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Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's X5 First Quarter 2018 Financial Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, 26th of April 2018. I would now like to hand the conference over to your first speaker today, Maxim Novikov. Please go ahead, sir.
Good morning and good afternoon, ladies and gentlemen, and thank you very much for joining us on this call where we would like to discuss X5's Financial Results for the First Quarter of 2018 as well as the recent changes to our team, which we have announced yesterday. Participating in the call today are our Chief Executive Officer of X5 Retail Group, Igor Shekhterman; Chief Financial Officer of X5 Retail Group, Svetlana Demyashkevich; and myself, Maxim Novikov, the company's Head of Investor Relations and Market Analysis. I'd like to remind you that we disclosed the press release and financial results this morning via our website LMS system and through our e-mail distribution list. Both the release and the presentation for the call are currently available on our website in the Investor Relations section. And before we start, I would like to draw your attention to the fact that some of the information that might be announced during this call may contain projections or other forward-looking statements regarding future events and future financial performance of X5 and please refer to the details to the beginning of the presentation for a full disclaimer with regards to such statements. I will pass the floor to Igor, who will comment on recent management changes in the company.
Thank you, Max. Good afternoon, ladies and gentlemen. To start off, I want to say a few words about [indiscernible] supervisory board decreased [indiscernible]. The decision was taken after many months of difficult discussion with [ Volga ] about the most strategic principles that will guide Pyaterochka development in the market landscape, and have changed significantly. Unfortunately, it hasn't been be clear for some time now because they need a fresh approach in order to succeed in the current environment, and to advance to the next stage of growth. The resulting phase of the company performance I believe demonstrates the risk is being start new ways in the areas where environment is changing quite rapidly. The key focus of the discussion was a necessity to timely acknowledge even the most glaring needs [indiscernible]: a serious focus on returns efficiencies; and more balanced approach toward selling space expansion and to prepare the company for a disruptive future and to respond accordingly. There is no denying that Pyaterochka performance well for a number of a years, under hold of the leadership, but the markets have moved on, the landscape has changed, and for any proximity format operator, even for the #1 player -- to succeed, we need a leader who understands how to take on a new challenge that we all face. Part of what it takes to succeed in the future is the ability to pay special attention to our culture and our corporate family, which must be based, not on a particular store front, but on a great team of professionals where each voice and opinion is valued and discussed. First and foremost, [indiscernible] is a team and our success is the team's success. I know that our competitor have worked Pyaterochka growth in the recent year and very carefully, and we have studied our average move very carefully. But while this approach may deliver first on result, Pyaterochka and X5 will already be at a far more advanced stage of development. As to the next step, as we have discussed in our recent meeting with investors, we have completed an important phase in the company's strategic development. We are now entering into a new phase, which is characterized by a different set of challenge and require a new set of skill. The market keeps changing, and the company must adapt without being limited to the same old solutions and approaches that worked in the past. In terms of external factor, this new phase is characterized by increasing competition for the consumer in an environment of this demand, the gradual completion of the [indiscernible] stage and the beginning of the digital transformation in Russian retail. In terms of internal factor, this phase is characterized by completion of the new renovation phase and the relative effect of Pyaterochka's ability. Right now, we are possibly seeing the first sign of the situations, the timing and more challenges. And while revenue continues to grow at a steady pace as our main format, and it remains a leader. [indiscernible] like other market participants began to see decline in traffic, sales, basket, profitability and return. We need a fresh look at the format [indiscernible]. Pyaterochka currently [indiscernible] helped made the company a leader. It is important that one stands to retain the different [indiscernible]; but on the other hand, we must actively adapt to all these customer needs. We need a fresh look at the pace of growth and in new areas for growth. To increase the efficiency of the format, it will be necessary to reduce losses, decrease [indiscernible], as well as improved the efficiency of the logistics and effectiveness of format. So the new phase of development will not strengthen [indiscernible] of the format team, which was less a priority during the previous stage. Until now, the team is primarily focused on growth. The new Pyaterochka set will need to introduce a new approach that will ensure a greater force on efficiency while maintaining efficient and profitable growth. Over the last year, we have done a great job in cost of creation talent pool. We have shift our focus from both market improvement to an active system of internal promotion. The new General Director will be appointed from a more internal candidate. And until then, I do come by the position of CEO of X5 and General Director of Pyaterochka. For me, this is also an important challenge which will require me to gain a deeper understanding of day-to-day process and to ensure us an [indiscernible]. I want to gain a deeper knowledge of the issues and challenges that Pyaterochka faces, hear the full range of opinion, the opinions of talented and the valuable colleagues who [indiscernible] the Pyaterochka format has. This is for me for now. Thank you for your attention. I will turn back -- now I would like to pass the floor to Svetlana, who will provide you with an analysis to the financial results.
