L?

Look, I think that I’m not sure exactly which year that is but I think it’s worth bearing in mind that when we sign a deal, it takes two year or so to build a facility. So, we spoke with the Kroger deal, about starting 20 buildings over the next three years which means that they will be live in five years’ time.

And obviously when you’ve got 20, 30, 40 50 buildings live, you’re going to generate some significant EBITDA. But it’s not a question of it’s not going to happen next year or the year after.

Just on the -- more probably for Duncan, but just on the guidance you’ve given for the second half. Could you just sort of talk through the bits, particularly around the extra capacity cost within the CFC3, particularly into CFC4?

Maybe just give us a bit of color on what’s happening there. And then, while I’m at it, just depreciation, bit of a dull question unfortunately, but one unfortunately for our models?

Thanks.

Sure. I think the big picture at this morning’s announcement was flagged in our outlook segment, two things for you to consider about.

The biggest one obviously is the management incentive cost, but -- as it were one-off cost for a five-year scheme where the expectation of payout and cost of payout is higher. So that’s not a recurring charge, of course, unless we keep quadrupling the share price, which I don’t think will be problematic.

So that’s one. The second was the extra investment in Solutions.

And you saw in the announcement this morning, we mentioned external consultants. So, there’s a little cost in that.

There is a bit more scaling in that. And we’ve been conservative in our revenue accounting as well and I hopefully explained a little bit of that.

So that’s the impact on Solutions. On Retail EBITDA, there is no comment about our outlook in terms of numbers, and I think that’s the steered view.

So, we are performing as we would expect in Retail. And we are expecting improvement in the sort of revenue versus EBITDA, unlike first half when it was -- frankly it was flowing back.

And that’s because engineering costs at Andover continuing to come down and certainly average across the half would be bigger. We’ve opened the Erith but it’s formally open from an accounting perspective.

So, we won’t take six months of fixed costs in Erith in the same way as we did with a slight gap between first order shipped and when it’s formally opened because in these early weeks, it’s still testing, to a certain extent it’s live testing of real customers. And so, the combination of those effects means the -- we’re expecting EBITDA growth in the second half and frankly thereafter.

And the one thing we’d say about Ocado is we open a lot of capacity, there’s always a bit of sore tooth but we recover and that you should expect on the Retail business.

And depreciation, presumably because you’ve not opened Erith, there is no big step up in that second half.

No, the big step up in the first half was primarily IT related. There was some for Andover but the biggest of that was IT related.

And I mentioned, it’s effectively on new software platform is now starting to depreciate. And it wasn’t at this time last year because it wasn’t being used live for a customer and it now is being used live for Morrisons.

They’re not using all of the capabilities but we are now starting to depreciate that.

Stewart McGuire from Credit Suisse. At least three questions from me as well.

Kroger, can you talk a little bit about next steps and are there any risks associated with the negotiations? Capacity growth, you’ve mentioned you are capacity constrained in UK.

Have you thought about CFC5 and where that might be located? And then third question is linked to your general merchandise.

Why don’t you do that within the hive? And are there any order consolidation issues, what is it about, general merchandise that makes it out of the hive?

And 3b is, your orders per week includes non-food orders. Can you give us any indication how that’s split out, please?

So, the first one is Kroger. Look, we are working seriously with Kroger at the moment.

And so, getting anything more detailed sign is not stopping either parties working towards the -- starting the work on their first three facilities. So, we have teams of people in the U.S.

and they have teams of people in the UK pretty much every week at the moment. So, as we mentioned in the release, we expect, so for example, move the structure of payments somewhat, so there’s more capital invested early on from Kroger certainly at no worth NPV on the deal for ourselves but to make it a bit more capital light for variety of reasons.

So that type of thing is what we’re negotiating, some fine detail in the contracts. But I don’t expect any problem now.

There’s a huge amount of commitment on both sides to drive the deal forward. And as I say, the contractual part is being dealt within one corner and in the other corner we’re busy working with them on the first three facilities that we’ll start building, and other parts of the roadmap on software and other areas.

