Half Yearly Report

10 September 2015

INTERIM RESULTS FOR THE HALF YEAR TO 2 AUGUST 2015

Making the core supermarkets strong again

Financial summary

Strategic and operating highlights

1. To be more competitive

2. To serve customers better

3. Find local solutions

4. Develop popular and useful services

5. To simplify and speed up the organisation

6. To make the core supermarkets strong again

· Progress being made on the six priorities and customer satisfaction improving

· Key appointments to the new Executive team

· £1bn cost savings programme on-track, a further £189m delivered in first half

· Substantial proposition re-investment, up year-on-year to £181m in first half

· £2bn operating free cash flow target on-track for 2014/15-2016/17

· Sale of 140 M local convenience stores announced yesterday

· Proposed closure of a further 11 supermarkets announced today

Andrew Higginson, Chairman, said:

"David has very quickly formed a new team that combines the best of Morrisons home grown and external talent. I am also delighted that two new non-executive directors - Belinda Richards and Irwin Lee - have recently joined and strengthened the Board. They bring a wealth of experience, which will prove invaluable to Morrisons.

"During the first half, the team has made good progress in starting the turnaround journey. Whilst the management team need time to settle in, make the changes they see as important, and build trading momentum, I believe the team will deliver much improved profits and returns for shareholders."

David Potts, Chief Executive, said:

"Since joining Morrisons, I have been struck by the passion and commitment of all our colleagues, and I want to thank them for their continued good work. Our colleagues have the key role in delivering an improved shopping trip for customers both in stores and online.

"Morrisons will be an organisation that listens. During the first half, the new Executive and leadership teams have been listening hard to colleagues, customers, suppliers and shareholders. They tell us there is a lot for us to do.

"The immediate priority is to deliver a better shopping trip to stabilise trading performance. Our six strategic priorities will then deliver improvement in the core supermarkets, where we have the greatest opportunity.

"It will be a long journey. We approach the challenge with energy, confidence and many strengths, particularly our strong balance sheet and cash flow, which enables investment in improving the customer shopping trip."

Outlook

Customers and colleagues are beginning to notice improvements, but the turnaround will take time and require sustained investment in the proposition.

As previously guided, we expect underlying profit before tax will be higher in the second half of 2015/16 than the first.

Sales performance (ex-VAT)

* For supermarkets, online and convenience stores, reported ex-VAT and in accordance with IFRIC 13

Summary of operational key performance indicators (KPIs)

* Excludes online and convenience

Notes:

Enquiries:

Media Relations

Management will host an analyst presentation this morning at 09:30. A webcast of this meeting is available at http://www.morrisons-corporate.com/Investor-centre/

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- ENDS -

This announcement may include forward-looking statements, which are statements made about potential future events or occurrences. These statements are made by the Directors in good faith, based on the information available to them at the time of the announcement. Consequently such statements should be treated with caution due to the inherent uncertainties, including both economic and business risk factors, underlying such forward-looking statements and information.

Morrisons has a commitment to reducing its impact on the environment. Accordingly we no longer send half-yearly communications to shareholders in paper format. Copies of this release are available to download.

Financial overview

Total turnover during the period was £8.1bn, down 5.1% year-on-year. Store turnover of £6.4bn, excluding fuel, was down by 1.1%, which comprised a LFL decrease of 2.7% (including a contribution of 1.0% from online) and 1.6% from new stores.

Fuel sales fell by 16.8% to £1.6bn, with deflation again a key feature as lower oil prices were passed on to customers.

Q2 ex-fuel LFL was down 2.4%, a slight improvement on Q1 (-2.9%), with online contributing 1.0%. For Q2, Items per Basket was down 1.1% year-on-year, and LFL Number of Transactions down 2.6%.

Underlying operating profit, which excludes impairment and provision for onerous contracts and property disposal profits, was £163m, with operating margin down 67bps year-on-year to 2.0%.

Impairment and provision for onerous contracts was £87m, driven by changes in estimates to provisions made relating to stores in the new space pipeline. Property disposal profits were £96m. Operating profit, including impairment and provision for onerous contracts and property disposal profits, was £172m.

Our definition of underlying profit includes restructuring costs and new business development costs. Restructuring costs were £24m, primarily comprising head office restructuring (2014/15: £35m). This was part of the £30m-£40m 2015/16 restructuring costs we announced at the time of the first quarter trading update in May. New business development (NBD) losses for online and convenience were £30m (2014/15: £38m).

