Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2020-Q2

[Operator]

Good morning, ladies and gentlemen, and thank you for holding. Welcome to the Qliro Group Q2 2020 Conference Call. [Operator Instructions] Today's conference is being recorded.I will now hand the call over to Mathias Pedersen, Chief Executive Officer. Please go ahead, sir.

[Mathias Pedersen, Chief Executive Officer]

Thank you, operator, and good morning, everyone, and welcome to this conference call regarding the second quarter interim report for Qliro Group. And let's go to the next slide. So the Group had a good operational development in the second quarter. Our financial services arm, Qliro, grew its business volume, its loan book, its revenues and the number of merchants using its services. It strengthened its market position and generally developed according to plan. The company is well prepared for a listing on NASDAQ and will provide the foundation for future growth.CDON doubled its gross sales from external merchants for the second quarter in a row, and this was driven by a rapidly increasing e-commerce, in general, and more specifically, the successful positioning of CDON as an important sales channel for other e-commerce merchants. The Marketplace is the core of its business with a highly scalable business model with a strong ability to generate cash flow, and CDON is well positioned to continue its successful development outside of Qliro Group. Nelly faced a tough environment this quarter but succeeded in maintaining its sales level in the Nordics in a very weak market. Despite lower overall sales, Nelly were able to deliver a profit in the quarter, achieved through higher efficiency, focused on the Nordic region, lower marketing costs and lower return rates. And in addition, Nelly lowered its inventory substantially, resulting in a strong cash flow. The company is prepared for its independence in the future as Nelly Group. Having described the quarter as operationally good, I would like to acknowledge the fact that financially, it came with losses. And this was partly driven by the previously announced one-offs in Qliro, changed method for revenue recognition, impairment of intangibles and higher reservations for credit losses due to COVID-19. But also because we had higher group overhead costs following the change of leadership and additional cost for projects related to the planned split up of the group. Going forward, the split-up is the Group's main target. And as announced yesterday, the previous financial targets were removed. The ambition is to complete the split-up before the end of 2020 and to keep Group overhead costs at a minimum in the process.So let us now look at each of our business model in more detail, starting with our financial services arm, Qliro. And you can switch slide. First, in my comments, I will exclude the previously communicated accounting adjustments that was made in the quarter. This affected total operating income negatively with SEK 8 million and included impairments of intangible assets of SEK 16 million. So Qliro is one of the clear leaders in its markets. And overall, the company strengthened its market position in line with its plans during the quarter. The total loan book grew 29%, and total operating income grew 10%, adjusted for the mentioned one-offs. New merchants came on board during the quarter and the business volume for payment solutions grew 9%, where our external business volume grew 17%, and operating income from digital banking services, that is consumer loans, grew 93%. During the quarter, Qliro signed and onboarded important new merchants, which improved business volume during the last month of the quarter. So as said, the operational development was very strong. Financially, you might ask, why total income for payment solutions grew only 2%, that is slower than the business volume growth of 9%. And the main reason for this was the Finnish regulations that we introduced in the third quarter of 2019, which put caps on certain fees in that market. Also, there is a natural delay between actual transactions and the generation of interest income. You might also notice that the operating expenses grew faster than total income, resulting in a lower operating profit when compared to the second quarter of last year. And in preparation for the planned IPO, there was a buildup of the organization in the fourth quarter last year, due to which the fixed cost increased. Let me highlight, however, that operating expenses have since decreased during the last 2 quarters. And as Qliro stands today, it has a set of fixed costs that shouldn't grow much further. In addition to that, there's a set of variable cost that will vary with business volume and season. And we should expect income to start outgrowing operating expenses by the fourth quarter of 2020.The COVID-19 pandemic has led to increased reservations for future potential credit losses according to IFRS. The company, however, has not experienced any changes in its customers' ability to service their debts nor their choice of payment method. Turning to the next slide for a look at the loan book development over the time. The loan book growth and its composition are one of the most important drivers of future income and results. Importantly, there are 2 main categories of loans: the shorter payment-related loans, which comes with relatively higher interest rates; and then there are consumer loans within digital banking services, which comes with relatively low interest rate, but which generate interest income over a longer period of time. Consumer loans presumably grow faster than payment-related loans. And apart from the natural delay from the time of lending to the continuous generation of interest income, this mix effect explains why the total interest income is not growing as fast as the total loan book. Also, an important takeaway from this slide is that the interest cost remains very low compared to the interest income.Let me