Ocado Group PLC

LSE:OCDO

Earnings Call Transcript 2021-Q4

[Operator]

Good day, and welcome to the Ocado Group Q4 Analyst Call. Today's conference is being recorded. At this time, I would like to turn the conference over to David Shriver. Please go ahead.

[David M. Shriver, Communications Director]

Thank you, operator. Good morning, everyone. This is David Shriver, Communications Director at Ocado Group. Welcome to the fourth quarter trading update for Ocado Retail, which, as you all know, is a 50-50 joint venture between Ocado Group and M&S. I'm joined today by Stephen Davis, Chief Financial Officer of Ocado Group; and Neill Mcbride, the Chief Financial Officer of Ocado Retail; as well as Neill Abrams, Ocado Group General Counsel, who is joining us from New York. I'm going to hand over to Stephen and Neill shortly to talk about the Q4 results. But because many of you on this call will no doubt be interested in the outcome of the judge's ruling in the ITC process out of a night. I'm going to hand over to Neill to give a few introductory remarks on what has been a decisive win for us. Neill?

[Neill Abrams]

Thanks, David. As many of you may have seen the judgment in the ITC trial was delivered last night and the Chief Administrative Law Judge has found in favor of Ocado. The headline is that Ocado does not infringe any valid AutoStore patterns and also request [indiscernible] objective. [indiscernible] AutoStore patents that were asserted against us are invalid and the fourth patent is not infringed by us. It was the first patent and a number of other patent claims that were abandoned by AutoStore the day before the trial after a preliminary ruling by the Judge that made it clear that it was impossible for Ocado to infringe them. We've consistently stated that Ocado does not infringe any valid AutoStore IP. We said that after the claim started last October, we said that in our annual report, we said that in our half year report, we said that in the media. And we're really pleased that the court has also now rejected AutoStores attend and to use the ITC process to obstruct the development of our business in the USA. Separately, I'll add that we are continuing to pursue our own plans against all to AutoStore patent infringement, both in the U.S.A. and in Europe. And we anticipate that core determinations awarding Ocado damages to AutoStore infringement of our patents and injunctions from doing so will flow in due course.And with that, over to you, Stephen.

[Stephen Wayne Daintith, CFO & Executive Director]

Thanks, Neill. Now returning now to the Q4 trading statement from Ocado Retail. We have a strong message around growth to give to you today. Bottom line, all the evidence over the course of this year points to the fact that we're seeing growing momentum in the channel shift from physical stores to online. Now you can see this from the number of consumers we are now serving as we head towards 1 million customers, a landmark for the business. We're on a strong long-term growth trajectory, and we're backing our firm conviction by investing in new capacity and in marketing to capture that growth in fiscal '22 and beyond. Now for details of the quarter, let me now hand over to Niall. Thanks, Niall.

[Niall McBride]

Thank you, Stephen. In the fourth quarter, customer orders per week were up 9% versus the prior year, driven by a 22% increase in active customers to a new high of 832,000. He growth in orders was positive, was impacted by the ongoing tight labor market in the U.K. in addition to the previously guided to reduced capacity at the Erith customer fulfillment center following the fire in July. As expected, this positive trend was offset by continued reduction in the average basket as many customers return to the office and the high number of calories consumed inside the home fell. The value of the average basket declined by 12%. Napping off these 2 factors, sales declined overall by just under 4%. Although it's important to note that we are still up 27% when you compare Q4 2021 with Q4 2019.Operationally, we performed well in the period, notwithstanding normalization in the trading week. The performance of Erith has been in line with the expectations we outlined at the third quarter, with effect from mid-November live peak day capacity at the site has returned to pre fire levels and our new CFCs are ramping up faster than ever before. We are already at 35,000 orders per week at our new robotic customer fulfillment center in Park Lake, only 3 months after go live. There were, of course, some well-publicized headwinds, which we highlighted in Q3, and which you've heard about from other companies in the sector, notably supply chain pressures and competition for labor. This affected us both in terms of revenue growth as well as costs. Revenue growth was impacted by a high degree of vacancies at the beginning of the period when we had arrived 1,200 roles to fill. 1,200 to circa 10% of our targeted levels of total staff. We have almost half this number to around 650 vacancies, thanks to temporary sign on incentives and increased ROE risks in certain locations. So overall, we expect FY '21 results to be in line with previous guidance. Looking now ahead to FY '22, thanks to the strong underlying growth momentum in the business, we expect top line growth to be at the top end of historic guidance range we've give pre-COVID. The strong underlying trend in trading gives us continued conviction to invest for growth. This means bringing on more capacity to fulfill customer demand, investing in our platform to improve the customer experience and higher marketing costs so that we can make more customers aware of what Ocado can offer. The investments we are making will have an overall GBP 50 million impact in FY '22. Around half of that can be attributed to the increase in capacity, including an increase in OSP fees and other fixed site-related costs. The remainder will be allocated broadly evenly across the following: increased marketing spend with continued investment in the brand to drive record customer growth, one-off costs associated with continued transformation of the non-OSP business platforms and investment in talent to support the future scale of the business and the impact of reduced operating efficiency typical and early ramp-up of new sites. These investments will mean that we'll be set up for growth for the years to come, and we are planning for margin to rebuild towards 2021 levels with long-term margins underpinned by technology and the operating leverage. Stephen, back to you.