Good morning, and good afternoon. Thank you very much for joining our call today. Since we just had our 2017 financial results call 1 month ago, I will briefly go through market environment. In the first quarter, [indiscernible] of the -- on our financial highlights, month-to-date results in April and then also move to Q&A session. So to begin with, I will retract on the external environment. The operating environment remains challenging. Food inflation remains at a record low level of 1% in the first quarter of 2018, which negatively affected both sales and margins of food retails. Despite the growth in real wages and a sharp increase in real income in February, growth in real food retail turnover remains weak, increasing by just 2% year-on-year in the first quarter. General demand remains weak due to consumers remaining cautious after long years of decline in real disposable income. Consumers are more inclined to save rather than spend. As of February 2018, for example, total retail bank deposits in Russia increased by 7%. During the quarter, consumers remained rational and highly sensitive to promo. At the same time, in Moscow, a trend in traffic, moving away from Perekrestok stores more upscale format, including supermarkets, indicate potential improvement in customer confidence. The confidence in this remains negative, but this improved from minus 11% in the fourth quarter 2017 to minus 8% in the first quarter of 2018. Unusually cold weather in Russia, 7 degrees Celsius colder than the average for the previous 3 years, and several major small storms affected traffic in February and March. At the same time, the decline in traffic was partially compensated by an increase in average check. As consumers fought to make fewer [indiscernible] accounts but was more during each visit. There is external and macro environment and negative operating leverage [indiscernible] seasonality, and they do not come as a surprise. Our plan of these trends during our budget process and discuss at the meetings with most of you. And our results are in line with 2018 budget, which is used at the start for the year due to low inflation. We do expect to see for the inflation accelerate during the year. During the quarter, we already have seen for the inflation move from 0.7% in January to 1.3% in March. Moving on to X5 financial performance. During the quarter, well, first of all, revenue increased by 19.9% year-on-year to RUB 352 billion on the back of positive like-for-like sales of 0.5% and a 26% rise in selling space. Due to X5's decision to control promo levels in an intense promo environment and consumers' high sensitivity to prices, like-for-like traffic declined by 1.6% year-on-year in the third quarter. While under pressure, the decline in traffic was partially compensated by an increase in the average ticket by 2.2%. Additionally, the base for the first quarter of 2018 year-on-year comparisons was influenced by -- one-off by additional pension payments made in the first quarter of 2017, which led to additional traffic and spending during the period, especially -- which is especially true for Pyaterochka stores. Looking at margins during the period, I would like to say that the gross profit margin decreased by 29 basis points to 23.8% but stayed at the level of the fourth quarter. Commercial margin expanded due to lower price investments. However, this effect was offset by a higher level of known loss as a result of increasing share of fresh products and larger share of regional stores. Another factor that affected the gross margin was high share of Pyaterochka and X5 sales. Gross margin was -- for proximity format is essentially lower in line of this format. In terms of adjusted EBITDA, we finished the quarter with an adjusted EBITDA margin of 6.3%, which was 142 basis points lower than for the same period last year but fully in line with our business plan. This was primarily due to negative effect from G&A on the back of increased staff costs, lease expenses and utilities costs. Staff costs as a percentage of revenue increased by 53 basis points year-on-year to 8.1% due to company's decision made in the third quarter last year to increase compensation for in-store personnel in line with market benchmarks. These expenses as a percentage of revenue increased by 44 basis points year-on-year to 5.1% due to the effect of accelerated new store openings and the growing share of leased space in the total real estate portfolio. Utilities costs as a percentage of revenue in the first quarter of 2018 increased by 22 basis points to 2.3%, mainly due to higher tariffs and energy usage as a result of