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Edited Transcript of WHS.NZ earnings conference call or presentation 8-Mar-17 8:15pm GMT

Thomson Reuters StreetEvents

Interim 2017 Warehouse Group Ltd Earnings Call

Takapuna Auckland Mar 8, 2017 (Thomson StreetEvents) -- Edited Transcript of Warehouse Group Ltd earnings conference call or presentation Wednesday, March 8, 2017 at 8:15:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joan Withers

The Warehouse Group Limited - Chair

* Nick Grayston

The Warehouse Group Limited - CEO

* Mark Yeoman

The Warehouse Group Limited - Group CFO

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Conference Call Participants

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* Chelsea Leadbetter

Forsyth Barr - Analyst

* Warren Doak

Macquarie Research Equities - Analyst

* Mo Singh

Craigs Investment Partners - Analyst

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Presentation

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Joan Withers, The Warehouse Group Limited - Chair [1]

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Good morning. I'm Joan Withers. I'm Chair of The Warehouse Group. With me this morning I have our Group CEO, Nick Grayston, and our Group CFO, Mark Yeoman. We're delighted to be presenting the interim financial results for FY17.

Today we're announcing a mixed half year result with an adjusted net profit after tax of NZD39.7 million, which is inside the guidance range that we issued on December 20, 2016, and it represents a 12.9% reduction with the comparable period last year.

During the half we enjoyed positive results from Noel Leeming, from Torpedo7 and from Warehouse Stationery, offset by weaker performances in the core Red Sheds business and in financial services.

One-off costs -- mainly a non-cash impairment of goodwill and financial services -- impacted our reported profit of NZD13.5 million (sic - see slide 2 "NZD13.6million"), which was 76.3% down on the comparable period last year.

The Group announced a major restructure in January as a first step in a broad program of change which is aimed at improving both profitability and customer relevance. Nick will be providing an update on that program later in this presentation.

The Board is very confident that despite the mixed result in the half year, the business is taking the steps needed to revitalize and achieve its full potential. We will inform the market and provide updates as appropriate as we go forward.

Now I'll hand over to Nick.

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Nick Grayston, The Warehouse Group Limited - CEO [2]

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Thank you Joan, and good morning everyone. I'm going to start by taking you through the total Warehouse Group H1 interim result. First, looking at retail sales, which were up 3.3% on last year, they really reflect the mix in fortunes across the retail buses, with Red being largely flat year-on-year, but very strong growth being seen in both Noel Leeming and Torpedo7.

A decline in gross profit margin rate reflects currency headwinds year-on-year, as well as an impact from the start of longer term strategies to rationalize product and move to more EDLP within rate. Sales growth was achieved at lower margin rates due to product mix. For example, products that we sold in Noel Leeming has an intrinsically lower margin rate.

Cost of doing business continues to be a focus. There is a lot more work to be done here. The recent structural reorganization is the first step in delivering a step change to our CODB rate.

Impacting the reported profit is a non-cash write-down of NZD22.7 million in goodwill in financial services. We had previously signaled this at the shareholders' meeting. Adjusted NPAT has been delivered within the range signaled to the market on December 20 at NZD39.7 million, which is 12.9% down on last year.

In summary, the first half result was characterized by margin compression resulting from the planned transition of product strategy, softening trading conditions and currency headwinds. The result reinforces our need to go faster on executing real change in the business, and we're taking those steps.

I'm now going to pass on to Mark, who's going to talk to the adjusted versus the reported results.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [3]

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Thanks Nick. I'll take you through the rest of the detail of the financials. To have a more comparable view of underlying business performance the Group adjusts its reported profit for unusual and operating items. These typically include any gains or losses from the sale of assets, adjustments in carrying value, any business acquisitions or disposals and restructuring costs. An adjusted profit is what the Group bases its earnings guidance on.

As Nick said in the first half, the major item here was the NZD22.7 million goodwill impairment in financial services, but we also booked NZD4 million worth of restructuring costs, which we'll touch on later.

Turning to the balance sheet. Overall, the balance sheet gearing remains at appropriate levels. There's been some movements in items due to timing. For example, trade and other payables are higher than last year as several scheduled payments, including GST, occurred after the cut-off date for the first half compared to previous years' timings.

The mark to market valuation of the Group's portfolio of foreign exchange derivatives has declined following an increase in the US dollar over recent months. After two years of efforts to secure a cost effective retail development for the Newmarket site, we have decided to sell that asset. We're confident that our remaining stores in the Auckland Central area will be able to serve that catchment adequately.

Turning now to the cash flow statement, the business continues to remain strongly cash generative, and a focus on consolidation and tight capital controls will continue to maintain the balance sheet in good shape. Our levels of retail capital expenditure continue on track at levels that are in line with depreciation.

During the half we made a couple of divestments of properties, including Rangiora and Gisborne, and our operating cash flow has increased again due to some of the timing of those payments that I touched on in the balance sheet.

I'll now hand back to Nick to take you through the brand financial performances.