2, part a was with CFC5. Yes, look, we spent a lot of time looking at CFC5 and where it may be and what size it may be and who might be in it and all that type of things, an ongoing debate in our organization.

And I don’t want to stay exactly where I think it might be, because obviously, that affects our negotiating position with landlords and others in terms of securing that facility. Obviously, the time of which we need CFC5 is dependent on the speed, both of which we can ramp up Andover and Erith as well at the speed that we’ll grow our own Retail business.

But expect some news on CFC5 in the in the coming year. Next one was number 3, part a?

General merchandise.

We can’t put the general merchandise range into Hatfield and Dordon because they don’t have the capability of having it. At the moment, they are the majority of our sales and we are already out of capacity.

So, we have built another facility to enable us to go faster. We will in the future, as we build more hive-type facilities, better put the general merchandise in there as well, as long as we decide to design it for the general merchandise range as well as the grocery range.

And so, it may be the last time we build an independent facility; it’s something that we haven’t fully decided. But yes, it’s -- they’re completely capable of storing that range as well.

And the last bit of the question…

It’s order consolidation if someone orders non-food and food and from two separate locations?

Sure. So, at the moment, what happens is we actually -- we, well, with that new facility, orders going out of Erith will just receive a regular round robin of totes per van that get out of the van with non-food deliveries in them.

So, the non-food deliveries come like a wrapped parcel like you get from any other ecommerce general merchandise with the customer’s name on it. And so, the driver gets instructed, there’s a parcel for Mrs.

Tatton-Brown, and it’s in this tote, as opposed to this tote is for Mrs. Tatton-Brown.

And so, there are a few other reasons why there is an advantage to having that product somewhat segregated. But it’s not a -- that parcel, a major logistics costs.

The new facility will lower our costs because at the moment everything’s coming out the one facility. The stuff that goes to the Hatfield-served spokes go straight into Hatfield is merged there in the tote buffer and then is distributed with the rest.

The stuff that goes to spoke sites served from Dordon predominantly goes and gets merged at the spoke site before it goes into the vehicle. And so, over time, it would be better if we ran them in the same facilities but it hasn’t been possible with Hatfield and Dordon.

Rob Joyce, Goldman Sachs. Another three for me Sorry.

So, the first one, just in terms of Andover. Do we think Andover is going to be operating margin accretive?

And at what point do we think it gets there? First, the sort of 10%, you’re doing prior to opening it.

Second one, just extrapolate in that run rate on Erith would suggest 200,000 orders a week in the back half of 2020. Is that the right way to think about the ramp there?

And thirdly, just so you could expand a bit on the operations in immediacy. It sounds quite interesting.

Is that sort of local hive-based solution?

So, your first one was…

Can Andover be operating margin accretive versus the 10%?

Well, Andover will become gross margin accretive, yes, because it will operate at a higher efficiency we assume and even the other two facilities. It’s just started to operate at some shifts higher rate than Hatfield.

So, it will at some point in the half probably exceed in some shifts the average of the business and then go to continue to grow. And so, at some point, it will become accretive.

Although exactly when, it’s not something we’re going to state at this point.

Perhaps just to add one point on that, even if Andover’s engineering costs haven’t yet got down Hatfield and Dordon, it’s actually got a slightly low labor cost than Hatfield as an example. So, it’s going to be positive, I have no doubt.

And it’s fundamentally dependent on putting more capacity through it that we are utilizing the fixed cost and get into UPH. And you’ve seen that we have capacity effectively and UPH is starting to go above Hatfield.

So, prospects are great but we won’t give you a date.

The third one was how long it’s going to take Erith to get to 220 I think you said, 200, 220?

Yes, I was going to extrapolate...

Look, I think you can extrapolate from Dordon went -- took off I think from a year to get to its original stated capacity, now does more than 10% more than its original stated capacity. I think the two to three-year time horizon is a sensible one to be thinking about.