the cold weather. In the first quarter of 2018, we continued to grow other expenses covering the second stage of the program. We will proceed its schedule with the last payment of the need in 2019. Other expenses, including tax, amounted to RUB 921 billion in the first quarter. Depreciation and amortization and impairment costs increased as a percentage of revenue by 23 basis points to 2.9% versus 2.6% for the same period last year. This was due to cautiously growing -- continuously growing share of assets with shorter use of life. Net finance costs increased by 10% year-on-year to RUB 4.2 billion purely due to the increased level of gross debt as of 31st March 2018 compared to 31st of March last year. In March 2018, X5 issued RUB 10 billion in ruble-denominated bonds maturing in 2 years with an annual coupon of 6.95%. This rate is the lowest amount among initial placements by corporate non-state issuers on the Russian market since 2014 and the lowest in history of X5's public debt instruments. As a result of all these factors, the company net profit in the reporting period totaled RUB 5.6 billion, which is 1.6% of revenue.Turning to our balance sheet. At the end of the quarter, our net-debt-to-EBITDA ratio was at a comfortable level of 1.88x. Total debt decreased by RUB 2.7 billion in the first quarter, but net debt increased due to the decline in the amount of cash compared to 2017 year-end. This was due to the large amount of cash accumulated during the weekend of 30th and 31st of December. Now I have just a few points on cash flow. Looking at operating cash flow, I would like to comment on working capital in more detail. The change in working capital in the first quarter of 2018 was negative of RUB 1.8 billion. This was significantly lower than the minus RUB 13.9 billion reported in the first quarter of 2017. The result from a year ago was primarily due to amendments to the trade law was seen the effect on 1st January, 2017, which caused accounts payable to decrease significantly in the first quarter of last year. We also had a slower increase in inventories in the first quarter of 2018 due to the high level at the end of 2017, which was the result of high promo levels in the fourth quarter of 2017. Net cash used in investment activities, which generally con sits of payments for property plants and equipment, increased to RUB 25.7 billion in the first quarter of 2018 compared to RUB 17.6 billion for the first quarter last year, mainly due to cash payment for acquisition of O’KEY supermarkets. Raising up on our first quarter 2018 performance, I will say a few words about CapEx. X5 total capital expenditure amounted to RUB 16.6 billion compared to RUB 14.4 million in the first quarter of 2017. Approximately 76% of CapEx in the first quarter of 2018 went to expansion of our store base. The remaining CapEx include refurbishments around 7%, logistics around 6% and IT and other investments around 11%. Now I have just a few points on our quarter-to-date results. We see results in April as strong. Net retail sales growth after 25 April is around 19% year-on-year. That concludes my brief presentation of the results, and thank you very much for your attention.
Ladies and gentlemen, we are now ready to take your questions. The session will last approximately 30 minutes, and we kindly ask that all participants limit themselves to 2 questions each. Operator, we're ready.
[Operator Instructions] The first question comes from the line of Nikolay Kovalev, VTB Capital.
I have 2 questions. The first question is on promotional activity. Can you mention what percentage of your revenue format represent at the moment? And if you started this, to what extent will you develop sort of those that can help to lower promos without also saving it. That's the first question. And the second question is on the departure of Naumova. Can you comment, to the best of your knowledge, is there any of these that important member of searching for will also lift and how this is a problem for X5 at the moment?
So I will start with promotional activities. The level of format we see in the first quarter, depending on the format, is different. For Pyaterochka and Perekrestok, we see a level of format in average from 30% to 35%. And for [indiscernible] hypermarket format, it's higher, in line with the market benchmark. It is challenging, as I said, for us to keep the promo level at a controlled level. But after -- through the fourth quarter last year, when we saw that the promo levels were too high and also on the targeted levels for us, our decision for the first quarter was to try to keep them at a controlled level.
