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Thank you for standing by, and welcome to X5's Q4 and Full Year 2017 Financial Results [Operator Instructions] I must advise you that this call is recorded today, on Thursday, the 29th of March 2018. And I would now like to hand over to our host today, Mr. Maxim Novikov. Please go ahead.
Good morning, good afternoon, ladies and gentlemen. Thank you very much for joining us on this call where we would like to discuss X5's full-year financial results for 2017. Participating in this call today: Igor Shekhterman, X5's Chief Executive Officer; Svetlana Demyashkevich; Chief Financial Officer and myself, Maxim Novikov, the company's Head of Investor Relations and Market Analysis.Before we start I would like to remind you that we have disclosed the press release and the financial statement this morning via our website LMS system and through our e-mail distribution list. All the documents and the presentation for this call are currently available on our website in the Investor Relation section.I would also like to draw your attention to the fact that some of the information disclosed during this call may contain projections or other forward-looking statements regarding future events or the future financial performance of X5 Retail Group. Please refer to the beginning of the investor presentation of this call for a full disclaimer with regards to such statements. I will now pass the floor to Igor, who will take you through the company's key results.
Thank you, Max. Good morning and good afternoon, ladies and gentleman. Thank you for joining us in our call. I hope you are happy to spend time with us today. In 2017, the food retail market in Russia showed the growth in retail terms for the first time since 2013. However, major players now face stronger competition than ever before, which is good for our consumers, but boost retailer to deliver increasingly higher operational efficiency. In this context, it's worth highlighting that efficiency and technology are among X5's core priorities. To start off, I would like to highlight of the company key achievements in 2017 and then walk you through each of them in greater detail. So let's start key achievements in 2017. First of all, X5 secured like-for-like sales and sales growth, reflecting a positive customer response to what we do. We delivered positive like-for-like sales performance across all formats, adding 5.4% in total, the fastest pace of growth among Russian public retailer for the second consecutive year. Like-for-like traffic increased by 3.0, the highest achieved by X5 since 2009. Moreover, 2017 was an important year as we started to prepare for sector-wide transformation, which is focused on Big Data, innovation and omnichannel sales. In this area, [ told ] the key results of our efforts were expanded by Pyaterochka loyalty program and loyalty across the base online platform. X5's impressive performance was also driven by operational excellence, especially in logistics and IT. Last year, we developed a supply chain strategy until 2025 to support a rapid business growth across Russia, including in remote regions. Furthermore, we identified key focus area on the IT front with a new IT road map 2020 approved. Considering the fast pace of X5 organic growth, our logistics and IT function did very well. 2017 was, certainly, one of the best year in X5's history. Total full year revenue rose by 25.3% to RUB 1.3 trillion. The Pyaterochka revenue exceeding RUB 1 trillion for the first time ever. Adjusted EBITDA margin was maintained at 7.7% (sic) [ 7.4% ] percentage despite [indiscernible] macroeconomic environment. In addition, a dividend policy was approved with the sales payout recommended in the amount of [ RUB 21.6 billion ][Technical Difficulty]sorry for disruption. A few words on external environment. Market indicators currently suggest that the Russian economy and consumption returned to growth, mainly driven by positive labor market development such as stronger real wage growth and consistent decline in unemployment rate. The economy is returned to an upward trajectory, led by the consumer sector. However, demand is growing mainly in the nonfood segment as consumer lending is growing. With no clear outlook for stated food retail recovery in the short term, we remain cautious about the market outlook for 2018. We realized that we are operating in highly competitive market with several strong players in every segment. Major retailer continue to add space therefore, increasing competition and as inflation slows and consumer still exercise rational behavior. This and other factors result in a higher share of promo, which require us to become even more focused on operational efficiency and cost control, which will be top priority for the company in this year.Moving on, I would like to focus on innovation. Innovation is one of the X5 priority and is an essential part of the long-term strategy of the company. As a leader in food retail, we strive to be as the leading edge of our sector transformation, leveraging automation, online sales and add advanced tools to boost efficiency and identify area for improvement in process. This enable us to better meet customer needs as the business expands. At this point, our main task is to ensure we successfully and effectively prepare for our journey into the future. In 2017, we launched strategic partnership with Internet Initiatives Development Fund and SKOLCOL Foundation that helped us to select and screen hundreds of startups offering groundbreaking retail solutions and technology. A few areas I would highlight are the following. Image recognition software will enable us to monitor the consistency of the shelf placement with planograms, ensure the shelf availability and manage store hours. Data analytics platform enable X5 and its key suppliers to analyze the effectiveness of promo activity by measuring the impact of targeted online advertising on appliance sales through no-name data about X5 customer. Big Data is another key area I want to mention. The company views Big Data as an important tool to boost the efficiency of business process and a source for developing potential new area of business. X5 plans to refine data analysis capability by integrating data from many internal and external sources, creating a portfolio of information product to enhance the company's CVP and to increase sales density.We view our Big Data strategy as key to the company growth going forward. This is why