Tesco Regulatory News (TSCO)

STEP UP IN SECOND QUARTER DRIVEN BY UK & ROI

· Group sales3 of £28.3bn, up 12.8%

- UK & ROI LFL sales8 up 3.8%, strengthening from 3.5% in 1Q to 4.2% in 2Q

o incl. Tesco UK LFL sales up 2.3% (1Q: 2.1%; 2Q: 2.5%) and Booker LFL sales up 14.7% (1Q: 14.3%; 2Q: 15.1%)

o significant investment in 'Exclusively at Tesco' brands; roll-out 81% complete

- Central Europe LFL sales declined by (1.5)% due to impact of Sunday trading regulations

- Asia LFL sales decline reduced from (9.0)% in 1Q to (4.8)% in 2Q following annualisation of bulk-selling impact; Government-issued welfare cards continue to impact sales in Thailand by c.(2)%

· Group operating profit before exceptional items and amortisation of acquired intangibles4 up 24.4% to £933m

- UK & ROI profit of £685m, up 47.6%; incl. first-time consolidation of £97m Booker profit and £16m synergies

- Central Europe profit of £59m, down (3.3)% reflecting £9m profit on property-related items in prior year

- Asia profit of £100m, down (29.1)% due to combined impact of sales deleverage, price investment and renegotiation of promotional investment

- Bank profit of £89m, up 6.0% mainly due to increased income and ongoing cost reductions

· Group operating margin4 of 2.94% (+29bps); margin of 3.02% excl. Tesco Direct

· Retail operating cash flow6 of £1.1bn, down (1.4)% (up 10.8% before £(139)m timing impact of P&H failure last year)

· £404m retail free cash flow (after net outflow of £(139)m relating to market purchase of shares)

· Interim dividend of 1.67p, up 67% year-on-year; on track to deliver c.2.0x EPS cover in the medium-term

· Statutory revenue up 12.0% to £31.7bn; operating profit down (6.5)% to £819m; profit before tax up 2.0% to £564m

· Brand health9 continues to strengthen; quality perception +3.6 points10

· In-year cost savings of £241m; savings of £1.1bn to date towards £1.5bn target

· Generated £1.1bn of retail operating cash6; net debt of £(3.1)bn is after £(766)m Booker cash consideration

· Improving the mix across geographies, channels and product; focus on sustainable general merchandise categories by closing Tesco Direct; on track to achieve 3.5-4.0% margin ambition11 by 2019/20

· Released a further £134m value12 from property; further buyback (Cirencester Extra) announced Sept 2018

· Innovations including 5,038 of 10,000 own brand products re-launched; eight new 'Exclusively at Tesco' brands; launched 'Jack's' as part of celebrating 100 years of great value at Tesco

"We have made a good start to the year. The step up in Q2 is driven mainly by the UK & ROI and delivers our eleventh consecutive quarter of growth.

At the same time, we have made further strategic progress.  We completed our merger with Booker in March and are delighted with performance so far. We announced a strategic alliance with Carrefour in July which goes live this month. And we are now more than half-way through the biggest own brand re-launch in our nearly 100-year history, including a significant investment in over 300 new 'Exclusively at Tesco' products at market-leading prices.

We are firmly on track to deliver our medium-term ambitions and are continuing to improve the quality and value of our offer for customers in all of our markets. In doing so, we are well-positioned to deliver strong, sustainable returns for shareholders."

Serving shoppers a little better every day

Like-for-like sales performance8

A full Group income statement can be found on page 13. 

Notes

1. Last half-year figures restated for impact of IFRS 15 'Revenue from contracts with customers'. Impacts include a £(9)m reduction in revenue and operating profit.

2. The Group has defined and outlined the purpose of its alternative performance measures, including its headline measures, in the Glossary starting on page 49.

3. Group sales exclude VAT and fuel. Sales growth shown on a comparable days basis and includes an adjustment to last year's figures to reflect a change in the reporting of consignment sales.

4. Excludes amortisation of acquired intangibles and excludes exceptional items by virtue of their size and nature in order to reflect management's view of the performance of the Group.

5. Headline earnings per share measure excludes exceptional items, amortisation of acquired intangibles, net pension finance costs and fair value remeasurements of financial instruments. Full details of this measure can be found in Note 9, starting on page 34.

6. Net debt, retail operating cash flow and retail free cash flow exclude the impact of Tesco Bank in order to provide further analysis of the retail cash flow statement.

7. Net debt includes both continuing and discontinued operations.

8. Like-for-like is a measure of growth in online sales and sales from stores that have been open for at least a year (at constant foreign exchange rates).

9. As per YouGov BrandIndex (customers recommend) August 2018.

10. Reflects year-on-year change in YouGov Brand perception measure of quality.

11. Ambition announced in October 2016 and excludes Booker. Booker contributed 9bps of the Group margin accretion in the half.

12. Value released from property relates to gross proceeds from property disposals in the half.

13. Capex is shown excluding property buybacks. Statutory capital expenditure (including property buybacks) for the 26 weeks ended 25 August 2018 was £0.4bn (LY £0.6bn).

We have continued to make further good progress in the half, guided by the six strategic drivers that we set out in October 2016, as we create long-term and sustainable value for our key stakeholders.