make a more general comment on the business model of Qliro. The fundamental growth in Qliro is based on the offer to e-commerce consumers to delay payments by using Qliro payment services. And as the e-commerce merchants grow their businesses and new merchants are onboarded to the Qliro platform, more business volume is created. Business volume then generate loans, which then generates fee income and interest income over time. And the total cycle of first signing and then onboarding merchants, followed by a loan book generation and then creating interest income takes time. And typically, there could be several quarters from the signing of a new merchant until the business volume from that merchant generates significant income in the Qliro. Moving on to the next slide, we'll look at the balance sheet of Qliro. So on the asset side, we had net lending amounted to SEK 2.2 billion, with SEK 1.3 billion pay-after-delivery financing and SEK 0.9 billion in personal loans. On the financing side, the Swedish loan book was mainly funded by public deposits of SEK 1.9 billion, while the multi-credit -- multicurrency credit facility was used to finance loans denominated in other Nordic currencies. And Qliro also had additional SEK 525 million in undrawn commitments from banks.Looking at the regulatory perspective. Risk-weighted assets amounted to SEK 1.8 billion and the capital base amounted to SEK 332 million, of which SEK 290 million was common equity Tier 1 capital. The capital adequacy ratio was 15.8%, and the consolidated situation, including the parent company, was also well capitalized at 23.8%. During the quarter, the Swedish financial services authorities accepted a new method for calculating capital requirement for operational risk. This, together with the lowering of the countercyclical buffers that we saw earlier, increased efficiencies when it comes to capital requirements. And I would like to highlight that since year-end 2019, the capital requirements for Qliro has been lowered with more than SEK 100 million, which increases Qliro's buffers towards capital requirements. With that, I would like to conclude the comments on Qliro by saying that I'm convinced that the promising operational development will manifest itself in the financial results from the fourth quarter of 2020 and onwards, and that the company is well prepared for listing on NASDAQ which will provide a solid foundation for future growth.With that, I'd like to turn our eyes to CDON. CDON had another great quarter. To provide a clearer picture for you, we have split the reporting into 2 segments: CDON Marketplace, selling other e-merchants' goods and services; and CDON Retail selling CDON's own products, either from its own inventory or through drop shipment. The marketplace is the core of the business, while the retail arm should be seen as complementary. The marketplace doubled its gross sales from external merchants for the second quarter in a row and was providing about 75% of the gross profit for the whole company. The success for the marketplace is driven by rapid increase in e-commerce in general and more specifically, the successful positioning of CDON as an important sales channel for other e-commerce merchants.CDON Retail sales declined but remains an important contributor to the CDON business, both financially and strategically where it can provide products in categories not yet covered by other merchants. The total gross profit for both business areas grew 39% in the quarter, and the cash flow was strengthened by the 62% decrease in own inventory. On the next slide, we have tried to illustrate the attractiveness of the marketplace business model. As more merchants are added to the Marketplace, the number of products increase. Consumers get access to a large supply of goods and services at more attractive prices, which enhance the customer experience. As the number of transactions and consumers increase, the more attractive it becomes for more merchants to sign up. And this creates a positive spiral that drives profits for CDON, which can realize more advantages to scale through the utilization of its infrastructure and technologies. And on the next slide are the actual financial proof-of-concept, where the numbers for the last 12 months are shown. And here you can see that external gross sales grew rapidly, the total number of customers increased as did the number of visits. The inventory, and therefore, the risk, declined significantly, gross profits were up and last 12 months operating results before depreciation and amortization reached SEK 25 million. And with this, I would like to conclude the comments by noting that CDON has built a highly scalable business model with a strong ability to generate cash flow and that it is well positioned to continue its successful development outside of Qliro Group. Moving on to Nelly. Nelly operated in a very tough environment this time, yet it succeeded in maintaining its sales levels in the Nordics in a very weak market during the second quarter. As previously communicated, Nelly is refocusing its businesses to the Nordic countries, and we have, therefore, split the top line into 2, so you can follow the Nordic business separately. Seasonally, most important categories for Nelly usually are party dresses and bikinis. And this time, there was very limited demand for those. And the great achievement by Nelly management during this quarter was to deliver bottom line profit despite the overall lower sales. And this was accomplished through a lot of hard work, higher efficiency, increased focus on the Nordic region, lower marketing costs and lower return rates. And in addition, Nelly lowered its inventory substantially, resulting in a strong cash flow.So my concluding remark on Nelly is that the company is ready to operate independently as the future Nelly Group.And that was all my comments on the business segments, and I -- now I would like to hand over the call to our new CFO, David Granath.

