Brown Group Regulatory News (BWNG)

11th October 2018

N Brown Group first half results for the 26 weeks ended 1 September 2018

Good growth in Financial Services, disappointing Product performance in a challenging market.

Full year expectations unchanged.

1before exceptional items as detailed on page 4 2before exceptional items and unrealised FX movement

3excludes debt securitised on the Group's customer loan book

Continuing our transformation into an online retailer

· Online Power Brands revenue up 8.6%

· 77% of Product revenue now online, 84% for new customers

· Adjusted EBITDA increased by 6.1% to £52.0m

Product revenue decreased by 3.1% (excluding stores)

· Simply Be up by 8.0%, Jacamo ahead by 2.7% and JD Williams down 3.1%

· Significant decline in offline sales as business focuses on growing online Power Brands

· Taken measures to address poor International performance

Financial Services revenue up 12.7% due to strong interest performance

· Customer loan book grew by £30.0m to £677.6m (gross basis) since 3 March 2018

· Core net debt3 of £30.5m, giving leverage of 0.3x

Tight control on operating costs, which decreased as planned by 1.5%

· Mainly due to lower marketing costs, down by 4.3%

Exceptional costs of £65.4m drive a statutory PBT loss of £27.1m

· New exceptional items relate to customer redress and non-cash asset impairment charges

Interim dividend reduced by 50.0% to 2.83p

· Rebased dividend to a more sustainable level from which the Group will seek to grow

Matt Davies, Chairman, said:

"Whereas much progress has been made transforming the business into an online retailer, we have not yet achieved the growth in product or international that we would have hoped for and have decided to rebase the dividend to a more sustainable level from which we will seek to grow.

"We are now in the process of searching for a new Chief Executive to take the Group forward through the next phase of its development. In the meantime, we are pleased that Steve Johnson will lead the business. We have a strong base on which to build. Over three-quarters of our product revenue is now online and we have industry leading expertise in fashion that fits. This is supported by a strong financial services business. Our goal of becoming a world class digital retailer remains unchanged."

Steve Johnson, Chief Executive, said:

"The Group's adjusted profit was in line with our expectations as we benefited from growth in our online Power Brands and Financial Services, along with improved marketing efficiency. We were however disappointed with our wider product performance which was impacted by the ongoing decline of our legacy offline business and challenging market conditions.

"Going forward we expect offline sales to continue to fall as we focus on online Power Brand growth. While this will hold back revenue in the short term, there are opportunities to drive profit particularly through improved efficiency, as the business further shifts online, and we accelerate the use of analytics to increase returns on our promotional spend."

"While first half trends seen in our product business are continuing into the second half, the positive outlook for Financial Services and scope for further efficiencies mean that our full year expectations are unchanged."

Meeting for analysts and investors:

Management is hosting a presentation for analysts and investors at 10.15 am today. Please contact Nbrown@mhpc.com for further information. A live webcast of the presentation will be available at: www.nbrown.co.uk.

Summary

Group revenue in the first half increased by 1.0% to £457.8m, with Q2 up by 1.5% compared to an increase in Q1 of 0.4%, driven primarily by a strong performance in Financial Services.

Product revenue excluding stores, which have all now closed, decreased 3.1% to £304.5m. While recognising that this was a disappointing performance, it reflects the challenging market conditions in fashion retail, ongoing headwind from the migrated Fifty Plus customers onto JD Williams and the decline in the Group's offline business. Product revenue including stores was down 3.7% to £311.4m.

Our three Power Brands (JD Williams, Simply Be and Jacamo) continued to outperform the rest of the Group, with revenue up by 1.8% excluding stores. In line with our growth strategy Power Brands now account for 58% of Product revenue.

Simply Be was again the Group's best performer, recording good revenue growth of 8.0% excluding stores. JD Williams decreased by 3.1% but was up by 7.5% excluding Fifty Plus. Given that the migration of Fifty Plus customers onto the JD Williams brand commenced in the middle of the prior year, we expect this headwind to soften during the second half of FY19. Jacamo was ahead by 2.7% excluding stores. Revenues from Secondary (excl. stores) and Traditional brands were down 6.9% and 11.2% respectively as the Group's focus continued to shift to its priority Power Brands.