It’s a very large facility. So, obviously the last 10% might take it a longer.

I don’t exactly know yet when we set a date on it. Obviously we need to generate the demand behind that and deploy robots and everything else in the facility at the same time.

So, it should be capable of scaling in that type of time frame.

Great. Thank you.

The third one was just on the immediacy solutions.

So, we are not going to say too much but what I will say is immediacy solutions we’ve seen to-date, got significant comprises in terms of the amount of range offered to customers and the pricing offered to customers, and have tended to operate with very poor economics. So, there is kind of a PR appeal and theoretical market appeal, because people think they sound sexy.

But actually, the economic models have been poor; the range has been poor; and the pricing has been poor for the customer. And so, we aim to use technology and robotics and automation over the medium term to cure those problems and we think that will open up an interesting part of the market.

And obviously if we prove a solution ourselves, then obviously we got a solution that we can provide to our partners.

Is there anyone near being able to show people?.

You will have to wait for future announcements.

Two questions actually only for me only. First one, can you give us a bit more details on the timing of the CFC openings over the next five years?

So, we’ve got 23 to open. So, can you give us a sense of the phasing?

And linked to that, you’ve got the preparation fee; you’ve got the ongoing fee. At what point of time shall we see all these fees delivering enough revenue for you to see a step up in your profitability?

So, I will let Duncan talk about revenue recognition and that type of thing. Just in terms of building, I think in the next two to three years, I’d expect to turn on stream the facilities that we’ve committed to in Paris and in Toronto and at least the first three or six facilities we committed to in the US.

And then, I would expect to see acceleration every single year for number of facilities that will turn on. I don’t think there is any limit to the number that we could build in a year but there might be -- there will be a growth trajectory, an exponential growth trajectory to how many we can turn live in each year, how many we will start each year, based on us currently building up the teams that we need to design them.

So, currently, we are working through the designs of multiple facilities in the UK, in the U.S., in France, in Canada and in Sweden all the same time. So, we have the capability of doing it.

But we will be accelerating all of those capabilities.

Yes. And I think on the economic profile, the reported economic profile rather than the cash flow economic profile, because as I was saying earlier, a lot of revenues or cash flows we’re getting in the early years, we’re not going to be recognizing, we don’t expect the first two years.

And then, of course in terms of the ramp up of CFC, after two years from signing the first one, if you open the first one, that’s only one CFC, and you’re still in the midst of building other 20 through and currently committed. And I am really saying expect that to be at the years out.

It’s the same problem -- you have the same problem that we have which is effect of this business and it is two years away before you start launching it, which is why we will continue to give you that stats that we can give you about how we are performing and you saw plenty today on Andover’s fulfillment solution because that’s what our customers are buying. And I think you saw today lots of metrics why our fulfillment solution is really working well and why we think it will really work well for our customers.

But we can’t really recognize a lot of revenues and then profits of that for a few years to come.

Hi. It’s James Lockyer from Peel Hunt.

Three questions for me, please. Firstly, can you help us understand a bit better the development teams, how they are split up?

For example, are they focused on the CFC hardware, CFC software, data analytics and the consumer front-end? And of the teams that are coming in, where is the focus going?

Second question, as the competencies have improved, have you seen your hardware and software release timing trends and also the frequency of the trend over time and where would you see that going? And then, finally, can you talk more about your AI investment?

How is that improving operations themselves and then also the consumer experience?

So, in terms of geographically, we’re about half in the UK. We’ve currently got about 225 in Krakow, we’ve got about 125 in Wroclaw, we’ve got about a 100 in and Barcelona and little bit less in Sofia.

So, we are growing all of those offices. In some of the offices, we are multidisciplinary and we are doing all of the work we spoke about.

We have some that have got particular focuses like mobile in Barcelona for fairly obvious reasons. A lot of the engineering, so the work relating to the actual robots themselves, is all here in the UK because of their proximity to the physical infrastructure.