Okay. And let me answer the second question. I would like to tell you that every member of the senior management team needs a guarantee that he or she, I believe, for 6 months [indiscernible] on each period. This is not just a reasonable expectation but normal practice globally. And as well as renew [indiscernible] program correspond to the new phase of development, which is aimed of achieving growth target for 2022. And increasing the shareholder value will also give [indiscernible] of managing the company.
The next question comes from the line of Taras Shumelda from PineBridge.
Given the big pressure on margins that you're experiencing, does that, in any way, causing you to rethink your store growth strategy? And also I was under an impression that 7% was the level of margin that you are prepared to defend. It has now collapsed to 6.3%. What is the margin that you are willing to defend?
Thank you very much for the question, and I think it's not the first time we discuss it. We do still remain with a targeted level of more than 7%. We're now at 7-plus for the year. And as we discussed recently at our Moscow and the meetings which followed the call, for us, first quarter seasonally is always a harder quarter in terms of maintaining margins. And actually, if we look at the dynamic of 2016 because 2017 was an abnormal year in terms of seasonality of margin performance. We -- in 2017, we had higher EBITDA margin in the first and second quarter of the year because of the new trade laws and also some savings on the costs, including staff costs, which also led to higher turnover and less quality in our stores. So that's why, as you remember, we discussed and we made a decision in the third quarter and fourth quarter to increase staff costs and to increase salaries and change motivation of our in-store personnel. So that brings us to the budget we prepared in November and December last year. And actually within this budget, we had a seasonality trend and also based on the -- based on seasonality of 2016 actually. So to remind you, in 2016, in the first quarter, EBITDA margin was 7.1%; in the second quarter, 8%; in the third quarter, 7.8%; in the fourth quarter, 7.8%. So looking also at the dynamics of 2015, 2016, I would say that this is the normal -- more normal dynamic of seasonality of margins for us. So we based our budget estimates as this trend. Also as I mentioned in the beginning of my speech, in the first quarter, we still have -- we still had historically lowest level of food inflation at the level of under 1%. So it's even lower than we had in the fourth quarter last year. So that's a new reality for all retailers, and that affects also all retailers. Of course with the percentage of our fixed cost, we need to implement a lot of optimization measures in order to work with our margin, and [ we'll ] stand for that. So looking forward for the year and looking forward to our margins, we hope and we think that we'll see high inflation through the course of second, third and fourth quarter. And as I mentioned, we will see the increase of inflation, even through the 3 months of the first quarter. And secondly, knowing our seasonality, we do expect that we'll see higher returns in the second, third and fourth quarter. Also, we do actively work on increasing efficiency. And as you heard also in Igor's speech, we're very much focused on efficiency. And we think that our personnel and our team should be more focused on efficiency while maintaining a healthy growth. As you know also from our meetings and the guidance we gave on the last call, our guidance in terms of store openings for 2018 is 2,500. But at the same time, it's not a number -- like a number in stone. So we discuss every new opening of the store in each of our format and our investment committees, and we do look at the performance of the existing stores and we make the decisions about new openings on day-to-day basis. So we still leave our hurdle rate of IRR at 19%. It's not decreasing. And we do see that the percentage of stores in clinic is still decreasing, so we have good trends in terms of our post investment appraisal. It's basically a job. We're doing that. And of course, we want to ensure healthy growth. So if we see that we need to have less opening...[Technical Difficulty]
Hello? You just -- may I ask a follow-up question real quick? Looking at the -- taking the 7% as the target, now depends upon what one assumes the sales for the remainder of the year, but let's say assuming about 20% sales growth, we're looking at about 7.2% average EBITDA margin in the each of the remaining 9 months in quarter to average about 7%. And I realize depending on sales growth, that number can change a little bit. How confident are you in your ability to do that? And looking at April -- and I realize you cannot mention specific numbers. And looking at April, are you getting anywhere close to the 7.2%?
