AA : Strategy Update

LEI: 213800DTPE4O5OI17349

This announcement contains inside information

Building a better AA

Putting Service, Innovation and Data at the heart of the AA

The AA is today presenting our new business strategy to innovate and grow the Roadside business and invest to accelerate the growth of the Insurance business.

Simon Breakwell, Chief Executive of the AA, said:

'The AA is a phenomenal business, with a market leading position in Roadside, a highly respected and trusted brand and thousands of highly skilled and committed employees with a deeply embedded customer service ethos. My review into all aspects of our business, from the bottom up, has further strengthened my confidence about the opportunities ahead of us and convinced me of the positive long-term outlook for the AA.

The strategic plan I am setting out today will unlock the full potential of the AA by delivering targeted and strategic investment in our people, our products, our systems and operations. We are building on the solid foundation that our investments since the IPO have created. It will take the AA from a company helping when you break down to one actually predicting when you might break down in the first place. This plan will deliver front line resource to improve the efficiency, predictability and resilience of our operations as well as investment in game-changing growth drivers - in Connected Car and Insurance. These investments, while reducing our short term profitability, are vital to our long term success. I am confident the priorities we set out today will transform our products and service offerings to our customers by creating a truly innovative and differentiated product proposition which will deliver long term shareholder value.'

Highlights

· Innovate and grow Roadside and accelerate the growth of Insurance with combined incremental investment of £45m of opex and capex in FY19

Roadside - innovate and grow

· Further embed the AA app as our 'core digital hub', building on the 35% of members who have already registered for it, and 100,000 accessing member benefits monthly

· Extended roll out of our Connected Car product to tens of thousands of our existing customers to establish customer impact and operational benefit

· Target new, younger customer groups to grow Roadside membership through new products and services

· Complete investment in Roadside membership systems to boost renewals, improve loyalty, and grow customer retention

Roadside - improve service resilience

· Invest in front line customer support to improve efficiency, predictability and resilience of Roadside - creating 65 new roadside patrols and jobs for 200 new call centre agents

Insurance - accelerate growth

· Broaden footprint by targeting new customers who have never been members of the AA and younger drivers

· Develop more competitive pricing through greater agility from investment in IHP (insurer hosted pricing) and improved customer analytics

· Integratedigital and Connected Car products and data across businesses to provide a leading customer offering through its simplicity and as a one-stop-shop for motoring needs

Updated financial guidance

· Following the strategic review, the additional investment the AA will make to support the business has resulted in a change in expectations for FY19. We expect Trading EBITDA of £335m to £345m in FY19

· This is the basis upon which we can return to growth, targeting annual Trading EBITDA growth of 5% to 8% from FY19 to FY23

· Despite the capex and opex investments, we expect to remain cash generative in FY19 and to generate in excess of £80m of free cash flow in FY20 and in excess of £100m pa thereafter

· We remain confident that our financial requirements are well funded

Dividends

· As a result of the investment outlined today and the operation of the dividend gating covenant under the Whole Business Securitisation, the Board has changed its policy on dividends. We propose paying 2p per share per year until such time as the Board is satisfied that the profit and free cash flow enable a change in policy

· We currently expect the dividend in respect of FY19 to be split 0.6p per share for the interim and 1.4p per share for the final

· We currently expect to declare a final dividend in respect of FY18 of 1.4p per share. Added to the interim dividend already paid, this would give total dividends for FY18 of 5p per share

Further enquiries

Investor Relations 0207 395 7301

Jill Sherratt

Zeeshan Maqbool

Media (Finsbury) 0207 251 3801

Jenny Davey

Philip Walters

[e-mail]

Presentation

Simon Breakwell, CEO, and Martin Clarke, CFO, will present the new strategy on Wednesday 21 February. It will be available to investors and bond holders on the AA plc website from 9am.

Webcast: http://www.investis-live.com/aa/5a7d7b9d2ce6891300608f05/ntsn

Dial in: [phone]

Password: 89 37 21

Replay: UK: 0203 936 3001

US: [phone]

All other locations: [phone]

Password: 82 02 05

The strategic update

The strategy set out today will invigorate the AA by putting service, innovation and data at its heart. By developing a digital product proposition which can transform our customers' experience. This will enable us to innovate and grow our Roadside business and accelerate growth in our Insurance business.

Following Simon Breakwell's appointment as CEO on 25 September 2017, he led a rigorous, bottom-up review of the business. The Board has closely examined a range of scenarios for the AA and concluded that this strategy maximises long-term shareholder value.

