Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2023-Q1

[Operator]

Welcome to Nelly Group First Quarter Report 2023. Today, I am pleased to present Acting CEO, Helena Karlinder-Ostlundh; and Interim CFO, Ola Wahlström. [Operator Instructions]

Now I will hand over to Helena Karlinder-Ostlundh. Please go ahead.

[Helena Karlinder-Ostlundh, executive]

Thank you, and welcome to the quarter 1 2023 call for Nelly Group. My name is Helena Karlinder-Ostlundh, and I'm hosting this call, together with Ola Wahlström, Interim CFO for the Nelly Group.

I would like to start by briefly outlining what we will cover in today's presentation. The first part will be a short overview of Nelly and our customer base. Following that, we will explain the key activities that continue to form the basis of our transformation towards profitability. We will then look at the operational and financial updates for the quarter, before opening up for questions from you. We have received some questions already, but you can also continue to send us your written questions during this presentation.

So before we dive into the quarter, let me briefly introduce our business and our customer base to you. Nelly was founded in Borås, where the company is still headquartered today, in 2004. At the time, it pioneered online fashion for young women in the Nordics and still, to this day, our business operates online only.

We have 1.3 million followers on social media. And via our website, we have built a virtual community, with 2.4 million members who love fashion as much as we do. We help our 1.1 million active customers look and, more importantly, feel their best, whether they're off to a party or just going about their everyday life. And we do this through the 2.2 million orders they placed with us over the course of the year.

Now let's move on and look at the first quarter of 2023. We launched a clear plan for how to rebuild Nelly as a profitable business halfway through last year, and we continued implementing this plan during quarter 1 of this year. Driving significant and fundamental change takes time. And therefore, one important step for us on this journey was the rights issue we announced in February. This process has now been concluded and we were pleased to see that our rights issue was oversubscribed through both existing and new shareholders.

With the proceeds of approximately SEK 53 million before issue costs, we have reinforced our financial position while we continue to transform our business step by step. Strengthening our assortment has been one of the most central elements of our transformation strategy right from the start. We have taken significant steps towards rationalizing our assortment breadth and buying deeper on our [ hero ] SKUs and big bets. This is a key enabler of profitability and will continue to shape our assortment over the coming seasons.

During the first quarter of this year, our own brand share increased, and we strengthened our position in more categories, pants being one example. We have also continued to evolve our external brand portfolio to ensure we complement our own brand offering with the very best IT brands that are profitable for us and important to our customer.

During the first quarter of this year, we continued to optimize our marketing activities and we saw a significant decrease in marketing costs compared to last year. Our organic share of total traffic increased and we also improved the efficiency of our paid marketing, including through a greater focus on social channels.

In the first quarter, we did, however, see a net revenue decline and lower conversion compared to the same quarter last year, which was undoubtedly driven, at least partly, by the even tougher market conditions we faced during this period. In this climate, our customer is price sensitive and considers each purchase carefully. So a truly attractive product range, combined with relevant and directly sales-driving marketing activities, will be key to lifting conversion going forward.

We continue to see a positive development in our warehouse and logistics costs during quarter 1 of this year in absolute terms. Due to the lower order volumes, these costs constituted a larger percentage of net revenue compared to the same quarter last year. But our variable handling and distribution costs decreased, our freight income continued to increase and we were able to mitigate some of our fixed costs through various initiatives, including third-party warehousing services.

During the first quarter, we also saw a further improvement in our other operating costs, which was driven in large part by the further rightsizing of our office-based team, which we delivered both in the second half of last year and during the beginning of this year. We will continue to see the effects of this during the coming quarters as we fully reach our target organization structure.

Lowering our ongoing cost base is key to achieving profitability for Nelly, and while we have already taken important steps in this direction, there is more to do during the remainder of this year. We will continue the work we initiated last year to overhaul our core IT architecture to both remove costs and drive efficiency, and we will also put a renewed spotlight on lowering our return rates given the significant cost and environmental impact this represents in our business.

So in summary, we did see a clear net revenue decline in the tough market in quarter 1 of 2023, but we are confident in the plan we launched last year for rebuilding Nelly as a profitable business. and we continue to implement this plan step by step. We continue to optimize our assortment, and we have already made progress in lowering our cost base across all areas of the business.

I will now hand over to Ola Wahlström to take us through the operational and financial updates.

[Ola Wahlstrom, executive]

Thank you for the introduction, Helena. Please let me provide some more details on the quarter 1 financials. Net revenue declined by 18.7% in the first quarter. The main driver was lower sales before returns, and that in turn was driven by a decline in conversion rates. Also, we had lower B2B sales and increased return levels, which was partly compensated by higher freight income. We saw a continued increase in organic traffic, while paid traffic was lower, which correlates with a lower spending on performance marketing in the quarter.

We experienced a high campaign activity in our markets, and the competition for customers was tough together with a late seasonal shift. The return rate increased by 2.6 percentage points to 37.8% during the first quarter due to reduced B2B sales, which, in turn, has no returns at all. And of course, then the product and market mix effects.

Looking at the gross margin. The gross margin decreased by 3.4 percentage points to 40.9% in the quarter 1 of 2023. The main reasons for the low gross margin were lower margins due to currency effects and higher campaign activity. The higher freight income partially offset this effect. The lower gross margin, combined with the lower net revenue, resulted in a SEK 32 million gross profit decrease in the quarter.

