Financial Resources

Generating returns for our stakeholders through effective management of our financial resources.

Group revenue in FY18, at £1,135.1m, was up 3.7% and comprised Retail revenue of £977.2m and Autocentres revenue of £157.9m.

Alternative Performance Measures

In the reporting of financial information, the Directors have adopted various Alternative Performance Measures (APMs). These are denoted with an asterisk (*) in this report. Further detail on these APMs, including definitions, can be found in the glossary.

Reportable Segments

Halfords Group operates through two reportable business segments:

• Retail, operating in both the UK and Republic of Ireland; and
• Autocentres, operating solely in the UK.

All references to Retail represent the consolidation of the Halfords ("Halfords Retail") and Cycle Republic businesses, Boardman Bikes Limited and Boardman International Limited (together, "Boardman Bikes"), and Performance Cycling Limited (together, "Tredz and Wheelies") trading entities. All references to Group represent the consolidation of the Retail and Autocentres segments.

The "FY18" accounting period represents trading for the 52 weeks to 30 March 2018 ("the financial year"). The comparative period "FY17" represents trading for the 52 weeks to 31 March 2017 ("the prior year").

Group Financial Results

* Alternative performance measures are defined in the glossary.

Group revenue in FY18, at £1,135.1m, was up 3.7% and comprised Retail revenue of £977.2m and Autocentres revenue of £157.9m. This compared to FY17 Group revenue of £1,095.0m, which comprised Retail revenue of £938.4m and Autocentres revenue of £156.6m. Group gross profit at £570.2m (FY17: £558.6m) represented 50.2% of Group revenue (FY17: 51.0%), reflecting a decrease in the Retail gross margin of 123 basis points ("bps") to 47.4% and increase in the Autocentres gross margin of 238 bps to 67.5%.

Total operating costs before non-recurring items increased to £495.6m (FY17: £481.5m) of which Retail comprised £391.0m (FY17: £379.8m), Autocentres £102.5m (FY17: £99.8m) and unallocated costs £2.1m (FY17: £1.9m). Unallocated costs represent amortisation charges in respect of intangible assets acquired through business combinations, namely the acquisition of Autocentres in February 2010, Boardman Bikes in June 2014, and Tredz and Wheelies in May 2016, which arise on consolidation of the Group.

Group Underlying EBITDA* increased 0.7% to £109.5m (FY17: £108.7m), whilst net finance costs before non-recurring items were £3.0m (FY17: £1.7m).

Underlying Profit Before Tax* for the year was down 5.0% at £71.6m (FY17: £75.4m). Net non-recurring items of £4.5m in the year (FY17: £4.0m) related predominantly to organisational restructure costs and the Autocentres operational review. After non-recurring items, Group Profit Before Tax was £67.1m (FY17: £71.4m).

Retail

* Alternative performance measures are defined in the glossary.

Revenue for the Retail business of £977.2m reflected, on a constant-currency basis, a like-for-like ("LFL")* sales increase of 2.3%. Non LFL revenue in the year included sales from the Tredz and Wheelies businesses prior to the annualisation of the acquisition date, alongside the contribution from Cycle Republic stores that have been open for less than 12 months.

Please refer to the Retail Operational Review in the Chief Executive's Statement for further commentary on the trading performance in the year. Like-for-like revenues and total sales revenue mix for the Retail business are split by category below:

Gross profit for the Retail business at £463.6m (FY17: £456.6m) represented 47.4% of sales, 123bps down on the prior year (FY17: 48.6%). This movement is explained as follows:

As previously guided, in the first half of FY18 the impact of the depreciation of the pound against the US dollar, pre-mitigation, reached its highest level of any half year period since the EU referendum. If exchange rates remain at around current levels, we do not anticipate further adverse impact in FY19. The table below shows the average exchange rate reflected in cost of sales along with the year-on-year movement.

Operating Costs before non-recurring items were £391.0m (FY17: £379.8m). The breakdown is set out below:

* The prior year costs have been restated from those disclosed in the prior year, in order to allocate the costs of the Tredz & Wheelies business to the respective cost categories.

Store Colleague costs increased by 3.9% and reflected the continued inflation in the living and minimum wage rates, additional labour hours, the impact of additional Cycle Republic stores and also the first-time inclusion of a full-year of Tredz & Wheelies costs.

Store Occupancy costs increased by 2.7%, principally driven by the write-off of assets no longer required, increased utility costs driven by the cold weather in the early Spring and additional costs associated with the store refreshes and new Cycle Republic stores. Rent and rates on the existing estate were broadly flat.