we have set up a Big Data department at the corporate center.Now a few words about our logistics. As you probably know, X5 has, historically, left behind our competitors in logistics. However, in the recent years, we have put special emphasis on this area. We're expanding our logistics infrastructure, improving the efficiency of warehouse, transport logistics and growing our fleet of trucks. In the last 3-year, we have opened 23 DCs including 10 DCs in 2017, an all-time higher for the sector. Storage could decrease where warehouse cost to bulk by 34% versus in 2015. In the last 3 years, the company's in-house truck fleet has become much larger. We took 2,562 new trucks including 1,231 in 2017 and to reach 3,144 vehicles in total at the end of the last year. The Centralisation level stood at 93% in 2017, up from 85% in 2015. The [ vehicles ] improvement in logistics efficiency included a lower cost and delivery times as well as SKU availability across stores.We have developed a supply chain strategy until 2025. Based on the CVP of each retail chain and long-term demand forecast until 2025 for specific location. The strategy is designed to help retail chains meets their market share targets.IT plays a key role in the 3 areas, I have just mentioned and in the summer of 2017, we adopted a new IT road map to 2020 designed to reinforce the IT infrastructure, so that it makes our high organic growth rate and higher process efficiency requirement. IT will develop in tune with innovations and technology is key to forward-thinking initiatives that help us maintain sector leadership. In terms of key achievements across format, I would highlight the following. Pyaterochka. In 2017, we launched a new Pyaterochka loyalty program that automatically generates personalized customer offer and uses Big Data analysis with more than 45 million cards is huge and over 20 million active users already registered. In 2017, we hit an all-time high in-store of openings, adding 2,862 Pyaterochka with more than 1 million square meters of selling space as we used the updated GI System to support high-quality opening in good location with minimum cannibalization. Now about Perekrestok. Our customer showed an appreciation for the new Perekrestok format. Like-for-like sales and traffic growth in 2017 was the highest across all formats, standing at 10.1% and 6.7%, respectively with like-for-like traffic now positive for 8 quarters in a row. December 2017 saw the approval of the acquisition of 32 key supermarkets. At the moment 28 supermarkets have already been opened under Perekrestok brand. These store are delivering strong performance with sales exceeding forecasted levels. In 2017, we refurbished 76 stores, meaning that all 73 of Perekrestok stores operated under the new concept at the end of the year. We seek to tailor our CVP to the needs a wider range of customers. And we believe this approach has been successful with a positive response of our satisfied customers reflected in Perekrestok like-for-like traffic performance, which reached 6.7% in 2017. This was the highest growth among all 3 formats. We opened a record number of Perekrestok supermarkets. 99 stores is the total selling space of 89,000 square meters. In 2017, we started our transition to a new omnichannel model having launched Perekrestok online in Moscow. We plan to expand the online platform and to open an online store in [indiscernible] in 2018. We're happy with the results that we see so far. The average ticket at Perekrestok online was 5 to 7x higher than the average for the format and the NPS was higher at 73% in 2017. We have expanded our private label proposition and are working closely with a new suppliers to the [ further boost our exclusive brand offering. The kitchen factory project is also developing well. Moving to Karusel. In 2017, we came up with a new business model and new brand concept for Karusel. The hypermarket, including some element of new model and brand was launched in St. Petersburg and has already shown positive results. The higher Net Promoter Score and sales of key product category at the pilot hypermarket show the customer are reacting favorably. The updated business model provides for an offering that is more focused on best-selling category and to what customers are buying more in some [ stores ] .The model is based on a different understanding of our target audience and current trends in retail. Our approach is to offer a modern and convenient shopping experience, which includes in-store entertainment and food service. For example, our own restaurant, cafe -- pizza place. And the product mix for one-stop shopping for the whole family to buy everything, we need for a longer period of 1 or 2 weeks. Our price and format supported by an attractive loyalty program are designed to create customer value and build long-term relationships. To wrap up my introductory speech, I would like to highlight our priorities and the guidance for this year, 2018. First, we have set ambitious target in our 2018 business plan. This includes an ever-greater focus on [ focused ] optimization in response to continuous rational consumer behavior and increasing competition, develop a unique product offering by expanding the list of strategic partners, adding and enhancing private label and to exclusive brand in order to increase the share of this category in our sales mix. Maintain the pace of infrastructure development to support X5 active growth, including further improvement to logistics and IT. Develop innovations and Big Data projects that help us continue to adapt to evolving customer needs while also making the business more efficient. Search for new growth opportunity in the form of digital platforms. In addition to our standard KPIs this year, set up specific targets for each of our retail chains. Pyaterochka. Focus on improved customer experience and in-store staff performance: fresh category offering, better product availability and merchandising. Perekrestok. Further develop the regional model and expand open live platform. Karusel. Launch the refurbishment program, increase sales density. As for annual guidance, as usual, we would like to stick to our policy and to refrain from giving any specific guidance on revenue and EBITDA. Having said that, we think it would be appropriate to estimate the number of new store opening in 2018 is around 2,500 across all format.Thank you for your attention. And now I would like to pass the word to Svetlana Demyashkevich, our CFO.
