CHIEF EXECUTIVE'S OPERATING REVIEW

Continued good sales growth and strong cash generation during the first half of our financial year reflect the successful implementation of our proven growth strategy, which is delivering clear benefits. This has enabled us to increase profits and earnings per share, and to reduce our gearing and interest costs, allowing us to pursue a progressive dividend policy and to make a special cash return to our shareholders.

Results

Group gross sales for the 26 weeks ended 28 January 2017 (2016: 26 weeks ended 30 January 2016) grew by 7.0% to £493.7 million (2016: £461.3 million). This included a 5.4% increase in DFS gross sales, reflecting like-for-like growth through established stores, the benefit of new store openings, and a further double-digit percentage increase in online sales. We also enjoyed increased contributions from Dwell and Sofa Workshop as we continued to grow these brands through the conversion of former DFS warehouse areas into new retail space. Group gross sales for the 52 week period ended 28 January 2017 were £1,012.8 million, taking us past the £1 billion sales milestone for the first time in our 47 year history.

Group EBITDA increased by 4.5% to £32.4 million (2016: £31.0 million), despite the anticipated pressure on margins from adverse foreign exchange movements, while profit before tax was 3.1% higher at £16.7 million (2016: £16.2 million). Underlying basic earnings per share, which are comparable year on year for the first time since our IPO, increased by 3.3% to 6.2 pence (2016: 6.0 pence).

Dividends

The Board has declared an interim dividend of 3.7 pence per share (2016: 3.5 pence), an increase of 5.7%, payable on 21 June 2017 to shareholders on the register at 2 June 2017.  The continued strength of our cash flow generation has also enabled us to fulfil our previously communicated intention to make an additional capital return to shareholders.  Therefore in addition to the ordinary interim dividend, the Board proposes to pay on the same date a special dividend of 9.5 pence per share.

Growth strategy update

We have continued to make strong operational progress in implementing all parts of our growth strategy, which builds upon our well-established fundamental strengths of market-leading scale, the flexibility of our cost base, and vertically integrated manufacturing and retail operations.

Broadening our appeal to customers

We have maintained our successful focus on extending our appeal to an even broader range of customers so as to consolidate our position as the UK market leader in upholstered furniture across all customer segments. Awareness and appreciation of the DFS brand has benefited from successive innovative advertising campaigns, which we took into new territory at Christmas 2016 with a multichannel campaign created in partnership with Aardman Animations to highlight the work of the skilled craftsmen and women in our UK factories. Earlier this month our Team GB Olympics campaign was named Retail Advertising Campaign of the Year at the annual Retail Week Awards.

Our Exclusive Brands collections have continued to deliver growth, benefiting from continued product innovation including the launch of new Country Living Keswick and French Connection Clay ranges. We have also successfully introduced two Sofa Workshop ranges throughout the DFS estate.

UK and Republic of Ireland DFS store roll-out

Our well-established programme of opening new 10-15,000 sq ft DFS stores in the UK and Republic of Ireland at the rate of three to five per year remains well on plan, with two new stores opened during the first half at Salisbury in August and Truro in September, and a third opening next month in Ashford. We have a clearly defined new store pipeline to maintain our planned store expansion for the next two years, subject to final negotiation.

In addition to our new store openings during the last six months we have undertaken major refits and relaunches of our Banbury, Nottingham and King's Lynn stores, where, as is usual, we have received the benefit of substantial lease extension incentive packages from our landlords.

We also opened a smaller 5,200 sq ft DFS store at Crawley in November, the third store in this trial format and our first outside the M25. The store is operating profitably and work is now underway to refine our small store operating model based on our learnings to date.

International expansion

Our measured strategy for the Group's international development continues to progress.  We opened two new stores in The Netherlands this year, at Heerlen (December) and Den Haag (March), giving us a total of five stores in the country. This brings us closer to a scale where we can begin to test national marketing, based on our proven model in the UK. Our operating profit investment in The Netherlands remains in line with our expectations and as previously indicated is likely to be in the range of £2-3 million over the current year as a whole.

In Spain we opened a second store near Malaga earlier this month to make DFS even more accessible to the substantial British expatriate community there. We have also made our interest free credit proposition available to both British and Spanish residents. Notwithstanding the uncertainities surrounding Brexit for UK citizens resident overseas, we expect DFS Spain to make a positive contribution to operating profit.

Retail space optimisation

As we outlined in the annual report, the proven success of converting store warehousing space for retail use has led us to accelerate our Customer Distribution Centre (CDC) conversion programme which consolidates our warehouse operations into larger, more efficient offsite facilities. Three additional CDCs opened during the first half, contributing to the current total of 14 CDCs serving 61 stores, of which 39 had been converted to release additional retail space by the end of January.

