Cnova's (CNV) CEO Emmanuel Grenier on Q2 2016 Results - Earnings Call Transcript

| About: Cnova (CNV)

Cnova (NASDAQ:CNV)

Q2 2016 Earnings Conference Call

July 26, 2016 10:00 A.M. ET

Executives

Christopher Welton - IRO

Emmanuel Grenier - CEO

Stéphane Brunel - Group CFO and CFO, Cdiscount

Analysts

Richard Cathcart - Bradesco

Pedro Jimenez - Goldman Sachs

Cedric Lecasble - Raymond James

Stephen Ju - Credit Suisse

Operator

Greeting, and welcome to the Cnova Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Christopher Welton, of IRO. Thank you. You may begin.

Christopher Welton

Good day to all and welcome to Cnova's second quarter 2016 financial results conference call. My name is Chris Welton, Cnova's IRO and I will be your host on today's call. Joining me today are Emmanuel Grenier, our CEO and Stéphane Brunel, our CFO.

The presentation slides that go with this call can be viewed at and downloaded from our website. This call is also being audio webcast, and a replay will be available on our website about an hour after the conclusion of this call. The agenda for today's call is to go through the slides, highlighting key points, and then to open it up to the Q&A session.

If we look at slide two, this contains our forward-looking disclaimers and I emphasize that these apply to the entire presentation and the related documentation and I strongly encourage everyone should read these disclaimers now. Before we go over the slides, our CEO, Emmanuel Grenier would like to provide you with some opening remarks. Emmanuel.

Emmanuel Grenier

Yes, thank you Chris and good day to everybody. So before we go over second quarter results and answer your questions I wanted to address three things upfront. First, Cdiscount is doing well. Our volume of activities is being pushed by our price positioning and customer value proposition. Our marketplace continues to grow and we are working to add further revenue to our traffic. We are leading the market in France in terms of new delivery options. We are the only player in the market that can deliver so many free products on a Sunday and weekends and during the evening.

Second, we have gone through a major cleanup at Cnova Brazil. We have taken care of logistical problems. Inventory management is coming under control. The order stock situation and delivery times are improved and we are moving to improve the quality of our customer call center. And on top of that the new ERP allowance is completed and the internal review that has been ongoing for the past seven months is now completed. Management can now concentrate all of its time and energy on commercial activities.

And finally, now that the internal review in Brazil is over, we can move forward with the talks with Via Varejo regarding the possible reorganization of Cnova Brazil. We see this as a win, win, win situation. Cnova wins because it would be able to focus on its most dynamic market, France. Via Varejo wins because it would be able to grow its multichannel offer. Cnova Brazil wins because it would be able to take full advantage of Via Varejo extensive and energetic infrastructure in Brazil. And with that I will turn the floor back to Chris.

Christopher Welton

Thank you, Emmanuel. So as usual we have separated our presentation into four sections. First we will take a look at the key indicators for the quarter. After that Stéphane will go over in more detail the financial performance of the group before he takes us through the conclusions of the internal review of Brazil that we just completed. And finally Emmanuel will come back and give us an update on what is going on in France and Brazil.

So if we look at slide four, the key indicators. There are two main takeaways here; first, Cdiscount continues to do well. GMV is up 13%, nearly a third of that is coming -- of GMV is coming from the marketplace. Net sales increased close to double-digits in a market that has been affected by labor strikes, unseasonably cold weather, and of course unfortunately terrorist attacks. Second, the reset at Cnova Brazil is under way but its impacts are not expected to be felt until the second half of 2016.

Moving on to the next slide, lets drill down a bit into volume of activity. This pretty much matches with what I have just said. Cdiscount is doing well. It had close to a 13% increase in its GMV. This is a combination of the value proposition of direct sales, marketplace expansion, and other revenue streams coming online. And then there is Cnova Brazil which had a 30% decline in volume. Yes, a good portion of this is due to the recession that is wrecking the Brazilian economy but some of it is also due to internal dysfunctions that we have to iron out ourselves. We are doing this and we expect to see fruits of our labor soon.

Moving on to the next slide, here we look at three metrics that are driving our growth. First, the marketplace is growing fast. The number of sellers is up 37% year-on-year. The number of product offerings are up even more, plus 90% and the market share, place share of GMV is up more than 760 basis points. It is important to note that this is positively oriented in both France and Brazil.