Customers

· 189,500 more customers are shopping at Tesco1

· continued improvement in Brand perception - quality up 3.6 pts, with stable value perception

· more than half-way through own brand re-launch; roll out to be largely complete by end-February

· significant investment in eight new 'Exclusively at Tesco' brands; already shopped by 51% of customers

· launched partnership with Jamie Oliver to make it easier for customers to eat well and live healthier lives

· Tesco customers now able to access Booker products: top 30 Booker products now rolled out to 70 Tesco stores; integrated Booker offer in Gallions Reach to be rolled out to eight more stores

· voted 'Britain's Favourite Supermarket' by customers for the fourth year running

· launched 'Jack's' - a new brand and store format - as part of celebrating 100 years of great value at Tesco

Colleagues

· 84% of colleagues recommend Tesco as a great place to work; scores improved in all markets

· implemented second stage of two-year, 10.5% hourly pay increase for UK store colleagues in July 2018

· continuing commitment to colleague health; over 17,000 colleagues benefited from mental health e-learning

· conducted UK's largest ever workplace health survey, with over 8,000 colleagues taking part

· new partnership with The Prince's Trust, helping 10,000 young people to develop skills and employability

· opened 'Heart' building in Welwyn Garden City in May, bringing together innovation and learning capability

Supplier partners

· retailer with most improved supplier relationships for third successive year in June 2018 GCA survey

· Supplier Viewpoint measure improved 330bps year-on-year to 74.7% for the Group

· ranked first for the third successive year in the independently-run Advantage supplier survey

· suppliers now accessing faster UK sales growth; joint Tesco Booker terms agreed with top 60 suppliers

· working together with suppliers to remove hard-to-recycle materials from all packaging by 2019, moving towards creating a closed loop approach

· established our tenth Sustainable Farming Group, with 1,600 beef farmers in the UK now benefiting from 12 month contracts that guarantee above-market prices

· worked alongside 358 of our existing suppliers to create new 'Jack's' brand with 1,800 products

Shareholders

· operating margin of 2.94%, up 29bps year-on-year; margin of 3.02% excluding Tesco Direct

· generated £1.1bn of retail operating cash flow (up 10.8% before £(139)m timing impact of P&H failure last year)

· retail free cash flow of £404m (after net outflow of £(139)m relating to market purchase of shares)

· announced interim dividend of 1.67p per share; targeting around two times EPS cover in medium term

· continue to take steps to strategically re-position the Group: Booker contributing to faster growth as planned; entered into long-term, strategic alliance with Carrefour; closure of Tesco Direct in July

· Booker delivering synergies; £16m in first half and on track to deliver at least £60m in full-year

We remain firmly on track to deliver the medium-term ambitions set out in October 2016: to reduce our costs by £1.5bn, to generate £9bn of retail cash from operations and to improve Group operating margins to between 3.5% and 4.0% by 2019/20. In addition, we will continue to strengthen the balance sheet and place increasing focus on growth in earnings and free cash flow generation.

We continue to maintain a disciplined approach to capital. Capital expenditure for the year is now expected to be no more than £1.2bn. Going forward, we expect annual capital expenditure to remain between £1.1bn and £1.4bn.

In Thailand, the combined effects of sales deleverage, price investment and renegotiation of promotional investment as we reposition our offer have impacted Asian profits in the first half. We expect this impact to continue in the second half as we maintain our investment in price in order to position the business for growth in a competitive and challenging market.

As planned, we anticipate that synergies associated with our merger with Booker will generate a benefit of at least £60m this year, growing to a cumulative c.£140m in 2019/20 and c.£200m by 2020/21.

1. KantarWorldpanel UK data for the 52 weeks ending 9 September 2018.

Financial Results

Sales:

1. UK & ROI consists of Tesco UK, ROI and Booker. Booker consolidated from 5 March.

2. Central Europe consists of Czech Republic, Hungary, Poland and Slovakia.

3. Asia consists of Thailand and Malaysia.

4. Sales change shown between 1H 2017/18 and 1H 2018/19 on a comparable days basis and includes an adjustment to last year's figures to reflect a change in the reporting of consignment sales; statutory Group sales change was 12.2% at constant exchange rates and 12.4% at actual exchange rates.

Group sales grew by 12.5% at constant exchange rates with like-for-like growth of 2.2%. At actual exchange rates, sales grew by 12.8% including a 0.3% foreign exchange translation benefit due to the depreciation of Sterling. Booker was consolidated into the Group from 5 March, contributing 11.8% to Group sales growth. Further information on sales performance is included in Appendices 1 to 3 on page 55 of this statement.

In the UK and the Republic of Ireland (ROI), like-for-like sales growth improved from 3.5% in the first quarter to 4.2% in the second quarter. In Tesco UK, like-for-like sales grew by 2.3% in the half and we gained 189,500 customers in the course of the last year. We are now more than half-way through the re-launch of 10,000 own brand products, initially focused on fresh food, and we expect the programme to be largely complete by the end of February. In addition, more than half of our customers have now bought at least one product from our eight new 'Exclusively at Tesco' brands, including 'Eastman's Deli', 'Hearty Food Co.' and 'Ms Molly's'. We have made a significant investment in lowering the price of these ranges, enabling us to offer our customers great quality food and market-leading value.

We continue to refine our range of general merchandise, focusing on sustainable categories that complement the grocery shop and deliver a simpler, more profitable business. As a result, we have reduced the number of products by a further 15% since the start of the year. Overall general merchandise like-for-like sales declined by (4.8)%, contributing c.(0.3)% to UK like-for-like sales as a whole, driven by selectively reducing certain categories such as Electrical, Media and Entertainment. Areas of focus such as Home and Seasonal continue to perform well, growing like-for-like sales by 3.6% combined. Our decision to close Tesco Direct from 9 July 2018 reflects our focus on achieving sustainable profitability. Our like-for-like sales performance has been adjusted to remove the impact of the closure from July onwards.

Clothing like-for-like sales outperformed the market with growth of 2.4%. Growth in menswear was particularly pleasing with a good customer response to our World Cup ranges. Improved stock routines and a strong summer season contributed to our lowest-ever level of realised markdown across the clothing business.