In addition, we are today announcing further restructuring and one-off costs, which will be incurred in the second half as we continue to reshape the business.

The proposed closure of 11 further stores will incur a restructuring cost of £20m, which will be included in underlying profit.

As announced yesterday, the sale of M local will result in a loss on disposal of around £30m. The intent to establish a new defined contribution pension scheme, which it is proposed will become the auto-enrolment scheme for colleagues in the future, will result in a charge of £35m. Both of these one-off costs will be excluded from our definition of underlying profit.

Net finance costs were £47m (2014/15: £49m).

UPBT(1) was £117m (2014/15: £181m). Adding back the £24m one-off restructuring costs, UPBT was £141m (2014/15: £216m). Reported profit before tax, after £9m net profit on property, was £126m (2014/15: £239m).

Underlying basic EPS(1) reduced by 35% to 3.73p (2014/15: 5.74p), reflecting the decrease in UPBT.

Capital expenditure fell to £139m, from £257m for 2014/15, with cuts in all areas, in particular new store openings.

Free cash flow pre-dividend was £479m, which included a further £125m improvement in operating working capital and £181m of property disposal proceeds. Half way into our three year plan to generate £2bn of operating free cash flow by the end of 2016/17, we have achieved £1,264m.

Overall, post-dividend and pre-property disposal proceeds, Morrisons was again cash flow positive, generating £64m during the first half.

Group net debt fell - to £2,086m - from £2,340m at the end of 2014/15, and is down over £500m from the same time last year.

The proposed interim dividend is 1.50p.

We opened one new supermarket (26,000 square feet) and five M locals (14,000 square feet). As previously announced, we closed ten smaller supermarkets and 23 M locals. The impact was a reduction of 94,000 square feet in net new space.

Return on Capital Employed (ROCE) was 5.3%.

Market update

The economic recovery has been sustained in recent months. A rise in consumer confidence, real wage growth, and higher disposable income are all potentially positive for food retailers. Fuel prices have fallen and are expected to remain low.

However, we have seen no change in shopping habits, with customers continuing to shop around for value and shopping more frequently. In addition, as we continue to lower prices, deflation has been a consistent recent feature of our LFL. Although some commentators predict the return of food price inflation, driven perhaps by higher global commodity prices, we expect deflation to continue as we keep investing in our proposition.

Strategy update

Morrisons has many strengths. It is a strong British business, with a reputation for fresh food, value-for-money, customer service, and the provenance provided by our unique vertical integration. Our colleagues are committed, passionate and highly skilled. The business is cash generative, with a strong balance sheet, a freehold property portfolio, a well-funded pension, falling debt and a well-invested manufacturing business.

However, sales, profitability and returns all need to improve. Our immediate priority is to deliver a better customer shopping trip to stabilise trading performance. We then need to rebuild.

We are defining our improvement programme by listening to key stakeholders - customers, colleagues, suppliers and shareholders - and this is shaping the development of our strategy. Today we are announcing six strategic priorities:

· To be more competitive

· To serve customers better

· Find local solutions

· Develop popular and useful services

· To simplify and speed up the organisation

· To make core supermarkets strong again

These priorities will deliver an improvement in the shopping trip and a turnaround of the core supermarkets. It will take time, and some components are still being developed or carefully reviewed by the new leadership team. However, we are confident the strategy is right for all industry trading conditions.

The six priorities also provide the business with many opportunities. The cost base can be reshaped and we can improve all elements of the Morrisons shopping trip. Improving the operational levers - sales, margin and asset intensity - will drive profit and ROCE. Improving the capital levers - addressing underperforming assets and capital returns - will grow the dividend and further enhance EPS. Throughout the process, debt will continue to fall.

The financial foundations of our strategy are unchanged. As previously guided, our proposition investment will increase this year. We also still expect to generate £1bn of cost savings and £2bn of free cash flow in the three years to 2016/17.

Initial success will be measured through execution and outcome. Improving the shopping trip will mean more customers and more volume growth. Then, once the business is stabilised, we expect to improve LFL sales, rebuild profits and improve Return on Capital, while continuing to generate cash.

The six priorities

1. To be more competitive

Morrisons is a value-for-money brand and must always be competitive. We invested over £300m into the proposition last year and will invest more this year, with a further £181m already invested in the first half.

In March we cut the prices of key commodities and in June we did the same for everyday items. There will be more to come. We are working towards a simple, great value-for-money Morrisons price list that is right for our customers.