[Stephen Wayne Daintith, CFO & Executive Director]

Thanks, Niall. So these are indeed exciting times for Ocado Retail. 2021 has clearly shown the strong underlying demand driving the cards to success. will not be deflected by short-term industry-wide cost We'll not be deflected by short term industry-wide cost pressures. Instead, we're going for growth. While this will mean a short-term margin impact in fiscal '22, we believe we have the best model to deliver for customers and we look ahead to realizing the huge potential of Ocado Retail with excitement and enthusiasm. Let's now take your questions. Thank you.

[Operator]

[Operator Instructions] Our first question today comes from Andrew Gwynn from BNB Paribas.

[Andrew Philip Gwynn, Senior Food Researcher & Analyst of Food Retail]

First question for as possible. So obviously, a number of other claims in process. It seems like it could go on quite some time. Do you have a time line loosely on when we might get sort of final resolution all of the AutoStore stuff hopefully gone away. The second question, just coming back to the guidance of GBP 50 million, I think consensus is looking for around about GBP 155 million of retail EBITDA next year. It sounds like the message is that should be nearer GBP 100 million. But I just wanted to clarify whether or not there's some gearing on the sales, maybe it's GBP 120 million, but any guidance on the absolute EBITDA number would be very much appreciated.

[David M. Shriver, Communications Director]

So the first question, I think, is for Niall actually -- sorry, Neill, AutoStore, do you want to give the answer.

[Neill Abrams]

It's easy to confuse an Irish accent and a South African accent.

[David M. Shriver, Communications Director]

Neill? Carry on, Neill.

[Neill Abrams]

Yes. It's very difficult to predict when this will end because it appears that depends on whether they're things like appeals. But there are some firm milestones in the time line. So we were in court last week Friday in Germany, and there are 3 more court cases in Germany, which will take place in January and February next year. And we'll have judgments on those in sort of March time, maybe March. We have a trial in London starting in mid-March for 4 weeks. I'm not sure how long a judgment will take to come out after that. But 2 months is a reasonable guess. And then we have cases pending in New Hampshire and East Virginia. We have share cases are independent of everything else because that's us soon or to store for infringing our patterns. And that's running on a time line where it will be in court towards the end of 2023. The East Virginia cases are all staid until the ITC process is completed. And if that gets appealed all the way to the federal court then East Virginia won't start until probably Q3 of 2023. And don't care how long that would take to run in so I think that's for the best information I can give you at the moment.

[David M. Shriver, Communications Director]

Thanks, Neill. And Andrew, on the second one, yes, I think based on our current view, that's -- we're getting to around GBP100 million for our FY '22.

[Operator]

We're now moving on to our next question from Victoria Petrova from Credit Suisse.

[Victoria Petrova, Research Analyst]

The first is also on the AutoStore. Do I understand correctly that the AutoStore litigation in the U.S. has nothing to do with your performance given that you are partnering with Kroger, which is your exclusive partner already? Or is there any additional upside coming from you winning? That's just important to understand. And similarly, with the processes in other country -- is there any upside to OSP from you winning, assuming you win everywhere in your OSP operations, apart from clearly a reputational one. And the second question, could you please run us through Erith capacity through 2021 and expected in 2022? And has Erith fire had an impact on your fourth quarter performance? Because obviously, order frequencies remains pretty strong in the fourth quarter with a lower average order value. But was there still a disruption in the fourth quarter coming from Erith? And if so, could you quantify it in the number of orders per week?

