Loraine Woodhouse

Chief Financial Officer

The financial year of FY20 was somewhat overshadowed by the ongoing turbulence caused by Brexit and Halfords undoubtedly felt the impact of subdued consumer confidence throughout the year. The concluding period of the financial year also saw a new and emerging threat – the COVID-19 pandemic. The impact in the closing two weeks of the year was significant with two full days of trading lost in week 52, followed by an almost complete lockdown of the UK. Yet despite seeing impacts on Group revenues from both, Halfords clearly demonstrated its resilience in delivering underlying Group PBT, pre-IFRS 16, of £55.9m. In fact, if it were not for the lost trading in week 52 and the dilutive impact of acquisitions, underlying PBT would have been in line with last year. The business worked hard to mitigate some of the top line revenue impacts through gross profit improvements and tight cost control, whilst continuing to deliver on longer term growth plans through the acquisitions of Tyres on the Drive ("ToTD") and McConechy's Tyre Service ("McConechy's") in the second half. Alongside a strong P&L result we also achieved targeted working capital reductions through more efficient stock management and improved creditor days, enabling our longer term growth strategy. That said, whilst the FY20 impact was contained within the final two weeks of trading, the pandemic is likely to materially impact the trading environment in FY21, amid significant uncertainty on the short-term outlook.

Group revenue in FY20, at £1,142.4m, was up 0.3% and comprised Retail revenues of £950.6m and Autocentres revenue of £191.8m. This compared to FY19 Group revenue of £1,138.6m, which saw Retail revenue of £977.2m and Autocentres revenue of £161.4m. Group gross profit at £584.0m (FY19: £579.0m) represented 51.1% of Group revenue (FY19: 50.9%), reflecting an increase in the Retail gross margin of 20 basis points ("bps") to 48.2% and decrease in the Autocentres gross margin of 250 bps to 65.5%. The overall Group gross profit % was impacted by both mix of product and by the acquisitions within Autocentres. Retail saw strong improvements in gross margin % compared to FY19, particularly the Cycling segment, but benefits were somewhat offset by both weaker winter product results and the relative mix into Cycling. Within Autocentres, the underlying business performed well, improving gross profit % by 180 bps, but the overall impact was eroded by the acquisitions, which were dilutive in the near-term but offer a good longer term opportunity.

Total operating costs before non-underlying items and pre-IFRS 16 saw a modest increase of 1.6% including mid-year acquisitions. Excluding these acquisitions, operating costs of the underlying businesses declined -0.5% after a continued focus on efficiency and better procurement practices. We worked hard on process efficiency in stores to mitigate National Minimum Wage increases. Lease renewal negotiations saw an average decrease of 15% and investments in store infrastructure saw energy consumption reduce by close to 20%. Cost and efficiency remain a significant opportunity for the Group and one which will see a greater focus as we move through FY21. Total underlying costs, pre-IFRS 16, increased to £525.3m (FY19: £516.8m) of which Retail comprised £404.3m (FY19: £410.5m), Autocentres £118.9m (FY19: £104.2m) and unallocated costs £2.1m (FY19: £2.1m). 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 pre-IFRS 16 decreased 3.0% to £95.3m (FY19: £98.2m), whilst net finance costs pre-IFRS 16 were £2.8m (FY19: £3.4m).

Underlying Profit Before Tax pre-IFRS 16 for the year was down 4.9% at £55.9m (FY19: £58.8m). Non-underlying items of £32.1m in the year (FY19: £7.8m) related predominantly to the closure of Cycle Republic and Boardman Performance Centre, as well as costs related to organisational restructure and strategic review. After non-underlying items, Group Profit Before Tax was £23.8m (FY19: £51.0m).

After non-underlying items and including IFRS 16, Group Profit Before Tax was £22.7m (FY19: £51.0m). The impact on the Group of adopting IFRS 16 in the period was a £1.1m net decrease to Group Profit Before Tax. Further details on the impact of IFRS 16 is shown later in this report.

As noted earlier, FY20 was a 53-week year and therefore saw an additional week of trading included in the full year results. In a normal operating environment, this would typically result in additional profit, but the UK lockdown announced on the 23 March due to COVID-19 resulted in an estimated trading loss of -£3.3m during this week. Although the Group was deemed an essential retailer and continued to trade throughout week 53, sales were materially impacted and as such resulted in the loss. At this early stage of the pandemic we operated from a very limited number of stores and garages with limited customer interaction due to social distancing.