Thank you, Igor. Good afternoon and good morning, ladies and gentleman.[Technical Difficulty]Well, hello, again. Sorry for this little pause. And let me start with a brief overview of our financial highlights, and then I would like to address some key concerns based on discussions within this results.So full year revenue for 2017 rose by 25.3% year-on-year, a 1.3% growth. One of the fastest rates of growth in our company's history. At the same time, food inflation declined from 6% in 2016 to 3% in 2017, which contributed to marginal slowdown. Net retail sales increased on the back of 5.4% gross in like-for-like sales and 27.4% rise [Audio Gap] 2017 year-on-year. In 2017, gross profit margin decreased by 33 basis points year-on-year to 23.9%, mainly due to our customer loyalty initiatives, including updating our CVP, expanding the fresh assortment with growing share of direct import operations and widening the share of local assortments and development of royalty programs across all formats. Another important factor behind the reduction of gross profit margin was the forward mix effect proportionally more sales coming from Pyaterochka. I would like to note that X5's gross margin declined less than the gross margins of its major competitors. And we believe this is evidence of our prudent approach to price investments and robust flexibility negotiating with suppliers. In 2017, adjusted SG&A expenses decreased by 33 basis points year-on-year to 16.8 of revenue, hitting its lowest level since 2010. Adjusted EBITDA margin was sustainable at 7.7%, the same level we had in 2016, despite the challenging macroeconomic environment and compared to decline in margins of our major competitors. In Russian ruble terms, our EBITDA growth rate surpassed that of our peers. In 2017, we continued to accrue LTI expenses, covering both the first and the second stages of the program. We will proceed as scheduled with the last payment to be made in 2019. LTI expenses for both stages, including tax, amounted to approximately RUB 2.9 million. Now the LTI program is more details actually annual report, you can see some details there.In 2017, total depreciation, amortization and impairment expenses remained flat year-on-year at around 3% of revenue. However, impairment expenses in 2017 also included RUB 1.1 billion of additional expenses related to Pyaterochka. As you might remember, in October 2017, we announced the plan to sell 8 stores operating under the Perekrestok Express brand. So in this regard, we decided to use more conservative assumptions for Perekrestok Express compared to those applied to other formats. In -- during last year, net financing expenses amounted to RUB 16 billion, down 7.5% year-on-year. The weighted average effective interest rate of our loan portfolio decreased from 11.3% in 2016 to 9.5% in 2017. As a result, both of decline interest rates in Russian capital markets and actions undertaken by X5 and specifically, our treasury to minimize interest expenses. X5's effective tax rate net of deferred tax rate related to dividend payments remain stable at 22.2%. In 2017, net profit rose by 41% year-on-year to RUB 31.4 billion, while net profit margin increased by 27 basis points to 2.4%. Net of impairment expenses and deferred tax related to dividends payment, X5's net profit reached RUB 33.8 billion, while margins stood at 2.6%. Net profit growth was higher compared to major competitors. This result is a source of particular pride for us given that the Supervisory Board recommended a dividend payout of RUB 21.6 billion, equating to RUB 79.5 per GDR, in line with X5's new dividend policy.Turning to the balance sheet. While X5's loan portfolio rose by 24.5% from RUB 156 billion as of end of 2016, so RUB 194 billion as at the end of 2017. Net interest expenses decreased by 7.5% on the back of lower interest rates, as I commented earlier, and also our continuous efforts to minimize interest expenses.Net debt-to-EBITDA ratio was 1.7x at the year-end, hitting a year-end low since X5's beginning of operations. We consider this level of leverage to be comfortable for the company and want to keep it as the range of starting from 1.6 to 1.8x while paying dividends going forward. In this context, I would also remind you that this week, X5 issued RUB 10 billion denominated bonds local market, maturing in 2 years with a coupon of less than 7%, so the coupon of 6.95 per annum. During last year, X5's net operating cash flow before changes to networking capital rose by 27.8% year-on-year. Working capital decreased by RUB 11.4 billion, mainly due to changes in accounts payable as a result of amendments to the trade war that came into effect from the beginning of 2017 and initiatives to increase shelf availability, including enhancing the share of local assortment and an increase in inventories due to intensified promo activities in the second half of 2017. Capital expenditures amounted to RUB 98.6 billion compared to RUB 80.7 billion in 2016. Most of this increase was driven by high organic growth. It should be noted also that capital expenditures included the acquisition of O'Key supermarkets in 2017.Now, as I said in the beginning, I would like to also address some questions that we believe are especially relevant based on our ongoing discussions with investors. So starting with probably outlook for macro environment. As Igor has already mentioned, the macro environment poses certain challenges on us causing us to increasingly focus on efficiency and cost controls. In addition to the standard budget, which were developed in the end of last year. We