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Nick Grayston, The Warehouse Group Limited - CEO [4]

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Thank you Mark. First, starting off with the Warehouse business, overall, sales were flat, slightly up, 0.2%, but same stores sales growth was at 1.3%. That sales growth appears modest compared to a very strong season last year. As we make changes to our promotional program it highlights that the momentum has been with our EDLP range, and we've continued also to accelerate our digital sales.

Gross margin was negatively impacted by currency movements against last year and the continued investment in price, especially in our EDLP products. Despite a modest cost of doing business increase of 1.1% on last year, that cost growth was higher than our margin growth.

Our CapEx in this segment was increasing as we invest as planned with systems to support ongoing growth, especially in the digital world, around order management systems, a new web platform and new sourcing platforms.

Turning to the highlights, sales in apparel departments have been very strong. It's especially pleasing given that we've had an expanded EDLP offer, high penetration of EDLP there, with improved margin and stock position, reflecting the benefits of a more curated assortment. Still more work to come, but very pleasing nevertheless.

The leisure categories, which includes toys, have also delivered good sales growth despite cooler weather through much of New Zealand through December and January. A slow kick-off to the summer season, but we did manage to drive some good business through effective events, promotional activity, and have good results from the range improvements that we've put in.

Online growth was supported by our new Demandware platform and a strong promotional program. Customer experience through the fulfilment process continues to show solid improvement to match the momentum now in this channel, but needs a lot of work to get it up to the same day/next day capability that we aspire to have.

Gross profit declined NZD2.9 million in the half. This is a combination of additional investment in price, lower in-flow margin which was impacted by currency impacts against last year, and promotions in seasonal categories which enabled us to maintain sales re-curves. As a result of this we managed to keep inventory quality good and current with a reduction in aged inventory.

With regards to cost of doing business, we've had a strong focus on this throughout the half. However, the leverage under the current structure is challenging with a largely fixed cost base. Productivity there continues to be a focus.

In summary, key categories performing well and getting some benefit from good range selections and solid trading plans, but a lot more work to be done.

In terms of stores, in this period we opened the Tauranga Crossing store in conjunction with other TWG brands, and Northland was refitted. Following the November 2016 earthquake we closed our Wainuiomata store permanently. That was actually bringing forward of a planned closure, and the Lower Hutt store is still temporarily closed until work is completed on the mall complex.

Our focus continues to be on delivering great products at great prices, ensuring that we deliver on our promise to make the desirable affordable and also the affordable desirable and offer great value. We continue to reshape our operating model to reduce complexity and cost while responding to the fast-changing needs of our customers, ultimately, to be set up for success in tomorrow's retail environment.

Moving on to Warehouse Stationery, very pleasing to maintain our profit growth here. We had continued growth in a very competitive market and increased our market share. Trading performance in the half benefitted from an increase in transaction count and a small increase in average basket. We did experience a slow start to back to school, but had a stronger finish in February which, of course, falls into Q3.

Gross profit percentage has been influenced by the product mix with a higher growth in some of the low margin categories, such as cellular. Cost of doing business was managed really tightly and the team did really well in doing that, resulting in significant improvement as a percentage of sales. Network expansion continued with the addition of the Tauranga Crossing store, and second half focus remains on sales growth, with a focus on improving gross margin percentage and continuing to manage cost of doing business.

Again, yet another solid year-on-year growth with focused management of cost of doing business resulting in operating profit leverage.

Noel Leeming had a spectacular growth in profit. Continued to grow market share during Q2 in an extremely competitive appliance and technology market. Sales momentum in half 2 continued into half 1 2017. Total sales growth of 11.1% was underpinned by strong same sales store growth of 9.9%. It's true to say that we do expect some softening of that same store sales growth in Q3 since we are now cycling against periods post the exit of Dick Smith from the market.

The categories of cellular, television and whiteware performed well. Gross profit was up NZD8.8 million on the prior year. This was a result of the increase in sales volumes. The focus continues to be on managing cost of doing business, so we were able to leverage the strong sales performance to deliver 44.1% operating profit improvement.

We continue to differentiate our sales in the market through our passionate people and services offering. During H1 2017 we opened new stores in Takapuna and Tauriko. In addition, we relocated Gisborne and Queenstown. This store activity is reflected in our CapEx expenditure, along with an investment in in-store faster band width. The significant increase in operating profit driven by strong growth in sales, careful management and the cost of doing business.

Moving on to our Torpedo7 Group, the Group delivered positive results with the key highlights being strong sales growth and tightening of cost of doing business management, which has translated into improved EBIT performance.

Torpedo7 house brand did really well, especially in the water category, which has been very well received by customers, and enables us to add a lot of value to our range and assortment.

1-day's performance has accelerated and maintained its profitability during that growth. We've extended the range of product offering and bolstered performance in what is a declining daily deals market.

No 1 Fitness and Shotgun Supplements businesses remain challenging. Promotional competitiveness of these markets created margin pressure. Priorities for the second half are focused on operating model review and improving store execution, as well as bedding in the operating model changes.

In summary, Torpedo7 Group continues to develop and offer a seamless experience for customers as New Zealand's leading outdoor adventure sports multichannel retailer.

