QVC Group Inc. (QVCAQ) Earnings Call Transcript & Summary

[Operator Instructions] Good day, and welcome to the Qurate Retail, Inc. call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Heather Balsky. Please go ahead.

Thank you, Ian. Good afternoon, everyone. Thank you for joining us for the BofA Consumer and Retail Technology Conference. I'm pleased to welcome Qurate's management team on the call, including Mike George, CEO; and Jeff Davis, CFO. I'm going to kick off the Q&A. And in case anyone on the line who's listening has a question, you can feel free to join the queue, and we'll open it up towards the end, just in case.

And with that, the first question, Mike and Jeff, let's kick things off with a broader macro question. Can you just talk about who the core QxH customer is and how you think your core consumer is today, excluding any sort of near-term coronavirus disruption?

Thanks, Heather, and thanks for having us on today. The QxH core customer is really surprisingly diverse. But if you had to put a frame around it, I would say the majority of our customers are 35- to 65-year-old women, typically above-average household wealth, women who love to shop and browse and are sort of engaged and inspired by the experience we offer. She shops at a number of retailers, but we're proud to have her put us high in her consideration set. We earn very high loyalty with her. The average existing customer makes 24 purchases a year. Our best customers make about 70. Retention rate, once you've made a few purchases with QVC or HSN, is in the high 90s. So an inspired, engaged, loyal, frequent customer. I would say, generally speaking, if we do exclude the impact of the coronavirus, we've been in a fairly healthy consumer environment. So I think that customer is doing okay. But the exception I would make is that we have been in a cycle in 2019, where apparel, accessories, footwear were all trending down for the industry. They're all in negative growth territory. And beauty, while not a negative growth, was at a much slower rate of growth. So she was less focused on those product categories in 2019. And that was one of the drivers of our more challenged results last year. It's got some of those categories that have been important growth drivers for us, which is in a little bit more of a macro dip, which we expect to normalize over time.

Thanks, Mike. And then, if you could just talk about what you think right now is most misunderstood about the Qurate story, that would be really helpful.

Well, I think when I look at the current share price and, internally, even the reaction to our Q4 results, to me, it just reflects this wall of worry that some investors have that we don't share, about whether we can sustain long-term growth in an environment where, admittedly, linear TV viewing has been declining. And so I think investors have looked at the down 3%-or-so sales performance in 2019 at QxH and wondered if that's a harbinger of the future. We've also had some -- a little bit of margin pressure in 2019. But again, I think investors have looked at that and said, "I wonder if that's a new normal. I wonder if Qurate, but more specifically QxH, can continue to generate the kind of high free cash flow conversion they historically have had." Our view is positive on all those questions. If I look at our Q4 earnings call, we talked about a number of actions we're taking on both the product side and the video distribution side to get back to growth. But we also said, as we have for the last year, that we're not going to predict exactly when we get back to growth. We want to get there first rather than try to make a prediction, especially in an uncertain environment that we face. I think some investors fear that, that was trying to suggest some major additional sales risk, which was not our intention, but rather confidence in getting sales back to growth, but caution about predicting the exact time frame for doing that. Yes, in the same way, the OIBDA margin side, we tried to signal for 2020. Though we've got some headwinds that are a little more front-of the-year loaded as we execute our network optimization, some tailwinds that are a little bit more back-of the-year loaded. Again, I think investors fear that we were trying to signal that OIBDA margins will be under much greater pressure than in 2019, which is not what we believe and certainly not what we were trying to message. We feel actually quite good about the actions we're taking under a variety of sales conditions to strengthen the OIBDA profile and get to improving OIBDA yield as we move through the year. We're investing heavily in things right now like network optimization that will provide benefits. And probably not well appreciated within that little bit of story, but our product margins have actually been strong and improving even in the competitive environment we're facing. And then, finally, because we had a bit of a pressured view of the free cash flow in 2018, especially as we executed our acquisition, there were concerns about our free cash flow conversion. We believe that it's strong, healthy. We grew free cash flow in 2019, and we shared that we fully expect to grow free cash flow in absolute dollars in 2020 at both the operating company level and the corporate level, absent some massive unanticipated impact from the coronavirus. So we feel good about -- we are protecting the business to get back to sales growth. And having a strong story on the OIBDA line and the free cash flow line, then we need to do a more effective job of conveying that to our investors.