developed a low-inflation forecast based on food inflation of 0.7% as was recorded in January. To maintain profitability, we plan to further increase our focus on efficiency improvement. Next, what are our key areas of focus for further efficiency gains? An all-around focus on efficiency is key to maintaining profitability, regularly monitor spending patterns in our stores, Logistics and Transportation units and the head office in order to minimize inefficiencies and optimize costs. Given fierce competition and the weak microenvironment, we are focusing on cost optimization and control. To achieve this, we have rolled out multiple projects to manage operating efficiency in each area of expenditure. For example, in logistics, we approved our Logistics and Transportation Strategy until 2025, and we'll focus on further optimization of storage and transport costs. We plan to continue developing our logistics infrastructure in Russia's regions and remote locations. We do -- need -- that we have various food development and improvement in terms of our shrinkages. We see that our shrinkage levels are still higher than those of some key competitors, and we still have not achieved significant improvements in 2017. At the same time, we expect positive changes in 2018, and certain KPIs have been set for the 4 months. Lower shrinkage rates will help to reduce margin pressure. In terms of SG&A, we do not expect significant increases in SG&A costs on the back of low inflation. We launched a comprehensive program, aimed at optimization of lease rates through negotiations better terms with landlords. We also do not want substantial indexation of salaries on the back of low inflation until we see trading upturns from our customers. In addition, we also see a potential for profitability growth due to increased share of mature stores, especially in Moscow and the Moscow region on the back of numerous store openings in the second half of 2017.I would also like to comment on the quality of store openings because it's one of the most frequent questions and competition for new locations in more detail. Though we are opening stores at a faster pace, we're quite comfortable with our performance. Over the last year, the share of stores in [indiscernible] decreased by 1 percentage points of total stores. New stores do not require a longer time to ramp up, which proves a consistent quality of store openings for us. New stores breakeven on EBITDA level in 4 to 5 months as they have in the past.Over the past few quarters, both the stores and the regions where X5 generally expands it footprint have become more mature. We do see improvements beyond Moscow and St. Petersburg. For instance, in South of Russia, our customers [indiscernible] Rostov and Volga and Ural, [indiscernible] which were lagging behind just 3 -- just 4 years ago. And now, they have become top 10 performance in terms of return on investments, greatly exceeding the minimum required rates of return company-wide. Though we are opening more stores in the regions, we will continue to focus on our key geographies too. For instance, X5's share in Moscow barely stands at 16% and the company may continue to aggressively build up its footprint here. However, Moscow and neighboring regions see traffic shifting to so-called specialized stores, selling alcohol drinks, dairy, meats and bakery products. In response, Pyaterochka will spin off standalone market division for Moscow and the Moscow region with it stores being quarterized into different segments to especially target consumer needs. We're also planning some changes in the assortments in all our formats. We will keep you updated on the results throughout the year. Looking at competition from new locations, we still see great potential for new value creative stores to be opened, in particular thanks to the long-proven track record of our development team and the use of advanced technologies such as our geolocation informational system. During last year, we're faced higher competition for locations driven by the rising number of peer stores being opened. At the same time, looking at competitors' plan for this year, we do expect the competitive pressure to decrease.This year, despite a challenging macroeconomic environment, X5 plans to focus on opening new stores in the regions where we already have operations, thus building up its concentration in these regions. Finally, I have a short update in first quarter 2018 results year-to-date. I would like to highlight the strong results that X5 has delivered year-to-date despite a challenging macroeconomic environment. Our net retail sales year-to-date increased by around 28% (sic) [ 26% ], while like-for-like sales rose by 0.5% year-on-year. I think that concludes discussion of our results. Thank you very much for your attention. And I will be happy to answer -- and we will be happy to answer all your questions.
Ladies and gentlemen, while coming to Q&A session, which will last approximately 30 minutes, [Operator Instructions] Operator, can we have first question, please.
Your first question comes from Maryia Berasneva.
My first question is with regards to the promotional activity in the market. Could you please share with us what is your current share of promotion as a percentage of sales? And how has it evolved so far year-over-year in the first quarter? Do you see any signs of promo activity changing or subsiding either in bigger cities or in the regions?
Thank you very much for the question. The promo is really driven, of course, most of our competitor, and I would like Svetlana more details regarding that.