[David Granath, Chief Financial Officer]

Thank you, Mathias. Having been through each subsidiary, let us take a look at the combined e-commerce cash flow. The nonfinancial business had a positive cash flow during Q2, mainly due to reduction of inventory, together with the seasonal pattern within e-commerce, which usually includes inflows in the second and the fourth quarter of the year. Net inventory levels decreased SEK 134 million, as Nelly had a focus on cash flow and CDON continued its transformation. We spent SEK 6 million on capital expenditure in Nelly and CDON and reduced debt by SEK 26 million. No further funding was needed to meet capital requirements in the subsidiary, Qliro. Overall, our focus on inventory reduction has strengthened our cash position.Moving forward to the balance sheet, once again, for the nonfinancial part of the business. We had a net cash position of SEK 173 million at the end of the quarter, utilizing SEK 75 million in external financing. Regarding inventory, CDON's continued transformation within the marketplace model, together with Nelly's inventory reduction, decreased the need for inventory within e-commerce with 42% compared to last year. Overall, our e-commerce balance sheet supports future growth.And now back to you, Mathias.

[Mathias Pedersen, Chief Executive Officer]

Thank you, David. So with that, we are now ready to answer your questions. Operator, can we have the first question, please?

[Operator]

[Operator Instructions] Now we will take our first question.

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

This is Nicklas Fhärm with SEB Equities. I have a couple of questions on sort of a divisional level, and maybe I can come back later with a few follow-ups as well. But let's start with -- actually with CDON. And I would like to ask you, there's quite a significant change in the net sales trend in this quarter compared to the past, say, 4 to 5 quarters. And I was just wondering if you would -- not in terms of guiding for 2020, but generally, just comment if this sales development, say, negative 10-ish in this quarter year-on-year. Is that sort of what you expect for the second half of this year as well, please?

[Mathias Pedersen, Chief Executive Officer]

Thank you, Nicklas. And I don't really want to comment on the future sales or guide anything, but we do have a shift here, of course, because of the growing Marketplace and the declining CDON Retail business. And the significant shift here is now that the combined volumes actually are growing significantly, I think you can expect that the CDON Retail will continue to diminish and the Marketplace to continue its further rapid growth.

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

Perfect. My second question, what would you say is the latest news on Amazon potentially entering with a local site in Sweden or the Nordics?

[Mathias Pedersen, Chief Executive Officer]

Yes, that is the million-dollar question, of course. And I guess, from what we hear, they are coming here, and they're coming here soon, this fall. Obviously, we don't know yet exactly when. And honestly, I'm starting to look forward to have them here, so we can know the effects of it. And we feel prepared, and we think that CDON is well positioned to deal with that. Increased competition that obviously will be the case. But we have no more facts than that.

