Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, ladies and gentlemen, and thank you for holding. Welcome to the Qliro Group Full Year Report 2018 Conference Call. [Operator Instructions] Today’s conference is being recorded.I would now hand the conference 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 Qliro Group's Fourth Quarter Results 2018. Let's start by taking a look at our strategic direction and some progress made during the last quarter.As you know, Qliro Group's strategy is to operate Qliro Financial Services, CDON Marketplace and Nelly as 3 completely independent companies. This will create the best prospects for the companies and, thereby, increase shareholder value. The process is proceeding as planned, and we took several important steps in this work during the last quarter.As part of this process, we have renewed the leadership in all 3 companies and strengthened the corporate governance at Nelly and CDON. And with that, now all our companies have separate boards with representatives from the group board and management, along with external members in the board of Qliro and Nelly.In practice, this means that the companies are run independently of each other and that the group management's primary focus are on making the companies independent and ready to be listed at the same time as we continue to evaluate potential transactions.Furthermore, we are making good progress in the work to separate the companies' financial, office IT and accounting systems, and our assessment is that all 3 companies will be operationally and structurally independent some time during the first half of this year.In addition, we continued the work to evaluate possible structured transactions for CDON Marketplace and with a divestment or a listing of Nelly, and we believe that all our companies should be ready to be independent listed companies some time during the second half 2019.With that, let's take a look at our businesses and their performance during the fourth quarter, starting with Qliro Financial Services. Qliro Financial Services provides financial services to consumers and merchants, and during the coming year, their focus will be to attract more merchants and further strengthen their Nordic offering.Business volumes grew 19%, to SEK 1.6 billion, in the quarter, and merchants that are not part of Qliro Group accounted for over 50% of e-commerce volumes, which in fact fulfills the target that was communicated in 2017 for the end of 2018.Total operating income increased 26%, to SEK 82 million, in the quarter. This was driven by the loan book, which grew 45%, to SEK 1.5 billion, with the fastest growth in personal loans. It is worth noticing that the income growth was somewhat hampered by the transformation in CDON, where CDON volumes in the fourth quarter were 14% lower to Qliro Financial Services than the same period the year before.To strengthen its position as an independent company, Qliro Financial Services increased its commercial investments and strengthened the organization that is working to attract and integrate new merchants. In addition, the company has further strengthened the management team and key functions as part of their work to become an independent company.These investments are vital to strengthen the company in the long term but affected profitability for the quarter. Personnel costs increased by SEK 8 million in the quarter, which contributed to a total operating expense growth of 31%. Depreciation increased by SEK 2.4 million, as we continue to roll out our technology platform and commissioned more projects during the year.Reserves for credit losses amounted to SEK 16.9 million in the quarter. The increase was driven by growth of the loan book and the effects on provisions for expected future credit losses linked to the implementation of IFRS 9. All in all, this resulted in an operating income before depreciation, amortization and impairment of SEK 3.2 million.We're also seeing good progress from our commercial team that we strengthened during the fall, and we have already signed new merchants that will go live during the spring.On the next slide, we can follow the loan book development in more detail. As mentioned, our loan book grow with 45% to SEK 1.5 billion in the quarter, with the fastest growth in personal loans. SEK 1,213 million of the loan book was for invoices, part payments and installments, and SEK 317 million was for personal loans, all financed through banks, savings accounts and equity.Our growth within personal loans is driven by digital marketing to existing customers, and we can see that 95% of our borrowers have a previous relationship with Qliro Financial Services, and many of the applications is done through our app. All in all, this allows for low acquisition costs and the possibility of selective credit granting. Credit scoring in Qliro Financial Services is automated and based on the combination of internal and external data, which we analyze in real time.The personal loans granted had a contractual maturity of just over 8 years, and we have an excellent opportunity to continue to grow this business effectively, going forward.Moving over to CDON. CDON Marketplace continues its transformation and transition towards a market-based business model to build an independently and profitable company. The external merchants increased their sales through CDON by 20%, which contributed to a 27% increase in commissions in the quarter.Together, the external merchants and dropshipment sales accounted for 41% of gross merchandise value, and the gross margin increased with 3.1 percentage points, to 15%.Meanwhile, the phasing out of our sales of owned inventory continued, especially in the lower-margin home electronics segment. Consequently, net sales, which do not include external merchant sales, decreased by 24%, to SEK 558 million. This is a natural part of the transition to the marketplace and will continue in the coming quarters with a negative impact on sales, but it will allow for long-term conditions for higher margins and profitable growth. The phasing out of home electronics sales also means that the average shopping basket decreased in the quarter.CDON has for several years invested in its technology platform and process automation. The company is now benefiting from these investments. This means that CDON Marketplace has reduced its number of employees, which contributed a 20% decrease in personnel costs during the quarter.Increased commission income and lower employee cost led to a doubling of the operating income before depreciation, amortization and impairment, to SEK 20 million for the quarter, and a corresponding margin of 3.5%.Moving over to the next slide, we can follow the transition in more detail. Compared to the same quarter last year, our owned inventory sales have dropped from 67% to 59% of total sales. This is driven by the already mentioned strategy to reduce low-margin owned inventory sales, but also by the fact that we continue to grow our dropshipment sales and external merchant sales.