Second traffic, up more than 16% at the Group level with the mobile share accounting more than 1000 basis points, excludes our expertise and customer loyalty program Cdiscount à volonté in France are key factors behind this very good performance. And third, the number of items sold is making gains as well primarily due to our positioning in electronics in France.

Now I would like to take you through some of the operational improvements that we have been working on. First, looking at Cdiscount we have upped our delivery gain. You can now receive your purchased items at night, on Sunday, or even by appointment. We are also moving into 3D packaging, a first in France to our knowledge. This optimizes the size of the package for the customer on one hand and increases truck fulfillment capacity on other. And it is worth noting that customer satisfaction as measured by NPS continues to grow.

Over at Cnova Brazil as we said earlier, the ERP migration costs include short-term customer disruptions but we are working through that. Our logistics have really improved and we are trying to improve our customers overall experience as well. And now I am going to turn the floor over to Stéphane who will take you through the financials as well as details of the internal review in Brazil.

Stéphane Brunel

Thank you, Chris. On the key figures slide, if we focus for a minute on Cdiscount France, we would see improvement across the board. GMV up, net sales in line, gross profit up with the gross margin better by 40 basis points, operating EBIT improved. And when we turn to Cnova Brazil it is pretty much the opposite. Remember we said that we initiated at the beginning of the year an ERP migration which is almost completed. We are confident that improvement is around the corner and that the second half of 2016 will be better than the first.

On this next slide we clearly see the potential for improvement at the Group level. Whilst the Cdiscount continues to do well, there is ample room for improvement at Cnova Brazil. Now there might not be much that we can do about the effects on ICMS impacts. But we can reduce the minus 127 million significant real/Euro mix in quarters trending eventually towards breakeven.

Now, turning to gross margin and SG&A. The gross margin at Cdiscount is progressing at 40 bps while that at Cnova Brazil has clear room for improvement. We expect these to get better in the coming quarters. In terms of SG&A Cdiscount has decided to increase its marketing spend resulting in the 20 bps increase which remains at the low-end of our 20 to 30 bps increased guidance we gave you for the full year. The Cnova Brazil cost structure has been penalized by the low level of volume as well as the fee migration and beyond that needs to improve expense reduction plan. As a percentage of net sales we expect fulfillment expense in G&A should reduce while tech and content should level us. This will give us the operating leverage we need to drive system enabled improvement in operating EBIT.

We see the potential for this on the following slide. Operating EBIT at Cdiscount is moving in the right direction resulting in an 11 million Euros improvement for the first half and we intend to continue this. Cnova Brazil's operating EBIT is expected to improve on a consistent basis over the next quarters. The negative cash flow is a reflection of the challenges that we have been facing. But our focus today is to build from here and improve operations. We have closed most of our international operations due to cash flow losses and 12 months free cash flow in France is expected to remain positive. We expect that negative cash flow to start to reduce and eventually move to zero over the next few quarters. For the time being we have put in place total financing the amount of $180 million to handle our near-term cash needs in Brazil.

Finally let's take one minute to summarize the issues that we have come across at Cnova Brazil. As more fully described in our 20-F from 2015, we have discovered a misconduct at our Brazilian distribution centers. In addition we have discovered misconduct as well within Cnova Brazil accounting department. As a result of the findings we decided to restate our previously issued financial statements. Additional detail concerning the finance of the review and the resulting adjustments updated in the 20-F. In addition, during matter of the internal review we performed a thorough review of Cnova Brazil's accounts and we have decided to add a more conservative accounting practices with respect to differed tax assets and suppliers contribution through the evaluation of inventory.

And now I will turn the floor back over to Emmanuel.

Emmanuel Grenier

Thank you, Stéphane. So, what are we working on at Cdiscount. First, customer service, in a way tentatively push our loyalty program Cdiscount à volonté which is working out quite well. As a result customer satisfaction which is measured on net promoter score or NPS is growing. This is helping us to increase the pool of our repeat customers.

Second mobile, it is important [ph] the mobile navigation platform you are unaware. We are well ahead of the account shift. Third, home is where the heart is. If you will see where we have a major competitive advantage in the market, we are going to grow in this category and make our number one position in France even stronger. Fourth, the marketplace, it is low cost revenue. We are bringing in funds [ph] under and we are adding new services such as fulfillment. Our plan is to multiply the number of value additions this year. And finally our express grocery service is going according to plan. All of our customers in Paris have 90 minute access to more than 4000 food items.