[David M. Shriver, Communications Director]

Thank you. So Neill, do you want to have a stab at the AutoStore question around any practical implications for the U.S. market and indeed, other markets with the outcome that was announced last night?

[Neill Abrams]

Sure. So I think the first thing I'd say is that the countries are generally independent of each other. And although there are some of the inventions that are being litigated in multiple countries, the patents are all limited to their particular jurisdiction, and they're interpreted in accordance with our national law, so there's not that much read across. Within the U.S., I think you asked, is there any upside for Ocado if we win all of the claims that are pending. And the answer is, yes, there's significant upside in the sense that we're seeing AutoStore in East Virginia for having importantly procured patterns from the U.S. patent office. And that that's a claim that will be held by a jury and decided by GO rather than buy a single minister of law judge. If we run that, we're automatically entitled to 3x our damages, including 3x our legal fees in all of the forums where we've had water store claims asserted against us. So that's one instance. The second is in New Hampshire. We're seeing AutoStore infringing 4 of our patents. And if we win that, AutoStore prevented from using the black line robot and from using the router, replanning system that they use with both Black Line and Red Line and also prevented from using the coating to functionality were partially completed orders can be returned to the good. Without those functionalities AutoStore will not have the capability to be a participant in the social e-commerce market.

[David M. Shriver, Communications Director]

Thank you, Neill. And now over to Niall for the questions on capacity and the impact of the Erith on Q4?

[Niall McBride]

So I mean, overall, I think, Victoria, the Erith fire impact in Q4 is relatively limited. So if I take it back to what happened, obviously, in the short number of days after the fire we -- the site was closed. The team worked incredibly hard to clear out the grid to get everything back up and running within -- I think it was 4 or 5 days, we're already supporting orders back out of Erith. And then we were turning the site back on. Obviously, you don't turn them on overnight. It takes a short amount of time to do and then we've geared back up. But I think the capacity is fully reinstated now in terms of the line capacity at the site, the bigger impact really through the quarter across the entire network was from the constraints on labor.

[Victoria Petrova, Research Analyst]

And in terms of 1,000 orders per week, what is it in fourth quarter? What is it now? And what is expected in next year? Just as a cross check, if you don't mind. I'm talking about Erith.

[Niall McBride]

Yes. I think you can see the sort of the constraints that we've had in the back half of the year I don't think we're going to get into site-by-site order numbers, but obviously, we'll be pushing the sites as hard as we can in Q1.

[Operator]

We're now moving on to a question from [indiscernible] from UBS.

[Unknown Analyst]

Three quick questions from me. A couple of them to Neill, I guess, and then one back on Ocado Group, First one, in terms of the 3 AutoStore patents, not we invalidated, was the basis -- was it the lack of candor? And if you can just quickly walk us through the field process here. Clearly, as Marko story is planning to do so. And secondly, any insight at all from the German section on Friday, was there any strong wording hints coming from there? And the last one is I realize this is a ORL trading update. But is there any hints with respect to other segments of Ocado Group as we think about FY '22, please?

[David M. Shriver, Communications Director]

Okay. So Neill, do you want to cover the 2 AutoStore questions at the start there, then I'll cover the overall group topic that came up at the end.

[Neill Abrams]

Okay. So the first question is to do with the 3 AutoStore that were found not to be valid. That wasn't for reasons related to lack of candor. That was for reasons that the AutoStore claims made in the patents related to things that they haven't invested. So the patent has got 2 components to it. The first part is the description we described in sufficient detail to the world and what your invention is? And then secondly, you set out the claims to which you want a 20-year monopoly AutoStore claims were for things that were not included in the description of their patents. And sort of 101 or patent laws that you can frame in entitlement or something you didn't invent. So that's why all 3 of those patents will help to be invalid. I'm sorry, I can't remember your second question was.

[Unknown Analyst]

So just in terms of appeal process here, AutoStore, clearly, they've already said they're planning to appeal and they've got obviously 30 days to do so. But I'm just wondering what happens after the appeal, how long sort of does it take.