[ Except ] that this transformation will be fruitful for our merchants and help us achieve profitability, the transition to a marketplace and dropshipment business model leaves room for continued growth with lower inventory levels, which over time is expected to provide stronger cash flow and decrease working capital needs. In line with this strategy, inventory levels were 31% lower at the end of 2018 compared with the end of 2017.And finally, let's take a look at Nelly. Nelly's growth initiatives led to an 11% increase in the number of customers and a 10% increase in average shopping basket for the quarter. The strong growth in number of customers is particularly important given the company's strong customer loyalty. In 2018 we can see that returning customers from the year before accounted for approximately 85% of sales, and the majority of sales came from customers who make more than 5 purchases per year.The combined offline and online fashion market in Sweden was characterized by weaker demand in the quarter, which led to generally higher campaign activity. Order intake increased by 6%, but the sales increase was limited to 1% due to increased provisions for returns in the quarter. Our sales increased in Norway, Denmark and Finland as well as outside the Nordics, but declined in Sweden.Sales in Sweden were affected by lower-than-planned sales of owned brands during Black Week and clearances of external brands during the after-Christmas sales in favor for owned brands. After a weaker Black Week, the focus was on selling products with a high risk of obsolescence, to ensure seasonally adapted inventories for 2019.It is also worth noticing when comparing that sales during the fourth quarter 2017 were affected by a campaign with extended return rights which, however, led to higher return rates during the first quarter 2018.Inventories decreased by SEK 54 million during the quarter, but at the year-end it was higher than last year. We do not see, however, that our current inventory carry a risk of obsolescence, and inventory levels create good prospects for a strong spring season.The operating margin before depreciation, amortization and impairment was 4.8% for the quarter, which is lower than last year but higher than for the full year 2018. Our operating margin was impacted by increased cost for fulfillment and distribution due to an uneven utilization of capacity in our warehouse, in combination by the already mentioned decrease in the proportion of owned brands from 46% to 43%.The last quarter's increase in return levels is slowing down if we look at it from a quarter-to-quarter perspective. And to further improve the return processes, Nelly will implement a project to digitalize and streamline the handling of returns during the spring. That was my comments 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 having been through each subsidiary, let us take a look at the overall group, starting with the combined results.On a total group level, sales declined. And you know from Marcus' presentation that it was the growth within Qliro Financial Services and external merchants volumes in CDON that were more than offset by the declining net sales within CDON. And you also know that this was the result of a conscious decision to phase out inventory-based sales in less profitable categories within CDON which, however, had a positive impact on the gross margins, though net sales were also slightly boosted by exchange rate fluctuations. Bottom line, the net results for the quarter before tax amounted to SEK 13.6 million.Moving on to the next slide, for a look at the e-commerce cash flow. So we had a seasonally very strong cash flow during the fourth quarter, of about SEK 150 million if we exclude the investments made in Financial Services. So during the peak season, inventory levels decreased while accounts payable increased. We spent about SEK 10 million on capital expenditures, most of it related to further investment in automation in CDON, and also SEK 30 million in equity contribution to Qliro Financial Services.Moving forward to the balance sheet for the non-financial businesses. We had a cash position of SEK 670 million at year end, and that represented a net cash position of SEK 420 million if we deduct the bond from that.And as announced yesterday, Qliro Group will now redeem its SEK 250 million bond during February. This is an early redemption driven by our strategy. As our subsidiaries are made independent, there is no logic in seeking common financing anymore. All businesses should be financed independently. And then an additional effect of the redemption is that the covenants today preventing us from distributing cash or assets to shareholders will be lifted in the process.And as a separate note and to highlight what Marcus might already have said, in the balance sheet inventory position you should note that the inventory for CDON actually decreased 31% compared to the end of 2017, illustrating the transformation to more dropshipment and marketplace sales. With that, I think we can say we still have a very well financed business.Moving forward to the balance sheet of Qliro Financial Services. So this is a strong balance sheet that puts Qliro Financial Services in a good position for further expansion. On the asset side we increased net lending to more than SEK 1.5 billion, as both the sales finance loan book as well as the personal loans book continued to grow.In addition to a small amount of cash, Qliro Financial Services held a liquidity reserve including municipal bonds and commercial papers amounting to SEK 197 million. And on the financing side, the Swedish loan book was mainly funded by public deposits of SEK 970 million, while the bank credit facility was used to finance the loan book denominated in other Nordic currencies to limit currency risks. We also had an additional SEK 342 million in undrawn commitments.A note on regulatory capital requirements. The risk-weighted assets amounted to SEK 1.5 billion. The capital base, or own funds, amounted to SEK 255 million, all of which was common equity Tier 1 capital. And the corresponding capital adequacy ratio was 16.9%.As previously announced, we now operate in a consolidated situation. This means that certain rules that apply to Qliro Financial Services also apply to the parent company of the group, and the combination is called the consolidated situation. Most significantly, it's the capital requirement rules that apply, and we can say that the consolidated situation is well capitalized and meet all requirements.As before, Qliro Financial Services remained well positioned for further loan book growth, supported by savings accounts, unused credit facility commitments, excess capital and a well-funded parent company who could support -- who could supply more capital when needed.And now back to you, Marcus.

