Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, ladies and gentlemen, and thank you for holding. Welcome to the Qliro Group Q3 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.

[Mathias Pedersen, Independent Non]

Thank you, operator. And good morning, everyone, and welcome to this conference call regarding the third quarter interim report for Qliro Group. This will, in fact, be the last interim report before the company changes its name and management team to fully focus on the Nelly business. As of yet now, we have 2 businesses in Qliro Group: CDON, the leading Nordic marketplace, which doubled its gross sales from external merchants during the quarter; and Nelly, now focusing solely on the Nordics, which continue to face a tough environment during the quarter but succeeded in maintaining its sales level in local currencies in the Nordics. At the end of the quarter, we span out the financial services arm, Qliro AB to the stock market, and it is now independently listed on Stockholm Nasdaq main market, and the company will hold its own earnings call for investors in about an hour. In our interim report, Qliro AB is reported as discontinued operation. And the distribution of the shares was recorded at a profit as a result of the opening trading value of the company exceeding the value of the net assets for the company that was previously recorded in our consolidated accounts. Going forward, the continue split up remained the main target. And as previously announced, the proposal to distribute the shares in CDON is up for a decision at an AGM next week. And following that decision, CDON is expected to be listed on First North in November. As a natural consequence of the split up and as announced yesterday, Qliro Group will change its name to Nelly Group on November 6. And Kristina Lukes, today, the CEO of our subsidiary, Nelly, will become the new group CEO. And with that introduction, I would like to comment further on CDON and Nelly in more detail, starting with the leading Nordic marketplace, CDON. CDON had another great quarter. It now reports in 2 segments: CDON Marketplace, promoting and relaying other e-merchants goods and services, generating business-to-business service fee income; and CDON Retail, selling CDON's own products through the CDON marketplace. The Marketplace doubled its gross sales from external merchants. And in the third quarter, the Marketplace generated 80% of the gross profit for the whole company. Success for the Marketplace is driven by rapidly increasing e-commerce in general and more specifically, the successful positioning of CDON as an important sales channel for e-commerce merchants. CDON Retail sales declined but remains an important contributor to the CDON business as it provides profit contributions and products in categories not yet covered by other merchants. The total gross profit for both business areas grew 33% in the quarter, and the cash flow was strengthened by the 70% decrease in inventory. On the next slide, we have illustrated the attractiveness of the Marketplace business model. As more merchants are added to the Marketplace, the number of products increase, and consumers get access to a larger supply of goods and services at more attractive prices, which enhance customer experience. And as the number of transactions and consumers increased, the more attractive it becomes for more merchants to sign up to the Marketplace. And all this creates a positive spiral that drives profit for CDON, which can realize more advantages of scale through the utilization of its infrastructure and technologies. And on the next slide, we have the financial proof where the numbers for the last 12 months are shown. 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 profit was up and last 12 months' operating profit before depreciation and amortization reached SEK 29 million. All in all, CDON has built a highly scalable business model with a strong ability to generate cash flow, and it is well positioned to continue its successful development outside of Qliro Group. So moving on to Nelly. Nelly continued to operate in a tough environment, yet it exceeded in maintaining its sales level in the Nordics in a very weak fashion market during the quarter. As previously communicated, Nelly is refocusing its businesses to the Nordic countries. And we, therefore, split the top line into 2, so you can follow the Nordic business separately. Net sales in the Nordics were down 3%, but it was flat in local currencies, mainly as a result of the weakening Norwegian krona. The great achievement by Nelly's management during this quarter was to deliver positive operating profit before depreciation despite the overall lower sales. And this was accomplished through higher efficiency, increased focus on the Nordic region and lower return rates. The management of Nelly continuously look for more efficient ways of working. And in this quarter, it decided to streamline its organization further by removing a number of positions, which resulted in extra costs of SEK 5.4 million. In addition, Nelly lowered its inventory substantially compared to last year same time, resulting in an improved working capital position during a quarter where inventory typically increases rapidly as it gets replenished with new products for the season. And that was my comments on our business segments. And I now would like to hand over the call to our CFO, David.