[Neill Abrams]

Yes. So they can appeal to the commission to disregard the findings -- we don't know exactly what is it against, but I think I could probably guess. And we might appeal against some of the other aspects of the findings as well that will go to the legal division of the commission, which will -- and I'll deal with that over the next few months and make a final decision in April. There won't be another hearing in terms of an ongoing -- there will be written briefs exchanged. When that's done mid-April, there's a -- if the commission decides to impose the control order, which is obviously contrary to what the judge has said than there's a 2-month period for the President to review that. And then finally, after that, there's an appeal to Federal court by the party that wants to appeal to Federal court, that can take another 15 months. But we think that it is highly unlikely that the commission is going to overturn to that decision. Obviously, what's been made public is just a 1 pager. But behind that 1 page, is a 167 page fully recent judgment, which isn't currently public. And although I haven't seen it personally because it's only limited to the attorneys on both sides. We know from discussions we've had with them that the judgment spends -- the majority or a substantial part, reasoning, validity or invalidity of the AutoStore patents in a very, very cogent reason way. And then the remaining points are no longer necessary because once the patents are invalid, it's not necessary for the jet make significant findings on things like the forward points or the candor points and the up with very briefly. So we think that the commission overturning someone with the sort of pedigree of the Chief Administrative Law Judge on a point like this is very unlikely.

[David M. Shriver, Communications Director]

Thank you. That was very helpful. And thank you for the question on the group. This is an Ocado Retail trading update. So I'm not going to say anything about our other business segments, but I can confirmed this morning that Ocado Group remains in line with guidance, and I'll just leave it at that.

[Unknown Analyst]

Sorry, can I just come back on the last question I had there was German court hearing on Friday. Was there anything there that we should be aware of pending hints from that or something?

[Neill Abrams]

So we give quarter on Friday, the judge or for more written briefs to be provided and gave a date of the 28th of January. And then based on that the court will make a decision and hands on judgment on the fourth of February. And that's obviously separate from the other 3 cases in Germany, 2 of which are going to be held on 27th of January, and the IL-1 is going to be held I think on the first of February. Those are all separate quarter on separate barges.

[Operator]

We now take our next question, which comes from Nick Coulter of Citi.

[Nick Coulter, Director]

Congratulations. Firstly, how quickly should we expect a margin rebuild? And I guess another way of asking the question is, which costs are specific to FY '22 and then kind of therefore fall away in the outer years. That will be the first one.

[David M. Shriver, Communications Director]

So Nick, thanks for the question. I think that this comes back to the leverage that we will get in the sites, right? So we are building capacity at the moment, and we're building up the capacity through the course of the year. And so there, if you look at that sort of the OSP element of that, as we fill those -- as we fill those sites up, that fixed leverage will be utilized -- And then the -- also the operating efficiencies in the site will get higher as well. So roughly half of that will get utilized as we go through the year. So -- and the rest of it in terms of the marketing spend and transformation, again, so a lot of that is specific to FY '22.

[Nick Coulter, Director]

Is there a chunk for zoom in there as well as you build out that portfolio?

[David M. Shriver, Communications Director]

No. It's -- there's an element of Zoom, but it's a smaller -- much, much, much smaller proportion.

[Nick Coulter, Director]

Okay. Great. A quick one for Neill joining from far away. Do we know if AutoStore managed to get the 2012 priority date for the IP patents? Have you had that feedback from counsel?

[Neill Abrams]

Sorry Nick, it's not something I'm able to tell you about. So that isn't in the public part of the decision.

[Nick Coulter, Director]

I'm sure it will come out in the public in due course. And then I guess just a broader one, what are your latest thoughts on dumbing down or using lower specification robots to fulfill nonfood? I guess, AutoStore's market cap suggests there's a fair amount of value in that direction. It's obviously something you've not focused on thus far, but all of this patent activity clearly suggests that there's an overlap and an application to potentially pursue.

[Neill Abrams]

I'll give you 2 quick thoughts on that and then ask Stephen to add thoughts of hits. But I'd say from my side, the sort of historical store products, the redline of the kind that we bought in 2012 is not protected by any patents. So it doesn't do anyone to recreate that. And obviously, when we look at what the capabilities are SP and how broader spectrum of retail, we want to be able to service, we are very open-minded about moving from grocery into non-grocery. And so we want to ensure that we have the technology that's able to do that.