All store formats and channels achieved like-for-like sales growth, with our large store business growing at 1.8% and our online grocery sales up 3.5% supported by increasing customer numbers. Growth in like-for-like sales of 14.7% at Booker (13.3% growth excluding tobacco) reflects a strong performance across the business as a whole. It includes particularly strong growth in symbol group sales and the benefit of new contract wins secured during the fourth quarter last year.

In ROI, like-for-like sales grew by 3.1% as we continue to gain customers and extend our market-leading position. Own brand volumes increased by 9.0% as customers responded to an increasingly competitive offer.

In Central Europe, changes to Sunday trading regulations in Poland resulted in thirteen fewer trading days in the first half, impacting like-for-like sales for the region as a whole by (1.2)%. We have continued to exit unprofitable stores in the region, with 18 store closures in Poland earlier in the year contributing to an overall sales reduction of (3.5)% at constant exchange rates. We announced the closure of a further 13 Polish stores in August.

In Asia, our like-for-like sales performance improved from (9.0)% in the first quarter to (4.8)% in the second quarter following the annualisation of our decision to remove bulk-selling. However, we are continuing to see a sales impact of nearly (2)% in Thailand from the issuance of Government welfare cards which cannot be redeemed in modern retail chains. In addition, we have made significant changes to our sales mix and promotional strategy. Combined with the deflationary effect of our own price investment in a highly competitive and challenging Thai market, this has resulted in some continued volatility in our like-for-like sales as we move into the third quarter.

Group statutory revenue of £31.7bn grew by 12.0% year-on-year and includes fuel sales of £3.4bn.

Operating profit:

Group operating profit before exceptional items and amortisation of acquired intangibles was £933m, up 23.9% on last year at constant exchange rates and up 24.4% at actual rates. Statutory operating profit of £819m includes the impact of exceptional items and amortisation of acquired intangibles, which are described in more detail below and in Note 4 on page 31 of this statement.

UK & ROI operating profit before exceptional items and amortisation of acquired intangibles was £685m, up 47.6%, with operating margin growth of 56 basis points year-on-year. Booker is consolidated in these numbers from 5 March 2018 and made an operating profit in the half of £97m. Excluding Booker operating profit, UK & ROI operating profit before exceptional items and amortisation of acquired intangibles was up 26.7%.

We have already delivered £16m of the synergies identified in the Booker merger process and are well on track to deliver at least £60m in the full year. Suppliers are benefiting from access to our combined sales growth and we have now completed negotiations of new terms with our top 60 suppliers. Tesco Magor and Middleton distribution centres are now being used by Booker to support growth, utilise spare capacity and enable us to reduce the lead time on orders for Booker customers. In addition, we have consolidated a number of core business services across Tesco UK and Booker.

Our cost savings programme is progressing well in the UK as we continue to deliver efficiencies across our store operating model. Our strategic focus on maximising the mix within our business led to the closure of Tesco Direct in July. The operating loss relating to Tesco Direct was £(23)m in the first half with one-off closure costs of £(57)m treated as an exceptional item.

Central Europe operating profit before exceptional items was £59m, down £(2)m year-on-year at actual exchange rates. The reduction reflects the inclusion of £9m profit on property-related items in the prior year. We are making good progress with the implementation of our cross-European cost reduction programme. However, in Poland, the ongoing loss of two trading days per month led to reduced volume in the half and resulted in significant operational de-leverage. Poland remains the only loss-making market within the Group, contributing a drag of £(32)m on Central European profitability in the first half. We closed 18 loss-making stores in Poland in the half and announced a further 13 store closures in August 2018.

Asia operating profit before exceptional items was £100m, down (29.1)% at both constant and actual exchange rates. In addition to operational deleverage resulting from the sales disruption mentioned above, profits in Thailand have been impacted by a significant price investment as we reposition our customer offer and the temporary effect of renegotiating promotional investment from suppliers into everyday low prices for customers. We expect this impact to continue in the second half as we maintain our investment in price in order to position the business for growth in a competitive and challenging market.

Further information on operating profit performance is included in Note 2, starting on page 23 of this statement.

Property-related items in operating profit:

Across the Group, £(8)m of net operating losses before exceptional items arose from a number of small property-related items.  The year-on-year movement is driven by profits on the disposal of a development site in Welwyn Garden City in the UK and a department store in the Czech Republic included last year.

An exceptional profit of £13m has arisen from disposals within the UK. The year-on-year movement is driven by two transactions last year including the development of our Hackney store as part of our 'air-rights' programme and the unwind of our joint venture with British Land where we regained ownership of seven large stores.

Further detail on exceptional property transactions and property-related items can be found in Note 4 on page 31 of this statement.

Exceptional items and amortisation of acquired intangibles in operating profit:

Exceptional items are excluded from our headline performance measures by virtue of their size and nature in order to reflect management's view of the performance of the Group.

In the first half, these include charges of £(57)m incurred as a result of the closure of our loss-making online general merchandise business, Tesco Direct. In addition, we have provided £(22)m restructuring costs largely in relation to announced store closures in Poland.

Higher claim rates than previously estimated in respect of Payment Protection Insurance have driven an increase of £(7)m in our provision for customer redress at Tesco Bank.

We have released £15m of the amounts provided in relation to the Shareholder Compensation Scheme in the first half, as we continue to process outstanding claims submitted before the 22 February 2018 deadline. As mentioned above, exceptional profits on property transactions of £13m have arisen from disposals in the UK.