I'm now going to pass on to Mark, who's going to take you through the financial services business.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [5]

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Thanks Nick. The operating result for financial services for the first half was a loss of NZD5.2 million, which compares with a loss in the first half last year of NZD2.7 million.

The size of our receivables book is NZD74.7 million which is a small growth on the book for the comparative period. The first half this year reflects that in the comparative period, the business was still partially in build mode and really only had two months of trading operations, compared with this year where we were 100% operational and in a growth mode.

The first half results this year have borne the majority of the costs associated with migration of the Westpac joint venture book, and those costs are not expected to be replicated in the second half. Focus has really been on getting the foundations of the business right, successfully migrating those joint venture customers on to our new Warehouse Money hosted systems. Continuing to develop our customer services process, and bedding down our systems and processes overall.

Following a revision of expectations around the transfer of those joint venture customers, and expected asset growth, the business has written off as a non-cash item, the carrying value of good will of NZD22.7 million, which arose from two items. Which was firstly the acquisition of Diners Club New Zealand, and the acquisition of Westpac's share of the joint venture business.

I guess it's difficult for an early stage company which is really what Financial Services is, with uncertain developing future cash flows to have sufficient certainty and outlook to support the carrying values of goodwill relating to strategic value and acquisitions, which is the reason we've taken 100% of that good will write down at the first half.

The focus for Financial Services for the first half was really building on launch and leveraging the Groups retail distribution. In terms of an outlook for the Financial Services business, which we said at the annual shareholders meeting that we would update at this session. As we signaled our expectations around asset growth and customer behaviour, from that joint venture book that we acquired from Westpac, had to be reset, after we've transitioned and re-carded those customers.

We saw more churn and less customer conversion that was expected. Consequently the asset base is only 1.6% up year-on-year, reflecting a combination of that churn, increased bad debt write offs, which is largely offset our asset growth in other areas.

We've done a lot of detailed scenario modelling around future cash projections for the business. Based on what we observe as run rates and customer behaviour to date. We'll make the point that the books still young, which brings with it a range of assumptions of how customers will behave, their revolve rates, the loss rates, and the growth potential of those customers. Financial Services, it's possible to accelerate growth by relaxing our risk settings.

However, we believe that our risk settings are correct, regarding customer acceptance and our cost of acquisition is low by industry standards. We're adjusting our timeframe for break even, as a consequence of not reducing those risk settings just in response to the slower growth that we've seen in the first half.

We've also yet to develop and launch additional product offerings that are fundamentally important to the future profitability of the business. In addition, our scenarios are realistically bound by capital constraints and what I'd describe as a reasonably conservative posture towards taking on additional risk. Our financial projections reflect various scenarios around product launch and penetration and key assumptions around leveraging or group distribution opportunities.

I guess that's signalling that there's still quite a bit of uncertainty in those future cash flows. But our focus primarily is on building scale. Presently the business is subscale and with the infrastructure investment and fixed cost base, our priority is to grow the customer book in the most capital efficient way possible and reduce our costs as a percentage of revenue.

In addition we've got a new CEO who will be joining the business this month, who will drive the business through this phase to profitability. In terms of seeking that scale, we believe that scale would come at an asset base of approximately NZD300 million and the current base is NZD74 million, so there's a bit of growth there to achieve.

Our key projections, or our updates to our projections are currently that break even has been pushed out to FY21, with two more years of losses of similar scale to this year forecast, as the business continues to invest in customer acquisitions. By that time, FY21, we'd project an asset base of around NZD320 million. That projected growth is able to be funded from existing capital in the Group, and we're noting that in reflection of that conservative setting, we're not including revenues or investments from any new to market products. But products based on our current strategy in that business. I'll hand now over to Nick for an update on overall Group strategy.

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Nick Grayston, The Warehouse Group Limited - CEO [6]

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Thank you Mark and as we continue to build our strategic objectives that are in line with what I presented at the year end. I think it's appropriate to pause here and give you a bit more detail.

There are four main areas that form our strategies. The first is around product, and all retailers are dependent on having good product to drive sales. Within that the things that are going to be increasingly important to us, are an increased mix of EDLP, greater price transparency, an increasing range duration, the reinvention of the bargain to give great value. As we say making the desirable affordable and the affordable desirable, and moving to a much more dynamic and flexible sourcing model. All of this will help us enrich our margin.

The second pillar is digital, as we signaled, we intend to move from much more -- from a transactional model to a much more engagement oriented model. We'll build out our Omni channel capabilities, serving customers as they choose to shop. Our extended portfolio of products and services will become an ecosystem, helping kiwis live their lives better. We will develop best in class logistics and fulfilment capabilities.

All of this will require a redeployment of investment. In terms of process, we need to reengineer this for simplicity and reduced complexity. This in turn will lead to cost reduction to eliminate non-value add for customers. We'll automate a lot of things and live by the maxim of test fast and fail fast. Process improvements will ultimately lead to further cost reductions.

The fourth plank is corporate social responsibility, our stated vision is to help Aotearoa New Zealand flourish and we intend to imbed CSR in everything we do. We'll continue to build our partnership with communities to give back to them. We'll continue to build out our environmental protection policies, and enable customers to choose who and what we support. This more than anything is us staying true to our heritage of being imbedded in communities, by kiwis, for kiwis.