Thanks, Mike. And so the coronavirus is top of mind for investors today. Can you update us on what you've seen from a supply chain perspective? And any impact you've seen to your sales, especially in international markets where it had spread?

Sure. Let me try to frame. Obviously, a fast-moving topic, but I'll come at it in a few ways. First of all, to state the obvious, our foremost concern is the health and safety of our team members. We have put a great deal of focus on that around the world. We are -- in our Italy operation, which is headquartered in Milan, we've moved to a largely work-from-home model. We've moved to a largely work-from-home model at Zulily in Seattle and a partial work-from-home model in Japan. So we do have businesses in some of the more affected regions, and our first focus is on our team members. And a great gratitude for all the efforts of our teams around the world to keep each other safe in that environment. So we feel like we're doing the right things from a team member safety and a business continuity standpoint. And the businesses in all those markets are operating just fine, as we operate in this work-from-home mode because that's most important for us. On the supply chain side, our sourcing and QA teams in China and our fulfillment center teams in China are largely back to work. We see factories ramping, so we're optimistic that there won't be major supply chain disruptions as a result of this. We haven't seen those -- to date, certainly, some products are delayed, but especially at QVC and HSN and also to a large extent at Cornerstone. We have a lot of inventory at QVC and HSN. We have a lot of agility to change what we feature every day on air and online so that we feel like we can respond to short-term product disruptions. The one area where we have been impacted on the supply chain side is Zulily. But because they have a low-inventory model and a lot of their product sourcing is sort of just-in-time, a big chunk of it was through China direct sourcing, so we felt a more immediate impact on sales in Zulily. That impact is probably moderating as we get people back to work in China, but still an impact. Not highly material at the Qurate level, but certainly meaningful for Zulily. A little harder to comment on is any potential go-forward supply chain risks. We just don't know if there are going to be some down-the-road consequences that we're not yet anticipating but kind of feeling okay for now on the supply chain side. On the consumer demand side, I would say we haven't seen anything to date that would suggest any change in underlying performance trends of the businesses that's due to the coronavirus. And so even in markets like Italy and Japan that have borne the brunt of this to date, it's not obvious that we're seeing some fundamental change in their trajectory. The caveat in all of that, of course, is if the world economic situation were to substantially worsen, obviously that could impact our consumers. But fortunately, we're not yet seeing that.

And you've referenced earlier that QxH is pursuing a pretty robust sales turnaround strategy. Can you help just break down the factors that have been impacting your business from a sales perspective, and how that's informing your priorities for 2020?