So actually, what we see now is that in our format, our levels strongly decreased comparing with the fourth quarter of 2017. Still stays at the level of 30-plus percent. At the same time, we don't see any irrational behavior of competitors in the market at the moment.
And the second question, can you please talk about how we should think about the target balance sheet structure and dividend evolution going forward in terms of what we should expect net debt-to-EBITDA to stay about 1.5x or more with the 70% dividend payout? Or how do you think about this?
As you probably know, in our dividend policy, we have a limitation of payout not less than 25% of net profit. At the same time, we are comfortable with debt-to-EBITDA level of 1.6 to 1.8x. So we would probably expect to pay dividends according to our targeting this debt-to-EBITDA level.
This is very helpful. Thank you very much. And just another question, just classification. Could you please repeat once again the traffic for Q1 -- sorry, not the traffic, the like-for-like?
Like-for-like sales, we're not disclosing traffic. But like-for-like sales, 0.5% year-on-year.
Your next question comes from the line of Brady Martin from Citi.
Couple of questions. One, just a follow-up on the guidance. And I appreciate giving us the overall store targets. Just wanted to see if you give us any more color there, one, in terms of CapEx, whether you can kind of investments outlook for the year? And whether also on the openings whether given that the Perekrestok refurbishment program's in advanced stage. Karusel seems to be stabilizing. Will there be a shift in the openings by a format? Or should we expect something similar to last year? So that's really first part of the question. The other question just on the gross margin. Just wondering if you can tell us what changed from October -- I mean, after the Q3 results in October, you characterized part of the gross margin contraction as one-off in nature, but there really wasn't much change in gross margin Q-on-Q. I'm just wondering what changed since October. Was this more pricing policy, or is it just your reaction to competitive environment or macro? I mean, how -- what changed in your thinking about the -- your gross margin or pricing in the last 2 months of the year?
Thank you for your question. So first, in terms of CapEx, we do expect the level of CapEx to remain pretty much at the same level in 2018 as we have -- as we had in 2017 depending on M&A activity also. And in terms of structure, I would say that probably less refurbishments in Perekrestok because we're -- at the end of 2017, we were as far as 73% through the refurbishment, so less CapEx on Perekrestok. At the same time -- and as you know, in Pyaterochka, the program of refurbishment is already finished, was finished in 2017. We will do refurbishments in Karusel and open several new stores. But overall, I would say that the structure of CapEx will remain pretty much as the same with guidance in openings that was announced by [ Igor ]. So answering your second question in terms of gross margin, I would say that, yes, first of all, the macro economy changed in terms of inflation in the third quarter and fourth quarter 2017. And as you know, fourth quarter 2017, we saw very low levels of food inflation of 1.6% and 1.1%. At the same time, that enhanced competition and from activities. So at the same time, we wanted -- we had very good results of the first half of the year. So we are ready to invest in our customers to support loyalty, including updating our customer value proposition, expanding our fresh assortment, growing our direct import operations and widening the share of local assortment. Also developing loyalty programs across all formats. So I would think that would answer your question.
Yes. Maybe just one follow-up on the gross margin. I mean, these -- all these factors that you mentioned seem to be continuing into the first part of 2018 and maybe most in 2018. Do you -- is there any reason for us to believe that gross margins would improve from the second half of last year? Or are you more focused -- most of your presentation was focused on efficiency, which is more on the cost side. Is there any reason for us to believe the gross margins are going to improve in 2018?
So far, we see the same trends in terms of inflation, even lower than we had in November, December. As you know, in January and February, we had 0.7%, 0.8%. So I would say there are no very strong reasons to believe that the gross margin will be expanding. And that's why, as I commented, we're focused also on costs -- freezing the costs until we see and if we see the expansion of the gross margin. That's why we did additional exercise on low-inflation prognosis also to understand what measures we could do in 4 months in order to save -- to optimize costs.
The next question comes from the line of Victoria Petrova of Crédit Suisse.
So my first question would be related to -- so then how different sell densities in your best-performing store density region and your worse performing sales density regions? And what would be the margin discrepancy? That's my first question.
Well, I think you know that we're not really disclosing the details of different -- particular different levels of our EBITDA margins in metropolitan areas and regions. And you also probably know that there are differences due to the different income of population in metropolitan areas and regions. In terms of trends, we do see the increase in competition in Moscow. And also, we do see the appearance of quite fast developing specialized players, as I mentioned, when I was commenting on recent development. So that puts pressure on sales densities in Moscow. And that's why we are making and taking a lot of steps in terms of our assortment, in terms of our marketing, in terms of understanding and understanding the demands of our customers and segmentation of our customers. And particularly in Moscow, we have project on segmentation by particular regions in Moscow to differentiate in pricing, to differentiate in assortments to increase share of local assortment of particular producers within Moscow. So it's the area of our focus at the moment. At the same time, also, as I mentioned before, we do see improvements in sales densities in regions. And we do see this improvement both in Pyaterochka and in Perekrestok. And actually, as when I'm talking about the pressure on sales densities, I'm mostly talking about Pyaterochka format. If you look at Perekrestok, we have improving trends. And actually, we do see that the supermarket in terms of like-for-like traffic and every check in all respects, we do have this positive trends.