This strategy builds on the AA's fundamentals, which remain as strong as ever. The AA is the clear market leader both in its consumer and business to business (B2B) Roadside markets. The brand remains one of the UK's most trusted, built on a strong service ethos. Investment since the IPO in marketing, our core IT systems and technology has strengthened the foundations, slowed the decline in Roadside membership and returned motor insurance to growth.

However, challenges remain, particularly for Roadside. These include regulatory changes, pricing transparency, need for a more distinctive and differentiated offering and competitive pressures. Against this backdrop, we need to do more to enhance and build our customer proposition for new and existing members. There is a clear opportunity to develop a digital proposition which can transform our customers' experience. We also have the opportunity to accelerate growth in our insurance business where we have not capitalised on our potential. By investing in the business we have the opportunity to build a business delivering sustainable profit growth.

This strategic plan will be delivered in three phases as we test and iterate new digital propositions and open up our Insurance offering. It will be underpinned by improving our operations, service, and culture. By phase three, we will fully utilise our data and digital offering to deliver connected, integrated Roadside and Insurance propositions that will give us a strong competitive advantage.

Innovate and grow Roadside Assistance

The strategy builds on a strong base. Since the IPO, we have increased paid new membership by 23% and improved retention by 3 percentage points. Our service ethos and dispatch system are strong. The foundations of our digital development are in place and our core membership IT system is well advanced. Despite this, we have not been able to grow our membership in a sustained manner.

Roadside initiatives

1. Connected Car

We are uniquely positioned to play a central role in shaping the way the market reacts to emerging trends, such as Connected Car, electric and hybrid vehicle growth and changing ownership models. We believe these present opportunities for the AA and are already advanced in our Connected Car development. Our implementation will mean that we are not simply layering digital onto the organisation, but actively embedding it deeply into our product set and operations.

Connected Car is expected to transform our Roadside offering by driving real benefits for customers as well as reducing costs. The AA's prognostic expertise and new products will enable us to move from reacting to breakdowns to predicting, preventing and protecting customers against them. Our trial and experience, since launch of Car Genie in August, demonstrates the potential to predict up to one third of breakdowns. Such digital products will appeal strongly to younger customer segments and continue to strengthen already significant app engagement. They have also attracted significant interest from our B2B partners and we are exploring ways to leverage these products with them.

During FY19, we will invest in rolling out Car Genie to tens of thousands more of our customers, allowing a larger-scale test of its impact on membership retention, operational benefits and distribution models. This will lead to the offering of a fully integrated, connected membership proposition. From FY20 we plan to extend the rollout to include B2B partners and connected insurance propositions, and to drive mass adoption. We believe we can reach scale with B2B partners from FY21.

2. Growing our base with younger segments

In addition to our traditional 50-year plus core demographic, we are now marketing to a younger base. We have already grown in younger customer segments over the past 12 months, but there is clear room for further growth in these under-penetrated segments. We will appeal to the needs of younger customers for a breakdown service to be simple, easy and digital through our innovative new products.

3. Digital adoption

Our breakdown app is highly successful and already over one third of our members have registered for it. The app simplifies the breakdown experience and 20% of consumer member breakdowns no longer involve a call as they are reported directly through the app or online. We will build on this to appeal to new customer segments and engage them in our app as a portal to a wider set of services and benefits, while reducing call centre costs.

The app is crucial to making the AA more relevant in the lives of our members and driving loyalty through membership benefits. Our app engagement programme is designed to expand the number of users who log in regularly and grow the number of users of our member services and benefits programme from its current level of more than 100,000 per month.

4. Membership systems investment to drive retention

We will invest in new systems to strengthen membership retention, increasing the sophistication of our retention activities. This will include the full implementation of the brand new membership IT system, including the Customer Relationship Management (CRM) system. Our 'Stay AA' reactive customer retention proposition continues to be effective, with an all-time high save rate of 72%, up from 57% at launch in 2014, and a discount rate at an all-time low of 22%, down from 35% at launch. We believe these actions can continue to increase retention.

Key targets for our Roadside business:

· Return to membership growth in FY21

· 50% of all members to be registered on the app by FY21

· 20% reduction in breakdowns reported through contact centres

We have included the costs but excluded the upside we anticipate from our Connected Car plans.

Accelerate growth in Insurance

The AA's Insurance business has fundamental strengths and we have a significant opportunity to accelerate growth over the next five years. Progress to date has been excellent, particularly in returning the motor book to growth, but we believe that with further investment in both our broker's pricing agility and our underwriter, we can accelerate that growth.