Our transformation to a leading online retailer continues at pace, with digital sales now accounting for 77% of Product revenue, compared to 71% in H1 FY18. Online revenue grew by 3.8% in the first half and was ahead by 8.6% for our Power Brands. Offline revenue decreased by 22.4% as the Group continued to shift its focus to its growing online business.

The Group's gross margin decreased by 60bps to 54.2% reflecting the decline in Product gross margin, which also fell by 60bps to 53.4% as we decided to invest more of our marketing expenditure in promotional activity. This reduced gross margin was counterbalanced by lower marketing costs, which decreased by 4.3%.

Financial Services performed strongly with revenue ahead by 12.7% to £146.4m, as we benefited from increased interest received from the Group's growing customer loan book. Gross margin was down 50bps, to 56.0% due to our requirement under IFRS9 to make a provision against every credit customer, including those that are trading normally.

The Group has kept a tight control on operating costs in the first half, which decreased as planned by 1.5% to £196.3m, principally driven by the reduction in marketing costs. Warehouse and fulfilment costs were marginally down, by 0.3%, and while admin & payroll increased slightly, by 1.3%, this was less than the rate of inflation. As a result, adjusted EBITDA increased by 6.1% to £52.0m. As anticipated depreciation and amortisation increased by 15.4% to £14.9m, reflecting our investment in IT systems. Adjusted operating profit was up by 2.8% to £37.1m and operating margin was ahead by 10bps to 8.1%.

As interest increased to £6.5m due to additional borrowings, adjusted profit before tax decreased by 5.0% to £30.6m and adjusted EPS was down by 4.6% to 8.37p. On a statutory basis the Group made a loss before tax for the half year of £27.1m due to exceptional costs of £65.4m.

Exceptional items

As previously announced in its Q1 trading statement, the Group has incurred exceptional costs of £22.0m (of which £9.3m is cash) relating to the closure of its store portfolio and £2.7m advisory fees associated with ongoing legacy tax cases.

New exceptional items announced today include £22.4m in respect of customer redress provisions, reflecting the estimated cost of remediating anticipated additional PPI claims. The majority of the cashflow impact is expected to occur over the next 12 months, with approximately half in H2 FY19 and half in H1 FY20.

This updated financial services redress provision has resulted from a significant recent increase in claims volumes. These have been experienced across the industry and have arisen due to both the 'Plevin' court ruling and additional marketing activity by the FCA, targeted at raising awareness of the August 2019 PPI deadline.

More specifically, the Plevin ruling has meant that if more than 50% of a consumer's PPI payments were paid as commission, customers could claim back payments, plus interest, even if they have had a prior PPI claim rejected. This has not only led to new claims from those who were previously rejected, but also has increased the general level of PPI claimants as the half has progressed.

The Group has also made two non-cash asset impairment charges in the half. Firstly, following a detailed review of the benefits likely to be achieved from its platform, the Group has terminated an agreement with a third-party IT Financial Services provider, Welcom Digital Limited ("WDL"), resulting in an asset impairment charge of £11.2m. Despite this termination, the Group has been able to deliver much of the required functionality by using in-house resources and other third-party service providers.

Secondly, following historical underperformance of Figleaves, a business the Group acquired in 2010, we have decided to impair its goodwill in full, resulting in a non-cash charge of £7.1m. Despite this impairment, the Group continues to believe in the longer-term opportunity for Figleaves and with a new management team, is implementing a turnaround plan to grow the business.

Dividend

While the Board understands the importance of dividends to investors, its current dividend cover is low and exceptional items, largely relating to legacy matters, have meant that distributions have not been covered by free cash flow.

The Board has therefore decided to rebase the interim dividend to 2.83p per share, a reduction of 50.0% on the prior year, which it also intends to reflect in the final dividend. This brings the Group's dividend down to a more sustainable level and from which the Group will seek to grow as its earnings progress.

Balance sheet

The Group has an available financing facility totaling £625m, made up of a securitisation facility of £500m and RCF of £125m, both secured until September 2021.

The Group's balance sheet is underpinned by its customer loan book, which at 1 September 2018 was £677.6m on a gross basis and £565.7m on a net basis, calculated under IFRS9.