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

Mathias, moving over to Nelly, I have 2 specific questions. First of all, I would like to ask you about the inventory level going forward. I mean, it's quite a significant change year-on-year in this quarter. And I was just wondering if you think you've hit sort of a new sustainable inventory level to sales going forward? Or if this is a particularly different quarter? And my second question would be your strategy in terms of prioritizing margins over growth also in the second half of this year.

[Mathias Pedersen, Chief Executive Officer]

I think the first question on the inventory levels of Nelly, it's a very good question. And on the one hand, we have aimed for quite some time to take down the inventory levels as we have had many quarters in a row because we came to a level where it was too high. This quarter, we really, really focused on generating cash flow. And because of the very tough environment we were operating in, we put an extra focus on that. So whether this level is sustainable? I would like to see the levels of inventory to remain fairly low, but there will be a seasonal pattern, and there will be a buildup, both usually in the third quarter. And then again, in the first quarter of the year. So there is a seasonal pattern, where we now are on the low side. But certainly, we should not come back up to the previously high levels we've had during the past 2 years. I hope that answers your questions on that. And the second question, could you please repeat that one?

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

Yes, yes. Very clear answer on the inventory. My second question was really, obviously, you've prioritized margins over growth in this particular quarter in Nelly. And I was just wondering if that is sort of the overall strategy for the second half of this year as well, please.

[Mathias Pedersen, Chief Executive Officer]

I think there's a fair amount of uncertainty in the market. I think, as I said before, Nelly has done a tremendous job in meeting the tough environment they have been operating in, and part of keeping that readiness is actually to focus on cash flow. But as we move into the fall season, I think it's going to be more normal -- going back to more normal business. But I think it is important for any business of this kind to keep its focus on the cash flow at all times.

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

All right. Final question from me on sort of the divisional level would go to Qliro. And I mean, I understand from reading the report that you've sort of increased cost levels reflecting several different types of investments, of course, but also including your personnel. And I was just wondering how many FTEs do you actually have at the end of the quarter? And have you sort of -- have you hired the people you need now for the rest of the year? Or should we expect sort of continuing increasing in staff also in the second half of this year, please?

[Mathias Pedersen, Chief Executive Officer]

We usually don't comment upon the exact number of employees. There's some 200 people, a little bit more. And there has been a shift in consultant versus employed staff, especially within IT development. So this might vary over time because it's sometimes more efficient to use external consultants. And sometimes, it's more efficient to actually hire people and have them on your own payroll, especially in a financial business, where it's difficult to take out the VAT costs. So that could be a tactical decision from time to time. But we do have the organization in place that we need. That is sort of the key message, especially when it comes to being -- governance wise, a company that can operate on their own. And then as I said, on the IT development side, this could vary up and down depending on how you choose to staff your IT development organization.

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

Excellent. Final question for now. I just noted the SEK 3 million cost in sort of relating to discontinued operations in the quarter in your P&L. And I was just wondering what they refer -- what are they, discontinued operations?

[Mathias Pedersen, Chief Executive Officer]

Well, they related to sales of one of our previous subsidiaries, which we settled with one of the buyers during the quarter -- sorry, which we actually made a reservation during the quarter regarding discussion we're having with one of the buyers.

[Operator]

[Operator Instructions] And we will take our next question.

[Simon Möller;Alecta;Trader]

It's Simon Möller from Alecta. Can you hear me?

[Mathias Pedersen, Chief Executive Officer]

Yes, absolutely.

[Simon Möller;Alecta;Trader]

Great. Cool. So my first question is regarding the cost development in CDON. I assume there are some costs associated with adding new merchants. How will that develop? And what kind of cost level are we talking about going forward when it comes to adding new merchants?

[Mathias Pedersen, Chief Executive Officer]

Okay. Well, I don't really see that we have any particular costs related to adding new merchants. The fact -- gross profit is growing and it's -- but not all of those profits end up on the operating profit line further down, and that's because of the increased marketing costs that comes with driving marketing for more products and more merchants. But it's not necessarily tied to the onboarding or recruiting of a particular merchant.