And to finish Cnova Brazil, look we have been quite transparent about the challenges we face in Brazil both internal and external. We have cleaned up internal problem and have also intensified three other areas where we can improve and see benefits in a relatively short timeframe. First, be good at what we do, a product that our customers want, increase free traffic to all the sides, and most importantly put the customer first in terms of service and how we treat them on a day-to-day basis.

Second marketplace, increase network and sales while making good progress here and finally improve the productivity of our dishes. We have streamlined profit deals and we are working with Via Varejo to promote synergies and share we discussed. In Brazil, Cdiscount is being awaited and we are working to build on that platform. Cnova Brazil is making progress but still has some way to go. And we are considering for the future. And that concludes our said presentation. We are now ready to turn for the Q&A. Operator may we have the first question please.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Richard Cathcart, a Private Investor. Please go ahead.

Richard Cathcart

Hi, it is Richard Cathcart from Bradesco today out here. Just a couple of questions on the performance in Brazil, first of all on the gross margin we found around 300 basis points instead if we looked just at the direct sales business it must be more, can you just go through if you have to prior visit the decline in that gross margin, I mean, is it more promotions, is it kind of lower prices across the board, has any of this got anything to do with the improvements you need to make in customer service or deliveries or the move to ERP -- the new ERP? And then secondly how much kind of that transition to the system has kind of had the negative impact on sales growth over the last three months? Thanks.

Stéphane Brunel

Okay, thank you very much Richard. Your question with respect to change in gross margin in Brazil is quite a tough one to explain. For sure we believe that the 300 basis points decrease in the overall gross margin reflects as well the impact on the gross margin for 1P [ph] product. In addition you have the positive impact of course of the share of the marketplace which is counterbalanced by negative change in the gross margin of B2b activities in Brazil.

With respect to the overall market environment, yes, the market is competitive as you know. And yes, we have been quite promotional on this quarter. With respect to the transition to the ERP I will let Emmanuel now answer your question.

Emmanuel Grenier

Yes, hello Richard. In fact it is very hard to answer the question very precisely but what I can you tell you during the year -- some weeks -- the ERP migration we had to make longer delivery times because we have to learn how to work with this new ERP. So we add the delivery times way longer to pool well during this. But now this is fixed. The system is stabilized so we went back to the delivery times we had before the migration.

Richard Cathcart

Okay, thanks and then just kind of quickly a follow-up. You mentioned in your comments before about making improvements to your customer services centers, again is this willing to reassure the new ERP system, do you have any kind of metrics to show perhaps the duration and improvement in customer perceptions?

Emmanuel Grenier

Yes, when we started in February our action plan in customer service, we improved a lot in the last -- in the first two months and with the ERP we have the same impact on the logistics and very good times. But we are not as good as before during the one and half to two months, no. Since last week we are working and we have now the same results as before the ERP migration. So, we had some tough times during the two months but this we are recovering and now we are going to improve and to get better than before the ERP migration.

Richard Cathcart

Okay, thanks. And then just a final question, you mentioned before about moving back towards breakeven in Brazil the following few quarters, I mean is there any specific target on when you make up back to breakeven at the EBIT level in Brazil? Thanks.

Stéphane Brunel

Yes Richard, it is true that we mentioned in the early days of this year that original target was to reach breakeven in Brazil at the EBITDA level for the full year which basically translates into a minus 50 million Euros, something like that at the EBIT level. And obviously after the performance of the first half and/or minus 58 million Euros EBIT for the full first half of 2016 we don’t think that this internal target is likely to be achieved. For sure I think that we have two key priorities for the second half of this year. The first one is to improve the net sales trends significantly from where it is and secondly to improve the second half of 2016 EBIT significantly from the second half of 2015 EBIT last year.

Richard Cathcart

Okay, thanks very much.

Operator

Thank you. Our next question comes from the line of Pedro Jimenez from Goldman Sachs. Please go ahead.

Pedro Jimenez

Hi, hello everyone. Thank you for taking my question. The first one I have two actually, the first one more specifically in Brazil, I was hoping you could run us through the trends in terms of take rates in Brazil specifically and for your marketplace? And the second question is regarding the MOU is with Via Varejo, what are the next steps and planning or anything else you could add in this regard? Thank you very much.