We have also made a provision of £(16)m in relation to a settlement payment agreed with the Financial Conduct Authority (FCA) following an online fraudulent attack on Tesco Bank in November 2016.

Further detail on exceptional items can be found in Note 4 on page 31 of this statement.

Amortisation of acquired intangible assets is excluded from our headline performance measures. Our combination with Booker resulted in the recognition of a £755m intangible asset, driving amortisation of acquired intangible assets of £(40)m in the first half. More detail can be found in Notes 4 and 19 on pages 31 and 45 respectively.

In total, the net effect of exceptional items and acquired intangibles amortisation on operating profit in the first half was £(114)m. This compares to a net credit of £126m last year, including £124m profit on the sale of Lazada in June 2017.

Joint ventures and associates:

Our share of post-tax profits from joint ventures and associates before exceptional items was £20m, an increase of £8m year-on-year due to an improved performance in Gain Land, our associate in China. An exceptional gain of £11m was also recognised on our share of profits from a mall disposal in Gain Land.

Finance income and finance costs:

The following table sets out the components of net finance costs.

Net finance costs before exceptional charges, net pension finance costs and fair value remeasurements of financial instruments reduced by £49m year-on-year to £(147)m. This improvement year-on-year was mainly driven by a £52m reduction in net interest payable on interest-bearing liabilities, resulting from debt maturities and bond tenders.

The £600m bond tender we undertook in April 2018 reduced interest costs by £10m in the half. We expect an associated reduction in interest payable of £33m on an annualised basis.

Net finance costs of £(286)m were £49m lower year-on-year. Within net finance costs, fair value remeasurements includes £(75)m relating to the premium paid on the repurchase of long-dated bonds. Net pension finance costs decreased by £36m year-on-year, driven by a lower opening deficit, partly offset by a higher discount rate.

Last year, an exceptional loss of £(68)m arose on the translation of the proceeds from the sale of our Homeplus business in Korea. This translation effect, which did not represent an economic cost to the Group, has not arisen again in the current financial year as the funds have since been moved to a Sterling denominated entity.

Further detail on finance income and costs can be found in Note 5 on page 33.

Group tax:

Tax on profit before exceptional items and amortisation of acquired intangibles was £(160)m.

As previously indicated, the effective tax rate on profit before exceptional items for the 2018/19 financial year is expected to be around 24%. This tax rate is higher than the UK statutory rate primarily due to the impact of the 8% supplementary tax surcharge on bank profits and depreciation of assets that do not qualify for tax relief. We expect the impact of these items on the effective tax rate to reduce as our overall level of profitability continues to increase. Therefore, along with the additional impact from the UK corporation tax rate reducing by 2% from April 2020, we expect the effective tax rate to reduce to around 20% in the medium term.

On a statutory basis, an exceptional credit of £22m is included and principally relates to the tax on exceptional items contained within operating profit.

Earnings per share:

Our diluted earnings per share before exceptional items, amortisation of acquired intangibles, net pension finance costs and fair value remeasurements of financial instruments was 6.36p, 18.4% higher year-on-year principally due to our stronger profit performance and partially offset by a higher tax charge. Statutory basic earnings per share from continuing operations were 4.40p, (14.2)% lower year-on-year, reflecting the impact of a net charge in respect of exceptional items this year compared to a net credit last year.

Dividend:

Reflecting the continued improvement in the business, the interim dividend has been set at 1.67 pence per ordinary share, an increase of 67% year-on-year. The interim dividend was approved by the Board of Directors on 2 October 2018. We anticipate a split of broadly one-third to two-thirds between the interim and final dividend and intend to reach our targeted cover of around two times earnings in the medium term.

The interim dividend will be paid on 23 November 2018 to shareholders who are on the register of members at close of business on 12 October 2018 (the Record Date). Shareholders may elect to reinvest their dividend in the Dividend Reinvestment Plan (DRIP). The last date for receipt of DRIP elections and revocations will be 2 November 2018.

Pension: 

On an IAS 19 basis, the pension deficit (net of deferred tax) has reduced from £(2.7)bn at 24 February 2018 to £(2.1)bn at the end of the half-year.  The movement in the deficit is primarily attributable to asset performance over the period, in addition to continued deficit contributions. Three Booker defined benefit schemes are now part of the Group and had a combined deficit of £(22)m on acquisition. These are all closed to future accrual.

Further information on the Group's pension liability is available in Note 16 on page 42.

Summary of total indebtedness1:

1. Total indebtedness is defined in the glossary, on page 51.

Overall, total indebtedness has increased by £(0.2)bn in the half driven by the £766m Booker cash consideration, partially offset by a reduced pension deficit.

Retail net debt increased by £(0.5)bn to £(3.1)bn due to the cash outflow relating to our combination with Booker. Discounted operating lease commitments increased by £(0.3)bn, including the consolidation of £(0.4)bn Booker lease commitments.

As outlined above, on an IAS 19 basis, our pension deficit decreased by £0.6bn primarily as a result of strong asset performance in addition to continued deficit contributions.

Our key credit metrics, which are fixed charge cover and total indebtedness/EBITDAR, have further improved since the end of the last financial year, from 2.7 to 2.9 times and from 3.3 to 3.2 times respectively.

IFRS 16 'Leases' will be effective in the Group financial statements for the accounting period commencing 24 February 2019. The Group intends to retrospectively adopt the standard, with comparatives restated from a transition date of 25 February 2018. The standard has no impact on the Group's underlying cash flows. It is, however, expected to have a significant impact on reported assets, liabilities and the income statement of the Tesco Group, as well as the classification of cash flows relating to lease contracts. The Group is in the process of finalising this work and setting out related accounting policies and procedures for leases. Until this work has been carried out, it is not practical to provide a reasonable estimate of the financial effect of IFRS 16.