[Marcus Lindqvist, CEO & President]

Thank you, Mathias. Just as a summary, in the fourth quarter we continued our work to build 3 strong independent businesses, and we took several important steps forward in that process. And we were, as you heard from Mathias, able to close the quarter with a strong financial flexibility and balance sheet.So with that we are now ready to answer your questions. Operator, do we have any questions on the line?

[Operator]

[Operator Instructions] We will take the first question from Nick Fharm from SEB.

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

My first question would relate to CDON Marketplace, and it would be very appreciated if you could give us some guidance on sales expectations for 2019 now that you've done a lot of transformational work in that business, please.

[Marcus Lindqvist, CEO & President]

Thank you for the question. Well, as you know, our guidance when it comes to growth is focused on external merchant sales, and that guidance is to achieve at least 20% growth on an annual basis. That's also the current trajectory, and we don't see any reason to change that target. When it comes to our net sales, that is more technically driven as we work that of course against a long-term plan but also with a tactical view on the short term. So it's not really easy for us to speculate on where it will end up. On an overall level, though, we believe it is most likely so that when we have done the transformation that we're working on we'll end up at approximately 30% of total sales that will be owned inventory led. And then on top of that, that will complement and be complemented by dropshipment sales that also counts as net sales. And then the rest will be external sales not included in our net sales. So that's as close as I can guide you on the development.

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

That's very helpful. Can I also ask you, you chose to announce yesterday the redemption of the outstanding debt or some of the outstanding debt that's listed. I was just wondering how that decision may impact in 2019 and 2020 your growth in the lending book at your consumer bank, i.e., what's your reasoning on sort of sales growth in that business compared to financing of that growth, please?