[David Granath, Chief Financial Officer]

Thank you, Mathias. Having been through each subsidiary, let us take a look at the combined cash flow for the remaining entities. The business had a negative cash flow during the quarter, mainly due to the seasonal pattern, which usually includes outflows in the first and the third quarter of the year, resulting in a cash position of SEK 222 million. Net inventory levels increased SEK 27 million in the quarter as Nelly prepared for Q4, while CDON continued to lower its inventory. As Mathias mentioned before, the inventory buildup in Nelly was significantly lower than what is typical for the season. We raised SEK 203 million in a directed share issue, of which we invested SEK 125 million in Qliro AB before distributing it to Qliro Group shareholders and repaid group credit facility of SEK 75 million. Moving forward to the balance sheet. As mentioned, we had a cash position of SEK 222 million at the end of the quarter, of which CDON had SEK 49 million, a healthy position ahead of its listing. Regarding inventory, CDON's transition to a service-based income model, together with Nelly's increased inventory turnover rate, decreased the combined need for inventory with 40% compared to the third quarter last year. Overall, both companies are ready for the peak season with a necessary inventory in Nelly and around 1,400 merchants selling more than 8 million products on CDON's marketplace. And now back to you, Mathias.

[Mathias Pedersen, Independent Non]

Thank you, David. And before taking your questions, I would like to acknowledge that this is my 17th and last interim report for Qliro Group, as the split up will be completed shortly. It's been a sound and full of learnings along the way, and I very much look forward to continuing my work on the Board of Directors for Nelly Group. And so with that, we are now ready to answer your questions. Operator, can we please have the first question?

[Operator]

[Operator Instructions] We'll now take our first question from the phone.

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

This is Nicklas Fhärm with SEB Equities. Can I start by asking you on the change in working capital, which kind of halved year-on-year, obviously, in a new group context. And the main driver, I assume, is the inventory being down close to SEK 100 million year-on-year. What are the run rate for CDON and Nelly stocking trade, let's say, as a percentage of sales going forward? Do you think you've reached sort of an appropriate inventory level in these 2 assets? Or do you still see inventory to shrink in 2021?

[Mathias Pedersen, Independent Non]

When it comes to CDON, I think we are approaching a point where we will not continue to lower the inventory as much relatively year-on-year. It might come down slightly further, but that will -- it will plateau as long as there is a CDON Retail business arm left. As long as that business makes sense, there will be an inventory for that business. There's no real target other than that. We will continue to run that as long as it's profitable and contributes to the business. When it comes to Nelly then, of course, Nelly will remain in their seasonal pattern with traditional buildup in the third and the first quarter, but we have really set a focus on increased turnover inventory in order to improve working capital, in order not to tie up and take too many risks. So that's going to continue to be a focus to be more efficient in handling the inventory, but the seasonal pattern will remain in place.

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

Excellent. My next question would be on the new guidance for central costs, that's about SEK 30 million per annum. I have two questions here. Does that imply that we should expect SEK 7.5 million in central costs in Q4? And secondly, assuming that CDON is actually dividended, what would central cost be as a run rate in the remaining group, Nelly?

[Mathias Pedersen, Independent Non]

Thank you, Nicklas, for asking that question. I realize that now the run rate is the number, as we say, the SEK 7.5 million per quarter, ending up in SEK 30 million, but that should go down. That's where we are now. And I will be leaving and this group will be the Nelly group, and this number will be lower going forward. We just haven't set a target. But it clearly will go down, and you will see that it would not go down to 0 because there are always the cost of actually being listed, and there is a little bit added on top of the Nelly business, but not at all close to these numbers.

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

Okay. And then perhaps I can come back into the call later on. But I have some specific questions on CDON and Nelly as well in terms of your comments on growth going forward. For CDON, in particular, I was wondering if you could give some sense for where you expect external merchant growth to be in sort of Q4 and 2021. Is that going to be growing at the same pace as we've generally seen now for the past couple of quarters? Or should we expect an increase for any reason or a decrease? And my second question in Nelly would also be to ask you a little bit if you could guide us on sort of where you think you will be in terms of growing the business vis-a-vis generating a higher margin, i.e., working and focusing on operating KPIs like return rates and your own label sales, et cetera, et cetera, please?

[Mathias Pedersen, Independent Non]

Okay. I'll start with the CDON question and the external merchants growth there. I mean we have -- it's for 3 quarters now in a row that we sort of year-on-year have reported 100% or more growth versus the year before. And I think it's fair to say that, that has exceeded our expectations. We have never dare to set a target at that level. So -- and I will not try to do that going forward either, and we don't really have any communicated targets. But this business is growing at a healthy speed. And you should expect continued high growth in it. But I wouldn't go as far to say it's going to continue at this speed because it's been really, really good. And on the Nelly, and please repeat the question, if I got it wrong, but the balance here between future growth and profitability is a clear focus on the Nordic business to establish the proper core business and to grow that one. And in terms of growth speed, I think we will firstly make sure that whatever growth we add to this business actually puts more money on the bottom line. So a little bit profit before -- or healthy margins before fast growth of top line. But clearly, we want the core business to continue to grow. Hopefully, that's an answer to your question.