Summary retail cash flow:

The following table reconciles Group operating profit before exceptional items and amortisation of acquired intangibles to retail free cash flow. Further details are included in Note 2, beginning on page 23.

1  The cost of major acquisitions and disposals are removed from the Group's definition of free cash flow. Note 19 (p.45) provides a full breakdown of the total Booker acquisition cost. 

2. Retail free cash flow includes the market purchase of shares (net of proceeds) of £(139)m in relation to share schemes. Last year's retail free cash flow has been restated by £6m to reflect this.

Retail operating cash flow decreased by £(16)m to £1,123m. As we outlined in April, working capital includes a £(139)m timing impact following the failure of a key supplier (Palmer & Harvey) at the end of the last financial year. Excluding this impact, retail operating cash flow was up 10.8%.

Exceptional cash items above include £(27)m relating to Shareholder Compensation Scheme payments. We expect the remaining cash outflow from claims still being processed to total £(18)m and have therefore released £15m of the c.£(60)m provision held on the balance sheet as at 24 February 2018.

We utilised £(32)m of our exceptional onerous lease provision in the half, of which £(3)m related to one-off costs to surrender leases and £(29)m related to ongoing lease agreements.

Cash capital expenditure of £(459)m was down 24.3% year-on-year as we maintained our disciplined approach to capital investment. Combined net cash interest and tax of £(274)m was £(101)m higher than last year mainly due to the resumption of tax payments in the UK.

We generated £134m of proceeds from property sales, including £66m on a number of small transactions in the UK and £58m relating to two Booker properties. We completed the buyback of Stroud superstore for £35m in the first half. Following the end of the first half we have completed the buyback of an additional store, Cirencester Extra, for £57m (net of costs and VAT).

A net cash outflow of £(139)m relating to market purchases of shares follows our commitment to offset any dilution from the issuance of new shares to satisfy the requirements of share schemes. We expect to utilise a total of around £(150)m cash in this and future years in line with this commitment, with the exact amount dependent on performance.

Acquisitions and disposals of £(693)m includes a £(704)m outflow relating to our merger with Booker in March 2018. The total cash cost excluded from our retail free cash flow definition is £(747)m, which includes a further £(43)m associated costs recorded within cash generated from operations. More detail on the breakdown of the cash impact of the Booker combination can be found in note 19 on page 45.

Capital expenditure and space:

Capital expenditure shown in the table above reflects expenditure on ongoing business activities across the Group. Capital expenditure for the half was £0.4bn, similar to last year.  In the UK & ROI, spend has been focused on the maintenance and refresh of our stores, along with a small number of openings in our convenience format in UK.  In Central Europe, capex relates mainly to the repurpose of our existing stores.  In Asia, our capital spend primarily relates to our new store opening programme in Thailand.

Across Central Europe and Asia, our repurposing programme has contributed a net reduction of (438)k square feet.  In Central Europe we have repurposed (271)k sq. ft. across nine stores, partnering with H&M, Decathlon and Costa Coffee.  In Asia, we have also repurposed nine stores, with the majority in Thailand where we have partnered with Mr.DIY, Echo Game & Karaoke and Cosmo Beauty.

In UK & ROI, we opened eleven stores primarily in our convenience formats in the UK, and closed a further five stores, including two Booker stores in March.  Central Europe had a net reduction of 20 stores, driven largely by the closure of 18 unprofitable stores in Poland.  In Asia, we had a net 39 store openings, primarily related to new store openings in our convenience format in Thailand.

Capital expenditure is expected to increase in the second half mainly due to the timing of maintenance spend in the UK. Capital expenditure for the full year is now expected to be no more than £1.2bn.

Statutory capital expenditure of £443m includes £35m relating to a property buyback.

Further details of current and forecast space can be found in Appendix 5 starting on page 56.

Tesco Bank:

Tesco Bank continues to focus on providing simple and straightforward banking and insurance products to customers. Active customer account numbers have reduced by (1)% year-on-year with growth in credit cards, loans and mortgages more than offset by a decline in car insurance policies, reflecting a highly competitive insurance market.

Operating profit before exceptional items increased by 6.0% year-on-year to £89m driven mainly by increased income and ongoing cost reductions. Exceptional items of £(21)m relating to Tesco Bank are detailed in Note 4 on page 31 and principally relate to a provision of £(16)m in relation to a settlement payment agreed with the Financial Conduct Authority (FCA) following an online fraudulent attack on Tesco Bank in November 2016.

Lending balances have grown by 13% year-on-year, with continued focus on secured lending growth. Mortgage balances have increased by 38% year-on-year and now comprise 29% of the lending portfolio. Unsecured lending grew by 5.1% to £8.6bn. The balance sheet remains strong and well-positioned to support future lending growth from both a liquidity and capital perspective with a Risk Asset Ratio of 18.2%.

The Group has adopted IFRS 9 'Financial Instruments' for the period ending 25 August 2018. IFRS 9 has been applied retrospectively at 25 February 2018 by adjusting the opening balance sheet at that date. For Tesco Bank, the adoption of IFRS 9 has resulted in a decrease in total assets of £223m, with a related deferred tax asset of £57m. The overall impact on equity was therefore a reduction of £166m. Further details on the impact of the adoption of this standard are described in Note 23 on page 47.

An income statement for Tesco Bank can be found in Appendix 6 on page 59 of this statement. Balance sheet and cash flow detail for Tesco Bank can be found within Note 2 starting on page 23 of this statement. Tesco Bank's half year results are also published today and are available at www.corporate.tescobank.com.