We opened 15 new co-located Dwell stores in former DFS warehouse space during the first half, and two new co-located Sofa Workshop stores. All are trading successfully and also helping to drive footfall and bookings in their associated DFS stores. To support the growth of the Dwell brand, we also successfully opened a new dedicated distribution warehouse at Milton Keynes in January.

We will complete our CDC conversion programme with the opening of the final five CDCs over the next six months, reaching nineteen in total, while our retail space conversion programme will continue towards completion during FY18. As previously indicated, by the conclusion of the programme we expect to achieve nationwide coverage with Dwell, giving us a chain of more than 40 stores, together with more than five new Sofa Workship stores.  We will use the expanded space released elsewhere in the DFS estate to offer additional ranges of beds and dining furniture.

The financial results of the programme are in line with our plans, with pre-opening costs offsetting the higher sales generated by additional retail space in the current year. As previously guided, we remain confident that the programme will deliver incremental EBITDA of £650k-£700k per CDC cluster converted.

Omnichannel

The web is now the natural starting point for most consumers considering a furniture purchase, and we know that today around 80% of DFS customers begin their research online. The DFS website retains strong market leadership, continuing to attract over 40% of all UK upholstery web traffic, and we have seen significant increases in website visitor numbers during the current year. DFS already has the leading presence in natural web searches, through effective search engine optimisation, and we have an ongoing innovation programme designed to increase the efficiency and impact of paid searches.

Although the majority of our customers progress to visit a physical store before completing their purchase, transactions completed online have continued to show double-digit percentage growth and are making a valuable contribution to overall Group sales growth. The increasing proportion of transactions made on mobile devices underlines the importance of our constant investment to ensure that our range can be viewed and appreciated on whichever device a customer prefers to use, from desktop computers to tablets and mobiles or our "Swoosh" screens in-store.

The online channel is also proving to be of steadily increasing importance for order progress tracking and the completion of payments.  Our investments in this area are providing customers with better visibility and control, while creating savings in customer service costs.

During the first half we completed the roll-out of our "Swoosh" furniture visualisation technology across the whole DFS estate, allowing us to project our range of models, colours and materials on a video wall in stores. This helps our customers to appreciate exactly how their chosen product will look in their homes, and assists our people in selling the full breadth of the DFS range from all store sizes.

People

Our key point of difference at DFS is the quality of the more than 4,000 people who make, sell and deliver our furniture, and provide our after-sales service. We were pleased that their feedback enabled us to feature among the Sunday Times' Top 30 Best Big Companies To Work For in the UK for the first time in February 2017, complementing our established Top Employer certification by the Top Employers Institute. We have further extended our apprenticeship and training programmes, and continue to align incentives for our people with Net Promoter Score (NPS) performance, which I am pleased to report reached a new record of 85.1% post purchase and 33.6% on an established customer (six months post purchase) basis during the first half.

Outlook

Consumer confidence to date has held up well, but we recognise that furniture retailing in the UK faces an increased risk of a market slowdown in 2017 because of the uncertain political and economic outlook. We saw in the first half some impact on our margins from adverse currency movements, principally the weakening of the pound against the US dollar. We are taking actions to mitigate these pressures through range management and supplier negotiations, and expect to see further benefits from these initiatives during the second half.

The scale of our business gives us significant advantages that allow us consistently to offer outstanding value to our customers. The flexibility of our cost base, our investments in infrastructure and our vertically integrated business model add to our confidence that we are very well positioned to respond to economic headwinds and cost pressures while continuing to grow our share of the UK retail furniture market.

Our expectations for revenues and profit before tax over the full year accordingly remain unchanged, recognising as expected a softer market environment in the second half of the financial year. We further believe that DFS continues to enjoy excellent prospects to deliver long-term profitable growth, strong cash generation and a progressive dividend policy as one of the UK's best-known brands, a major British manufacturer and the country's leading retailer of upholstered furniture.

Ian Filby

Chief Executive

FINANCIAL REVIEW

Our continued good sales growth has enabled us to increase profits and earnings per share despite the anticipated pressure on margins from adverse foreign exchange movements, which we are working hard to mitigate. The continued strength of our free cash flow is reflected in reduced gearing and lower interest costs, and permits us to make a special return of cash to shareholders in addition to an increased interim dividend.

Sales and revenue

Group gross sales for the half year increased by 7.0% to £493.7 million (2016: £461.3 million), including a 5.4% increase in DFS gross sales as well as increased contributions from Dwell and Sofa Workshop. 

Group revenue grew by 6.8% to £379.9 million (2016: £355.8 million).  The slightly different growth rate to gross sales reflects increased uptake of interest free credit by Dwell and Sofa Workshop customers, and a change in the rate of insurance premium tax increasing the cost of certain aftercare services. 