Being competitive is not just about price. We need to set out an offer that has real resonance with customers and organise the business to deliver this consistently. This means striking the right balance of price, coupons and promotions. As part of this process, we are currently reviewing our Match & More proposition.

In addition, we are providing much simpler and clearer in-store messaging for customers. In June, we re-set all in-store point-of-sale material. We further clarified and simplified our promotions, especially at front-of-store and on the key promotion ends. We now have fewer and more impactful promotions, with the typical display now carrying two or three of our very best deals at a simple price point.

2. To serve customers better

Morrisons has a reputation for good customer service. Our butchers, bakers, fishmongers and other skilled colleagues combine to make Morrisons different from other supermarkets. We are doing more to enhance that reputation. During the first half, we recruited 5,000 new in-store colleagues and re-scheduled the mix of hours to serve customers better at the busiest times of the week.

We have launched initiatives to remove wasted effort, improve on-shelf availability and ease pressure on the tills. For example, we have introduced express checkouts into all our stores. We are also currently replacing and upgrading the self-scan checkouts in all stores in time for Christmas, a programme of 40 stores per week.

We have listened to the preferences of our customers and will be re-laying Wine to a new look, by colour and country of origin throughout the next few weeks. In addition, all our Produce departments are currently being given a new look and feel. These are the first of many improvements to come. Customers are beginning to notice and our customer satisfaction scores have improved.

3. Find local solutions

Morrisons stores are generally well located, serving neighbourhoods and communities. We have an opportunity to improve our local customer offer store-by-store and make every square foot work harder to increase sales and profit.

We will tailor each store's offer to local tastes and demographics. A core offer will apply for each store, with managers given autonomy to flex outside the core to best suit local customers. The organisation will be largely central, but the execution local.

In addition, we are introducing programmes to be more active with local marketing and to better utilise our stores as centres of the local community.

4. Develop popular and useful services

We plan to further enhance Morrisons reputation for great customer service. We already have some very strong service areas - for example dry cleaning, where we are the second biggest in the UK, petrol stations, pharmacies, and popular cafés.

Plans are at an early stage, but we see several opportunities to provide third-party in-store or on-site services that will drive footfall to our stores. These will not require us to commit significant capital, but will generate income and enhance returns.

5. To simplify and speed up the organisation

Morrisons is at its best when it keeps things simple. We are delayering the business and building a culture based on speed and teamwork, so we can become more agile and responsive.

During the first half, we completed the in-store restructure and now have fewer management layers, allowing colleagues to focus more on serving customers better.

In addition, we have just completed a major consultation and restructuring at head office, which will result in the removal of 720 roles. The leadership team has reduced from 110 to 65 people. This smaller team will have greater responsibility and accountability for bigger areas of the business.

6. To make core supermarkets strong again

We aim to deliver our strengths in every store. We have nearly completed a programme to get all of the estate to a consistent standard, Back-to-Best, both inside and out. This will be done by the end of October.

We will accelerate the refit programme. We have over 200 stores that have not been brightened-up for over five years. Our new Fresh Look refit programme will upgrade the estate by the end of 2018/19.

All these improvements will be achieved within our existing capital expenditure expectations.

New leadership team

Key to delivering the strategy and six priorities will be a strong management team. We have made good progress during the first half and now have a leadership team comprising home grown talent and experienced industry professionals recruited from outside Morrisons.

We have almost completed the formation of a new Executive team, which oversees the day-to-day operations of the business. It will comprise seven people. Alongside David Potts (CEO) and Trevor Strain (CFO), are Darren Blackhurst (Commercial Director), Gary Mills (Retail Director), Clare Grainger (People Director) and Mark Amsden (Company Secretary and General Counsel). We are seeking to fill the one remaining vacancy, Customer Director. After 25 years' service, Martyn Jones (Corporate Services Director) will retire at the end of October.

Darren has extensive commercial experience. He joined Morrisons from B&Q, where he was Commercial Director. Previously he was Chief Executive of Matalan, and Chief Merchandising Officer of Asda.

Gary has more than 30 years' retail experience, with Stewarts Supermarkets in Northern Ireland and with Tesco in both Ireland and the UK. Gary's experience covers all areas of retail and all formats, including supermarkets and convenience.

Clare has nearly 25 years of experience in Human Resources and management, mostly in the retail sector with Morrisons and, before that, Asda. Most recently she has been Morrisons interim Group Retail Director and has been leading the business through a number of measures to improve the customer shopping trip.