So as you know, we don't give guidance, and we do refrain from giving guidance on our EBITDA margin for the year. But I can talk about the plans we have and the internal budgets we have. So as -- also as we mentioned at the last call, we have different scenarios for the different scenarios of food inflation. And even in the low inflation scenario, our targeted EBITDA margin is about 7%. So we work for that. We have our motivation schemes based on our targets for the year. We have some [ queued ] in place, and we have also different dynamic and different formats. As I said, in supermarkets, for example, we have very positive trends, both in terms of like-for-like growth and sales growth and increase of EBITDA margin, both in the Moscow region and other regions. Also in many regions of Russia for Pyaterochka, we do see positive trends in terms of growing returns and growing EBITDA margin of the performance of the stores in this region. I'm talking about Krasnodar, [ Yuzhny ], [ Enem ], so different regions in Russia. We do see some challenges in terms of performance of Pyaterochka in Moscow, but we're actively working on that. We just had recently changes of management in Pyaterochka in Moscow region. We're doing a lot of actions in terms of switching the Moscow regions by pricing strategies by more focused management teams. And I think all these measures will give results through the year.
The next question comes from the line of Victoria Petrova from Crédit Suisse.
We obviously observed an addition of 3,000 stores between first quarter 2017 and first quarter 2018 and the 33% drop in net income. This is something we haven't seen in X5 performance this much ever. And this is, by the way, something we saw in your competitor's performance over the course of the last 2 years. We understand that in Pyaterochka, which worries me the most, the impact of refurbishments, which was helping the performance on any level, is over. What is the key problem in Moscow? And usually, Moscow is a leading indicator for the rest of the country, as we saw. How are you addressing what went wrong there? Because you have a great store, we know you -- the store. Have you created an environment where your competition, like smaller stores of different formats, are capitalizing on it? Have you created an environment where you already capitalized completely on your customer base? What are you going to change you, yourself? Because so far, I hear a lot of hopes of on inflation pickup, and I'm sure it will pick up, but that's not the only solution. What Pyaterochka, specifically, will be doing? And how do -- long do you think it will take you to basically start delivering net income growth, again? Is it 1 quarter, is it 2 quarters? As far as I understand, your EBITDA in the second quarter is super high, with EBITDA margin of 9.2%, which means that probably there will be next -- net income correction next quarter as well. Do you think you can take some super-rated action? I understand you already changed management, probably it's already an emergency measure the company is taking. That would be very helpful. And can you comment on your budget, this budget which you are in line with in the first quarter, in terms of net income dynamics, not on EBITDA? I understand that it's 7-plus percent EBITDA margin, what is the general approach in net income in your budget? These are 2 questions. So what has to be done? What went wrong and what -- how you look at net income if your IRR is 19%?
So just to start with net income, actually if you look, the recent results is just mostly due to the performance of EBITDA margin and also higher finance cost, which is also caused mostly by the volume because...
Yes [indiscernible] which didn't bring any extra EBITDA, yes?
No, not at all. Basically, our debt, if you compare with the first quarter of 2017, increased. It's due to the fact that we do invest not only in store openings, but also in our IT development. And actually, the structure of CapEx is different for this year comparing to last year, when there's more into our development, into our new strategies. And also, you probably do remember that we will pay dividends in recent -- in nearest future. So that also entails some changes in our financial strategies. At the same time, we do keep the leverage level at -- and best EBITDA level at 1.8%, which is, I think, very healthy, and even lower than best EBITDA than we have in the first quarter of 2017, which was 1.9%. So it was higher. So continuing with the rest of the question, because your questions were like very complex.
I'd like to keep all questions into 2. Sorry about that.