This document is available at www.tescoplc.com/interims2018

As with any business, effective risk management and controls are critical to successfully achieving the Group's strategy. Tesco has an established risk management process to identify, assess and monitor the principal risks faced by the business. A robust review of those risks that the Group believe could seriously affect its performance, future prospects, reputation or its ability to deliver against its priorities, is performed on a regular basis. The Tesco Board has overall responsibility for risk management and internal controls within the context of achieving the Group's objectives. At the Group level each principal risk has an Executive Owner. The Group Chief Executive has overall accountability for the control and management of risk.

The principal risks and uncertainties faced by the Group remain those set out on pages 22 to 25 of our Annual Report and Financial Statements 2018: customer; transformation; liquidity; competition and markets; brand, reputation and trust; technology; data security and data privacy; political, regulatory and compliance; health and safety; people; responsible sourcing and supply chain; Booker synergy realisation and integration; Brexit and Tesco Bank. There have been no significant changes to the description of these principal risks or key controls and mitigating factors in the period.

As previously reported on pages 22 to 25 of the Tesco PLC Annual Report and Financial Statements 2018, law firms in the UK have announced the intention of forming claimant groups to commence litigation against the Group for matters arising out of or in connection with its overstatement of expected profits in 2014, and purport to have secured third party funding for such litigation. In this regard, the Group has received two High Court claims against Tesco PLC. The first was received on 31 October 2016 from a group of 112 investors (now reduced to 78 investors) and the second was received on 5 December 2016 from an investment company and a trust company. The merit, likely outcome and potential impact on the Group of any such litigation that either has been or might potentially be brought against the Group is subject to a number of significant uncertainties and therefore, the Group cannot make any assessment of the likely outcome or quantum of any such litigation as at the date of this disclosure. Further details relating to this matter and the Group's other contingent liabilities can be found in Note 20.

The Directors are responsible for preparing the Interim Results for the 26 week period ended 25 August 2018 in accordance with applicable law, regulations and accounting standards. The Directors confirm that to the best of their knowledge the condensed consolidated interim financial statements have been prepared in accordance with IAS 34: 'Interim Financial Reporting', as adopted by the European Union and that the interim management report includes a fair review of the information required by DTR 4.2.7R and DTR 4.2.8R, namely:

• an indication of the important events that have occurred during the first 26 weeks of the financial year and their impact on the condensed consolidated interim financial statements, and a description of the principal risks and uncertainties for the remaining 26 weeks of the financial year; and

• material related party transactions in the first 26 weeks of the year and any material changes in the related party transactions described in the last annual report.

The Directors of Tesco PLC are listed on pages 28 & 29 of the Tesco PLC Annual Report and Financial Statements 2018, with the exception of Charles Wilson who was appointed to the Board until 16 July 2018 and Melissa Bethell who joined the Board on 24 September 2018. A list of current directors is maintained on the Tesco PLC website at: www.tescoplc.com.

By order of the Board

Directors

John Allan* - Chairman

Dave Lewis - Group Chief Executive

Alan Stewart - Chief Financial Officer

Deanna Oppenheimer*- Senior Independent Director

Mark Armour*

Melissa Bethell*

Steve Golsby*

Byron Grote*

Stewart Gilliland*

Mikael Olsson*

Simon Patterson*

Alison Platt*

Lindsey Pownall*

*Non-executive Directors

Company Secretary

Robert Welch

2 October 2018

This announcement contains inside information which is disclosed in accordance with the Market Abuse Regulations.

This document may contain forward-looking statements that may or may not prove accurate.  For example, statements regarding expected revenue growth and operating margins, market trends and our product pipeline are forward-looking statements.  Phrases such as "aim", "plan", "intend", "should", "anticipate", "well-placed", "believe", "estimate", "expect", "target", "consider" and similar expressions are generally intended to identify forward-looking statements.  Forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from what is expressed or implied by the statements. Any forward-looking statement is based on information available to Tesco as of the date of the statement. All written or oral forward-looking statements attributable to Tesco are qualified by this caution.  Tesco does not undertake any obligation to update or revise any forward-looking statement to reflect any change in circumstances.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 and reclassification of derivative interest income as explained in Note 1 and Note 23.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 as explained in Note 1 and Note 23.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 as explained in Note 1 and Note 23.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 as explained in Note 1 and Note 23.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 as explained in Note 1 and Note 23.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 as explained in Note 1 and Note 23.

The notes on pages 20 to 48 form part of these condensed consolidated interim financial statements.

* Restated for the adoption of IFRS 15 as explained in Note 1 and Note 23.

These unaudited condensed consolidated interim financial statements for the 26 weeks ended 25 August 2018 were approved by the Directors on

2 October 2018.

These unaudited condensed consolidated interim financial statements have been prepared in accordance with the Disclosure and Transparency Rules of the UK Financial Conduct Authority, and with IAS 34 'Interim Financial Reporting', as adopted by the European Union. Unless otherwise stated, the accounting policies applied, and the judgements, estimates and assumptions made in applying these policies, are consistent with those described in the Annual Report and Financial Statements 2018. The financial period represents the 26 weeks ended 25 August 2018 (prior financial period 26 weeks ended 26 August 2017, prior financial year 52 weeks ended 24 February 2018).

These condensed consolidated interim financial statements for the current period and prior financial periods do not constitute statutory accounts as defined in section 434 of the Companies Act 2006. A copy of the statutory accounts for the prior financial year has been filed with the Registrar of Companies. The auditor's report on those accounts was not qualified, did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying the report and did not contain statements under section 498(2) or (3) of the Companies Act 2006.