Retail

* ^{This report includes Alternative Performance Measures (APMs) which we believe provide readers with important additional information on the Group. A glossary of terms and reconciliation to IFRS amounts is shown here.}

Revenue for the Retail business of £950.6m reflected, on a constant-currency basis, a like-for-like ("LFL") sales decrease of -2.3%. Total revenue in the year declined -2.7% after the impacts of closed stores are included. The Cycling performance was strong, with like-for-like growth of +2.3% rebounding from a slow start to FY20. Motoring finished the year with a like-for-like decline of -5.3%. A similar trend prevailed with results improving as the year progressed, but it was Motoring that was significantly impacted by the pandemic and lockdown from week 52. Conversely, Cycling demand was boosted by a more health conscious consumer and the avoidance of public transport. The Retail Operational Review in the Chief Executive's Statement contains 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 £458.4m (FY19: £469.3m) represented 48.2% of sales, 20bps up on the prior year (FY19: 48.0%). Underlying gross margin improved more significantly than the headline number, which was diluted by a product mix, into lower Gross Margin % cycling, and out of the motoring category alongside additional costs as we expand sales through finance and B2B. The gross margin improvement reflected the significant work carried out over the last 18 months on our sourcing strategy for both bikes and motoring products, as well as our work to optimise promotional activity throughout the year. Over the year, Cycling gross margins improved by 117bps and Motoring by 138bps vs FY19.

The table below shows the average exchange rate reflected in cost of sales along with the year-on-year movement:

Retail operating costs before non-underlying items and IFRS 16 were £404.3m (FY19: £410.5m) a decline of 1.5% on FY19. The focus on operational efficiency and procurement continued in FY20 and, as mentioned previously, helped to mitigate a challenging market. Our stores saw modest increases in overall labour costs despite a 4% increase in the National Minimum Wage, as we continued with our 'We Operate 4 Less' programme. Rent costs also reduced as the market begins to reflect excess supply in the Retail rental market and we continued to negotiate improved lease terms on renewals. These initiatives were coupled with capital investments such as LED lighting, which significantly reduced energy consumption across the estate.

Autocentres

* ^{This report includes Alternative Performance Measures (APMs) which we believe provide readers with important additional information on the Group. A glossary of terms and reconciliation to IFRS amounts is shown here.}

Autocentres generated total revenues of £191.8m (FY19: £161.4m), an increase of 18.8% on the prior year with a LFL increase of 1.4%. Non-LFL revenue in the year included benefits from the acquisitions of both ToTD in October, 2019, and McConechy's in November 2019, alongside existing Autocentres that have been open less than 12 months.

Gross profit at £125.6m (FY19: £109.7m) represented a gross margin of 65.5%; a decrease of 250 bps on the prior year. As stated earlier, the decrease in gross margin % was solely a result of the acquisitions, which will have a dilutive effect before we migrate the product mix to servicing and repair in the future. The underlying business saw its Gross Profit % improve significantly by +180bps, with the continued development of our PACE Digital Operating Platform aiding buying efficiency across garages alongside a marginally lower mix into tyres, which tend to be lower margin. The benefits of later phases of PACE also began to be felt in Q4 with the digital operating platform improving resource allocation to jobs.

Autocentres' Underlying EBITDA before IFRS 16 of £12.6m (FY19: £11.1m) was 13.5% higher than FY19. Underlying EBIT before IFRS 16 was £1.2m (21.8%) higher than FY19 at £6.7m (FY19: £5.5m).

Portfolio Management

The total number of fixed stores or centres within the Group stood at 844, with a further 75 mobile locations. The portfolio of fixed locations as at 3 April 2020 comprised 472 stores (end of FY19: 477) and 371 Autocentres (end of FY19: 317). Mobile locations grew by 67 vans, increasing coverage of the most in-demand regions within the UK.

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

Within Retail, the focus in year continued to be on re-laying stores to optimise the space allocated to key growth categories, including E-mobility. Four Retail stores closed on the natural expiration of their leases as closure was considered more profitable to the Group when the anticipated sales transfer to other channels and neighbouring stores was considered. Although nearly all of our Retail stores continue to trade profitably, the number of lease expiries or breaks under option increases significantly within the next five years. Retail will see two-thirds of stores experience optionality within five years, allowing for a high degree of flexibility within the estate.

Within Autocentres, one centre was opened and 57 locations acquired in the year. Four were closed, taking the total number of Autocentre locations to 371 as at 3 April 2020 (end of FY19: 317). Fourteen Autocentres were refreshed in the year (FY19: 8).

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

Net Non-Underlying Items

The following table outlines the components of the non-underlying items recognised in the 53 weeks ended 3 April 2020:

• In the current and prior period, separate and unrelated organisational restructuring activities were undertaken.
  Current period costs comprised:
• Redundancy and transition costs of £1.4m relating to roles which have been outsourced or otherwise will not be replaced (FY19: £1.5m); and
• £1.4m of asset write-offs, principally resulting from the strategic decision to re-platform the Retail and Autocentres websites (FY19: £5.3m)
• In the current and prior periods, costs were incurred in preparing and implementing the new Group Strategy.
• £0.4m of external consultant costs (FY19: £2.0m); and
• £0.6m of store labour costs, point-of-sale equipment and other associated costs in completing the cycling space re-lay across the store estate (FY19: £nil).

  Prior period costs also included £0.4m of warehouse and distribution costs in order to align our network with the new strategy.