Sure. So as we look back over the last, call it, 12 to 18 months, we've seen a confluence of factors that have pressured sales, some, we believe, are fairly short-term in nature. So we went through a pretty complicated acquisition. We made a number of organizational changes associated with that acquisition that created some disruption. But we also made some purposeful choices associated with that acquisition of HSN, like exiting their -- some of their largest brands because of the underlying cost structure, like putting in place new planning and programming disciplines that caused some adjustment in the business. So some of those pressures were self-inflicted, but we thought the right things to do. Also the work we're doing to restructure our distribution network will be very beneficial in the long run, but clearly caused some short-term service pressures. So that's sort of one set of factors that have pressured the business. Second set, which I mentioned briefly, is just our most attractive growth categories of fashion and beauty have been on a bit of a down cycle. I've learned over the years that we try to adjust as best we can to those cycles, but you can't be totally immune from them. And so we need to find new ways to earn growth in categories that are somewhat down cycling, at least in the short term. And then, finally, I would say that some of these broader secular trends, while in our view not nearly as negative as some investors may fear, but these broader secular trends are influencing the business as well. So that would include people spending less time viewing traditional linear TV, less relevant in our core demographic, but still a factor, as well as just a generally competitive e-commerce environment, the rise of DTC brands, just the sort of higher volatility you see with the brand. So all of those we feel are addressable issues and we're very confident in the plan we have to go after them. But because there's a number of different factors there, we've -- we have been hesitant about exactly calling the timing of the sales turnaround. So for us, it's about just leaning into product, leaning hard on increasing our differentiation. We're tripling down on our proprietary design, development and sourcing capabilities. We'll be launching 10 new proprietary brands this year, leaning hard into getting great new national brands, leaning hard into product discovery, bringing more entrepreneurial brands on air, going after segments that we feel are underserved or where we feel like we have a particular advantage, like size inclusivity that we haven't fully exploited. So a number of things on the product side to start to earn our way back to growth. And then coupled with a number of things on, let's call it, the distribution side to just give more people more ways to find that product. So that's about leaning into other forms of video distribution, from skinny bundles to Roku to Samsung's live streaming service. It's about upping performance marketing. It's about a number of initiatives to optimize the digital experience. So we feel good about that combination. We think that gives us more platform for growth, more products to drive growth. And I'm energized by the actions we're taking on that front.

Great. Thanks, Mike. Jeff, on the margin side at QxH, can you just help frame the headwinds that impacted 2019 and how you think about the give and take in 2020?

Yes. So as Mike had mentioned, there are a number of items that we'll be cycling through in 2020 that were a headwind for us in 2019. One of which was, as he had mentioned, as we were looking to improve the service element of our network, we call it the network optimization project, which had some unfavorable impact on our warehouse expenses as we were -- from a productivity standpoint. So that was one headwind that we had. Another headwind that we had was, as he had mentioned also, our accelerated exit out of certain key brands of HSN, where we were taking some more aggressive actions and move through that inventory. That gave us some pressure from a margin perspective. And we're principally through those activities. Though, we do expect, as we go to decommission some of our facilities in 2020, in the first half of the year, we will have a little bit of a headwind as it relates to how we decide how much of that inventory we will transfer versus how much of that inventory we may look to be a little more aggressive on from a pricing perspective in order to sell it that much quicker. And then the last area that we had some headwind was with respect to freight. Our freight rates -- term freight rates were elevated increases in 2019. We're seeing that moderate in 2020, but that was definitely a headwind for us in 2019. That, coupled with, as we alluded to, some of the service elements of our fulfillment network, where we were not able to maintain the pack factor or the number of items that we would include in a package to a customer and being more efficient there. That was a little bit of a headwind for us. In the back half of next year, in our expectations, we'll cycle through that in the first half of this year as these new facilities get up to capacity. Last year, we had a couple of headwinds or tailwinds also. One of the tailwinds that we had, and Mike had mentioned, was that we were able to continue delivering increased product margins through all of these and through a number of different activities. And our expectation is that we will continue to do so through other strategic sourcing activities as well as we balance out our proprietary and exclusive offering going into 2020. And then also, we had a head -- tailwind, a very substantial tailwind for us as it related to commissions. And about 70% of that number was tied to the change of accounting associated with the HSN distribution contracts that we had, where they were previously expensed on a quarterly basis due to the way that we were making sort of lump sum payments. They were being amortized over a longer period of time. So it was just moved from above the line to below the line, if you will, between being operating expense to being depreciation. The other 1/3 of that commissions was associated with our synergies. And while those synergies associated with a number of contracts that we have negotiated from a distribution perspective, our expectation is we'll continue to have that in our run rate. But the further expansion beyond that is we would not anticipate further expansion.

Got it. Thanks for that help. You guys are in the process of implementing a distribution network optimization. Can you remind us on the changes that are being implemented and the expected benefit? I guess you just walked through the margin impact in 2019 and then 2020, but if you could just kind of elaborate on when we start seeing that benefit from a synergy standpoint, that'd be really helpful.

So at the highest level, we're essentially going from 9 facilities from a QxH perspective down to 7. There's a new facility that we're opening up -- which has opened up. We're actually now shipping some initial levels of activity for QVC out of our northwest facility in Bethlehem. We will continue ramping that up to, of course, get to capacity with respect to QVC. But also we will start to, in 2020, carry not only QVC product but HSN product out of that same facility. And our expectation there is that, that ramp-up will occur through the first 3 quarters of this fiscal year. We will actually decommission 2 facilities: 1 in Lancaster; the second in Roanoke, Virginia. And that's where -- as I was mentioning earlier, that as we go through that decommission and look at inventory transfers, we will determine what's the best method to do so at the lowest cost. But by doing so, also, we'll start to reduce our duplicate costs associated with manpower. We will also have the ability to be that much closer to our customer and our expectation around reduced freight, not only from being closer to the customer being able to service multiple categories out of the same facility, but also being able to improve on our pack factor. These activities will happen in the first half of the year with sort of a full expression as you get to the second half.

Great. Thanks for that color. Mike, just back to sales and sort of factors impacting your sales at the moment. You talked about shorter product life cycles in the last earnings call. Can you discuss more what's changed the impact that's having on your business and steps you're taking to help offset this change in life cycle timing?

Yes, maybe I can. And maybe I'll just start by kind of refreshing everyone on the core model. Because we're very different than a traditional retailer that has the diversity of products, that are kind of level loaded and no individual item is hugely meaningful in the overall sales. And we have this unique position of having this remarkably stable customer behavior over long periods of time, but these more volatile results over short periods of time. And that reflects the fact that, every day, we're focused on a handful of key items. 20% to 25% of our sales on any given day will be one single item. And so you can get into better or worse trends with those items, and we need to be right more often than we're wrong. What's always been true about our business in that context is we'll bring in a new idea, a new item, a new brand. We'll build it up to be really meaningful over a couple of year time period, and then it will inevitably have a life cycle. And it will go down, then something new will come behind it. What we're seeing right at this moment is maybe a combination of 2 things. Some of those brands may -- well, actually it's all really about 1 thing. It's really about those brands that come in, may be peaking at a somewhat lower level of sales or declining somewhat earlier in a life cycle than what we have traditionally seen. So we shared on the Q4 earnings call as an example, that in 2019, just 10 brands representing just 12% of sales, explain more than 100% of the sales decline. Again, in some ways, that's not unique, but we need to be able to come behind those brands with new fresh brands. And we're just seeing those new fresh brands not quite get to the same productivity. That's a reflection of a more competitive environment, more forms of distribution. There's this rapid birth of new DTC brands. We've never seen more brands birth at any point in time, as you've seen in the last couple of years. So how do we deal with all that? Well, we deal with it by, again, diversifying into more kinds of products and brands, by doing more proprietary development so that we're not as dependent on the vendor to develop the new products we need at the pace we need them. We'll take over more of that innovation as well as work with vendors in deeper ways to accelerate their innovation cycle. So that we've got that pace of fresh innovation that we need. We're experts at that. We've done it well for 33 years. We just need to accelerate the pace at which we do that and give ourselves more tools in the arsenal to innovate both for our own proprietary development and to our vendors, and also by going back to a tried-and-true strength of our business, which is finding those amazing entrepreneurs. And we did programs like THE NEXT BIG IDEA program, where we went around the country and judged up thousands of entrepreneurs and are launching 38 new brands in Q1 alone from these entrepreneurs. That's all the things we can do to create excitement and energy and compensate for this change in cycles. Final point I would make on all of that is, it's been very interesting to see this whole DTC phenomenon go through kind of a predictable trend, which is a couple of years of explosive growth, great hype. And now, all of a sudden, a recognition that, boy, it's really expensive to build a brand, go direct to the consumer, pay Facebook, Instagram, everyone else enough money to get your brand out there. And the cash characteristics of those brands are not looking so attractive right now. That's a general statement. There are many that are amazing. And so our message to those brands has been we're a powerful and efficient platform for reaching consumers. We've built the platform. It's amazingly efficient. And so whether it's someone else's DTC plan or the brands we're developing on our own, which is often the path we go to just because the end-to-end economics are better than working with third parties, we think actually, in today's world, we're going to see a resurgence in recognition of the power of the platform we've built over many years and the ability to efficiently connect with a broad audience of customers.

Ian, I just wanted to check to see if there was any Qs or any queue for -- to asking questions online.

[Operator Instructions] And we do have one question at the moment.

Go ahead.

[Operator Instructions]

This is Yahyin Shen from MetLife. At a recent conference, I think Greg had mentioned something about not repurchasing shares this year but finding other ways to improve shareholder value. And I was just curious what the different tools he was talking about in terms of trying to do that.

Yes. No, Greg said -- just first of all, to clarify the comment. I'm not sure he said we're not repurchasing this year, more a statement of the fact that we have not been repurchasing recently. And we actually shared on the Q4 call that we had not done repurchases in the most recent reported time period. So not so much a forward-looking statement. We chose to kind of do a pause on share repurchases, while we evaluated a range of options in a fairly volatile environment. We'd rather be in the mode of sort of building cash and then making the best, most purposeful choice about how to redeploy that to shareholders in a way that we think will drive shareholder value. I don't want to tip our hand on any specific plans because I would say we're looking at lots of options. But you could envision a range of things from flavors of share buybacks to flavors of dividends to flavors of debt reduction to flavors of green energy investments to reduce our tax burden, of which we've done quite a bit very successfully, to ways to diffuse some of the risk in our longer-term debentures. So we're in a very fortunate position of generating high and growing cash flow and a very attractive balance sheet for the uncertain environment that we're all entering and a number of good choices we can make to drive returns to shareholders. And we're going to be thoughtful about making the best possible decisions we can make on that front.

Just as a follow-up on that. Can you talk about how you think about leverage, both at the QxH level and as well for the Qurate business as a whole?

Sure. So as we said, at the operating company level, we've set sort of a financial policy for ourselves that we would operate the business in around 2.5x leverage. Given the way that this business, the seasonality and how we see funding our growth and the cash flows generated in this business, we feel very strongly that 2.5x gives us the appropriate sort of leverage and leeway to grow the business the way that we believe we need to. And our leverage has been maintained around 2.3 to 2.4x against that. As we think about the operating company level, kind of layer on an additional full turn of leverage that would then cover the long-term debentures that sit there today. The -- at the operating company level, there is a restricted payment covenant, that as long as we're under 3.5x, we can dividend cash unrestricted up to the holding company level, and that gives us sufficient cash flows for that -- at the holding company level to do a number of things to deploy that capital to be allocated. And we feel that it is a -- for this business and where we sit today, given our options that we have, that we can operate very comfortably within that.

Okay. Thank you. And Ian, is there -- are there any other questions in the queue?

We have no further questions at this time. [Operator Instructions]

Okay. I'm going to just ask a few other questions. We haven't spoken about your international business in this conversation. So maybe we can talk about that. International sales have grown at about 1% in constant currency in the last 2 years. Can you talk about what's driving that performance? How is performance in each of your geographic regions? And where are the areas of opportunity?