[Mathias Pedersen, Chief Financial Officer]

Nicklas, this is Mathias. We have concluded that we don't need the bond financing to continue to grow the loan book in Qliro Financial Services. We can finance that loan book growth without that.

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

Okay. Any more details you would like to share on financing of QFS, going forward?

[Mathias Pedersen, Chief Financial Officer]

Well, obviously, we can still use more public deposits, and we have a bank credit facility that is not -- that is still -- we can take more on. And then you can also have a discussion on adding other sources of financing to that, but that would have to be a discussion on the board of Qliro Financial Services. But the idea is that the company should be financed by itself, not through the group.

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

Right. And finally, for now at least, it would be very meaningful if you could -- I think I've asked this same question for the past quarters, but anyway, if you could give us some more flavor on how you expect to reach the guidance for QFS on the EBITDA level in this year, please.

[Marcus Lindqvist, CEO & President]

Well, as communicated when we set out our financial target, it is highly dependent on our ability to recruit new merchants, adding then e-commerce volumes which we then can utilize in order to build our loan book, both when it comes to our payment services as well as our consumer loans. So that's the kind of entire engine of both our growth and profitability, going forward. And as we wrote about and talked about here on the call, so you can see a little bit about that in our interim report, we have increased our efforts and we have strengthened the capabilities in the commercial team, and that has actually yielded quite a lot of success for us. So we have signed new merchants that will come live during spring, but we have a policy to communicate as they go live. So you will see more of that coming in the coming weeks and months from the team. So that's the kind of engine of it. And then of course it's always important to keep a tight eye on cost development. And then of course reservations for credit losses, it is important that we don't increase as much as we did this year. But the majority of the impact this year was moving from IAS, but an eye to IFRS 9. So we feel secure in that prediction coming into this year.

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

But the change in accounting is of course included in the guidance, right? So you're not saying that it will be [ 112.5 ] adjusted for change in accounting, no?

[Marcus Lindqvist, CEO & President]

No, what we say is that you have seen quite an increase in reserves for future credit losses over the last year, and we don't see that increase coming into 2019. So the increase in reserves for credit losses will slow down quite a lot versus where we ended up this year. That's what we're saying. So that in combination with adding new volumes, that then will yield more interest income, will take us to our financial targets.

[Operator]

[Operator Instructions]

[Marcus Lindqvist, CEO & President]

Okay. It seems like there is no more calls. Do we have one more?

[Operator]

We have a follow-up question from Nick Fharm from SEB.

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

Just one quick one. On Nelly, it seems like returns and return handling has been sort of quite a bit of an issue in that business over the past year. And you're writing what I interpret as slightly more optimistic about this situation in the results comments. And I was just wondering if you could share some more specifics or some more details on how you actually will go about to try to reduce sort of the return ratios that we're looking at right now in that business, please.

[Marcus Lindqvist, CEO & President]

Well, if we take a look at the return increase at first over the last year, it is driven by a few factors. One is changing behavior of our customers. The other is product mix and also country mix, because we see quite a lot of different return levels in the various products as well as in different countries. We don't see a dramatic mix shift in that sense coming into 2019. So we believe that that itself will stabilize the return increase, and we don't see another step in behavior change from our customers, either. In combination with that today, the return handling process within Nelly is a manual process. So that means for the customer as well as for the team and the company. And beginning of this year now, so coming into the first month of the year, this will be digitalized, and that in itself will help quite a lot when it comes to handling of returns. So you will have a much bigger and greater flexibility as a customer to swap to another product as well as we will also be able to remove returns that are a little bit older than they should be, because we had quite a lot of returns coming in after our return policy says it will be. So that entire product -- project will have a rather high impact on the levels of return during the year. And that project is well underway, and it will roll out in the next coming weeks.

[Operator]

As there are no further questions, I would like to hand the call back over to Marcus Lindqvist for closing remarks.

[Marcus Lindqvist, CEO & President]

Thank you, operator. And thank you all for participating today and for your interest in Qliro Group. Me and Mathias look forward to seeing and speaking to you again soon. And may I also remind you that our first quarter results will be announced on April 17, later this spring.So with that, thank you and goodbye.

[Operator]

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