[Operator]

[Operator Instructions] We'll now move to the next question.

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

It's Nicklas Fhärm with SEB Equities again. Can you hear me now?

[Mathias Pedersen, Independent Non]

Yes.

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

Yes. All right. Just a few more questions on the details in -- let's start with Nelly. I was just wondering, return rates at 36% is obviously improving a couple of percentage points year-on-year in Q3 this year. But it's also a particularly strong margin driver, of course, for 2021. And I was just wondering, do you care to share any thoughts on where you actually think it should be at least inside a medium-term perspective?

[Mathias Pedersen, Independent Non]

Well, without making any forecast, I think it should be lower just for the fact that this is -- we live in an industry where we waste too much things by shipping things back and forth. So I think the whole industry will need to deal with the fact that returns is not necessarily sustainable at these levels. But that's more like my view on things rather than a forecast of what we will be able to achieve within the company. Because clearly, the customers also have this real need of buying out their clothes before they decide to buy them. So there is a trade-off, there will always be returns, and that should be okay, but I think they should be lower. When it comes to how much we can lower them? I don't know. And also, it's much a question of product mix. Certain product categories do have higher return rates than others. For instance, dresses, which has been a top seller of Nelly for years, has higher return rates than some other basic clothes. So -- and it's also a question of regional mix where some countries from culture tradition and also regulatory reasons have higher return rates. So it will be a combined mix effect of sales in different product categories and regional distribution of sales, combined with an effort from the company to try to figure out more efficient way of handling this to take the return rate down if possible.

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

I appreciate this answer, of course. And let me just rephrase it a bit. You -- I know you've done some particular investments in sort of digitizing/automizing the return process, the return handling process in the past. And I was just wondering if you expect any particular sort of structural reasons or sustainable reasons for why return rates generally should continue to trend down.

[Mathias Pedersen, Independent Non]

Well, I mean, you can always improve in terms of setting the expectations right for the customers. The better you are describing the actual product online, and the easier it gets to match the customers' expectation when they open the package at home. So you can always improve that. And then I think it's going to be a discussion between companies and customers on the value of things. And then you can have incentives and schemes put in place. But once again, we must acknowledge that there is an actual real need for customers to actually change the things that they buy. And there's nothing wrong with that. We just need to tweak the system, have it as a clear goal that this should be lower. And I think more in terms of continuous improvement rather than actual -- setting any specific target. And the digitalization here is an important part because it's easier to track. The faster you can track the return behavior of a certain product or a product category, the sooner you could sort of reset the expectations that the customers have or coming customers have for buying the same products that has been returned in the past. So digitization is an important part of improving this.

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

Perfect. Maybe two more questions. The last one on Nelly for now. I was just wondering if you could share -- I know you don't disclose sort of geographical EBIT in Nelly, but could you confirm that operating losses, perhaps, in your European business has shrunk in Q3? Or is it the other way around that because you have actually deliberately lowered your efforts in these markets that you've also in Q3, taking a slightly larger hit on earnings in your European Nelly operations?

[Mathias Pedersen, Independent Non]

I'm sorry, Nicklas. I don't think I can share any particular light on that question. I mean we are sort of passively exiting these markets outside the Nordic region by not putting any effort into them. And to the extent there is some work done in the overall OpEx for this, I don't really have that number at my fingers.

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

Yes. Okay. Fair enough. Final question back to CDON Marketplace. Obviously, a significant expansion of gross margins in Q3 this year compared to the same period in last year. And I assume that the main reason for this is the actual mix between the marketplace and -- the growing marketplace and the shrinking retail business. But is there any other particular reason for why gross margins will continue to expand that going forward, apart from the business mix, that you would like to highlight, I should add?

[Mathias Pedersen, Independent Non]

No, no. I mean, you're clearly right there. It's about the business uses. It's completely 2 different business model, and one have very, very high gross margin rate. And the other one is like a traditional retailer. But I guess, on the traditional side, as we have taken out product categories from CDON Retail, continue to do in the last year, I think it's fair to say that we have sometimes put more things on sale just to get out of some categories. So once the core assortment in CDON Retail has been -- is reset to where it should be, I think there is some argument that, that margin actually should increase, but there's no promise in that.

[Operator]

We'll now move to next question.