Warehouse & Distribution costs increased by 5.5%, driven by a combination of wage inflation, an increase in storage costs and also additional courier costs, resulting from our improved home delivery proposition. There was also an impact of greater demand for more bulky items, such as roof boxes, cycle carriers, camping products and metal storage.

Support Costs increased by 0.5%, reflecting the impact of pay rises and increased depreciation, partially offset by savings elsewhere as costs were tightly controlled.

Autocentres

* Alternative performance measures are defined in the glossary.

Autocentres generated total revenues of £157.9m (FY17: £156.6m), an increase of 0.8% on the prior year with a LFL* increase of 0.2%.

This sales performance reflected the successful transition away from low-margin third party affiliate tyre sales, towards direct tyre sales, and service, maintenance and repair work, which, along with improved purchasing, resulted in an improvement in gross margin.

Gross profit at £106.6m (FY17: £102.0m) represented a gross margin of 67.5%; an increase of 238 bps on the prior year.

Autocentres' Underlying EBITDA* of £10.5m (FY17: £7.6m), was 38.2% higher than FY17, and Underlying EBIT* was £1.9m higher than FY17 at £4.1m (FY17: £2.2m).

Portfolio Management

The Retail store portfolio at 30 March 2018 comprised 480 stores (end of FY17: 479).

The following table outlines the changes in the Retail store portfolio over the year:

36 Retail stores were refreshed in the year (FY17: 17). Management currently anticipates continuing to refresh stores and to open new Cycle Republic stores in FY19; further guidance to be provided later in the year.

Three Autocentres were opened in the year, taking the total number of Autocentre locations to 316 as at 30 March 2018 (end of FY17: 313). Six Autocentres were refreshed in the year (FY17: 16).

With the exception of eight long leasehold and two freehold properties within Autocentres, the Group's operating sites are occupied under operating leases, the majority of which are on standard lease terms, typically with a 5 to 15-year term at inception and with an average lease length of just less than 6 years.

Net Non-Recurring items

The following table outlines the components of the non-recurring items recognised in the year:

In the current and prior year, separate and unrelated organisational restructuring activities were undertaken. These comprised:

• Redundancy costs of £0.7m (FY17: £0.6m);
• £1.0m provision for compensation to the new CEO on joining for foregoing entitlements from a previous employer, as outlined at the time of announcement of his appointment;
• £1.5m in relation to a restructure of the Boardman business. Boardman has stopped selling directly to customers through the Boardman website. The website will be maintained as a 'brand' website, with customers being directed to purchase bikes predominantly through Cycle Republic; and
• £1.1m in relation to asset write-offs, principally resulting from the strategic decision to close the marketplace offer on Halfords.com.

Costs of £0.6m were incurred in FY18 in relation to the review of the operating model of the Autocentres business.

Explanations of the remaining non-recurring items are included in Note 5 to the Group financial statements later in this report.

Finance Expense

The net finance expense (before non-recurring items) for the year was £3.0m (FY17: £1.7m). The increase was due to the non-repeat of £1.4m income from forward foreign exchange contracts. The interest costs on bank borrowings were slightly down on the previous year, reflecting the improved terms negotiated in the amendment of the revolving credit facility.

Taxation

The taxation charge on profit for the financial year was £12.4m (FY17: £15.0m), including a £0.8m credit (FY17: £0.9m credit) in respect of non-recurring items. The effective tax rate of 18.5% (FY17: 21.0%) differs from the UK corporation tax rate (19%) principally due to non-deductible depreciation charged on capital expenditure, overseas tax rates and the impact of share options accounting.

Earnings Per Share ("EPS")

Underlying Basic EPS* was 29.6 pence and after non-recurring items 27.8 pence (FY17: 30.3 pence, 28.7 pence after non-recurring items), a 2.3% and 3.1% decrease on the prior year. Basic weighted-average shares in issue during the year were 197.0m (FY17: 196.6m).

Dividend ("DPS")

The Board has recommended a final dividend of 12.03 pence per share (FY17: 11.68 pence), taking the full year ordinary dividend to 18.03 pence per share, an increase of 3.0%. If approved the final dividend will be paid on 31 August 2018 to shareholders on the register at the close of business on 27 July 2018.

We continue to target coverage of around 2 times on average over time. However, the impact of adverse FX movements will reduce cover initially until fully mitigated, which will take some time.