Do you see any downside from 2017 sales densities? Are you seeing under your 0.7% inflation scenario or not?
Actually, it will depend on particular locations. We'll see in 2018, but overall, we wouldn't expect a big difference.
And my very last clarification question. How much margin do you think you might have given to specialists, like, alcohol specials because as far as I understand, they compete with you in high margin businesses? Have you done any sensitivity analysis or any analysis on that which you could share with us?
I would rather say that we are concerned with the specialists in terms of traffic rather than margin because we do see that consumers in many cases prefer to purchase different categories, food in different stores, which locates next to each other. And in many cases, the specialized stores are just located next to our stores. So that's most of the change in terms of on the traffic. And, of course, in categories where we see this specialization, we do have the strategic analysis. And we analyze the measures we could take to react.
As we have -- our guidance especially the main problem we considered so we've taken traffic from us. That is why at the moment, we're discussing with all our all formats first of all to adopt our CVP and add some interest in category in assortment as well to improve our private labels. This is the main target for us and all our format till the end of the current year to adopt our CVP to compete with the specialists.
Your next question comes from the line of Nikolay Kovalev, VTB Capital.
I have a couple of questions. The first one is on CapEx. You mentioned last year CapEx is RUB 98 billion, but in cash flow, I see RUB 88 billion. So is it fair to assume that RUB 10 billion should be paid for O'Key supermarkets in February or March, or I mean, first quarter? And if so, can you mention what was the transaction amount for this acquisition?
Well O'Key supermarkets wasn't the only acquisition we did last year. There was a number of acquisitions. They all disclosed in our financials. So -- but, yes O'Key supermarket deal was the biggest one. Apart from that, we had a couple of acquisitions in Moscow and a couple of regions.
Okay. And also, I want to follow up on promotional activity you mentioned. If share of promo are 30% at the moment are higher, do you see any upside potentially? And also, do you think about any measures that can help you to lower the share of promo and sustain the current traffic?
Well, we think that present level of promo activity is quite normal for our format for the CVP. So now I would say in the first quarter of 2018, they are at targeted level, normal level for Russian market. And when it's -- it plans promo done together with the supply, it could be very effective for us and interesting for the customer. That's why we think that we are now in more in health environment than the environment we saw in the fourth quarter of 2017. And we would like to stay in such a state. And so far, as I said, we don't see any aggressive or irrational behavior from our competitors. So I hope that we will just keep going like that through the year.
And in addition to that, we have already decreased a percentage of the promo for Perekrestok stock because we did big efforts to improve the metrics last year and the same we are discussing in our Pyaterochka adopt the promo and [indiscernible] beating their percentage of the promo in this year.
Your next question comes from the line of Elena Jouronova of JPMorgan.
However, if I can focus on your Q4 stand-alone, I think even though you mentioned your gross margin does not decline as much than that of your competitors. But the cash operating cost per square meter have gone up surprisingly even though in preceding quarters, they've been consistently down. Can you please comment what's happened particularly in Q4 that OpEx went up on [ percentage ] basis? And then you mentioned that you're going to focus on costs in 2018. So maybe you can quantify what kind of cost savings you could achieve in 2018, again as percentage of sales, if possible? That's my first question.
Thank you for your question. So during the fourth quarter of 2017, staff costs increased as a percentage of revenue to 7.8%, mainly due to fine-tuning the maturation scheme of in-store personnel in line with market benchmarks. You probably remember that during our call on the third quarter results, we were saying that we changed the maturation of in-store personnel to increase the level of salaries to the markets benchmark in order to increase quality of service in our stores and the quality of personnel in our stores. So we think we did this investment as we had the ability to do this knowing the strong results of the first half of the year. And that also affected our comparative costs of fourth quarter 2017 comparing with the fourth quarter of 2016. Then lease expenses, actually, the increase of percentage of lease expenses to revenue was due to structural reasons. We constantly have the growing share of elite space and also towards our strategic choice to shift towards renting the trading space rather than having it as an ownership. So that I would say was also as a structural change. Also, in fourth quarter of 2017, third-party services expenses increased as a percentage of revenue by 1%, due to increased expenses for consulting and marketing services related to promo activities, including the development of recently launched Pyaterochka loyalty program. So I would say that within this other third-party services, probably the biggest investment were into loyalty program, our consulting and development of the program. We've also launched the projects on segmentation of our customers based on data -- IT data we have in our company. So we think that long term and even during 2018, it will bring positive results to the development of our customer value proposition and to the quality of services and to the quality of stores.