[Unknown Analyst]

Can you guys hear me? This is David here. I really appreciate -- let me ask the question here. I'm just kind of curious, for the 3P business, the GMV up 100%, gross profit up 80%, can you just talk a little bit about what -- why is the gross profit up as much in GMV? I'm curious what's going on on the take rate? What's kind of impacting that to create that difference?

[Mathias Pedersen, Independent Non]

So the question is, why isn't the growth in gross profit for the Marketplace business growing as fast as external merchants?

[Unknown Analyst]

Yes, that's right.

[Mathias Pedersen, Independent Non]

Yes. So yes, this could vary, and it varies with -- it's a lot about the mix effect. If you add a larger merchants, it comes in with a lot of GMV. In a category such as home electronics products, that product category comes with lower commission rates, for instance. So we have this average commission rate that has been varying in the 9 to 11 percentage point rate over the past 2 years. But as we've added in the last year, fairly large home electronics merchants to the marketplace. Clearly, that takes down the commission rate a little bit. But then one should know that this commission rate is also very much split up in different product categories and not only home electronics versus other things, it's also the latest, greatest gadgets versus the long tail, the things that people are buying, not so very often. And then we plan to adding new services income to this going forward as well. Subscription fees for merchants coming in going forward.

[Unknown Analyst]

Okay. And also, if I look at the total -- so if look at the EBITDA, the total gross profit, right? Is the cost structure for Q3, the cash cost looks like it's about SEK 49 million, which is up from close to SEK 40 million year-on-year, right? Can you just talk about the costs, operating expenses for CDON Group going forward? Is this the right way to think about it? How should you -- how do you guys think about it as you continue the mix shift? Where the operating expenses is going to be?

[Mathias Pedersen, Independent Non]

That's a really good question. And the way I look at it, a little bit generally, is that we don't really increase our underlying organizational costs. It could be vary on the margin. But we don't really need to grow that much the overhead cost of this business. But clearly, marketing cost is a factor here, and we could choose to drive traffic and sales, more or less by spending more or less money on marketing. So the differentiating here is marketing cost. And that's always a strategic -- or more like a tactical choice going forward in how much money to put into that to further drive the gross profit growth here.

[Unknown Analyst]

Okay. Can you maybe -- I mean, I understand you guys will probably break this out in the future, but is there -- can we get a sense of what the marketing cost actually is for the quarter? And how much of it you guys are investing in marketing versus mostly just organic traffic, organic customers, is there a organic number?

[Mathias Pedersen, Independent Non]

We haven't really disclosed that number. I'll have to -- we have to look for that number going forward and see if we -- if it will be disclosed or not.

[Unknown Analyst]

Okay. And also going back on strategic, once the CDON Group become an independent company, when do you think they will start -- the new management team will come out sort of giving a presentation or addressing the views strategically? How CDON is going to be positioned with more disclosure, more commentary how you guys run the business? When should we expect that?

[Mathias Pedersen, Independent Non]

Well, as -- what will happen now is that we had the decision next week on the AGM to make the distribution, and it's in the hands of the Board to set the final date for distribution of shares, and that is also dependent on our dialogue with the stock market, Nasdaq. And at the end of that process or just before a listing, there will be a -- not a prospective, it's actually called a company description for the First North market, which will be published with more details about the company. And around that time -- and also the new management team will be able to meet the market based on that information that is coming out.

[Unknown Analyst]

Okay. And the last question I have is...

[Mathias Pedersen, Independent Non]

And they are already out marketing the company. So you're free to -- we can set up course with them already now if you want to speak to the CEO of CDON and the CFO of CDON. Clearly, they are available to that already.

[Unknown Analyst]

That's great. Got it. That's great. And that's fantastic. And also, can you just -- lastly, the logistics of this. When is the actual -- when should they start trading at the separate CDON stock? I'm just kind of curious, is there set date already determined or does post AGM?

[Mathias Pedersen, Independent Non]

I have a target date in my head, but we haven't gotten that confirmed. We have said in November, I would go as far as to say, early November. But we need to come back on the exact date.

[Operator]

[Operator Instructions] As there are no further questions in the queue. I'd like to hand the call back over to Mr. Pedersen for any closing remarks.

[Mathias Pedersen, Independent Non]

Well, thank you very much, everybody, for listening in, and thank you for all these really good questions that -- given to us. And thank you for the time that I've had the opportunity to lead this company, and really look forward to seeing this develop as well as I believe it will. So with that, thank you, everybody.

[Operator]

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