Outside the Executive team, we have also made some key internal and external appointments in Commercial, Operations, Property, and Human Resources. We continue to identify the talent required to improve capability and are confident we are developing a strong leadership team to deliver the turnaround.

Online

We remain pleased with the key customer metrics of our online business and are on track with our original plan. We are also considering the broader digital opportunity, and how we can grow our online proposition while achieving an attractive return on capital.

Convenience

Yesterday we announced the sale of 140 M local convenience stores for a consideration of c.£25m in cash. We expect to incur a loss on disposal of around £30m during the second half of 2015/16. Morrisons retains a guarantee on individual lease obligations, which could revert to Morrisons if the new business does not succeed. The residual contingent liability in this event is estimated at up to £20m.

Convenience remains an important growth channel, and we will continue to consider capital-light, returns-enhancing opportunities in the future.

Financial strategy and update

Capital allocation framework

Our capital allocation framework is unchanged. Our first priority is to invest to support the store estate and infrastructure, and reduce costs. Second, we will seek to maintain debt ratios that support our target of an investment grade credit rating. Third, we will invest in profitable growth opportunities. Fourth, we will pay dividends and; finally, any surplus capital will be returned to shareholders.

Optimise assets

We are continually reviewing the performance of our supermarket store portfolio. In addition to the ten stores closed earlier this year, we are today announcing the proposed closure of 11 further stores which do not cover their cost of capital. For 2014/15, sales of the 11 stores were £86m and they were slightly EBIT loss making. 

There will be a related one-off closure cost of £20m for the 11 stores during the second half of 2015/16.

We have opened one new store this year and do not plan to open any more during the remainder of 2015/16. In 2016/17, we expect the sales contribution from net new stores to be negative.

Shareholder returns

The 2015/16 total dividend will be not less than 5p per share, which the Board believes reflects the commitment to the capital allocation framework, while enabling cash flow flexibility to invest in delivering the turnaround. Beyond 2015/16, the dividend will be determined and communicated as appropriate by the Board.

£1bn cost savings

We achieved first half cost savings of £189m, bringing the total to £419m in 18 months. We continue to expect £1bn of cost savings in the three years to the end of 2016/17, but are reviewing the different opportunities and re-prioritising components.

The recently announced head office restructure and harmonisation of the pension schemes will have immediate benefits. We have also been developing some new in-store cost saving initiatives, many of which have been successful and are already being introduced. For example, improved planning and control initiatives in our in-store warehouses have enabled better visibility of stock flow.

We are not rolling-out sales based ordering (SBO) immediately. One of our key priorities is better on-shelf availability, through improved and streamlined in-store process and updated stock ordering technology. These changes will deliver many of the cost saving benefits of SBO without the time, capital, and disruption risks SBO roll-out could have brought.

Cash flow and working capital

Our free cash flow plans are progressing well, and we remain on-track to generate £2bn operating free cash flow in the three years to end-2016/17. This includes a target of £600m of operating working capital improvement. With £125m in the first half, we have now generated £331m of operating working capital 18 months into that plan.

Property disposals

Our £1bn three year property disposal plan is on-track with £629m achieved so far, including £181m during the first half. We remain committed to a freehold store portfolio of over 80%, and are currently at 85%. The focus is now on property development opportunities and non-core asset disposals. We expect a net annual rent impact towards the lower end of the previously guided £20m-£25m range.

Capital expenditure

We have reviewed our capital expenditure plans in detail. All components fell during the first half - new stores, non-core channels and IT. We still expect full year capital expenditure to be around £400m, as the Fresh Look refits start in the second half.

In future, we expect core supermarkets' capital expenditure to be sustainable at around £400m-£450m per annum. In addition, we now expect the previously announced 2015/16 £100m onerous contracts to be spread over the next two years, meaning £50m is now expected in 2015/16 and a total of £100m in 2016/17.

Debt

Net debt has fallen by £254m since year-end, and we expect further progress in future. The half-year position of £2,086m is already within our 2015/16 year-end target range of £1.9bn-£2.1bn.

Pension

We intend to launch a defined contribution scheme to sit alongside our Retirement Saver scheme. This will provide a lower cost option for our colleagues to save for retirement. Subject to consultation, we anticipate this will become the auto-enrolment scheme for colleagues in the future, and we expect to incur a related charge of £35m in the second half.

Commercial income

During the first half, commercial income was £179m (2014/15: £194m). Our definition comprises suppliers' marketing contributions and volume-based rebates, but excludes promotional funding as these are automatic deductions from costs and are triggered as units are sold with no subjectivity or judgement applied.