And a follow-up I had on what's the cost improvement potential in 2018 if can be quantified at this stage?
Well, I'm afraid we're not giving such a guidance. So -- but we'll comment, of course, during our call on the first quarter results.
And I actually had the second question on your margins in regional business as opposed to the key cities, Moscow, St. Petersburg and St. Pete and Moscow region. And did you actually see that the margins of mature stores in the regions where you have a well-established logistics backbone are getting close to that 7% target that the company has in mind? Because I think initially when X5 started that regional rollout, probably margins have been below company average, but my guess is that as the business and the regions matures and you have your own logistics you should be improving the margins. Maybe you can give us some color as to how these margins are progressing in the regional stores?
Of course, we do monitor the developments in the EBITDA margin in each regions and even within the regions by cities and by towns. And we do see in most of the regions positive developments, and that's very optimistic trend for us actually. We do see the improvements mostly because of the decrease in our logistics cost. As you know, we're investing a lot in logistics and building in development of our transportation company, increasing the number of our owned trucks. And that all also gives the fact in terms of logistics. But also, of course, when you have more stores in the region, it gives you effect of better-trained personnel, better business and operational activities. So we do see improvements in -- on the south of Russia, Krasnodar, [indiscernible], Rostov and Volga and Ural and in -- I would say yes that in developed regions in some cases, the EBITDA margin is even higher than our leverage target.
Your next question comes from the line of Yulia Gerasimova from Goldman Sachs.
Two questions, shot questions from me. One will be on the LTI program. I just noticed that Q4 LTI expenses came, I think, lower than initially was commented by the company on the previous conference calls. I would like to just clarify is it was just delay of the accruals to the next year, or just indeed the total size of the program was lower? And also can you comment on the future LTI because that's going to be a second LTI program in place. The company mentioned that in the past with some higher focuses in return. Can you comment on this one? That's the first question.
Let's start with the LTI program and Svetlana will comments on the current LTI. The new LTI target attracted long-term interest of the shareholder and management with a continued focus on net revenue generation and as an additional long-term objective leadership in terms of enterprise radial multiple relative to the competition. So those would be the 2 main targets for our new LTI program.
So in terms of the existing program, actually, that was an exact calculation, including the personnel who is still in the company and including the change amounts of EBITDA, which is the basis for calculation of LTI program. So no, I wouldn't say that there were some -- I don't know, changes in order terms, just more calculation based on overall performance efficiency.
Maybe just to -- as regard the new LTI includes some triggers, I mean, the new LTI, its EBITDA margin to assure that the profitability is not specified and also it will be -- debt-to-EBITDA ratio. And so also what is important consistently with the current LTI programs and new program is designed with a condition of payout as a deferred component subject to continued achievements of target beyond the end date of the program.
Okay. That's clear. And actually to that was my second question. You mentioned bigger without sacrificing on the margins. I think in the past, you commented that the comfortable range of the EBITDA margin for X5 is somewhere between 7% and 7.4%. Does it still stay, considering there is a decidedly more challenging environment out there? And second question is -- second point of that is that in your stress test scenario with 0.7% inflation, what kind of margin do you have in 2018? Is it within this 7% to 7.5% range or not?
Well, actually, of course, it will depend on macro economy and competition environment. At the same time, in all scenarios of our budget, the positive one and the stress one, we do have the target of 7% plus. And that's why we do have the targets for cost saving. But of course, we do see the pressure from our macro and low inflation. We will do our best to keep the margin, yes and the target margin is still 7% plus.
And it would be correct to say that your LTI is conditional to maintaining that target 7-plus? Or it's more like flexible -- it's not like a strict threshold?
Well, we do have the trigger in the new LTI program, which is -- which supports the long-term plans for the company on more or less supporting the EBITDA margin.
Your next question comes from the line of Marat Ibragimov, BCS.
In the previous press release's full year results, you provided breakdown of the EBITDA between different formats. Unfortunately, I didn't see that at this time. Could you please provide are would like to see the EBITDA margin evolution in Perekrestok because the -- surprisingly you had lower get in --in Perekrestok.
Marat, this is Max. You can find this information in the segment reporting of our annual report. So it is all provided in the annual report that you can pull up because it's in the report.
Okay. And then could you please help us -- tell us if you have any plans for an SBO in the agenda or not?
No. We don't have any plan for SBO as we have a sufficient cash flow generation and [ board's ] continued growth.
[indiscernible] And then final question. Your softening targets for this year is below the one which you had for last year, but you said that real estate inflation is pretty favorable for expansion, your financial position, your leverage is pretty good. You can fund even higher CapEx. So it looks pretty counterintuitive that you are reducing the pace of your expansion unless you do it for purpose to unlock your balance sheet and to be ready for some mid-size or large size M&A. Could you please comment on that?