But I will just start with the next one. Well, first of all, there is no emergency and please don't use this, this quarter. We don't feel internally like any emergency and we're still leader on the market. Pyaterochka is still getting very well and we do see positive dynamics in most of the regions. We do see some challenges in Moscow in terms of competition, increasing competition and environment. We do now. It means that probably we were quite slow in reacting to this new trend. And that actually is a question internally that we need to learn ourselves and to learn with the team and, most of all, in Pyaterochka. So trying to react faster from such challenging new trends and challenging environment. And these changes I'm talking about is mainly -- I mentioned also in the beginning of my speech. We do see in Moscow some outflow from proximity and mass segment to more upscale segments including supermarket, including specialists. And we do see this competition coming. We need to react after this process. We have several projects already in process, both in Perekrestok and in Pyaterochka, which are based on these trends. And also, we are developing a new strategy, as Igor was saying, we'll look at it first and discuss it with the board in June. I think we'll be ready after discuss it with you, with analysts and with the investors in autumn during our Investor Day. And I think, this strategy will, first of all, include changes in CVP in Pyaterochka because you are right, that's probably the area which worries us also. And we -- yes, you are probably right that we'll look sometime. We were supposed to start changes in CVP of Pyaterochka earlier. And that's why we want to move quite fast now to develop this new CVP, to develop the strategy and to move faster ahead to support our leadership position.
And how long do you think it will take you to implement it? Is it like 2 quarters? Any indication on the time?
As I said, we're doing all that. And the team is very focused and we'll try to be as dynamic as we can. We're sure on that. Comparing with banking industry, believe me, retail is very dynamic and it's very active.
I'm sure it is. I'm very sorry. I have one very, very last, super quick. Are you seeing any competition with #2 player? Or it's not an issue at all right now for you on Pyaterochka level?
So we still see -- so your question is about whether the competition changed with #2 player...
Yes, yes. If anything has changed in the first quarter, yes, absolutely.
Actually, we don't see any big changes in competition. We didn't see any big rational moves. And I think we had more worries even regarding some rational moves of our competitors in the fourth quarter of last year. So I would say that, yes, we do in some regions see some new trends and we will be reacting to them. But also, as I said, looking at developing longer-term strategy, because we understand the environment is changing very quickly and probably we need to develop some new ways of doing business. At the same time, of course, we need to do everything to improve our operations. We talked about shrinkages and known loss. We need to address that. And I believe we have very big potential in terms of improving our business processes internally, and first of all in Pyaterochka, and we'll see some positive results in that too.
The next question comes from the line of Maryia Berasneva from Morgan Stanley.
My first question is related to the subject that Taras already touched upon and it's the store growth strategy. First of all, could you please comment on the store closures, which appear to have been elevated from the first quarter? What was driving this and should we expect that in the quarters to come? And also, overall, with the -- maybe it's a bit of a simplistic way of looking it, but if your returns are under pressure and the macro dynamics have changed quite dramatically for the industry with very low inflation, why are we -- why are you still sticking to 2,500-store guidance rather than maybe focusing a lot more on improving sales densities, improving like-for-like dynamics? I just want to understand how you think about that.
Well, first of all, on the closures. Well, traditionally, first quarter is the best quarter to be closing the stores, after the high performance in the high season of the fourth quarter. And so it's normal. We do see that we had more store closings in the first quarter comparing with our first quarter of last year. We are trying to be more efficient. At the same time, overall, looking at the percentage of stores in clinic, the percentage is not increasing, it's decreasing. So we're just more efficient and faster in making the decision that we need to close a nonperforming store and we're faster in doing this. And first quarter is the right timing to do that. So I think, we don't see any problems in that respect. At the same time, in terms of openings, well, you asked for some guidance, we'll give you some guidance. We have these numbers in the budget. At the same time, as I said, we are now working on the strategy. We will be discussing the guidance for new openings for 2019 and '20. And I will not be surprised if we will see some slowdown of openings in the coming couple of years. And this will also allow us to focus more on the efficiency on improving the durations of the stores, et cetera. So I don't see any contradiction here. At the same time, we're still quite successful in openings. As I said, we do see that the growth is still healthy. We do focus on the existing regions, so we're not starting up any new regions. We're not going to new locations, like Krasnodar, for example. So in terms of efficiency of our logistics, it's more efficient to have more stores in the existing regions [indiscernible] and it's improved our average logistics force. So I think, we clearly see growth at a controlled pace. We have very good IT system list, new location information system. It's improving over time. And we do include all available information on our competitors, on the changes in infrastructure, on changes in number of households, the income of population, et cetera. So we think that our investment process and the process of making decisions about openings of new stores is still the strongest on the market, so we can allow ourselves to grow -- to have this growth and healthy growth.