Compared to 3 March 2018 the Group's overall net debt increased by £73.7m to £420.5m principally due to exceptional cash outflows of £36.8m, the majority of which relates to customer redress, and £30.0m growth in the Group's gross customer loan book. £390.0m of the Group's debt is securitised against the loan book on a non-recourse basis.

Core debt, which is defined as the amount drawn on the Group's RCF less cash, was £30.5m. On this basis, the Group's leverage is 0.3x on a net debt/EBITDA basis.

Guidance

The following updates to FY19 guidance have been made:

· Product gross margin: 0 to -100bps (was 0 to +100bps) due to continued promotional investment

· Group operating costs: down 1% to 3% (was up 1.5% to 3.5%) due to tight cost control

· Net interest: £13m to £14m (was £12m to £13m) due to growth in customer loan book

· Exceptional costs: c.£67m (was £22m to £26m) due to increased customer redress provisions and asset impairment charges

· Net debt: £450m to £475m (was £425m to £450m) due to increased customer redress provisions and the likely acceleration of lease surrenders on store closures

Other FY19 guidance is unchanged:

· Financial Services gross margin: -100bps to -200bps

· Depreciation & Amortisation: £32m to £33m

· Capex: c.£40m

· Underlying Effective Tax Rate: c.22%

Outlook

Going forward we expect offline sales to continue to fall as we focus on online Power Brand growth. While this will hold back revenue in the short term, there are opportunities to drive profit particularly through improved efficiency, as the business further shifts online, and we accelerate the use of analytics to increase returns on our promotional spend.

While first half trends seen in our product business are continuing into the second half, the continued positive outlook for Financial Services and scope for further efficiencies mean that our full year expectations are unchanged.

FX hedging

For FY19 we have hedged 100% of our net purchases at a blended rate of £/$1.33, which will result in a c.£3m tailwind compared to FY18, when the hedged rate was £/$1.28. For FY20, we have to date hedged 77% of our net purchases at a blended rate of £/$1.34. Our policy is to be 100% hedged for FY20 by the end of FY19.

Closure of store portfolio

As announced in the Q1 trading update and following employee consultation the Group closed its remaining 20 stores during the period. In H1 FY19 the Group's stores generated £6.9m revenue and an EBITDA loss of £1.0m (H1 FY18: Revenue of £9.4m and EBITDA loss of £2.1m). To benefit from more favourable terms, the Group is likely to accelerate the surrender of leases on several stores.

Transformation into an online retailer

* Continuing operations

The Group's transformation to a leading online retailer continues, with online sales now accounting for 77% of product revenue in H1 FY19. For new customers revenue generated online is even higher, at 84%. Whereas online revenue grew at a compound annual average rate of 8.9% over the FY14 - FY18 period, with online Power Brands up 13.8%, the Group's offline revenue has decreased at a compound annual rate of 6.5%.

In H1 FY19 online revenue grew by 3.8% and was ahead by 8.6% for our Power Brands. Offline revenue decreased by 22.4% as the Group continued to shift its focus to its growing online business. As the Group focuses more of its resources on growing its online business, going forward it expects a continued double-digit decline in its offline revenue. Although this is likely to hold back overall revenue growth, this channel shift is expected to benefit the Group's profitability as marketing and distribution costs are lower for online customers.

Product performance by brand

* Excludes stores

JD Williams is our modern online department store, positioned for 45+ female customers and their families. Although revenue was down 3.1% this was due to the continued drag from migrated Fifty Plus customers, one of our legacy offline brands. Excluding Fifty Plus, JD Williams revenue was up 7.5%. Given that the migration of Fifty Plus customers onto the JD Williams brand commenced in the summer last year, this headwind is expected to soften during H2 FY19.

Research conducted by JD Williams found that more than half of women aged 45+ are unhappy with what the high street has to offer their age group, despite 60% of this age group having more money to spend on fashion now than they did in their twenties.

In response JD Williams staged JDW Midster Live AW18 - a celebration of fashion for women aged 45+. The show included the winners of the JD Williams' recent Midster Model search, a nationwide competition to find two unsigned models in their mid-life years, as part of its ongoing commitment to use age-appropriate models in its brand and advertising campaigns. This event kick started London Fashion Week and was live streamed on jdwilliams.co.uk with a click to buy functionality - allowing customers to buy the clothes they see on the catwalk.