But in terms of things like our other front end capability, they are spread sometimes between different offices. In terms of growing capability, today, the capabilities are roughly split a third, a third, a third between the existing solutions that are running the core Ocado, dot com retail business in the old warehouses, a third on the OSP kind of front end and back end non-warehouse, and a third on the OSP warehouse which itself is split about a third on the WMS, the warehouse management system, a third on the algorithmic controls that decide the routine controls and the layout software, and a third on the on-bot software.

And the two areas that are going to -- are growing dramatically -- have grown dramatically over the last year and will continue to grow are those two areas of the new software, and they will grow quite significantly. And I think over the long-term, the one that will grow the most is the front end and the machine learning and AI part that will drive efficiency, will grow at a faster rate than the actual warehouse and robotics teams.

We are using machine learning and AI in some areas in the in the live business today. So, the type of examples, the places that we would be using it would be, we’ve been improving our forecasting, which is seeing relatively notable improvements using some of those new technologies over what we were doing historically.

We’ve been using it, as we’ve mentioned before, in the call center, that’s been reducing the amount of call volumes by -- or email volumes by characterizing emails for us. We’re starting to train it for responses to live chat, to emails and actually to voice as well, also using the skills that we developed in AI for language cognition that we’ve been using in things like Alexa.

So, those same skill sets will actually translate into future call center technologies. We’ve been using machine learning to analyze some of the behavior of the bots to identify if there’s some condensation on oil spillage or track deviation.

So, we use machine learning to analyze things like the torque on wheels to see if there’s anything out there that could advise us that there’s an issue on our grids, for example, because we need to build scalable solutions. So we’re using machine learning to do diagnostics on the robots.

So, the robot tells us that it’s not feeling healthy and it wants to come in. So rather than it breaks down on the grid, we want it to come in and tell us it’s not healthy and actually tell us what’s not right with it by diagnosing its own behavior and telling us what that probably means has gone wrong with it.

So, we’re building what is a truly scalable business using these technologies.

I think the one thing that Tim didn’t ask on was timing of release, and I think Tim has talked through the structure changes and talked about the fact that we’ve had external review. It’s early days post that, but there’s an encouraging early signs.

It’s clearly something we’ll keep monitoring.

Hi. It’s Nick Coulter from Citi.

Three from me, please. Firstly, are the exclusivity agreements for the new partners, are they loosely based on Morrisons, i.e.

are they just for large grocers, or where does that exclusivity cut off, given the ambition but the different categories?

So, in terms of exclusivity, the way I always describe is their conditional exclusivity. We want to be the largest player in that market.

If we can bring our unique skills with the unique skills and properties of a leading grocer in that market and create the dominant business there, then that’s a win-win for us and our partner. If we can’t, and we don’t have a dominant market share, then exclusivity will fall away, and we can then sell it, sell a solution, if others wanted to others.

But it’s not a Morrisons one, where it’s -- we chose a relatively big partner, sign a deal and exclusivity’s in place for 20 something years. It is dependent on that business being a winner and therefore us having a significant market share in that market.

And second one, could you talk about the tech solution in GMDC 2? Obviously, I think you used an auto store in DC 1.

So what are you actually using?

We’re using the same solution in there, because it works well for us at the moment with large range and much lower throughput volumes than we do in grocery, like a 10th of the volume for the amount of scale. And so, it works well for us for that solution.

In the future, we may choose to deploy our own solution in that, but that would require for more coding to make it do a slightly different operation for us. And at the moment, our priority that is the coding to enable us to deploy it globally to do grocery.

So, it’s just the priorities thing for us at the moment.

So that’s a second auto store?

The second one, yes

Okay. And then, lastly, I think you disclosed, sorry, Duncan, this one’s for you.

I think you disclosed $180 million less of credit with a one-year term from Kroger. Can you talk around that, obviously hints at some quite large near-term cash flows?

No. I think that really reflected what Tim was saying earlier.

The relationship with Kroger is very good. The operational relationship is good.