[Simon Möller;Alecta;Trader]

Okay, okay. So when I look at the take rate, so to speak, I know you can calculate the commission...

[Mathias Pedersen, Chief Executive Officer]

Sorry, Simon, could you please start over because I hear you, unfortunately, quite poorly.

[Simon Möller;Alecta;Trader]

Oh, okay. So there is -- if you look at the revenues generated from external merchants and compare that with the sales numbers you have for external merchants, it's around 10% and 10.8% in this quarter, some kind of a take rate.

[Mathias Pedersen, Chief Executive Officer]

Right.

[Simon Möller;Alecta;Trader]

Is that a fair level going forward?

[Mathias Pedersen, Chief Executive Officer]

I think that could be a reasonable assumption, though it could also vary a little bit because different merchants that are signed up will have different terms for their products being sold, and certain product categories comes with low margins and certain product categories comes with high margins. That [indiscernible] from category differ very much. And if you sort of for one quarter or one period starts to add products within a low-margin product category that, of course, takes that number down or if you, vice versa, you add high-margin products, it comes up a little bit. And it's not only tied to the product category, but also what we call the long tail products. Even low-margin product categories could come with a long tail of products, which have -- that is not sold that often and that are sold with a higher commission rates.So I don't really want to make a guidance on it, but I think it is where it is now, and it can vary over time. I think it's at a good level.

[Simon Möller;Alecta;Trader]

Okay. And to adding to the question from Nicklas and regarding the level of own sales or inventory sales from CDON, it's around like SEK 150 million now. Is that going to SEK 0? Or will it -- when will it flatten out?

[Mathias Pedersen, Chief Executive Officer]

As I said, we think this is a strategically important complementary business to the Marketplace. But in order to fulfill that role, it must be profitable and contribute to the overall business financially as well. So I don't think it will go down to SEK 0, but I do think it will go down somewhat further. And part of that reason is because there is the media category in there where we still sell DVDs and music and other things that have a natural decline in the market, even though that is a niche market where we are one of the few players left and which is definitely profitable.

[Simon Möller;Alecta;Trader]

Okay. Good. So moving on to QFS. How far can you grow the loan book in QFS without raising new capital on the capital base you have at the moment, how far can you go?

[Mathias Pedersen, Chief Executive Officer]

I don't really have that number at my fingertips. But clearly, there are capital requirements and those put the limits on how much you can lend. And we still have quite some room in the balance sheet, but in order to grow a business like Qliro Financial Services, you do need to have a fair amount of equity.

[Simon Möller;Alecta;Trader]

Yes. But is it fair to assume that, if that does not -- if that is not a restriction or a constraint for you to grow at the moment. You can continue to grow...

[Mathias Pedersen, Chief Executive Officer]

It's not a constraint at this time. At this very point in time, it's not a constraint, no.

[Simon Möller;Alecta;Trader]

Okay. So my final question is regarding the cash position you have in the group. When you are splitting up or splitting up the group and will be distributing the 3 different subsidiaries, how will you distribute the capital that is held at the group level? How should I think about that...

[Mathias Pedersen, Chief Executive Officer]

Most of the cash actually is not at the group level, but in fact, already within CDON and Nelly. And they have -- they operate their own separate balance sheets today. And of course, since we are a group, we could shift some of the cash around. But Nelly will take its cash and CDON will take its. And what those exact amounts will be? We will have to come back to in the future. We did make a dividend from CDON this spring to the parent company, taking up some of the cash that was generated there over the last year since they had a very strong cash flow and really don't need more.

[Operator]

[Operator Instructions] There -- it appears there are no questions in the telephone queue at this time. [Operator Instructions]

[Mathias Pedersen, Chief Executive Officer]

Well, thank you, operator. If there are no more questions today, I would like to thank you all for participating and for your interest in Qliro Group, and I look forward to speaking to you again. And the next interim report will be published on the 21st of October. Thank you, and goodbye, everyone.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.