Underpinning all of this is a need to change our culture to ensure that we remain customer centric, but increase our pace and become flexible and agile. We believe in transparency and feedback, celebrate diversity and move towards a learn all as opposed to a know it all orientation.

The key enablers of this are to recruit and retain top talent, to take a lean approach where we value everything in line with what value adds to the customer. Data driven insights informing metrically driven decision making, engaging proactively with our customers and team, our process a relentless prioritization supported by a strong Board.

To reiterate, our strategy is to be New Zealand's most successful retail group, both in terms of relevance to customers and in order to do this, we need to build sustainable profitability. In terms of reengineering Group performance, this slide really shows us the need for change. Over the last five years, we have driven unprofitable sales at the expense of operating margin.

We need to continue to get our retail fundamentals right and invest in our future, especially with regards to the digital capability and the testing new store designs to ensure we maintain relevance and drove Omni channel. All of this needs to be underpinned by operational efficiency, to remove duplication and fragmentation across the Group. We has as you know made multiple acquisitions across the last six years, the change to a shared services model will underpin the changes in process and through efficiency and automation. The key levers as we see them are gross margin, which we will see as being a 2 to 3 point improvement over three years.

We seek to reduce our cost of doing business by 2 to 3 points from a current 28% rate over those three years, with EBIT going from less than 4% to a three year target of over 7%.

The next slide just reiterates those financials, and although we've started to reshape the business to the new operating model, there are many initiatives in the program to realize our goals. The following slides give a little bit more detail on for example, two of those initiatives, and the scope of changes within our program. These two highlight the operating model change that is underway, and will also demonstrate the changes we're making to our logistics and fulfilment capabilities.

The first around operating model change. The Group recently announced a structural reorganization around the introduction of a new operating model for the retail businesses and support services. These operating model changes are an important first step in executing our strategy.

The impacts of this phase will be completed by the start of FY18. This is designed to support the implementation of changes to improve our retail fundamentals, such as more dynamic sourcing I just spoke to, and set the foundation for investment in to areas, better to engage today's customers.

Evolving our marketing capabilities and investing in digital expertise. We seek to remove duplication, promote streamlining of business processes and systems. What does this really mean in terms of the businesses? Well the operating models in blue and red involving consolidating the leadership and specialist retail functions of the two businesses.

We need to bed down the new operating model and business processes and transport or transfer the support functions to Group Support Services, so things like finance, property, people, support and information systems. Similarly within Noel Leeming and Torpedo7, we're going to consolidate the leadership of those specialist retail functions, identify some quick wins in terms of improving retail operating practices and digital practices.

Typically we've done a good job in Noel Leeming of operating our businesses, it's a very slick operation from which we believe Torpedo7 can benefit. Equally Torpedo7 as an original pure play business has some digital practices, which we think will promote best practice in Noel Leeming.

Similarly we will transfer support functions to Group Support Services, again finance, property, people, support and information systems. Those Group Support Services, by pulling them together in to one central resource, will be able to remove duplication and inefficiency, so a complete back office integration of Group businesses. And enable those retail businesses to focus on trading and customer related activity, rather than diving their time with business support services. This will require a redesign and harmonization of those support business processes, which is already underway. In terms of the next phase.

The next phase of our operating model change, is to redesign those businesses processes and ways of working, to improve our organizations speed to market, flexibility and efficiency. The identification and realization of those synergies will result from combining the business operations, but the majority of the benefits will start to be recognized in FY18.

We do see potential growth opportunities, product rationalization and opportunity to look at reconfiguring our physical space, which will test our way in to. Supply chain and sourcing economies and business process improvements. The structural changes and realignments are also key enablers of other initiatives within the broader change program.

An example of that would be the move to more EDLP focused product strategy in Red. The implementation of technology changes will enable a more streamlined and efficient and lower cost retail operation, that can support those business strategies, to engage customers and shorten sourcing cycles.

Within that, the operating model change key financials will look something like this. Personnel cost savings in the half will be around about NZD1 million to NZD2 million because we're quite a way through the half by the time they're implemented. But will represent NZD13 million to NZD15 million annualized.

In addition to that, we will realize another NZD1 million or NZD2 million in non-personal cost savings, which looks like more like NZD5 million annualized, so in the range of NZD18 million to NZD20 million annualized.

The cost of change is something of an unknown at this time, but will be in the range of NZD10 million to NZD13 million. The reason why it's been -- why it's unknown at this stage is that we first established a new structure and further savings and growth will flow from the implementation of those change strategies. That process is still very much in play.

The second example I'm going to give is how we've innovated our fulfillment and logistics business. Following the acquisition of a number of businesses in the last six years, the Group has had a fragmented and siloed logistics and fulfillment capability. We have made some incremental improvements over the years, but our strategy is now to centralize a best practice logistics capability, and develop the necessary capabilities to support both a next day and same day, in some cases, delivery model for online fulfillment, which we believe is going to become increasingly more important, and will become table stakes very soon.