Let's take a look at the cost side of the P&L. In total, the fulfillment and distribution costs were SEK 6 million lower than last year, where we are happy to see a high efficiency despite the lower volumes. The distribution costs fell, largely in line with the lower volumes shipped in the quarter. Marketing costs amounted to SEK 24 million in the quarter compared to SEK 36 million a year ago. The main reason for the decline in cost was a more efficient marketing spend. In addition, more cost-efficient ways of working as well as a reduction on PR and brand marketing activities also contributed.

Admin and other operating costs were down SEK 3 million compared to last year. The decrease in costs was mainly driven by a healthier payroll level. All in all, EBIT in the quarter was SEK 10 million lower compared to quarter 1 last year. And to summarize, while operating costs were markedly lower than last year, the SEK 32 million lower gross profit implied a negative SEK 34 million EBIT.

Now let us look at a few other aspects of the quarter we just closed. The first quarter is always a tough quarter for fashion, but a positive highlight is that the organic traffic to Nelly's sites increased for the fourth consecutive quarter. The lower spend on brand and performance marketing compared to last year has led to lower volumes of paid traffic to our sites. In the Nordic, the traffic declined by 3%.

Despite recession levels, we saw a decrease in conversion rate, with 0.3 percentage points year-over-year. The slightly lower traffic, combined with a lower conversion rate, implied that the number of orders fell by 16% in the Nordics.

Lower operating costs. So moving on to the operating costs, that were down by more than SEK 22 million in the quarter, it is again evident that the cost base for Nelly has come down. In the first quarter of 2023, we had already realized cost savings equal to the lower communicated run rate range of SEK 40 million to SEK 50 million from the cost reduction program that we announced in August 2022. And we expect that the full annual rate to be realized by quarter 2 of 2023. In February, we announced the additional cost savings that will be performed, and we are confident that the full effect will be seen in Q4 of 2023.

Moving on to working capital changes. The cash flow in quarter 1 was minus SEK 61 million, which was affected by negative working capital changes of SEK 28 million. But altogether, this is an improvement against last year from minus SEK 147 million. In seasonal terms, the first quarter has lower sales than the other quarters, and it involves building inventory ahead of the second quarter, in which sales are seasonally strong. After having moved through the seasonal cash flow point of the first quarter, we expect to build up cash through the course of Q2. Cash at the end of the quarter amounted to SEK 36 million and we used SEK 12 million of our short-term credit lines.

And finally, as communicated during the quarter, Nelly initiated a fully guaranteed rights issue, which, after the period end, we could happily communicate was oversubscribed and significantly improves our financial position.

So having been through the financials, I'd like to hand back over to Helena.

[Helena Karlinder-Ostlundh, executive]

Thank you very much, Ola. This concludes our presentation for today's call, and we will now open up for questions.

[Unknown Executive]

Thank you, Helena. Thank you for your submitted questions. We have received questions in advance and during the presentation. We will not be able to answer all questions in this call, but we'll try to cover your areas of interest.

Let us start with our first question. What is your conclusion so far of the impact from the strategic decision to change your assortment going into this year given deterioration, order conversions and a contraction in gross margin from concurrent markdowns?

[Helena Karlinder-Ostlundh, executive]

Well, it's a valid question. But I would like to be clear to start with that we do continue to have full confidence in our assortment strategy, which we are, to be fair, in the middle of implementing. We do also see some positive green shoots from the changes we've made in our assortment and marketing already. But they are, at this point, at a level that I would say is not as easy to see at this aggregate level of reporting.

However, it's also important to remember that truly fundamental change takes time, and we will continue to see the effects of our new assortment strategy over the coming quarters. So we continue to implement our transformation plan step-by-step.

[Unknown Executive]

Thank you. Moving on to the next question. Can you walk us through the Q1 gross margin bridge, please?

[Ola Wahlstrom, executive]

Yes. Thank you, [ Ana ]. So firstly, we have had an impact of the FX effect foremost in the U.S. dollar. Secondly, we have had an impact from campaign activity, primarily in the beginning of the quarter. So firstly, FX. Secondly, campaign activity.

[Unknown Executive]

Thank you, Ola. Third question, what is your take on site traffic being down 17% year-on-year, while orders are being down 34% year-on-year?

[Ola Wahlstrom, executive]

Yes. So conversion has been a challenge for the quarter. It has been a challenge in the market to buy profitable traffic for us.

[Unknown Executive]

Thank you. Next question, can you give us an update on the inventory composition leaving Q1, please?

[Ola Wahlstrom, executive]

Yes, of course. So we are satisfied with the composition of the stock based on good levels from the spring and summer season going forward, as well as have had focus on higher sell-through rates on previous seasons during the quarter.

[Unknown Executive]

Thank you. We're closing up with our last question. Are there any nonrecurring items burdening reported Q1 losses before interest and taxes of SEK 34 million?

[Ola Wahlstrom, executive]

Yes. So of course, we have had our cost programs related to these, with our one-off costs connected to the Q1. And these are linked, of course, then to the restructuring and the core message of change, as well as the change of CEO. And these are in the mid-single digits range.

[Helena Karlinder-Ostlundh, executive]

Okay. Thank you, Ola and [ Ana ]. Those were all the questions we received. So thank you very much for today, and we'll see you again next quarter.

[Ola Wahlstrom, executive]

Thank you.