For its latest campaign JD Williams has adopted both a new creative direction as well as the campaign mantra of 'I AM….'. Shot and directed by an all-female crew aged between 45-60 - our target customer. This celebrates everything about life after 45, the bold and empowering campaign features a mix of models and real women, diverse in age and shape, who the audience can really relate to, showcasing the AW18 collection, available in sizes 10 - 32.

Further building on our industry leading expertise in fit, we have continued to improve our fit accuracy by using body scanners at events for our JD Williams and Simply Be customers. Following hundreds of scans, we now have with over 200 measurements for every women's size compared to a traditional retail model of just 12. Based on these findings, we are now rolling out new adjusted size blocks to our suppliers and are targeting to have covered c.70% of our ladieswear by the end of the year.

Simply Be is the go-to online destination for fashionable size 12-32 women, offering a range of own and third-party brands, often in larger sizes on an exclusive basis, reinforcing our curvy credentials. Simply Be delivered another good performance, growing by 8.0% during the period excluding stores.

To further enhance our beauty proposition, we have recently partnered with L'Oreal, the world's leading beauty manufacturer, launching 200 lines across their big three consumer brands, L'Oreal Paris, Maybelline and Garnier on Simply Be, JD Williams and Jacamo.

Our Autumn Winter campaign, called More than our bodies, encourages women to tell the world their story through their fashion choices. It is brought to life through four familiar models that embody this ethos including Felicity Haywood, who is a pioneer of the body confidence movement and Clementine Desseaux, founder of the All woman Project.

Jacamo caters for 25-45 year-old men of all body shapes and sizes. Jacamo product revenue was up 2.7% excluding stores. Building on our successful distinctive and aspirational Live YOUR Moment campaign, as part of our summer edition we collaborated with former England international and Match of the Day pundit Jermaine Jenas and rapper Wretch 32. Extending over an 11-week period, this was our largest Jacamo campaign to date.

Following its success, we are continuing this campaign into the Autumn Winter season, showing a diverse range of men reliving their inspirational life moments using three different influencers: snowboarder and Olympic medal holder, Billy Morgan, Rugby League player Luke Burgess and model and body confidence ambassador, Raul Samuel. All were chosen for their ability to convey their inspirational life moments and to promote body shape inclusivity supporting our size inclusive offer from small to 5XL.

Secondary brands revenue decreased by 6.9% excluding stores reflecting our shift in marketing investment towards Power Brands. In addition, this reflects the ongoing decline in offline revenue, down by around a quarter, more pronounced than originally anticipated. The decline was principally driven by a double-digit reduction in revenue for Marisota. As this is increasingly being used a product brand through JD Williams, the Group has been reducing investment in the Marisota brand and has stopped offline recruitment.

There was also a small decrease in revenue for Fashion World, which is the largest brand in this category. Following the success of its Simply Be and JD Williams apps, the Group launched its third app in August, Fashion World. This is targeted at improving the online experience for our Fashion World customers. Pleasingly Figleaves returned to growth as we implemented our turnaround plan, led by its new management team.

Revenue in the Traditional segment decreased by 11.2% as the Group continued to increase its focus on its online business and scaled back its offline marketing and recruitment. Given that this segment is more heavily weighted towards offline than the rest of the Group, as it typically serves more mature customers, this segment it is expected to experience the fastest rate of revenue decline going forward.

Technology

Given the termination of our relationship with WDL, alongside proactive internal efforts mitigating this impact, the Group is currently reappraising the timeline and delivery of its systems migration project. Once this has been completed it will provide more details on the expected timing of the migration of Fashion World onto Hybris.

We continue to deploy leading edge Artificial Intelligence ("AI") techniques in Merchandising. We are already operating AI in product promotions, where we've measured benefits in promotional ROI of 25% to 40% together with an improved stock position. Given this success, we are planning to extend this application in the second half to end of season sale building and the development of AI-led predictions of size curves for product purchasing, which will help to reduce stockouts and markdowns.