We continue to progress on the contractual relationship. But our previous relationship meant that Kroger made certain commitments and the lesser credit is to demonstrate that those commitments are good.

So, the worst -- so the least likely outcome is we’ll call on that letter of credit.

David, you got from…

Yes. Just a question from the web, Mark Hiley at The Analyst.

I know you’ve -- I think you’ve touched on this, Tim. But Mark asked this question in a slightly different way.

Please, can you explain the plan for future capacity in UK beyond CFC4? So, is CFC4 the last big out-of-town box?

Is it likely that you add multiple proximity CFCs close to large towns and cities in the next phase? And what is the timing on opening CFCs 5 to 10 in the UK?

So, I think the timing of the opening, you can predict yourselves, based on the amount of capacity that we’ve built, how fast we’ll ramp it up, and how fast the UK market will grow. I think what we are doing is expanding the range of CFC sizes that we’re capable of building.

And therefore, sometimes they come with different -- slightly different economic models, but also slightly different opportunities and things like immediacy. So, it’s not clear that it’s the last big box we’ll build.

We might build one just as big as it again, but we might build more smaller ones as well. So, I don’t think we’re going to state exactly what size and where we’re going to build those facilities and the timing for 5 to 10 will depend on the size that we build them, obviously whether we need more of them or less of them, and the speed at which we’re going to grow.

Suddenly, all the hands are going up. I’ll come back to you.

This is Charles Allen from Bloomberg Intelligence. There is three from me as well.

First of all, sorry, you just made me think of a third one. But is getting -- you said just over $300,000 per week at the moment was your peak.

What do you expect your peak capacity will be by the end of this year in terms of what you can deliver? Second, in terms of immediacy.

Are you actually working on something that would enable you to do same day delivery? And thirdly, one for Duncan is the assets held under finance leases continue to fall.

Should we expect this number to fall away almost completely? I mean, I recognize the vans are likely to be -- continue to be held that way.

So, I’m not going to put a number of target for the end of the year. Clearly, we’re going to expect to continue to grow Andover and Erith facilities.

You can make your own predictions as to what kind of volume levels we hope to get to. Your second question was about immediacy.

We’ve been doing same-day deliveries for the last 10 years. So, same-day is something we’ve done in -- to a portion of our geography for that period of time.

It represents a single-digit percentage of our business today. The demand for it is not as large as some people would have one believe.

I think we were very early to that game. What the immediacy solutions that we’re working on will achieve is more same-day, more immediate as opposed to just same-day, but this might change that market a little bit.

So that’s something that we’re working on. And the last question was about leases.

So, that’s one for you.

Yes. And I think obviously given the very strong cash position currently, there’s little requirement to utilize, let’s call it more expensive forms at that.

I think from a vehicle perspective, we continue to do and use that. And that I think makes sense, particularly because the combination of that, plus the maintenance that we get some times with the same player.

So -- but no, generally, I would say, assume finance leases outside of vehicles is coming out.

Sorry, Bruno from Bernstein back with two. Two of your first partners, Morrisons and Casino did also deal with Amazon.

And that would sort of suggest there’s some form of a gap in what you offer to your current partner that they feel the need to do so. Could you speculate about what that gap is that these partners feel they need -- that they need an alliance and is there anything you can do about it in your future developments?

The second question is, would you consider retiring Hatfield once your other capacities are coming on, given that’s much less productive?

I thought for a minute he was asking if I would consider retiring. Look, I can’t say the motivations behind Morrisons and Groupe Casino working with Amazon.

Obviously they’re both working in Amazon in the capacity as a wholesaler, not in the capacity as a retailer. And in those markets, we are not a retailer; we’re a partner of the retailer.

So, we don’t have a retail offer to ask them to wholesale too. I think particularly in the case of Morrisons as you are all well aware, they have a large food production business unlike their competitors.

And therefore, they run a large wholesale business selling not just to Amazon but they were a seller to Booker, to the petrol forecourts, to Costco and to various other retailers in the UK. So, I don’t think it’s a huge surprise there.