Stéphane Brunel

Okay, so just answering briefly your questions, with respect to the marketplace in Brazil for the second quarter, the marketplace share of the GMV was 16.6%, that is close to 800 basis points year-on-year. So, we are quite pleased with our marketplace growth and positioning in Brazil. It grows well.

Then let's take your second question which is the status of the discussions with Via Varejo regarding a possible potential combination with Cnova Brazil. Obviously we are actively pursuing discussions with Via Varejo, Via Varejo special committee, and its advisors. And as you know we have finalized and published our 20-F and concluded our internal investigation which is obviously a key milestone. And we will communicate with you once or if a disciplined agreement is reached.

Pedro Jimenez

Thank you. On the first question in Brazilian marketplace, what could you add into most trends with regards to the take rates more specifically, have they increased even in your marketplace or competition?

Stéphane Brunel

Thank you very much for this. Our take rate is about stable for us and nothing has changed and it has been stable for the past quarters. And we are happy with the position we have.

Pedro Jimenez

Okay, could you give us a reference of what are the level for your current take rates?

Stéphane Brunel

So, as you know we grew category by category. So different take rates according to the kind of product we are selling. On average we are around 13% in Brazil which is obviously an average for the whole product mix and that can change according to product mix.

Pedro Jimenez

Okay, that is really helpful. Thank you very much.

Operator

Thank you. [Operator Instructions]. Our next question comes from the line of Cedric Lecasble from Raymond James. Please go ahead.

Cedric Lecasble

Yes, good afternoon gentlemen. A very easy one from me on the way you manage the French business, could you tell us for Cdiscount how you managed the couple between profitability and market share, how you invest, how you decide to invest more or less in marketing expenses, client acquisition cost, how do you manage that over the long-term and what are your mid to long-term targets in France? Thank you.

Emmanuel Grenier

Clearly our long-term target is to increase our market share year after year on the French market is the first thing. The second thing is our strategy on that is very clear. We have been the same for several years. We have really low prices in France between 5% and 10% compared to the competition. And we own this and stick to the point we have been investing in low marketing in the last year around 1% not more. So, when everybody is investing between 4% and 5% we are at 1% of net sales in marketing.

So our price variation is very low and mid on prices and low marketing. Now we decided this year to move it and push really hard on delivery options. So we developed in the last coming year to Cdiscount [ph] which is growing very fast and the number of subscribers this year grew 120% compared to last year. And as we explained we opened lot of new delivery options for big products because as you know certainly we are leader in France in home appliances and furniture. So we are able to deliver Paris and surroundings same day, on Sunday, and night. So to be able to conclude delivery on prices by minimum of 5%, low marketing, and push very hard on delivery options.

Cedric Lecasble

Okay, but you don’t include the promotional campaigns spends in this marketing spend?

Emmanuel Grenier

Promotional campaigns are in the gross margin. Promotional campaigns are included in the gross margin.

Cedric Lecasble

So, maybe my question also relates to how do you decide from time to time to be more aggressive on promotional campaigns and how do you -- and maybe it is the same question if I may in terms of previous one, on to take commissions in France for your marketplace that could be very useful also?

Emmanuel Grenier

You know in promotions we are very promotional and this is coming from our Cnova where as Cdiscount was low in pricing and high promotions. But this is accelerating the company from here. High promotion order and our customer was like that and they are coming back to Cdiscount for that. This is not a choice not to be or to be. We are and this is returning our business well. About the take rates of the marketplace, this is around 12% for France.

Cedric Lecasble

Thank you very much.

Operator

Thank you. [Operator Instructions]. Our next question comes from the line of Stephen Ju from Credit Suisse. Please go ahead.

Stephen Ju

Okay, thank you. So, Emmanuel I think unfortunately in France you had your share of external distractions and I think major sports tournaments during the second quarter. So, is there anything you can share about the current state of consumer activity in the country and Brazil also I think, if there is anything you can share in terms of whether the overall consumer sentiment is improving there? And also in terms of your marketplaces platform share improvements, where do you think you are gaining share from? Thanks.