Market share gains in the UK

We are focused on continual improvement of the customer experience, further development of our product offer and increasing the choice of third-party brands on our websites, many of which are extended to larger sizes on an exclusive basis. Recently added brands on to our websites include Apricot, Club L London, Kate Spade, Valentino, Guess, L'Oréal, Barry M, Peter Werth, Schott and Berghaus.

We made good progress on these objectives during the first half. On a rolling twelve months basis our market share in Ladieswear (size 16+) was up 30bps at 5.6%, with gains across all age ranges except for 60+. Our menswear market share (chest 44"+) also improved, by 10bps to 2.7%. Our active customer file decreased by 3.2% to 4.3m, with Power Brands also down by 2.8% to 2.2m, both due to the drag from Fifty Plus on JD Williams. However, the active customer files for Simply Be and Jacamo increased by 8.3% and 3.1% respectively.

International performance

The Group was disappointed by the performance of its International business, where revenue was down 7.9% to £15.3m. This was due to revenue from the USA decreasing by 16.7% (down 11.2% in constant currency), to £6.8m, whilst Ireland was up 0.6% (down 1.8% in constant currency) to £8.5m.

In line with our strategy of shifting the Group's business mix online, during the period we switched marketing expenditure in the USA from offline to online recruitment. The anticipated lower offline revenue was not however counterbalanced by adequate levels of online growth. In light of this underperformance, we have therefore changed the management team, reappraised our digital marketing strategy and appointed new third-party providers as we look to re-engage with our target customers.

We remain committed to our international business and will be narrowing our growth focus to the USA and Ireland.

Good progress on Partnerships

This includes selling capsule ranges on other retailers' sites, on both a wholesale and marketplace offering. We also see a significant growth opportunity in influencer marketing, working together with bloggers and opinion formers to improve brand cut-through and further strengthen customer engagement.

We have made excellent progress on our partnership strategy, which despite only commencing last year, is already making a positive profit contribution to the Group. During the first half we signed new partnership deals with Lipsy (UK) and Wehkamp (The Netherlands), bringing the total number of partnerships to eleven, of which we are already live on eight. In addition to providing additional sources of revenue, partnerships provide the Group with access to new markets and customers for relatively small amounts of investment.

Financial Services performance

The Group's Financial Services business continues to perform well, driven by the continued improvement in the quality of the customer loan book. Revenue was up by 12.7% driven by a 14.2% increase in interest payments, with other non-interest lines being marginally ahead.

Although gross margin was down 50bps, to 56.0%, this was principally due to our requirement under IFRS9 to make a provision against every credit customer, including those that are up to date on their payments and trading normally. For the prior year, reported under IAS39, a provision was only made where there had been objective evidence of impairment, such as a customer falling into arrears or moved on to a payment plan.

While credit arrears increased slightly, by 40bps to 9.7%, this was due to the rate normalising compared to the prior half year, which had temporarily benefited from changes in the minimum payment rate following the reduction in the rate from 5% to 4% to give customers greater flexibility in managing their finances.

During the first half we recruited 90k new credit recruits who rolled a balance, down by a third compared to the previous half-year. This decline was in line with a disappointing product performance, which resulted in fewer new customers and reduced the number of credit recruits.

Following promising initial results from our variable APR trials, we have fully implemented our variable rate pricing strategy. Our headline rate for our Power Brands has been reduced to 24.9%, and to compliment this we have launched a pay no interest offer until March 2019. This has driven an improvement in the risk quality of credit customers and increased acceptance rates.

IFRS9

* restated for IFRS9. The bad provision previously reported under IAS39 was £48.8m (7.5%).

This is the first time that the Group has reported under IFRS9, which replaces IAS39 and relates to receivables provision accounting. For the first half of this year the bad debt provision under IFRS9 is £111.9m, compared to a restated figure as at 3 March 2018 of £116.0m. The provision rate under IFRS9 therefore decreased by 140bps from 17.9% to 16.5% compared to 3 March 2018.

Compared to the same period last year (restated on an IFRS9 basis), the provision rate decreased by 320bps principally due to an underlying improvement in the quality of the loan book, and the disposal of some high-risk payment debt which was sold at a better rate than the book value.

As previously indicated, although the P&L impact of IFRS9 is broadly neutral, the higher provision rate that is required under the standard does impact the net customer loan book value, which is now £565.7m.