The logistics and fulfillment scope includes both international freight forwarding from point of origin into our distribution centers in New Zealand, local product supply from agents, distributors or manufacturers in New Zealand, warehouse stock management, distribution to stores, distribution direct to customer, online fulfillment, and including Click and Collect from our stores.

As at the half year, we've progressed a number of these initiatives within the fulfillment and logistics program. Most of these initiatives however are still in progress, but they include consolidating our North Island distribution centers across brands, centered on our warehouse facility at Wiri in South Auckland; investing in and expanding our South Island distribution center, with the objective of consolidating South Island distribution into that facility wen completed on March 20 this year.

We are in the process of transitioning our international freight forwarder relationship to Mondiale. We are making improvements in the electronic transfer management of product data; changes in how apparel is shipped from manufacture to improve -- will improve distribution efficiencies, and hence speed to market. We are currently implementing a new OMS that will underpin online fulfillment, and work is progressing on developing a next-day delivery to customer capability, and in some cases we seek to be able to deliver same day.

I'm now going to hand back to Joan, who is going to talk about dividend and outlook.

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Joan Withers, The Warehouse Group Limited - Chair [7]

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Thank you Nick and Mark for taking us through that presentation. I'll now cover off the outlook and earnings guidance.

In terms of the current retail environment, while retail conditions remain generally favorable, there are signs that retail spending is softening. The headwinds that we're facing for the second half of FY17 remain increased competition and of course the transition timeframe around the strategic change, both internally and with customers, that Nick has outlined.

Full year guidance, for FY17 our adjusted net profit after tax, subject to material changes and trading conditions, is expected to be in the range of NZD54 million to NZD58 million. This represents a decrease of 10% to 15% in profit for the full year. We are targeting a full year dividend of NZD0.15 per share, but the Board has today declared the interim dividend of NZD0.10 per share, which is payable on April 13 this year.

I'll now invite questions. Thank you.

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Questions and Answers

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Operator [1]

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Thank you. (Operator Instructions) Your first question comes from Chelsea Leadbetter with Forsyth Barr. Please go ahead.

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Joan Withers, The Warehouse Group Limited - Chair [2]

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Good morning Chelsea.

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Chelsea Leadbetter, Forsyth Barr - Analyst [3]

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Thanks moderator, and good morning guys. Good morning. Just a couple of questions from me. If we could start with the 7% margin target. I appreciate you've given us some degree of color on you are thinking about getting it from a growth margin and cost of doing business perspective, but can you talk a little bit more on the divisional expectations that underpin that 7% and what we should be thinking about to get to that 7%?

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Nick Grayston, The Warehouse Group Limited - CEO [4]

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Well, you know, as you know Chelsea, the majority of our profit is generated from The Warehouse business. That's where the -- most of the improvements will come from. Noel's has a good sales growth. It returns investment in cash -- it's cash-generative, but really the biggest opportunities, and it's backed up by the collapse that we've seen over the past few years, does come from The Warehouse business.

You know I think it is going to come from a number of areas. As we consolidate our assortment it gives us greater buying power, and we are, as you see this time round, subject to a lot of currency fluctuations. You can make your own predictions about where currency is going to go. We think it's going to be an advantage in the second half, but we know it was a NZD22 million or so headwind in the first half. Being able to consolidate assortments and be much more crisp about those deliveries, and be able to gain the volume together and get critical mass will help us buy better.

In addition to that, the more we move to EDLP, the less we'll spend on promotional mark-down. That whole high-low pricing cadence is one that drives an awful lot of cost and has been one of the reasons for the cost expansion. As we move to a higher proportion of EDLP, we will be spending less on promotional mark-down, we'll be spending less in terms of store labor, we'll be administering fewer items, we'll get more critical mass behind the items we buy, and less handling costs in stores. Those are going to be major drivers.

In addition to that, we'll change our we spend our marketing dollars. That will enable a wider change of how we go to market, and not be so dependent on continually having a sale and high-low pricing cadence. We will be much more driven by an engagement model, supplying a portfolio Group -- of Group opportunity to supply services and products, using data to understand our customers better, and to be able to assort better. That's really the margin side.

In terms of the cost side, as I said, that change will also help us be much more efficient around costs. There will also be a benefit from centralizing the shared services model, which means a lot of the back-off in efficiencies of four or five different systems stacks, four or five different accounts payable elements of the business, that has existed, will be eliminated as part of the cost take-out that we're doing at the moment.

Intrinsically, high-low pricing is also going to take out a lot of marketing expense, and enable us to be much more focused and streamlined about the business. I hope that answers your question, Chelsea.

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Chelsea Leadbetter, Forsyth Barr - Analyst [5]

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Yes it does, thanks Nick. Just to dig into the EDLP a bit more in Red though, can you comment on where you're at today, versus where you want to be in six months, and then where we're going to get to?

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Nick Grayston, The Warehouse Group Limited - CEO [6]

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Yes, I --

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Chelsea Leadbetter, Forsyth Barr - Analyst [7]

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It's not obviously going to be 100% EDLP?