Capital Expenditure

Capital investment in the year totalled £37.3m (FY17: £36.1m) comprising £30.3m in Retail and £7.0m in Autocentres.

Within Retail, £12.8m (FY17: £11.5m) was invested in stores, including store relocations and refreshes, and the opening of four Cycle Republic stores. Additional investments in Retail infrastructure included a £12.2m investment in IT systems, including development of the till hardware and software upgrade. The balance of £5.3m was invested in warehousing and logistics upgrades, trading initiatives and Tredz & Wheelies infrastructure improvements.

The £7.0m (FY17: £6.6m) capital expenditure in Autocentres principally related to the replacement of garage equipment and replacement of fixtures and fittings, and development of new till hardware and software.

On a cash basis, total capital expenditure in the year was £37.0m (FY17: £34.4m).

Inventories

Group inventory held as at the year end was £195.5m (FY17: £191.1m). Retail inventory increased to £194.1m (FY17: £189.8m), reflecting increased stock in transit, higher Tredz and Wheelies stock and the impact of the weaker pound, which increased the cost of imported goods.

Autocentres' inventory was £1.4m (FY17: £1.3m). The Autocentres business model is such that only modest levels of inventory are held within the centres, with most parts being acquired on an as-needed basis.

Cashflow and Borrowings

Adjusted Operating Cash Flow* during the year was £95.4m (FY17: £90.0m). After acquisitions, taxation, capital expenditure and net finance costs, Free Cash Flow* of £41.5m (FY17: £37.7m) was generated in the year. Group Net Debt* was £87.8m (FY17: £85.9m), with the Underlying EBITDA ratio* at 0.8:1. During the year there were £8.6m of planned follow-on payments in respect of the Tredz acquisition and Tyres on the Drive investment, and c.£9m working capital impact from timing of VAT payments. The latter is anticipated to reverse out over the medium-term, but not in FY19.

Brexit

As we have previously explained, the decision of the UK to leave the European Union ("Brexit") presents significant uncertainties to the Group as a result of the impact on the wider UK economy. We have previously set out the main areas in which we considered Brexit was likely to impact the Group. We reaffirm and update our assessment of these below:

1. Impact on exchange rates. The Group buys a significant proportion of its goods in US dollars; between $250m and $300m a year. As previously guided, the majority of our US dollar sourcing is for cycling products, and, in 2017, bike prices rose across the cycling market, both from suppliers into retailers and then onto customers. We have also increased some of our bike prices, but we maintained good value against the competition. Our bike volumes declined, but this was more than offset by the increase in average selling prices.
   
   We have now experienced a cumulative additional £40m of input costs compared to FY16, in respect of the weaker pound against the US dollar. Our plans to offset the gross impact (through supplier negotiations, operational efficiencies and pricing) have worked well and the net impact on Retail gross margin visibly improved over the year with a year-on-year movement in gross margin of -182bps in H1 and -48bps in H2. We have now recovered over half of the gross impact and at current exchange rates we do not anticipate any further FX headwind in FY19 or FY20.
   
   As explained in the CEO statement, we now expect the remaining unmitigated amount to be recovered through the improved exchange rates rather than through further price rises. Given our hedging policy, this benefit will be mostly felt in FY20 rather than in FY19.
   
   
2. Prolonged uncertainty over exit terms and continued weakness in Sterling could lead to a slowdown in the UK economy, and consequent loss of consumer confidence, impacting trading conditions for the Group. However, Halfords has strong positions in fragmented Motoring and Cycling markets, and a service-led offer that differentiates us from our competitors, physical and online. Much of our sales are in needs-based categories that are more resilient to macro-economic cycles and our discretionary categories, such as cycling, camping and travel solutions, could benefit from an increase in the number of people choosing to stay at home rather than holidaying abroad; a trend that we observed in 2009.

Principal Risks and Uncertainties

The Board considers risk assessment, identification of mitigating actions and internal control to be fundamental to achieving Halfords' strategic corporate objectives. In the Annual Report & Accounts the Board sets out what it considers to be the principal commercial and financial risks to achieving the Group's objectives. The main areas of potential risk and uncertainty in the balance of the financial year are described in the Strategic Report in the Our Principal Risks and Uncertainties section. These include:

• Economic risks; including market risks
• Business strategy risks
• Competitive risks
• Compliance
• Supply chain disruption
• Product and service quality
• Information technology systems and infrastructure
• Dependence on key management personnel

Specific risks associated with performance include Christmas trading as well as weather-sensitive sales, particularly within the Car Maintenance and Cycling categories in the Retail business.