Well, thank you for the question. So first, I would say that, actually, the -- our target plans for opening's more or less in line with the target we had last year in 2017. So I wouldn't say that we have some significant changes in strategy in that respect. At the same time, we do want to be very conscious of the effectiveness and healthy growth we have in all formats. And that's why just opening the stores is not a target by itself. So of course, we do want to sustain high growth. At the same time, we want this growth to be profitable for the company and for the shareholders, so.
Your next question comes from the line of William Rice from Capital.
I just have a couple of follow-up questions related to the dividend policy and the new KPIs, the new remuneration program that you put forward to the AGM. Starting with the KPIs, could you just clarify what percentage of the overall program is related to total shareholder return, be it as you said, the enterprise value and dividend payments?
Well, we want this targets to be balanced. The leadership in market share and the leadership in multiple and enterprise multiple but we're not particularly commenting the share.
I would say it's quite a balanced share.
Between those metrics and the operating metrics that you set them out to?
No. For LTIs, we have balanced 2 main targets. First is maintaining leadership in market share. And the second is having leadership in terms of enterprise leader in multiple.
This is an LTI target battle. So we have annual target that include in our management annual KPIs, operational target and annual KPIs.
Okay. So the new program no longer contains any explicit market share goals you have to achieve beyond maintaining leadership?
Yes.
Yes. You're right.
Yes. Just maintaining the leadership.
Okay. And on dividend, again, just a clarification point. While you've been talking about in terms of a minimum -- you 25% payout ratio. Do I understand correctly that the way you're thinking about it is on a free cash flow basis, you will essentially be paying out as much cash as you can afford to whilst keeping your leverage within that 1.6 to 1.8x band on a forward-looking basis?
Yes. Absolutely, you're right.
You're absolutely, right. Yes.
We have a second question from the line of Nikolay Kovalev.
Just a quick clarification. Can you help us to somehow estimate what can be the potential ultimate size of LTI program for the second stage? And how it can be calculated?
This is Max, Maxim Novikov. In clarification materials for the AGM, there is a detailed explanation on this -- on the fund of the program, which has kept at 5% of the average EBITDA for the 3-year period, '18, '19 and '20. So this is the maximum amount, which doesn't necessarily mean that the full amount will be accrued or paid. And we have -- operator, we have the last question from Elena Jouronova.
Your line is open.
So my first question was a bit philosophical. The changing market fundamentals and you've mentioned macro and increasing competition from specialized stores, does it make you think that maybe is the right time to start slowing store openings? So I'm wondering what are the management thoughts on that. And also a clarification, if the store openings numbers you gave were on the gross basis or net basis?
So as we commented already, I think that, for us, the main words for next year, and 3 years and now strategy is balance. We want really to balance between market share and between shareholders' BDO between the pace of growth and efficiency and returns to the shareholders. So it's quite challenging to be successful in both. But so far, we are achieving our targets. So I think it's quite doable. So that's why we are quite careful in terms of post-investment analysis of the performance of our stores and refurbishments and the M&A activities. And on quarterly basis, we have very detailed review by investment committees of all the recent developments in that respect. Also, I would like to mention that the percentage of stores in clinic, what we call in clinic, by EBITDA, nonperformance stores, is decreasing related to the total number of stores, so. So far, we also don't have a pressure in terms of decreasing our internal rate of return level. It still stays at 19%, and we are able to open new stores with returns which are well above this hurdle rate. So I would think that we still have the opportunity to grow both for 2018 and for several years where we developed our longer-term strategy. At the same time, of course, we do want to focus on efficiency, on development of our company in terms of IT, Big Data, analytics, cost control, so all quality factors, which is inevitable for us to keep developing overall as a company and to keep increasing our shareholders saving.
Maybe just a short philosophical answer, just as Svetlana mentioned that our new target to be leader in revenue and in multiple focused on very balanced and pragmatic growth, you have to be focused on efficiency.
Thank you very much Elena. Thank you very much to all attendants. Before we disconnect, once again, until the next time. I would like to note 2 things. First of all, we have created a special mailbox on dividend at x5.ru. So please feel free to send all your questions regarding dividend payment process. We are more than happy to respond and to answer all the questions. And second, for those of you who want to attend a group breakfast with us next Friday in London, please also send me or Svetlana, Igor a request, and we will be more than happy to invite you for this event. Once again, thank you for the participation and do not hesitate to contact us in every time you have any questions or require additional information. We appreciate your interest in our company. Thank you very much.
Thank you.
Thank you very much.
Thank you, ladies and gentleman. And that does conclude your call for today. Thank you all for participating, and you may now disconnect.