Key Performance Indicators

1 Customers who have ordered in each of the last four seasons

2 Company estimate using internal and Kantar data for the 52 weeks ending 26 August 2018

3 Restated for IFRS9. The bad debt provision previously reported under IAS39 was 10.3%.

4 Last six months, rounded figures. Rollers are those customers who roll a credit balance.

Financial performance

1before exceptional items as detailed on page 4 2before exceptional items and unrealised FX movement 3see note 8 for calculation of adjusted EPS

4excludes debt securitised on the Group's customer loan book

Revenue

Group revenue was up 1.0% to £457.8m, driven by a strong performance in Financial Services where revenue was ahead by 12.7% to £146.4m as we benefited from increased interest received from the Group's growing customer loan book. Product revenue decreased by 3.7% to £311.4m, reflecting the ongoing challenging market conditions for fashion retail, headwind from the migration of Fifty Plus and closure of our store portfolio. Excluding stores, which are all now closed, Product revenue was down 3.1%.

The Group's revenue performance by quarter was:

Product revenue by category in the first half was:

Gross margin

The Group's gross margin was 54.2%, down 60bps compared to H1 FY18. This decline was due to a 60bps reduction in Product gross margin, to 53.4%, which was due to the promotional retail environment, although this was counterbalanced to some degree by lower marketing costs.

Financial Services gross margin also declined by 50bps to 56.0% mainly due to the requirement under IFRS9 to make a provision against every new credit customer, including those that are trading normally.

Operating costs

The Group has kept a tight control of its operating costs, which decreased by 1.5% to £196.3m principally due to a 4.3% reduction in marketing and production costs, to £84.4m. Warehouse and fulfilment costs were down marginally, by 0.3% to £42.4m, reflecting lower product volumes, and with admin and payroll costs only up by 1.3%, to £69.5m, less than the rate of inflation.

As a result, adjusted EBITDA increased by 6.1% to £52.0m. As anticipated Depreciation and Amortisation increased by 15.4% to £14.9m due to investment in IT systems, resulting in operating profit before exceptional items and unrealised FX movement of £37.1m, up 2.8%.

Net finance costs

Net finance costs were £6.5m, an increase of £2.6m on the H1 FY18, because of the Group's increased overall debt, which is principally due to ongoing growth in its customer loan book.

Taxation

The effective underlying rate of corporation tax was 21.8% (H1 FY18: 23.2%). The overall tax charge was a credit of £1.1m (H1 FY18: £6.4m credit).

The Group has on-going discussions with HMRC in respect of a number of VAT positions, the most material of which relates to the VAT consequences of the allocation of certain costs between its retail and credit businesses. These proceedings have been to tribunal during the half and we are currently awaiting the court's judgement.

As previously disclosed in our FY18 Annual report, the Group estimates that an unfavourable settlement of these cases could result in a charge to the income statement of up to £53.1m and a cash payment to HMRC of up to £10.3m. A favourable settlement would result in a repayment of tax and associated interest of up to £41.2m with no impact on the income statement. Further details are set out in Note 11.

In addition, following the review of the carrying value of Figleaves goodwill the Group has also written off the remaining deferred tax asset of £3m in relation to future unutilised tax losses. This has been presented as an exceptional tax item.

Earnings per share

Loss per share from continuing operations was 9.14p (Loss in H1 FY18: 7.50p) due to exceptional items. Adjusted earnings per share were 8.37p (H1 FY18: 8.77p).

Balance Sheet and cash flow

Capital expenditure was £17.9m (H1 FY18: £21.8m). Inventory levels at the period end decreased by 6.1% to £98.3m (H1 FY18: £104.7m), lower than the 3.7% decline in product revenue.

There was a net cash outflow from operations (excluding taxation) of £22.3m (H1 FY18: £43.8m inflow) mainly due to exceptional cash costs of £36.8m and £30.0m growth in the gross customer loan book. After funding capital expenditure, finance costs, taxation and dividends, overall net debt increased by £73.7m to £420.5m (H1 FY18: £305.7m) compared to £346.8m as at 3 March 2018.

The group's defined benefit pension scheme has a surplus of £23.8m (H1 FY18: £8.7m surplus).