ROCE

We remain focussed on ROCE as an important KPI, and are committed to improving future returns.

2015 Long Term Incentive Plan awards

Once the performance targets for the 2015 Long Term Incentive Plan awards have been determined, they will be communicated to shareholders via a disclosure in the Investor Relations section of the Morrisons website.

Corporate responsibility and community

How we operate is very important to us. Our corporate responsibility programme ensures we work in a way that is right for our customers, colleagues, suppliers and communities, creating longer term sustainable growth. In June, we published our 2014/15 CR Review, which was independently verified by our assurance providers, DNV GL. It is available to download at www.morrisons-corporate.com/cr

Shortlisted for Most Sustainable Retailer of the Year

We've been recognised for our responsible business programme at this year's Retail Industry Awards and have been shortlisted for Most Sustainable Retailer of the Year. This award is for retailers who can demonstrate their full commitment to driving change by improving the sustainability of their operations.

Sustainable Fisheries - Ocean Disclosure Project

It is important that our customers know where our fish comes from and how it has been caught. We continue to work hard with our suppliers to ensure that all fish we stock is responsibly sourced, and to improve and certify all areas of our supply chain.

We have taken part in the Ocean Disclosure Project and demonstrated our commitment to corporate transparency by publishing the full lists of fisheries we use for sourcing alongside data on sustainability. The initiative, conducted with the Sustainable Fisheries Partnership, represents a step forward in corporate reporting.

Supporting National charity partner, Sue Ryder

Our customers and colleagues have so far raised a fantastic £3.2m for our partnership with Sue Ryder. We are working with the charity to help and support families throughout the UK. At the heart of the partnership is a shared belief that everyone should be able to get the care they want when they need it most, and that their families should be supported through the most difficult times.

Morrisons partnership will enable the charity to establish community clinics, end-of-life-care online support communities, and family support teams.

Reducing our carbon emissions

Our commitment to reduce operational carbon emissions by 30% by 2020, from a 2005 baseline remains a significant focus within our business. With five years of investment still to go, we have so far achieved a reduction of 23%.

Colleagues

Earlier this year we introduced flexible benefits for colleagues - with the opportunity to sacrifice salary for childcare vouchers, cycle-to-work, laptops, tablets and mobile phones, plus a range of health and wellbeing options such as health assessments, dental and optical cover.

We are committed to supporting our colleagues in playing an active part in their communities. We have launched the Morrisons Foundation, through which we aim to improve people's lives, through match funding colleagues and offering grants to registered charities throughout the UK.

Notes:

Wm Morrison Supermarkets PLC

Condensed consolidated financial statements

Consolidated statement of comprehensive income 

26 weeks ended 2 August 2015

Consolidated statement of changes in equity

Consolidated statement of changes in equity (continued)

Notes to the condensed consolidated financial statements (Continued)

26 weeks ended 2 August 2015

During the period assets costing £66m became fully depreciated (3 August 2014: £361m, 1 February 2015: £439m). Included above are assets under construction of £12m (3 August 2014: £84m, 1 February 2015: £27m) and the net book value of land is £3,328m (3 August 2014: £3,764m, 1 February 2015: £3,329m).

Notes to the condensed consolidated financial statements (Continued)

26 weeks ended 2 August 2015

Total working capital movement (the sum of items marked 1 above) is £191m in the period (3 August 2014: £120m, 1 February 2015: £289m). This includes £83m (3 August 2014: £nil, 1 February 2015: £157m) as a result of the impairment and provision for onerous contracts charge in the period (see note 2) and is net of £17m (3 August 2014: £24m, 1 February 2015: £74m) of onerous capital payments. The working capital inflow excluding impairment and provision for onerous contracts is £125m (3 August 2014: £144m, 1 February 2015: £206m).

Included within debtors in the Consolidated balance sheet is £1m in respect of property disposals recognised in the period (3 August 2014: £80m, 1 February 2015: £nil).

Notes to the condensed consolidated financial statements (Continued)

26 weeks ended 2 August 2015

13 ANALYSIS OF NET DEBT

14  FINANCIAL INSTRUMENTS (continued)

All financial instruments carried at fair value within the Group at 2 August 2015 are financial derivatives and all are categorised as Level 2 instruments (3 August 2014 and 1 February 2015: Level 2). Level 2 fair values for simple over-the-counter derivatives are calculated by using benchmark observable market interest rates to discount future cash flows.

Notes to the condensed consolidated financial statements (Continued)

26 weeks ended 2 August 2015