Emmanuel Grenier

[Indiscernible] France. As you know French environment has been soft but Brazil serious effects. Not only one but several and there were strikes due to censorship by the government. So, it didn’t help us but at the end since we cannot control we focus on things we can control. So I spoke about Cdiscount à volonté, there are so many options, marketplace and new buyers. About Brazil, this is changing. You know that better than us and all the players are facing changing conditions. So all what we can control there is different. It is not basic, it is no doubt out of stocks, delivery times, things which were slow in terms five or six years ago we have to solve them now in Brazil.

We are working on search engine, we are working on mobile, we have cleaned up the back office. We are looking into improve the account and look at some experience on the side. Now coming to -- about the marketplace, I think that there are three things are in there on our marketplace. First, we have enough traffic. Just for you to know, in late April and May Cdiscount had the second in the April and first in May. Second in terms of growth and traffic in France, the older reference [ph]. It means that we are ahead of them. This is according [indiscernible] which is a French institute which is measuring traffic on the site.

So first we have sites where there is traffic, second we have these services like four times for instant payments in installment. I know that it is very common in the U.S. but in France we are the only player to be able to offer payment in installment. We got booking and we get to pay profit to person [ph]. We are the only one. It seems strange to U.S. people that if you like that in France. And the third one is our fulfillment services. We started towards our fulfillment services to win about one and half year ago and we have no more than 700 vendors taking advantage of our fulfillment services. It proves that we are taking advantage of our peek and collect network, of our same day delivery, of our Cdiscount à volonté program and this is why they like that.

Cedric Lecasble

Thank you.

Operator

Thank you. Our next question comes from the line of Richard Cathcart with a follow-up. Please go ahead.

Richard Cathcart

Yeah hi, just a final follow-up on Brazil. I am just wondering if so far in the third quarter you have seen any improvement in the top line trends, so second quarter GMV is down almost 20% in constant currency is that beginning to improve or are we still at the kind of level of around minus 20%?

Stéphane Brunel

Thanks Richard, for the time being the current trending in Brazil into Q3 is basically in line with Q2 performance.

Richard Cathcart

And should we -- then does that mean for the gross margin as well or are there any kind of different trends there on one of the gross margins?

Stéphane Brunel

You know it is too early -- it is perhaps too early into the quarter to tell and what to show that we are convinced that having done all that has been done we should improve the top line and sustain gross margin in the second half. It is perhaps little bit too early to be actually precise about the outlook given and the status of our performance right now. But we can say that from a top line perspective for the first three weeks of July that we are in line with the future.

Richard Cathcart

Okay, thanks very much.

Operator

Thank you. [Operator Instructions]. Our next question is a follow-up from the line of Pedro Jimenez. Please go ahead.

Pedro Jimenez

Hi, thank you. Just a follow-up question, I see in your presentation that a lot of your key initiatives to expand the marketplace in Brazil will be and I quote "expense level base focusing on coaching and quality control", could you elaborate a little bit on what are these coaching and quality control initiatives you are putting in place in Brazil in your marketplace? That's it, thank you very much.

Emmanuel Grenier

Yes, coaching is, you know, U.S., UK, France are quite mature in the marketplace but Brazil is not mature at all. This country is not mature. So we have to explain to them in this coaching, how business work, what they have to do and how they have to behave with the customer. It seems to be very obvious that it isn’t. And about quality, obviously all these under even in France they don’t have this. So basically we have to check this quality every week, every month, and we have stopped the vendor which has not the good level of quality. Because when these guys can deliver the good quality they have an impact on the quality of the site.

Pedro Jimenez

Okay, just on the coaching, is this just specifically for your TATs [ph] line or do you provide any current guidance with regards to product offering in the consulting service in that regard?

Emmanuel Grenier

So far this is only about the plus one.

Pedro Jimenez

Okay, guys thank you very much.

Operator

Thank you. [Operator Instructions].

Emmanuel Grenier

So just to sum up

Operator

Ladies and gentlemen we have no further questions in queue at this time. I would like to turn the floor back over to management for closing remarks.

Emmanuel Grenier

Yes, Emmanuel speaking, just to sum up very briefly France is doing well and gross margin is expanding. We have run through a major clean up activity in Brazil and the 2016 and 20-F clears the way to create and this is key the win, win situation for Cnova, Via Varejo, and Cnova Brazil. Thank you very much.

Operator

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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