• A one-off royalty income was received in the prior period in relation to the use of a software licence.
• In the current and prior periods, costs were incurred in relation to the investment in McConechy's and ToTD. ToTD acquisition costs comprise £1m principally relating to the costs of dual running Halfords Mobile Expert and ToTD, as well as the write-off of the receivables balance due from ToTD; and
• £0.9m relating to professional fees in respect of the acquisition of McConechy's
• £0.2m of costs were incurred in the prior period in relation to the investment in ToTD and costs relating to a potential acquisition which did not progress.
• During the year, a provision was recognised for expected costs of settling an ongoing court case, which was then settled during the second half of the period. In addition, a provision of £0.6m has been recognised in relation to the audit by HMRC relating to National Minimum Wage.
• Closure costs represent costs associated with the proposed closure of the operations of Cycle Republic and the Boardman Performance Centre ("Cycle Republic") following a strategic review of the Group's cycling businesses. This relates mostly to the impairment of right-of-use assets, as well as the impairment of intangible and tangible assets.
• In light of the ongoing COVID-19 pandemic, the Group has revised future cash flow projections for stores and garages. As a result, £0.9m incremental impairment has been recognised in relation to garages where the current and anticipated future performance does not support the carrying value of the right-of-use asset and associated tangible assets. This charge is directly attributable incremental impairment due to COVID-19 and relates primarily to the right-of-use asset value.

Finance Expense

The net finance expense (before non-underlying items and IFRS 16) for the 53 weeks ended 3 April 2020 was £2.8m (FY19: £3.4m) reflecting lower average levels of net debt throughout the year.

Taxation

The taxation charge on profit for the 53 weeks ended 3 April 2020 (before IFRS 16) was £2.8m (FY19: £9.1m), including a £4.7m credit (FY19: £1.4m credit) in respect of non-underlying items. The effective tax rate of 13.9% (FY19: 17.8%) differs from the UK corporation tax rate (19%) principally due to the impact of overseas tax rates, adjustments in respect of prior periods now closed with HMRC, and the impact of the change in deferred tax recognised in the Balance Sheet.

Earnings Per Share ("EPS")

Underlying Basic EPS before IFRS 16 was 22.9 pence and after non-underlying items 8.9 pence (FY19: 24.5 pence and 21.2 pence after non-underlying items), a 6.5% and 58.0% decrease on the prior year. Basic weighted-average shares in issue during the year were 197.0m (FY19: 197.1m).

Dividend

In light of the COVID-19 pandemic and the likely impact on short-term profitability, the Board has taken a series of measures to preserve cash, one of which is a suspension of the dividend. The final dividend payment is therefore nil, taking the full year ordinary dividend to 6.18 pence (FY19: 18.57p per share).

Capital Expenditure

Capital investment in the 53 weeks ended 3 April 2020 totalled £35.8m (FY19: £31.0m) comprising £31.0m in Retail and £4.8m in Autocentres. Within Retail, £15.9m (FY19: £11.4m) was invested in stores, including store relocations, space optimisation and building a management system across one third of the estate to reduce energy consumption. Additional investments in Retail infrastructure included a £9.7m investment in IT systems, including development of a new Group website.

The £4.8m (FY19: £4.7m) capital expenditure in Autocentres principally related to the replacement of garage equipment and replacement of fixtures and fittings alongside the development of PACE, our digital operating platform.

Inventories

Group inventory held as at the year-end was £173.0m (FY19: £173.7m). Retail inventory decreased to £168.0m (FY19: £172.3m), reflecting reduced stock levels and working capital efficiencies.

Autocentres' inventory was £5.0m (FY19: £1.4m). The existing Autocentres business model is such that only modest levels of inventory are held, with most parts being acquired on an as-needed basis. The increase in inventory related to the acquisition of McConechy's which typically hold low levels of tyres.

Cashflow and Borrowings

Adjusted Operating Cash Flow was £109.9m (FY19: £88.5m). After acquisitions, taxation, capital expenditure and net finance costs, Free Cash Flow of £54.6m (FY19: £42.7m) was generated in the year. Group Net Debt was £73.2m (FY19: £81.8m), with the Underlying EBITDA ratio at 0.8:1. All these numbers are pre-IFRS 16.

Adoption of IFRS 16 "Leases"

The Group has initially applied IFRS 16 "Leases" as at 30 March 2019. A right-of-use asset and a lease liability is included on the balance sheet, and depreciation and interest has been charged to the income statement instead of existing rental charges and operating expenses.

Discount rates ranging between 0.76% and 3.94% have been applied based on UK Government Gilt rates of an appropriate duration and adjusted by an indicative credit premium.

The Group has adopted the modified retrospective approach. Under this approach, comparative information is not restated and the cumulative effect of applying IFRS 16 is recognised in retained earnings at the date of initial application.

A summary of the impact on the Group income statement and balance sheet for the 53 weeks ended 3 April 2020 is as follows:

The £11.8m net impact on Operating costs is comprised of £10.9m for Retail and £0.9m for Autocentres as shown above.

Brexit and Impact of Movements in Foreign Currency Exchange Rates

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:

• 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.
• 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 macroeconomic 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 the risk assessment and the identification of mitigating actions and internal control to be fundamental to achieving Halfords' strategic corporate objectives. In the Annual Report and 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 of the 2020 Annual Report and Accounts. These include: