Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen, and thank you for holding. Welcome to the Qliro Group Q1 2019 Conference Call. [Operator Instructions] Today's conference is being recorded. I will now hand the call over to Marcus Lindqvist, Chief Executive Officer of Qliro Group, who is joined by Mathias Pedersen, Chief Financial Officer. Please go ahead.

[Marcus Lindqvist, CEO & President]

Thank you, operator. Good morning, everyone, and welcome to this conference call regarding our first quarter results 2019. Let's start the call by taking a look at our strategic direction and some progress made during the last quarter. As you know, our strategy is to operate Qliro Financial Services, CDON and Nelly as 3 independent companies. This will create the best prospects for the companies and thereby increase shareholder value. And in the first quarter, Qliro Financial Services were successful when it comes to new merchant recruitment, CDON Marketplace increased sales for external merchants rapidly and Nelly delivered strong growth. We have also greatly increased Qliro Financial Services' loan book. Further, we continued to increase the efficiency in CDON and went live with a fully digitalized return process in Nelly. All 3 companies improved their operating income and strengthened their market positions during the quarter. Concurrently, strategic efforts to establish 3 independent subsidiaries continues according to plan. In addition, we continued the work to evaluate possible structured transactions for CDON Marketplace and with a divestment or listing of Nelly. And we believe that all our companies should be ready to be independently listed companies sometime during the second half this year. With that said, we are still not even halfway against the 2-year time line we set out in our strategic communication in June last year. With that, let's take a look at our businesses and their performance during the first quarter, starting with Qliro Financial Services. Qliro Financial Services provide financial services to consumers and merchants, and during the coming year, our focus will be to attract more merchants and further strengthen our Nordic offering. Business volumes increased with 15% to SEK 1.1 billion and this is despite that CDON Marketplace volumes declined with 17% due to the phasing out of own stock sales. I will talk more about CDON in the next coming slides. And merchants that are not part of Qliro Group accounted for over 50% of volumes. This share is also expected to increase as new merchants are onboarded during the spring. Total operating income increased 26% to SEK 86 million in the quarter. This was driven by loan book, which grew 49% to SEK 1.5 billion with the fastest growth in personal loans. Following our investments last year to strengthen the team that are working to attract and integrate new merchants, we can conclude that these initiatives have been successful, and during the quarter, contracts were entered with several merchants such as Eleven, Nordicfeel, Baresso, Best of Brands, Dollarstore and iPiccolo. The majority of these merchants have yet to go live with our platform and we have, therefore, not -- and they have, therefore, not affected our business volumes substantially during the quarter. Qliro Financial Services now have the scale to cost-effectively manage significant growth in the loan book, and we can see that employee costs only increased with SEK 2 million in the quarter compared to the same quarter last year. Our depreciation increased with SEK 3 million as the technology platform was rolled out and more projects were commissioned during 2018. Looking at our results for expected future credit losses, they were in line with previous year despite the strong growth in the loan book. This lowered relative level of resource was mainly driven by shift in the mix between port payments and consumer loans in the loan book. Moving over to the next slide, we can follow the loan book development in more detail. As I mentioned, the loan book increased with 49% in the quarter to SEK 1.5 billion while SEK 1.1 billion were for invoices, port payments and installments. And SEK 420 million was for personal loans, all financed through bank savings accounts and equity. We continued to see that over 95% of our borrowers had an existing relationship with Qliro Financial Services and many applied through our app. This resulted in lower customer acquisition cost and the chance for us to restrict credit granting by identifying people with good credit worthiness based on their history with Qliro. Our credit assessments are automated and based on a combination of internal and external data. The personal loans granted had a contractual maturity of just over 8 years and we see that we have an excellent opportunity to continue to grow this business effectively going forward. Let's move to the next slide and make a brief summary of the key value drivers in Qliro Financial Services during the quarter. As you can see, Qliro Financial Services are clearly on the right track as total loan book increased with nearly 50% and that the sales finance part shows hefty growth despite CDON phasing out own sales. Furthermore, when we leverage our existing consumer relations, we see how personal loans grew nearly 300% as a result. This means that we can report healthy growth in total income and this, combined with a slower growth in total operating expenses, gives us a triple EBITDA result year-over-year. Moving over to CDON. CDON Marketplace continues its transition towards the marketplace business model and external merchants increased sales with 36%, which helped to contribute to a 32% increase in commission revenues. The phasing out of own sales, that is own inventory-driven sales, continued especially focusing on the lower-margin consumer electronics segment, mobile phones, TVs, et cetera. And the home electronics offer is instead beefed up through external merchants with a wide range at competitive prices. Consequently, our net sales decreased with 31% to SEK 261 million in the quarter. This is part of the transition that will continue in the coming quarters with a negative impact on net sales, but it will give us the long-term conditions for higher margins. The transition to a marketplace and drop shipment business model also leaves room for growth with lower inventory levels, which, over time, is expected to provide strong cash flows and decrease our working capital needs. The transition resulted in a gross profit increase of 11% to SEK 44 million and the corresponding margin increased 6.3 percentage points to 16.8%. CDON has, for several years, invested in its technology platform and process automation and the company now benefits from these investments and has reduced the number of employees, which resulted in a decrease in employee costs of 26% in the quarter. Our EBITDA amounted to minus SEK 7 million for the seasonally weak first quarter. Moving to the next slide, we can follow the transformation in more detail. Compared to the same quarter last year, our own inventory sales have dropped from 62% to 48% of total sales. This is, of course, driven by our strategy to reduce low-margin own inventory sales but also by the increase of drop shipment sales and external merchant sales. It's important to note that we do not aim to reduce own sales completely. Over time, it's fair to believe that about 30% of total gross merchandise value will be own inventory sales and the rest will stem from external merchants and drop shipment. Except that this transformation will be fruitful for our merchants and help us achieve profitability, the transition also leaves room for continued growth with lower inventory levels. And in line with this strategy, inventory levels were 31% lower at the end of the first quarter as compared year-over-year. CDON Marketplace does significantly reduce its working capital during the quarter. Let's move to the next slide for a brief summary of CDON Marketplace first quarter. Looking at the key value drivers of CDON Marketplace, external merchants grow their business significantly through our platform, reaching a milestone with over half of the business from external merchants and drop shipment. The enlarged assortment following onboarding of new merchants generates more visitors and we see that our new business model is more capital-efficient, lowering inventory and increases gross margins. Finally, we can see that we strengthened our market position, and in combination with a reduction in staff, we improved our EBITDA with SEK 14 million compared to the same period last year. Finally, let's take a look at Nelly. Nelly's growth initiatives led to 10% increase in sales, 7% increase in number of customers and 11% increase in average shopping basket for the quarter. The product margin increased from 46% to 48%. The strong growth in the number of customers is a key value driver given the company's strong customer loyalty. We can see that returning customers account for approximately 85% of sales, and most sales come from customers who make more than 5 purchases per year. During the quarter, sales through Zalando were launched to cost-effectively reach new customers, mainly in countries that complement Nelly's own reach. The launch has been successful and the team has begun to work with Zalando to plan for the next season. The return rate was unchanged compared to the fourth quarter 2018 although higher than the first quarter 2018. The return rate increase of recent quarters, however, did not continue. And during the quarter, Nelly was -- digitalized its return process to bring goods back to sales stock faster and to make it easier for customers to handle returns as well as purchase replacement goods. Growth and higher product margin resulted in a gross profit increase of 19% and amounted to SEK 69 million and the corresponding margin increased by 1.8 percentage points to 22.8%. Our operating profit was affected by increased marketing initiatives of SEK 5 million and higher costs for good handling, and despite this, our EBITDA improved to minus SEK 7 million for a seasonally weak first quarter. Let's move to the next slide for a brief summary. Looking at the value drivers for Nelly, customers come to Nelly for inspiration and we see that we were successful to grow our customer base during the quarter. Net sales increase was in line with our financial targets and we improved both product and gross margins. The return ratio stabilized compared to last quarter, and all in all, EBITDA improved SEK 8 million compared to last year. That was my comment on the business. Mathias, could you please take us through our financials and balance sheet, please?

[Mathias Pedersen, Chief Financial Officer]

Thank you, Marcus. So if we turn to the next slide. Having been through each subsidiary, let us now take a look at the overall group and starting with the income statement and the combined results. On a total level, group sales declined 11%, and as you've heard, the very strong growth within Qliro Financial Services, Nelly and external merchants' sales in CDON was more than offset by the declining net sales in CDON. And as we've said many times, this is the result of the conscious decision to phase out inventory-based sales in certain less profitable categories within CDON, which, on the other hand, had a very favorable impact on gross margin, which rose to 25%. Also net sales were boosted by 1.7% due to exchange rate fluctuations. Financial net came with the added cost of SEK 6 million related to the early bond redemption. Bottom line, the net loss before tax amounted to SEK 44 million, reflecting the seasonally weakest quarter of the year. Moving to the next slide for a look at the combined e-commerce cash flow. So we had a negative cash flow during the first quarter where the bond redemption obviously had the largest impact. Typical for the first quarter, working capital increased mainly as invoices due following the peak sales season were paid in January. Inventory levels, however, did not increase as CDON continued its transformation offsetting the spring inventory buildup in Nelly. Also, we spent SEK 14 million on capital expenditures in Nelly and CDON while SEK 35 million were put to work through equity contributions into Qliro Financial Services. Moving forward to the balance sheet for the nonfinancial part of the business. We had a cash position of SEK 205 million at the end of the quarter. This was also the net cash position as we no longer had any financial debt within e-commerce. That is the bond that was repaid to reduce debt and cut interest costs with SEK 12 million annually. Other rationale for the bond redemption was that we no longer have any efficient use of joint financing on the group level in the consolidated situation that we're in and while executing on our strategy to make the subsidiaries independent. Note that as the bond covenants are lifted, the group is once again allowed to distribute dividends or shares to its shareholders if it so decides. Meanwhile, we continue to have a well-financed business. Moving forward to the balance sheet for Qliro Financial Services. On the asset side, net lending amounted to SEK 1.5 billion with SEK 1.1 billion in sales finance and SEK 400 million in personal loans. In addition to a small amount of cash, the company held a liquidity reserve including municipal bonds and commercial papers amounting to SEK 193 million. On the financing side, the Swedish loan book was mainly funded by public deposits of SEK 962 million while the bank credit facility was used to finance the loan book denominated in other Nordic currencies. This was to limit currency risks.We also had an additional SEK 346 million in undrawn commitments. Looking at the regulatory capital requirements, we note that the risk-weighted assets amounted to SEK 1.6 billion and the capital base or own funds amounted to SEK 281 million, all of which was common equity Tier 1 capital and the corresponding capital adequacy ratio was 17.2%. The consolidated situation with the parent company stipulates that certain rules also apply to the parent company of the group, most significantly, the capital requirements. And the consolidated situation is also well capitalized and meets all these requirements. Qliro Financial Services remain well positioned for further loan book growth supported by savings accounts, unused credit facility commitments and its parent company. And with that, back to you, Marcus.

[Marcus Lindqvist, CEO & President]

Thank you, Mathias. And so with that, we are now ready to answer any questions. Operator, do we have any questions?

[Operator]

[Operator Instructions] We will take our first question today. Please go ahead.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

This is Nicklas Fhärm with SEB Equities. My first question would be on the change in accounting to IFRS 16. I note that, that has had some smaller implications from a balance sheet perspective, around SEK 100 million. But my question is has there been any sort of impact on the EBITDA, EBIT and pretax level in the P&Ls, please.

[Mathias Pedersen, Chief Financial Officer]

Nicklas, Mathias here. So we have chosen to portray the segments without the effects of IFRS 16, so they are -- you see them clearly in the -- on Page 11 in the report in the P&L in the column called elimination where we have single amount. So there is about a little bit more than SEK 4 million that has impacted EBITDA, but then been taken down from the EBIT level. So the bottom line is very limited. And you can see the numbers in those 2 columns.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

Excellent. Thanks for pointing that out. Then if I can ask you, adjusted for the actual volume reducements in CDON Marketplace, would you say that QFS sales were rather in line with or below or even above your internal expectations for Q1, please?

[Marcus Lindqvist, CEO & President]

Well, the short answer is on expectations. As you know, we have contracted a large amount of merchants during the quarter. They will all go live during the spring now, so during -- mainly during Q2. That will then affect volumes upwards, of course, as they go live, but Q1 was in line with expectations.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

And just for the record, in terms of operating leverage for the rest of the year, how should we think about the cost base? Do you think there's a need to expand cost in line with your expected revenue improvement for the rest of 2019? Or should we expect a fairly fixed cost base this year, please?

[Marcus Lindqvist, CEO & President]

The expectations you should have is that this business continue to scale further as we go ahead during the year. So we see the scaling of it. So the delta between cost increase and income increase will -- that delta will increase.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

And then I think -- I'm very interested to learning a bit more about the digitization of the return process at Nelly and the potential implication on gross margins and EBIT margins for the rest of the year. Could you give us some idea of what you actually have been doing, if there's any more cost associated with this change going forward or whether it's pretty much in the books by now? And if you could give us some idea of the margin impact, please, at least expectations.

[Marcus Lindqvist, CEO & President]

Well, when it comes to costs, the project has been fairly limited when it comes to costs and the capitalization of this project has been fairly small as well. So single million kronor in CapEx in total. When it comes to the kind of added benefit, it is what we are trying to explain in our report, that the majority of this will be something that our customers will appreciate because they will be able to have a much smoother return process with us going from a totally manual process to a fully digitalized process. It will also help us to have much better control of the entire flow of returns in our system because it will all be kind of real-time and digitalized. So we will be able to follow the development of the returns much, much closer. It will also give us an added benefit when it comes to getting product back faster on stock so we can sell the product in season, so that will help us drive incremental sales within the season. Typically, otherwise, you get the product back after the season. It's very hard to sell or at least you have to sell it at very high discounts. And that is the kind of -- what I would like to kind of point out at this point, was we are 1, 2 months into this. We expect quite a lot more to follow this, and hopefully, some good news coming out of this project further on, but we want to kind of keep the expectations low at this point.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

So just to give us some idea, do you think, for example, that the return rate, currently at 39%, obviously, will that start to decline now onwards as in Q2, that is?

[Marcus Lindqvist, CEO & President]

I would say that we don't see it continue to increase in the way it has during last year and you can see that we kind of stabilized on the level we were in Q4 and Q1. The one side effect of this is, of course, that we will make it much easier for customers to exchange products. So if you don't want to return it, you perhaps want to exchange to a new product or to a different size. That entire experience is much stronger today for our customers. So you would most likely see more sales out of this rather than lowered returns.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

And what's the reason for the increase in the gross margin in Nelly in the quarter year-on-year, which is quite marked?

[Marcus Lindqvist, CEO & President]

It is that we have been able to sell more in-season products, so less markdown basically.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

Yes. That's perfect.

[Marcus Lindqvist, CEO & President]

As you can see, our share of own brands have declined a little bit compared to last year. So that's not the key driver. The key driver is less markdowns.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

Excellent. And final question for now at least. You singled out the investments you've done in marketing in the quarter. Could you just give us an idea, is there any particular reason for that SEK 5 million increase in A&P spend in the quarter? And where you expect -- is this a timing? Have you changed your marketing budget accordingly for the full year? Or where are we, please?

[Marcus Lindqvist, CEO & President]

We're spending a little bit more on brand as we are now comparing the companies for a stand-alone basis scenario. So we want to make sure that we invest enough money in our brand-building activities. And on the other side, it also has been a tactical initiative to drive a little bit more traffic to the site and that is due to the high repurchase rates. We could see that it made sense for us to acquire more customers on the levels -- the kind of total level of acquisition cost was in favor for our kind of total customer lifetime value. So it's just kind of a tactical thought as well. Looking at the kind of ratio, marketing versus net sales, we're still on fairly low levels. We're around 10% of sales when it comes to marketing costs in the quarter, which is, in comparison to our kind of peers, still on a fairly low level. So we don't see that we overspend and we're quite happy with the levels that we are at.

[Operator]

There are no further questions in the queue at this time. [Operator Instructions]

[Marcus Lindqvist, CEO & President]

Doesn't seem that we have any more questions, operator.

[Operator]

Yes, we actually do have one question right now. Please go ahead.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

Yes, it's Nicklas from SEB again. If I may, just one more follow-up question. I was just wondering -- sorry, if I missed this in your presentation, but there's quite a significant change in working capital in your e-commerce business in Q1 this year compared to Q1 last year. Could you give us just a quick wrap of where that is coming from? I guess it's stock in trade, but then where?

[Mathias Pedersen, Chief Financial Officer]

Yes. But typically, the first quarter is a quarter where working capital increases significantly as we usually leave the fourth quarter with very low levels of working capital. It's both we -- you have to replenish inventory and then you have to pay off invoices that usually are due directly after the new year. So it's a much -- but it's a much lower buildup of working capital this year compared to last year, and that mainly is because CDON's transformation allowing them to decrease inventory in the period and generally keep down -- release working capital in this transformation. So that's sort of the significant part of it.

[Nicklas Fhärm, Country Head of Sweden Research & Analyst]

Excellent. And final question, you've now redeemed the outstanding bonds and you took some SEK 6 million, I think it was, cost for doing that. Is that the final financial cost relating to that item? And what do you expect the implication on the net financials to be for the rest of the year, please?

[Mathias Pedersen, Chief Financial Officer]

Well, the net financials in the quarter, that was those SEK 6 million in addition to the interest cost that accrued during the quarter and that amounts to about SEK 8 million altogether and the rest is related to fluctuations in exchange rates related to assets held in other -- funds held in other currencies. And we don't expect to have any finance net -- or any extra finance costs other than those that would arise from exchange rate fluctuations. And of course, in the combined income statement, there are some effects from IFRS 16 because when you start to capitalize released assets, some of that will come as an interest cost, but that's a fairly low amount.

[Operator]

[Operator Instructions] Okay. So there are no further questions in the queue.

[Marcus Lindqvist, CEO & President]

Thank you, operator, and thank you all for participating today and for your interest in Qliro Group. I look forward to seeing and speaking to you again soon. And may I also remind you that our second quarter results will be announced on July 12. And finally, I would also like to take the opportunity to wish you all a Happy Easter. Thank you, and goodbye.

[Operator]

Thank you. That will conclude today's conference call. Thank you for your participation. You may now disconnect.