The Directors consider that the Group has adequate resources to continue in operational existence for the foreseeable future and have therefore continued to adopt the going concern basis in preparing the condensed consolidated interim financial statements.

Discontinued operations

In accordance with International Financial Reporting Standards (IFRS) 5 'Non-current Assets Held for Sale and Discontinued Operations', the net results of discontinued operations are presented separately in the Group income statement and the assets and liabilities of these operations are presented separately in the Group balance sheet.

Adoption of new IFRSs

The Group has adopted IFRS 9 'Financial Instruments' and IFRS 15 'Revenue from Contracts with Customers' effective for the period ending 25 August 2018. IFRS 15 has been applied fully retrospectively and comparatives for the prior periods have been restated, whilst IFRS 9 has been applied retrospectively at 25 February 2018 by adjusting the opening balance sheet at that date. Further details on the transitional impact on adoption of these standards is described in Note 23.

Prior period reclassification of hedged interest income and expenses

During the period, the Group reclassified interest income arising from derivative financial instruments hedging the Group's borrowings from finance income to finance costs. This reclassification more appropriately reflects the net finance cost to the Group. Prior period comparatives have been restated to align to the current period approach.

The impact of this reclassification on prior period balances has been a reduction of finance costs and finance income by £15m.

Line item name changes

"Loans and advances to customers" has been renamed "Loans and advances to customers and banks". There were no balances relating to banks in this line in the prior periods.

"Other investments" has been renamed "Financial assets at fair value through other comprehensive income"

Accounting policies

Impairment of financial assets

Since adoption of IFRS 9 on 25 February 2018, the Group assesses on a forward-looking basis the expected credit losses associated with its financial assets carried at amortised cost and at fair value through other comprehensive income. The expected credit losses are updated at each reporting date to reflect changes in credit risk since initial recognition of the financial asset.

The three-stage model for impairment has been applied to loans and advances to customers and banks, financial assets at fair value through other comprehensive income, and loan receivables from joint ventures and associates. The credit risk is determined through modelling a range of possible outcomes for different loss scenarios, using reasonable and supportable information about past events, current conditions and forecasts of future events and economic conditions. A 12 month expected credit loss is recognised, unless the credit risk on the financial asset increases significantly after initial recognition, when the lifetime expected credit loss is recognised. 

For other financial assets, primarily trade and other receivables, the Group applies the simplified approach permitted by IFRS 9, with expected lifetime credit losses recognised from initial recognition of the receivable. These assets are grouped based on shared credit risk characteristics and days past due, with expected loss allowances for each risk grouping determined based on the Group's historical credit loss experience, adjusted for factors specific to each receivable, general economic conditions and expected changes in forecast conditions.

Supplier financing arrangements

Management reviews supplier financing arrangements to determine the appropriate presentation of balances outstanding as trade payables or borrowings, dependent on the nature of each arrangement. Factors considered in determining the appropriate presentation include the commercial rationale for the arrangement, impact on the Group's working capital positions, credit enhancements or other benefits provided to the bank and recourse exposures.

Balances outstanding under current supplier financing arrangements are classified as accounts payables, since the financing arrangements are agreed between the supplier and the bank, and the Group does not provide additional credit enhancement nor obtain any benefit from the arrangements. These outstanding balances are not material to the Group.

Critical accounting judgements

During the period to 25 August 2018, the following judgements were made by management in applying the accounting policies to determine the presentation and reported amounts of assets, liabilities, income and expenses.

Operating segments

Following the acquisition of Booker Group PLC (Booker) on 5 March 2018, management has applied the guidance of IFRS 8 "Operating Segments" in determining the presentation of Booker's performance and balances within the Group.  Management has carefully considered a number of areas including how the business is managed on an integrated basis with the rest of the UK retail business, the strategic rationale of the merger in forming the UK's leading Food business, the significant synergies flowing across the UK businesses, and the level at which the Chief Operating Decision Maker (CODM) monitors performance and allocates resources to the business.

Based on these considerations, management concluded that the most appropriate presentation for Booker is within the UK & ROI segment. This presentation reflects that the CODM is monitoring performance and allocating resources at a combined UK & ROI level which includes Booker.

Standard issued but not yet effective

As of the date of authorisation of these condensed consolidated interim financial statements, the following standard was in issue but not yet effective:

IFRS 16 'Leases'

IFRS 16 'Leases' will be effective in the Group financial statements for the accounting period commencing 24 February 2019. The Group intends to adopt the standard retrospectively, with comparatives restated from a transition date of 25 February 2018.

IFRS 16 provides a single lessee accounting model, requiring lessees to recognise right-of-use assets and lease liabilities for all applicable leases. IFRS 16 is expected to have a significant impact on reported assets, liabilities and the Group income statement, as well as the classification of cash flows relating to lease contracts. The standard will impact a number of key measures such as operating profit and cash generated from operations, as well as a number of alternative performance measures used by the Group.

The Group's IFRS 16 Project is governed by a Steering Committee, which regularly reports progress to the Group Audit Committee. During the current reporting period, progress continued on the collation of the additional lease data required to support IFRS 16 calculations, establishing systems and processes required for accounting and reporting under IFRS 16 and in determining the appropriate discount rates to apply to lease payments. Until this work is complete it is not practical to provide a reasonable estimate of the financial effect of IFRS 16.

Alternative performance measures (APMs)

In the reporting of financial information, the Directors have adopted various APMs. These measures are not defined by IFRS and therefore may not be directly comparable with other companies' APMs, including those in the Group's industry.

APMs should be considered in addition to, and are not intended to be a substitute for, or superior to, IFRS measurements.

Purpose

The Directors believe that these APMs assist in providing additional useful information on the underlying trends, performance and position of the Group.