[Stephen Wayne Daintith, CFO & Executive Director]

Thanks, I think you answered the question. It's -- our focus is very much is a big grocery market for us to go for around the world. And that's our core focus. We remain open-minded about on the opportunity to enter nongrocery. And we clearly have the technology that can do that as well, whether it be sort of legacy technology or new technology or future technologies. So it's an avenue that remains open to us, but the core focus is grocery.

[Operator]

We now move on to our next question, which comes from Fabienne Caron from North America Securities.

[Fabienne Caron, Head of Food Retail Sector]

Just one question actually for me. You mentioned the loyalty of customers on the 5 you were hiring or have Lloyd customers on 862,000. What is the opportunity to work with M&S going forward, you're going to invest in the marketing. But where can you get this number? And how much does it cost to acquire new customers? And lastly, what help do you get from M&A on that side?

[David M. Shriver, Communications Director]

Thanks, Fabienne. I think overall, we are about 2% of the grocery market in the U.K. When we think about acquiring customers, we've got the strongest NPS. We've got the widest range for customers, including a fantastic M&S range. We've got the best fulfillment statistics. We've got the most popular drivers, and we're offering the customers fair value for money. So we see a very, very large opportunity to increase the number of active customers at 832 now. We would love that number to be higher coming out of the year, and we're going to push pretty hard in FY '21. With M&S, I think it's a fantastic opportunity for us to work together. We are doing that. We're looking at how we can jointly market on things and what products we can bring forward as well for customers that can be specific to ORL, but also for good products for both of us. So I think it's -- I think the combination remains compelling. And yes, we look forward to doing more in '22.

[Fabienne Caron, Head of Food Retail Sector]

And just a quick follow-up question. Just on the margin guidance you've given and you're talking about recovering to 2021 levels. So what number do you have in mind when you're talking about the 2021 level?

[David M. Shriver, Communications Director]

I mean I think the -- we were operating in the first half at around 6% in terms of the EBITDA margin. And we'll -- as we see that leverage come back, we'll -- sorry, as we go through FY '22, that leverage will come back through the system as we sort of grow into it.

[Fabienne Caron, Head of Food Retail Sector]

Okay. So 6% is the number?

[Timothy Steiner, CEO & Executive Director]

Yes. I mean that's what we're aiming to get back to.

[Operator]

Rob Joyce from Goldman Sachs has our next question.

[Robert Joyce, Equity Analyst]

Two from me. First one for Neill. So you mentioned in passing that there might be some appeals of your own. What is it within the -- this ruling in that regard all seem to be fairly much gone in your favor as far as we can see. And then the second one is just on the guidance for next year in terms of EBITDA. Am I right in reading it, though, that since quite a bit of that EBITDA was related to OSP fees that retail will pay up to the group, the impact of group should be less than the GBP 50 million headline ORL EBITDA investments?

[Stephen Wayne Daintith, CFO & Executive Director]

Yes, I'll do the second question. It's Stephen here. Yes. No, you're quite right. The portion of, we say, around half of the GBP 50 million is due to OSB fees, but also the fixed costs related to the new sites that are coming on board in line with Niall's earlier comments, but those OSP fees are very much group fees to our U.K. Solutions business segment and therefore, are neutral to the group. So the only portion of it is the drag in fiscal '22 is the fixed costs on the new sites.

[David M. Shriver, Communications Director]

So Robert, a good question on your situation is what might Ocado appeal against to the full commission? I think the answer to that is there were a number of findings that we are considering a feeling against, including the finding that there was that happens or not an enforceable because of an excitable conduct or equitable stock all. So effectively, the -- related to the fall point that was mentioned earlier. We think it's clear that material information with die withheld from the U.S. patent office. And the final here is because there's no doubt that the nations withheld is how material information was information that was at this point in Europe and in Norway when those same patterns came before the patent office is there. So I think that's the main candidate for an appeal by.

[Operator]

[Operator Instructions]As there appears to be no further questions at this time. I'd like to hand the call back over to David Shriver for any additional or closing remarks.

[David M. Shriver, Communications Director]

Thank you, everyone. That concludes our call. We're next reporting on the eighth of February with Ocado Group's FY '21 results. I'm sure we'll be speaking to most of you before then. But for the moment, thank you very much. Have a good day.

[Operator]

Thank you. This concludes today's call. Thank you for your participation, ladies and gentlemen. You may now disconnect.