Okay. And could you please elaborate on how you are looking to -- or what initiatives have you got planned to address the increases in shrinkage or cost pressure from shrinkage and also cost pressure from the core SG&A lines like labor, rent? Because if I look at the last 2 -- the previous 2 quarters and the last 2 quarters of 2017, the first quarter of 2018, I see that the sales growth has slightly slowed down but the actual growth and expenses has accelerated. So how -- what initiatives have you got planned, if you can give us just a taste of a couple of them?
So we do realize now -- and actually that was a discussion for the last several months within management. We do realize now that the level of shrinkages we have now in Pyaterochka is higher than the benchmark for the market. So we need to address this issue with a big focus and we need to concentrate the team on this issue. There's a lot of internal initiatives which should be done within the company. It's not an easy topic. And of course, shrinkages is a result of all business processes we have in the company. So it means that, just more focus and deeper focus on all operational aspects, including performance of logistics, direct imports, including business operations in the stores, training of personnel, motivation, correct motivation of personnel. So it's always complex of measures we will be doing. And I'm not saying that we will not address previously underperformance but we just think that we should bring more focus to it. And to focus the team more on this issues, rather than just growth, as we said previously. So talking about level of staff cost, actually what we see now in the first quarter of this year, it's a structural change. We were underpaying our in-store personnel during the first and second quarter of last year, in 2017. That actually led to increasing turnover of personnel last year and, well, it's a measure that leads to increasing shrinkages, to decreasing NPS levels and decreasing quality of services in the store. So we think that now after increases we'll have in the third and fourth quarter of the year, the level of in-store personnel compensation is at the good market level. So we are not claiming any further increases in the second quarter of the year. We didn't have any indexation for salary in the first quarter of the year. So it's more correct to compare level of staff cost of the first quarter 2018 with the level of fourth quarter of 2017, rather than with the first quarter of 2017. And actually, we were talking also about it on our last call and during all of our meetings we have with the investors and analysts. So on lease cost, we're working actively and we have a separate program who's working with landlords and renegotiating contracts, rent contracts, to try to keep indexation of rent cost as close to 0 level. Unfortunately, in Russia, after the devaluation we had in 2014, '15, most of the landlords still live in this perception of constantly increasing rent cost and rent -- indexing rent contracts to compensate for the sharp devaluation they faced in 2014, '15. We are working with that. We have separate program, even in PR -- in terms of PR. We're working on giving a message, a clear message to the public that we're not increasing food inflation. We do not expect that rent cost will be increasing. So at the same time, again, structurally, we do see that the percentage of rent cost is increasing. We have 74% of rented properties comparing to 69% we had in the first quarter 2017. So that gives you the structural change. But that's our strategy. We think that long term and overall, it's more efficient to rent, rather than to own the property, because we have retailers who want to focus not on real estate risks but rather just do our business.
The next question comes from the line of Victor Dima from Aton.
I have a sort of a broader question about the trends in the industry and that specifically relates to the promo campaigns. And my question is, we've seen the increase of the promo campaign with ceilings probably stabilizing lately, according to what different retailers see. But what will take fundamentally industry to start reducing this level of promo for the benefit of retailers? And do you see any signs, not only by you, but by your competition trying to do that and what it will take? Will it take just you and Magnit agreeing on that? Or it will take sort of a wider implication of all the retailers? That's sort of the first question. The second, you mentioned that the inflation is already accelerating. So I assume that you infer that there will benefit for the company. And I guess, my question is will stop your competition or any other players in the sector from sharing this benefit from high inflation with the consumers for the higher share of promo?