We've been pleased with our international performance. As you noted, it's been consistently growing, although, clearly, we'd like to see it grow a couple of points faster than that 1%. In any given year, there are -- some markets underperformed, some overperformed, though this past year has been a really strong year for Japan. A lot of credit to that team because they faced some adversity, including the big consumption tax increase that went into effect in Japan in October. So just a lot of work on the fundamentals of that business that's driven -- in an economy that's not very vibrant, that's driven nice growth. A little more mixed performance in Europe, up and down, depending on the market but probably healthy. I would say the focus right now is the international leadership team under Aidan O'Meara are really looking at how do we rethink how we work internationally and get better leverage across our markets. In many ways, we've been working on that for years. But we've taken a more specific focus in this last year and just recently announced a new international organization, where we're pooling together at the regional level or at the international level some core strategic capabilities in areas -- but mirror some of the investments we're making in the U.S., areas like performance marketing, advanced data analytics, product strategy, performance marketing and so forth. And the idea is can we build deeper expertise, put more investment in those kinds of capabilities to drive to the benefit across international. So in many ways, the strategies are not inconsistent with the kind of strategies we're doing in the U.S. to increase product discovery and bring those products to life over doing better platforms. But the international team has taken a nice approach of building some new capabilities to enable that focus. It did put a little bit of pressure on our results late in the year because we did have some severance associated with structural changes we were making to achieve that. But I think it gives us a really nice foundation to build off of.

Great. And Ian, I'm going to check one more time. Otherwise, I will ask the last question.

Yes. And we have no further questions at this time.

Okay. So just touching on Zulily. Your 2019 sales were under pressure, but you guys are still bullish on the long-term opportunity for that business. Can you just break down the challenges the business has faced near term and what you're doing to address those headwinds?

Yes. We've always loved the Zulily business, love the core essence of its value proposition when we acquired the company, but clearly did not anticipate the extraordinarily challenging 2019 that we experienced. And we've signaled that this is a turnaround that's going to take some time. Obviously, that's separate from the coronavirus impact, which adds to the short-term challenges Zulily faces. I think whenever you see a business has this kind of an adjustment, it's usually a confluence of factors. That's what I think we have here as well. Starting with the fact that it's more clear to us in hindsight than it was at the time. We've got some of the things we did to grow the business. We were probably bringing in a customer that just wasn't of the same quality, meaning she didn't quite have the same appreciation of the core value proposition, wasn't quite as likely to engage and repeat purchases as we had expected. And so some of our marketing spend was probably not as efficient as we would have liked. And then you have the problem of having to compound that in the next year, at a time when just marketing costs in general are rising. So we've struggled a bit with customer acquisition. We've paused, and we're trying to get refocused on attracting the kinds of customers that we think are great, long-term Zulily customers. As a result of that, we've reduced our marketing spend. But obviously, that reduction in marketing spend while helping keep OIBDA in some guardrails, it does obviously further exacerbate the revenue challenge. But we're committed to gating the marketing spend based on the returns we're getting and to continue to innovate with ways to find new customers of quality efficiently. And that's very much a work in progress by 2 really dynamic new leaders over our marketing space. I've spent some time with them last week and really excited about what they're bringing to the company. And then for our existing customers, we just feel like we've got a double down on product freshness, that's why she comes to us. Now we have a new -- 2 new leaders in merchandising really working to excite major national brands to come to Zulily, some really great wins like Nike. We're going to keep at that, having lots of discussions with great national brands that I think will be additive to the value prop but also, doubling down on our investment in finding those cool boutique brands and working on the quality of the China direct-sourced brands. Because that's been a source of growth for us, but quite frankly, it had uneven quality. And we can do better, and we are doing better at raising the quality standard in our direct-sourced product. And then, finally, a number of things on the experience side. We're trying to give her more ways to shop beyond just the daily events, more of an ongoing discovery process. A lot of good work on the digital store, some good work on enhancing the brand expression. Some work on making the returns program more attractive to customers. And we're going to be testing some ways to make shipping costs more structured in a way that we can incent, build in a bigger basket. So we're working on a lot of things. We feel really good about the leadership team, feel really good about the core of the value proposition, but know that it's going to take a bit of time to have those things kind of kick in and have the kind of impact that we believe they can have.

Great. Thank you, Mike and Jeff, for your time and for answering our questions. We really appreciate it. And thank you, everyone, who's been listening to the call. Hope you enjoy the rest of the conference.

Thanks, everyone. We appreciate it.

This concludes today's call. Thank you all for your participation. You may now disconnect.