APMs are also used to enhance the comparability of information between reporting periods and geographical units (such as like-for-like sales), by adjusting for non-recurring or uncontrollable factors which affect IFRS measures, to aid users in understanding the Group's performance.

Consequently, APMs are used by the Directors and management for performance analysis, planning, reporting and incentive-setting purposes.

The key APMs that the Group has focused on in the period are as follows:

• Group sales: This is the headline measure of revenue for the Group. It excludes the impact of sales made at petrol filling stations due to the significant volatility of fuel prices. This volatility is outside the control of management and can mask underlying changes in performance.

• Like-for-like sales: This is a widely used indicator of a retailer's current trading performance. It is a measure of growth in Group online sales and sales from stores that have been open for at least a year (but excludes prior year sales of stores closed during the year) at constant foreign exchange rates.

• Operating profit before exceptional items and amortisation of acquired intangibles: This is the headline measure of the Group's performance, and is based on operating profit before the impact of exceptional items and amortisation of intangible assets acquired in business combinations. Exceptional items relate to certain costs or incomes that derive from events or transactions that fall within the normal activities of the Group but which, individually or, if of similar type, in aggregate, are excluded by virtue of their size and nature in order to reflect management's view of the performance of the Group.

• Retail operating cash flow: This is the operating cash flow from continuing operations, excluding the effects of Tesco Bank's cash flows.

• Retail free cash flow: Retail free cash flow includes all cash flows from operating and investing activities and the market purchase of shares net of proceeds from shares issued in relation to share schemes, excluding the effects of Tesco Bank's cash flows. The following items are excluded: investing cash flows that increase/decrease items within Net debt, and cash flows from major corporate acquisitions and disposals.

• Net debt: This excludes the net debt of Tesco Bank but includes that of the discontinued operations to reflect the net debt obligations of the Retail business.

• Diluted earnings per share from continuing operations before exceptional items and amortisation of acquired intangibles, net pension finance costs and fair value remeasurements on financial instruments: This relates to profit after tax before exceptional items and amortisation of acquired intangibles from continuing operations, net pension finance costs and fair value remeasurements on financial instruments attributable to owners of the parent divided by the weighted average number of ordinary shares in issue during the financial period adjusted for the effects of potentially dilutive share options.

Some of the Group's IFRS measures are translated at constant exchange rates. Constant exchange rates are the average actual periodic exchange rates for the previous financial period and are used to eliminate the effects of exchange rate fluctuations in assessing performance. Actual exchange rates are the average actual periodic exchange rates for that financial period.

Changes to APMs

During the period, the following change has been applied to the Group's APMs:

• The Directors and management have decided to exclude the amortisation of intangible assets acquired in business combinations from profit measures. The amortisation charge is excluded because management does not consider the incremental amortisation charge arising from acquired intangible assets when assessing the underlying trading performance of the Group. Business combinations which occurred before the acquisition of Booker did not result in a material amortisation expense arising from the acquired intangible assets.

As a result of the change above, the following APMs have been changed to exclude the amortisation of intangible assets acquired in business combinations:

• Operating profit before exceptional items and amortisation of acquired intangibles;

• Profit before tax before exceptional items and amortisation of acquired intangibles, net pension finance costs and fair value remeasurements on financial instruments;

• Earnings per share from continuing operations before exceptional items and amortisation of acquired intangibles, net pension finance costs and fair value remeasurements on financial instruments;

• Effective tax rate before exceptional items and amortisation of acquired intangibles; and

• Effective tax rate before exceptional items and amortisation of acquired intangibles, net pension finance costs and fair value remeasurements on financial instruments.

Operating margin is now calculated as Operating profit before exceptional items and amortisation of acquired intangibles divided by revenue.

Refer to the Glossary for a full list, comprehensive descriptions and purpose of the Group's APMs.

The Group's operating segments are determined based on the Group's internal reporting to the Chief Operating Decision Maker (CODM). The CODM has been determined to be the Group Chief Executive, with support from the Executive Committee, as the function primarily responsible for the allocation of resources to segments and assessment of performance of the segments.

Following the acquisition of Booker on 5 March 2018, management has applied judgement in determining the presentation of Booker within the UK & ROI Retail segment. Note 1 provides further details on the rationale for this presentation.

The principal activities of the Group are therefore presented in the following segments:

· Retailing and associated activities (Retail) in:

- UK & ROI - the United Kingdom and Republic of Ireland;

- Central Europe - Czech Republic, Hungary, Poland, Slovakia; and

- Asia - Malaysia and Thailand.

· Retail banking and insurance services through Tesco Bank in the UK (Tesco Bank).

This presentation reflects how the Group's operating performance is reviewed internally by management.

The CODM uses operating profit before exceptional items and amortisation of acquired intangibles, as reviewed at monthly Executive Committee meetings, as the key measure of the segments' results as it reflects the segments' underlying performance for the financial period under evaluation. Operating profit before exceptional items and amortisation of acquired intangibles is a consistent measure within the Group as defined within Note 1. Refer to Note 4 for exceptional items and amortisation of acquired intangibles. Inter-segment revenue between the operating segments is not material.

Income statement

The segment results and the reconciliation of the segment measures to the respective statutory items included in the Group income statement are as follows:

Balance sheet

The following tables showing segment assets and liabilities exclude those balances that make up net debt (cash and cash equivalents, short-term investments, joint venture loans and other receivables, bank and other borrowings, finance lease payables, derivative financial instruments and net debt of the disposal group). Net debt balances have been included within the unallocated segment to reflect how the Group manages these balances. Intercompany transactions have been eliminated other than intercompany transactions with Tesco Bank in net debt.