Gross margin

Gross profit for the half year grew by 3.9% to £53.5 million (2016: £51.5 million).  As we anticipated in our full year results announcement in October, gross margin has been affected by the weakening of sterling, particularly against the US dollar.  Against this background, we have continued to give priority to the maintenance of our value for money proposition and competitive price points.  We have been pursuing clearly identified action plans on our sourcing, cost base and range mix intended to mitigate the currency impact, and these are beginning to bear fruit, although more work remains to be done.  We continue to benefit from increasing operating leverage, particularly in the spreading of marketing costs over a wider revenue base, as the business continues to grow.

The actions we are taking together with the scale of our operations, geographical mix of our sourcing and our significant UK own-manufacturing capability provide us with significant advantages compared to many other retailers in our sector.

Central costs

Underlying administrative expenses rose by £0.6 million to £21.1 million for the half year (2016: £20.5 million). This increase derives from our continued investment in an accelerated retail space optimisation programme, and anticipated increases in share based payment charges as outlined in the annual report.  We continue to anticipate an increase in central costs of some £2 million over the year as a whole, in line with our previous guidance.

Operating profit and EBITDA

The net impact of the sales and margin effects noted above was a 4.5% increase in underlying EBITDA for the half year to £32.4 million (2016: £31.0 million). 

The significant investment in strategic growth initiatives over the last two years, including our CDC development and retail space optimisation programme, and the further development of our omnichannel proposition, has resulted in an increased depreciation charge of £9.2 million for the half year (2016: £7.8 million).  As a consequence, despite the increase in EBITDA, underlying operating profit was unchanged on the previous half year at £22.0 million.

Finance costs

Interest payable of £5.4 million (2016: £5.9 million) primarily relates to the Group's senior bank facility of £200.0 million (together with an undrawn revolving credit facility of £30.0 million).  The £0.5 million reduction in costs compared with the prior half year reflects our improved gearing ratios, which have resulted in a modest reduction in the rate of interest charged.

Tax

The tax charge recognised in the interim financial statements has been calculated on the basis of the expected effective tax rate for the full year of 21.0% (2016: 21.2%), slightly higher than the applicable UK Corporation Tax rate of 19.7% (2016: 20.0%).  During the prior year interim period a tax credit of £9.9 million resulted from a settlement in the Group's favour of certain outstanding items relating to prior years with HM Revenue and Customs for which no benefit had previously been recognised. 

Earnings per share

Now that we are in our second full year since our IPO, statutory earnings per share figures are comparable year on year.  Underlying basic earnings per share ("EPS") for the half year were 6.2 pence (2016: 6.0 pence), an increase of 3.3%. 

Capital expenditure

Cash capital expenditure for the half year was £17.4 million (2016: £11.0 million), in line with our expectations.  This significant increase in expenditure compared with the first half last year reflected the acceleration of our CDC and retail space conversion programme, as previously highlighted, together with our continued new store opening programme and investment in other growth initiatives. This expenditure, together with phasing of working capital has impacted cash conversion  for the first half (2017: 84.0%, 2016: 121.6%).  As we have previously guided cash capital expenditure for the full year is expected to be between £28 - 30 million, and is thereafter likely to be lower than FY17.

Cash flow and balance sheet

The Group continues to maintain a robust balance sheet to support future growth.  We closed the half year with cash of £69.4 million (2016: £45.0 million), giving a net debt position of £135.6 million (2016: £158.1 million) and achieving a gearing ratio of 1.42 times underlying EBITDA (2016: 1.71 times).  As a result of the Group's continued cash generating ability and negative working capital model this strong improvement was achieved despite the increased capital expenditure noted above and the payment during the half year of last year's final dividend at a cost of £15.9 million.

Dividend

The continued strength of our cash flow allows DFS to consistently both reduce leverage and to return cash to shareholders as part of our total shareholder return.  In line with our previously stated dividend policy of a pay-out ratio of 45-50% of profit after tax the Board has therefore declared an interim dividend of 3.7 pence per share (2016: 3.5 pence), an increase of 5.7%.

At the time of our full year results we noted our intention to make a special capital return during FY17, subject to the capital needs of the business and continuing to target a net debt to EBITDA ratio of approximately 1.5 times.  The Board therefore also proposes a special dividend of 9.5 pence per share, which will be paid at the same time as the interim dividend.

Subject to the capital requirements of the business and there being no significant change in the trading environment,  the Board's intention is for this return to form a sustainable and recurring increment to the Group's Total Shareholder Return.

Nicola Bancroft

Chief Financial Officer