We have significant scope to sell insurance to Roadside members (only 9% of our 3.3m base have AA motor insurance) as well as non-members (whom we have not targeted in the past). We will build on our brand consideration, which is the highest in motor insurance, and our valuable data and analytics. Growing the underwriter will require solvency capital, half of which we can fund from the profits of the underwriter. A further £20m to £25m will be funded from PLC resources.

While additional growth is expected to result in a short-term negative impact on EBITDA, it will help deliver long-term growth. We are targeting c2m motor and home policies by FY23 and growth in profitability.

Insurance initiatives

1. Broaden footprint to include non-members and younger customers

We will target greater market share and growth from broadening beyond our narrow customer base. In our Underwriter, we are currently focused on 30-year plus members and former members, but we will expand our proposition to underwrite non-members, including younger customer segments. This will also promote opportunities to cross-sell Roadside membership.

2. Driving more competitive premiums

Since its launch two years ago, the underwriter has grown rapidly by using our proprietary data to drive more competitive premiums and, in its first year, bringing in a majority of customers who were new to AA Insurance. We will also continue to invest in IHP, which enhances our broker's pricing agility, and improve our data analystics. This investment will allow us to create bespoke pricing and unique insurance products for customers which more accurately meet their needs.

3. Digital and Connected Car offers

We expect to benefit from using the data collected from Car Genie, and other Connected Car products, prior to pricing and insuring customers, allowing for compelling telematics economics.

The integration of our digital and Connected Car products and data across our Roadside and Insurance businesses will enable a leading customer offering through its simplicity and as a straightforward, one-stop-shop for motoring needs.

We believe Connected Car offerings will unlock new propositions for younger, more digitally-focused drivers. The Driving School also gives us strong positioning with younger driver segments, reaching c100,000 customers per year.

Restore operational and service excellence

Building resilience into our operations and service will enable us to achieve more consistent service delivery. We plan to improve customer service at peaks in demand and decrease our reliance on third party garaging. We believe that investment in the front line, including additional patrols and call centre agents, will give us the resilience we need to achieve consistent service levels. In addition, our new leadership team is conducting a management restructuring and has plans to improve efficiency. In addition, we are reviewing ancillary sales performance.

The measures to be undertaken in FY19, will build a more resilient base for improving both service and cost with the following targets:

· Absorb inflation in FY20 and FY21

· Improve consistency of call-to-arrive times to 45 minutes

· Increase consistency in call handling, answering 80% of calls in 20 seconds

· Achieve 10% growth in ancillary sales

Create a high-performance culture

Driving a culture of high performance will be critical to realising our strategy because our people are a key enabler of our business. Our three year planning process will focus on delivery, clear accountabilities and embedding operational improvements. Key drivers will be greater agility and improved listening and engagement.

The financial implications of the strategy

As a result of the new strategy, FY19 Trading EBITDA is expected to be between £335m and £345m. We expect a net impact from a decline in Roadside revenue on Trading EBITDA of c£12m. This reflects a marginal decline in memberships and business customers and the IPT increase of June 2017. Growth in the insurance motor book is expected to contribute £9m to Trading EBITDA.

Our planned investments are expected to amount to £26m of additional operational expenditure in FY19. We will invest £15m across all initiatives in Roadside, including operations, enhancements to the digital platform and Connected Car. Growth in our Insurance portfolio is expected to result in lower short-term profitability in FY19 and incremental operating costs of c£10m.

Strategic projects are expected to generate EBITDA of £6m this year. These largely relate to the acquisition of AA Cars, in which we held a 50% profit share, and the disposal of our Home Services consumer business which we previously announced.

We expect a number of one-off adjustments and releases, partially offset by non-recurring tax benefits, to negatively affect FY19 EBITDA by £14m.

Additional central and people costs, net of savings, and additional pension charges, following last year's triennial review, is expected to lower EBITDA by £12m.

Growth projections to FY23

From the base in FY19, we expect to grow revenue and Trading EBITDA to FY23. The benefits of the investment in Connected Car are not included in these estimates.

	Revenue CAGR from FY19	Trading EBITDA CAGR from FY19
Roadside Assistance	2% to 5%	3% to 6%
Insurance Services and the Underwriter	6% to 9%	9% to 14%
Group	3% to 5%	5% to 8%

Capex guidance

1. IT transformation

As indicated at the interim results, we expect the balance of the original IT transformation programme to cost an additional £35m, with £31m incurred in FY19 and the balance of £4m in FY20. The last leg of the IT transformation relates to the roll-out of the membership system and CRM to our existing members, which has now commenced.