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Nick Grayston, The Warehouse Group Limited - CEO [8]

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That's to be confirmed, to be honest with you, in terms of the 100% EDLP. There are plenty of global retailers, low-cost mass merchants like Walmart for example, who are 100% EDLP. That's to be confirmed. At the moment, we are just over a quarter of our assortment is EDLP.

For next year, all of our private label will be the EDLP. There is an open question about the balance of the assortment. We know that it's a delicate balancing act. We've seen how difficult it can be to make that transition. You've seen Target in the US, it took three or four years to get through that, but then its business came out the other side and had a period of prosperity.

We saw some of the struggles at mid-market department stores, from the likes of JCPenney and how they approached it -- that's another conversation, and lots of other things went on. It's a careful transition. More than anything else, we'll listen to our customers. As you know, The Warehouse is where everyone gets a bargain, but the concept of an everyday bargain is one that is completely aligned in terms of our mission to help Kiwis live their lives better.

So, it will be a journey Chelsea, and it will be one that we will take our customers along on. We will be dynamic in terms of what products and when, and how much. We're not going to make any foolish decisions there.

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Chelsea Leadbetter, Forsyth Barr - Analyst [9]

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Okay. Thanks Nick. Just one last question perhaps for Mark; just trying to understand the financial services plan to get from NZD74 million to an asset base of around NZD300 million by FY21. Can you talk us through how you -- what's the drivers of that?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [10]

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Yes sure. Without announcing our intentions around products to market, there are a couple of products that we are pretty confident in of our ability to deliver that will be growth drivers for us in that timeframe. Work is currently underway in terms of planning for that.

We don't believe we can get there just by continuing to push the existing product set. It's an important component of the products going forward, but it does need other offers in the retail market in order to support that growth. We've made some assumptions around that, but as we pointed out, those are products that are currently in the market in terms of retail finance, so we're not relying on bringing any wild innovation to the market as part of those forecasts. Our aspiration still is to innovate, but in terms of putting the forecast together we've been reasonably conservative.

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Nick Grayston, The Warehouse Group Limited - CEO [11]

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Yes, let me embellish on that a little, Chelsea. To Mark's point, the forecast of break-even 2021 is driven by continuing to do very much the same things, rather than any radical disruption. Now, if you look at FinTech particularly, there is a lot of radical disruption about to happen to that world. For us, financial services is an important element of the ecosystem that we seek to offer to our customers, along with mobile, along with Noel's expertise and technology, BizRewards from business to business perspective. There's a lot of exciting stuff that could be a facilitator of that.

Think about blockchain for example, and how that is disintermediating a lot of financial services in FinTech. We're looking very heavily at how we might use that in various different ways, and use it as an ability perhaps to take out cost of processing, of financial exchange, inject small amounts of cash to financially change customers.

I think it's really exciting, because in addition to that ability to serve, it's extremely data-rich. As you know, the -- in the second digital age, data is king in understanding your customer. Switching the paradigm from being a supply-side organization to being a data-driven, customer-focused, and solving customer problems, is really the whole game in modern business. For us to not change would be a more dangerous decision than to put underway the radical changes that we're seeking to implement.

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Chelsea Leadbetter, Forsyth Barr - Analyst [12]

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Okay. Thank you very much. That's all for now.

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Operator [13]

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Thank you. Your next question comes from Warren Doak with Macquarie Research Equities. Please go ahead.

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Joan Withers, The Warehouse Group Limited - Chair [14]

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Good morning Warren.

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Warren Doak, Macquarie Research Equities - Analyst [15]

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Good morning. Look, I had one question that's a bit shorter term than Chelsea's one. If I look at FY18 and try to interpret your comments there about business sort of circa NZD20 million in costs savings, if we go back one year to FY16, the Red Shed and Stationery businesses combined delivered just under NZD104 million of EBIT.

This year there will be a bit of a shortfall. We've talked about currency and EDLP, and bits and pieces. From what you've said, you'd expect an improvement in the core business in FY18 that may take us back towards, say, the 2016 EBIT levels for those businesses.

Then from what you're saying on top of that we should be expecting NZD15 million to NZD20 million in EBIT improvement. And so that would sort of take those collective businesses to somewhere around NZD120 million to NZD124 million of combined EBIT in FY18. I guess that would flow through to an NPAT number of the high NZD70 million to NZD80 million. So is that pretty much what you're saying from a guidance perspective?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [16]

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So Warren, Mark here. We're not actually giving any guidance with respect to FY18 at this time. The only guidance we're issuing is in respect to how we think FY17 is going to close out. I guess there are a lot of moving parts as part of the strategic initiatives.

We've got a bit of work to do over the next six months really to sequence a lot of those things in order for us to put confidence around the numbers when we give guidance for FY18. I mean I understand what you're saying in terms of sort of a broad-brush picture but look, without actually having completed that work it wouldn't be responsible for us to comment in more detail on that at this time.

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Nick Grayston, The Warehouse Group Limited - CEO [17]

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Yes, Warren I'd add to that as well. The action that we're taking at the moment is necessary and I've seen some commentary to say that it's overdue. But you look at how business has changed and dynamic businesses continually re-prioritize their financial and human capital.