Well, these promo levels are not just existing by themselves. So it's all driven by the situation with the trends in consumption and the situation with the income of population which we're able to see. So I think that the structural change and -- really decreasing. The promo levels could come only from changing the behavior of the customers. So if we do see the growth in the real income of the population, if we do see the growth of customer demand and change in consumer behavior, so less promo orientation and more increasing the confidence of consumers, then, of course, we'll be doing our best to keep promo levels or to decrease promo levels to more healthy level. We do see these trends in terms of increasing consumer confidence in Moscow. And that is positive from one side, at the same time, we understand that the structure of income of population -- income of Moscow population is very different comparing to the rest of Russia. So it's very hard to think that the trends we see in Moscow will automatically continue and we'll see the same trends in Russia. Unfortunately, we see -- we still see that the percentage of our poor population is increasing overall. And we don't see any big changes in terms of consumption patterns in other regions, apart from Moscow. Also, you should -- you'll understand that we're always exposed to volatility on the markets, driven by different events and political events we see. And we're also subject to that and our consumers are also subject to that. So now of course, if we will see some big structural changes and improving confidence of consumers, we will try to do our best to follow these trends and to update our facilities also to be able -- to be in line with the trends, as we now do in Moscow.
The next question comes from the line of Olesya Vorobyeva from Alfa Bank.
I have a question regarding Olga Naumova. So do I understand correctly that Olga left the company without LTI bonus payout? And if so, how that part would be distributed?
Well, I think it's just not correct to comment on the specific terms of Olga's departure. So maybe some other question?
No. Thanks, very much.
The next question comes from the line of Marat Ibragimov from BCS.
A question on the LTI cost. You have clear vision on the total amount of LTI payments for meeting the LTI last year. So what's LTI cost for this year? Shall we take next 3 quarters with the same figure as you expensed it in the first quarter?
So the accruals for this year will be from RUB 2.5 billion to RUB 3 billion; and for 2019, from RUB 0.5 billion to RUB 0.8 billion. So that's -- I'm talking about the recent LTI program, and this is including social taxes. The new LTI program, we will be discussing with the auditors at which year the accruals start. I would probably think that it will not start during 2018, because the probability for achieving the target should be more than 50%, which is not the case into my opinion now -- in my opinion. So I think, that, for 2018, it will be this accrual of LTI.
And next question on the gross margin. Your gross margin was 29 basis points. Can you split between promos and increased share -- and the largest share of fresh products. Of course, there is some contribution from growing part of Pyaterochka, but would you please split this 29% -- basis points into 2 parts?
So we intentionally tried to keep our formal levels at a more targeted level, at a more controlled level. That's also resulted in increased -- above our budget and above our planned commercial margin. We're not disclosing the numbers, but commercial margin is above our budget. At the same time, it was mostly offset by higher level of known loss and shrinkages we'll see in the first quarter, and actually we discussed these trends also during discussing the previous questions.
So mostly -- most of the decline is due to higher share of shrinkages, not to the -- due to higher share of promos, right?
Well, overall, yes, the promo levels are actually lower than the levels of promo we have in the fourth quarter. And as you see, the level of gross margin is at the level of the fourth quarter. But within that, I would say that the commercial margin is high and the shrinkage is not high.
Marat, the improvements in supplier terms have been partially -- reinvested partially into the prices, which led to some gain. But this gain was eliminated due to the high shrinkages and because of a lot of these factors. The gross -- we see the gross margin reduction.
Okay. And then final question: You've started to raise salaries to employees in the third quarter; on that account, shall we expect that in the third quarter this year, risk bases have to diminish starting from third quarter? And then into the fourth quarter we shall see a reduction of SG&A as percentage of sales is the result of that obviously.
Not necessarily a reduction, but you're absolutely right in terms of the base.
[Operator Instructions]
So -- and we have no more further questions. Well, thank you very much for being with us on this call. And we are happy to stay in touch with you. I appreciate your interest in our company, and we look forward for a continued dialogue. Thank you very much, and bye-bye.
Thank you.
Thank you.
That does conclude teleconference for today. Thank you for participating. You may all disconnect. Have a nice day.