2. Growth capital expenditure

Capital expenditure to drive growth of £19m relates to the investment required to position the AA for growth from FY19. This includes the enhancement of our Roadside digital capability, additional investment in IHP, new systems and solvency capital to support the growth of the underwriter. It also includes our planned investment in Connected Car of c£7m per year over the next three years.

3. Maintenance capital expenditure

We expect maintenance capital expenditure to be stable at £55m over the next three years. This includes additional IT maintenance spend given the increased sophistication and scale of our requirements.

Strong free cash flow normalising after low point in FY19

Factoring in the lower EBITDA and additional growth capex in FY19, we expect free cash flow to equity this year to be c£20m. Adjusting for the one-off impacts in FY19, our normalised free cash flow to equity would have been in excess of £100m.

Following the low point in FY19, we are confident that we can deliver free cash flow to equity in excess of £80m in FY20 and in excess of £100m from FY21. Having created a more resilient base from which to grow profits and with normalised levels of capex, we believe we will be in a position to delever.

Dividends

We operate under a dividend gating covenant relating to the leverage of the senior Class A notes. The release of cash from the Whole Business Securitision (WBS) debt structure to the PLC level can only be permitted providing the senior leverage ratio, after payment, is less than 5.5x and providing there is sufficient excess cash flow to cover the payment. We currently have cash of c£80m at PLC level, outside of the WBS.

· Dividend policy

As a result of the investment outlined today, and the operation of the dividend gating covenant under the WBS, the Board has changed its policy on dividends. We propose paying two pence per share per annum until such time as the Board are satisfied that profit and free cashflow enable a change in dividend policy.

· Dividend proposal for FY19

We currently expect the dividend in respect of FY19 to be split 0.6p per share for the interim and 1.4p per share for the final.

· Dividend in respect of the Financial Year ended 31 January 2018

We currently expect to declare a final dividend of 1.4p per share in respect of FY18 as part of our final results scheduled for 17 April 2018. Added to the interim dividend already paid, this would give total dividends for FY18 of 5p per share.

The strength of our debt structure

We remain well funded to meet all of our operational and debt financing requirements. The combination of our WBS debt structure, our successive refinancings and our strong cash generative business model give us the following attributes:

· The average cost of debt, at 4.52%, is significantly lower now than it was at IPO

· The average maturity of our debt is just over 5 years

· We have significant headroom above our financial covenants which are not linked to leverage. Trading EBITDA would have to fall to c.£200m for us to be close to breaching our default covenants

· The WBS is flexible from an operational perspective and its credit enhancing characteristics enable refinancing at attractive rates

· Long-dated bonds paying fixed interest rates and pricing reflecting the investment grade of the A notes

· We pay a lower debt service charge than we would with a traditional bank facility as a result of the lack of amortisation on debt payments

Conclusion

The strategic plan will unlock the AA's potential by fundamentally transforming the way we support our customers through a differentiated product proposition. This will enable us to innovate and grow Roadside and accelerate growth in Insurance, securing a better future for the AA, our members, customers, employees and investors.

Disclaimer

This announcement contains 'forward-looking statements' which are prospective in nature and are not based on historical facts, but rather on current expectations and projections about future events. Such statements are therefore subject to risks and uncertainties which could cause actual results to differ materially from the future results expressed or implied by the forward-looking statements. Often, but not always, forward-looking statements can be identified by the use of forward-looking words such as 'plans', 'expects' or 'does not expect', 'is expected', 'is subject to', 'budget', 'scheduled', 'estimates', 'forecasts', 'intends', 'anticipates' or 'does not anticipate', or 'believes', or variations of such words and phrases or statements that certain actions, events or results 'may', 'could', 'should', 'would', 'might' or 'will' be taken, occur or be achieved. By their nature, forward-looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future. There are a number of factors that could cause actual results and developments to differ materially from those expressed or implied by such forward-looking statements, including business, economic and regulatory changes as well as the risks set out in the AA's annual report and accounts, which can be found on its website (www.theaaplc.com/investors). Such forward-looking statements should therefore be construed in the light of such factors. Neither the AA, nor any of its associates or directors, officers or advisers, provides any representation, assurance or guarantee that the events expressed or implied in any forward-looking statements in this announcement will actually occur. You are cautioned not to place undue reliance on these forward-looking statements. Other than in accordance with its legal or regulatory obligations (including under the Market Abuse Regulation, the Listing Rules and the Disclosure Guidance and Transparency Rules), the AA is not under any obligation to update, revise or correct any forward-looking statements, whether as a result of new information, future events or otherwise. No statement in this announcement should be construed as a profit forecast or relied upon as a guide to future performance.