Call it the 3G capital effect if you like but clock speeds have been radically accelerated and that's a process that will continue to happen as we start a transformation office on a weekly basis. And so this is the first tranche but we will radically reshape our Company and this is not going to be the end of our aggression towards taking out costs. This is really the start.

As you know in New Zealand there is a detailed period of consultation and we fully involved our team members. The reason why we're not able to give more specific guidance of the short term impact in terms of costs is because that process is still ongoing, but this will be a continual process following our customers and leading our customers to the future. So we will of course, at the appropriate time, be giving formal guidance but at this point we're giving you an assurance that the process has started and this is a tangible cost takeout.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [18]

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I think just to round that out, as Jane said Warren in her opening comments, we plan to update the market pretty regularly as a lot of the sequencing and a lot of the thinking of the rest of the strategy lands and is confirmed. So I appreciate that you guys are keen to get more into the detail and get some certainty around what the goalposts look like, but we'll give you that information as we can when we can.

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Warren Doak, Macquarie Research Equities - Analyst [19]

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Sorry to harp on about the same point but if I look at FY18 and I look at a combined Red shed Blue shed result, if you do not deliver NZD20 million improvement over the FY17 year as a combination of a cost out and the improvements you've got in EDLP, would that be a fail?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [20]

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No. To be honest with you Warren a fail would be to not take action on our business model and transition it. We are in the process of a fundamental ground up transformation of our business.

I know you want to get assurance around joint 2018 and when we give guidance we'll give guidance. But the more important thing for us to do is to manage our business for a very radically changing environment. We've seen what's happened to retail in the US and Europe and what happens when you don't front foot a change to the environment. I mean it's not just retail, it's throughout the world, and so our focus is on fixing our Company long term, embedding in that transformation.

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Warren Doak, Macquarie Research Equities - Analyst [21]

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Okay, but if you go back to the guidance that you gave synergy benefits for Noel Leeming, your EBIT went backwards over the two year period where it went through so it was hard to tell whether there were synergy benefits or whether without the benefit for the synergies result would have been even worse. From the outside, and we can only judge you from the outside, we have to see some level of improvement. I guess if you've identified NZD20 million of tangible cost savings, if that is not delivered then that means your business is facing a structural challenge and the strategy that you've got is not arresting it.

I've covered this stuff for a long time and this is the third or fourth iteration of this long term bottom up transformation. This delivered nothing in terms of EBIT growth. So where is the tangible sign that this is any different. When there's an opportunity to identify and stand behind it, you know, all your comments are fair but it's not providing any confidence is it? Well to me it's not anyway.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [22]

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Okay, well Warren you're going to have to make your own decisions on that. We're telling you that we're taking out NZD18 million or NZD20 million in cost. You make your own conclusions.

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Joan Withers, The Warehouse Group Limited - Chair [23]

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The point Warren though that Mark made is we do intend, and we discussed this at Board level yesterday, we understand that the market will need to see our progress as we move forward. We are doing something more fundamental than has been done in The Warehouse I think since its early days. I was on the Board in the late 1990s and early 2000s. Nick and his team now are really reshaping this business to make it fit for the future. So there will be some rocks along the road but in the interests of transparency we intend to keep the market abreast of what's happening as we go forward.

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Warren Doak, Macquarie Research Equities - Analyst [24]

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Thanks.

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Operator [25]

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Thank you. Your next question comes from Mo Singh with Craigs Investment Partners. Please go ahead.

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Joan Withers, The Warehouse Group Limited - Chair [26]

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Good morning.

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Mo Singh, Craigs Investment Partners - Analyst [27]

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Morning guys. Just can you clarify, I'm just following up on Chelsea's question a little bit, you mentioned initially that your NZD300 million target for financial services didn't include -- it was conservative and didn't include any new product introduction out to FY21. But you just mentioned before that to get to that target one of the things you're going to do is to introduce new products. Can you just clarify if there is or if there isn't any new product development embedded in that expectation out to FY21?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [28]

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Yes, thanks. That's a good question to clarify because it is an important point. Look, we definitely see bringing new financial service products to market as part of achieving that growth.

I guess the distinction in our mind is there are products that consumers are familiar with today and that there's an existing market for. And then there are new products, such as some of the FinTech innovations that Nick touched on that perhaps haven't got a proven market and may involve training customers and new ways of doing things.

Our projections don't involve any of that second group of those sort of new innovations and sort of radical customer innovation around financial services, although our aspiration remains to deliver innovation in that sector for our retail businesses. The projections are really focused on introducing products that we know there is a market for and that we can believe that we can take some share in that space. So that's the distinction but good question.

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Mo Singh, Craigs Investment Partners - Analyst [29]

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Okay and just sort of sticking with that segment. I mean obviously you must be disappointed with the lack of growth and your points sort of churn and some other things there that potentially you weren't expecting when you initially took this business on. But I guess you've had a couple of resets in terms of break even and you've gone from sort of I think first half 2017 and now you're out to FY21. I mean that's a sort of stretch of five or six years now of loss making for this financial services business which is something that was expected to break even sort of coming into next year.