We have seen Amazon with their immediacy offerings come into the markets in Spain, in France, in the UK and look for grocery retailers to work for. So, I guess if you are one of those retailers, you have to decide do you left -- would you prefer them to work with you or with a competitor.

And if I was one of those retailers, I might make a different decision but it’s not my call. And then, your sixth question this morning, will we retire Hatfield.

Look, at the moment, Hatfield is a phenomenal facility. It still has very good levels of productivity.

It’s shipping record numbers of orders, 170,000 plus orders a week, around 150 units of productivity. And so, it’s a highly cash generative facility, highly, highly cash generative facility.

And there’s no reason to retire it at the moment. Obviously, the facility is now 16 years old.

And so, it is still tough over number of years. It’s largely depreciated and I think we’ll enjoy running it for a number of years further.

And I think we’ve highlighted today a couple of million pounds of ongoing CapEx in our mature facility that shows just how little extra money that we have to put into it. And I think I highlighted earlier that we spend which run through its operating costs, about 75 basis points plus or minus on its engineering.

So, it’s very, very efficient, runs very well.

Good morning. Dusan from Berenberg.

Just a quick question on consensus for PBT. On PBT this morning, you said it’s a bit -- the loses should be higher than what we had in consensus for now.

On EBITDA, you haven’t made any comment. I think you said it is £86 million now.

And I think this morning you flagged another £5 million remuneration cost to be written in the second half and another £4 million of incremental OSP costs. So just any comments on that first question?

Yes. I mean I think the published consensus this morning was EBITDA of £86 million.

And hopefully it was pretty clear in the outlook statement that those two figures to take account of the full-year management incentive costs at the share prices of the day when we announced this morning of about 9 million and extra investment in solutions, with the consultancy in solutions and slightly more conservative accounting in solutions is 4 million there. So I’d take that of the full year, that’s £13 million of the full.

And clearly that flows through direct the bottom-line as well.

If Bruno had another kick at the can, I figure, I could too. Just one question for me then, on the bots.

We look at the CapEx required for a facility. It seems that most of the CapEx is in -- going into the bots.

Can you give us an idea what the split is between the CapEx of bots versus everything else? And what we might expect the generation 2, generation 3 presumably the CapEx for those bots is coming down materially?

Have you thought about giving us any guidance on an Andover type facility, if you were to build out in three years, what are the costs?

Look, we’re specifically not going to say what it’s going to cost to build a facility because obviously that’s commercially sensitive, and would affect our negotiations with our current and future partners. It is true that from generation 2, generation 3, we expect both the initial capital costs of the bots come down quite substantially, as well as its long-term cost of ownership.

The bots themselves are just under half of the total investment in a facility, you’ve got the bots, you’ve got the grids and bins, and you’ve got the peripherals and then you’ve got all the -- you’ve got the tech itself, and obviously, the project management installation and other MHE costs, like waste conveyors and a little bit of traditional MHE that goes into those buildings. And so yes, we expect the cost of the solution to continue coming down over the next few years.

And we’re working very hard on that. But, we’re not going to give guidance as to where it is.

It would be commercially damaging to do so.

Just only one more. Just on the immediacy and the long run potential there, can you just correct me if I’m wrong.

I understand you’ve owned and you’ve written the entire technology hardware stack for you. However, is your software written in such a way that you could plug into third-party software, such as, say Uber’s and Uber API such that you can potentially use Uber to deliver some more immediate orders in the future?

Look, what our software does today, what our software can do tomorrow, obviously two slightly different things. As we develop all the software in-house, our ability to modify, enhance and change is very significant.

And yes, we do expect in the future to allow ourselves or our customers to plug into a variety of different delivery options, whether those were, the 3.5 ton vans that we use here in Europe or whether they were motorbikes being driven by our staff, someone else’s staff or crowd sourced, or bicycles, or a little robot or whatever else it might be, our system is engineered to talk to all of those possibilities.

No questions.

No more? Great.

Thank you very much for coming this morning.