I know Nick touched on the fact that this is strategically somewhere you want to be but at what point do you internally start having conversations about is this a viable business for you guys to be in given that you're now saying that it's going to take you six years to get to a breakeven position. And your receivables book is basically stagnant when you're seeing credit growth at pretty substantial rates over the last 12 months to 24 months.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [30]

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Yes, look I guess it is a push out in timeframes. There's no denying that but as I said we're not going to change our risk settings just in order to meet timeframes that we don't believe are appropriate.

The Board is still very supportive of financial services in terms of its end state and what it could deliver to the Retail Group if we execute. You asked the question, at what point do we start examining the viability of this business and I'd say that those discussions are ongoing and constant and there's been a lot of challenge around the strategy for financial services and sort of shaping the future.

So I think it's not just a case of cross our fingers and hope. The business is under constant review and we have internal milestones to hit as well. I think as with any business that has a prize to be achieved there's a period of investment. That period is a bit longer and a bit slower than was initially forecast and I think that's a reality we just have to face. Our challenge is to take the business as it stands now and chart the best course we can to build profitability and build value into that business, so that's what we're doing.

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Mo Singh, Craigs Investment Partners - Analyst [31]

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Okay. Just one last one on financial services before I move on. Just you sort of recorded a loss of NZD5.2 million in that first half and you noted that a lot of the migration costs were embedded in that. So what's the sort of number we can look to for the second half or how much sort of one off costs were in that first half?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [32]

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Yes, so in terms of the second half I'd say that in terms of the earnings guidance of NZD54 million to NZD58 million, the number for financial services in there as a component, won't be another NZD5.7 million but it will be probably north of NZD4 million in terms of a loss for half two.

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Mo Singh, Craigs Investment Partners - Analyst [33]

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Okay, so you're saying sort of effectively NZD10 million for the full year 2017 as a loss for financial services. Is that correct?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [34]

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That's correct.

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Mo Singh, Craigs Investment Partners - Analyst [35]

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Are you there?

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Mark Yeoman, The Warehouse Group Limited - Group CFO [36]

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Sorry, yes that's correct. Sorry, I did answer.

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Mo Singh, Craigs Investment Partners - Analyst [37]

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Oh okay and just to be clear then, you're saying similar loss levels for two more years. So you're going to have another two years of NZD10 million of loss effectively in the financial services business now.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [38]

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Yes, that's the basis of the forecast to get to break even by financial year 2021. Obviously there's development costs in bringing new products to market, customer acquisition costs and the business's subscale. We're pleased with the revenue rates that we're seeing from customers on the existing products to date but we've got an infrastructure and a fixed cost base that means it's subscale. So in order to achieve that growth there are short term investments that need to be made to realize it.

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Mo Singh, Craigs Investment Partners - Analyst [39]

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Okay and just one final one from me. Just on your full year guidance of NZD54 million to NZD58 million. Even if we take the top end and say you hit the NZD58 million that's still implying the second half reduction on the PCP, and arguably this year in the second half you'll have more tailwind from the back to school sales which you got in the first half last year.

The macro environment is still pretty supportive. Your FX headwinds are coming off. Can you just sort of talk to outside of financial services what other sort of risks you're seeing out there that sees you pretty conservative even at the top end of your range.

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Mark Yeoman, The Warehouse Group Limited - Group CFO [40]

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Yes, look I can probably comment on a few and then Nick may sort of augment those. I guess one of the risks we see is transition risk as we take the business through what's quite a significant shift in its operating model and reorganization. We're not naive enough to think that that potentially isn't going to have an impact on our trading performance as people are focused on internal matters and getting new business processes up and running.

So we've taken a view on a potential impact on the business from that, but that combined with a second half financial services performance that we've just outlined I think is probably in my mind sort of the two main factors that are driving that range.

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Nick Grayston, The Warehouse Group Limited - CEO [41]

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Yes, I'd reiterate what Mark said. In any transformation, especially one that is as fundamental as this in terms of changing our operating model, there's always risk that the team loses focus as we go through this process. We're obviously doing our best to mitigate that.

In addition to Mark's comments on financial services I'd tell you that as we've said before, and I've just reiterated, we are going through a process of being much more curated about our assortments and so that throws our inventory that we're managing our way through.

As I said before we are more current than we were this point last year in terms of our ageing but as we refine our assortment we'll manage our way through that product. As we showed before Christmas when we faced headwinds, we're not afraid to attack them promotionally which is what we did. So I think it's true to say that this is a fairly conservative approach but we think it's prudent at this time.

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Mo Singh, Craigs Investment Partners - Analyst [42]

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Okay, thank you. That's all from me.

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Nick Grayston, The Warehouse Group Limited - CEO [43]

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Thank you.

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Operator [44]

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Thank you. We're showing no further questions at this time and I'll hand back to Miss Withers for closing remarks.

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Joan Withers, The Warehouse Group Limited - Chair [45]

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Thank you very much for your attendance on the call this morning. We are, as we said earlier, looking forward to updating you as we move forward, achieve the milestones and set the business up for the future. So thank you again for your attendance. Good morning.