Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2023-Q2

[Operator]

Welcome to Nelly Group Second Quarter Report 2023. Today, I am pleased to present Acting CEO, Helena Karlinder-Ostlundh and Interim CFO, Ola Wahlström.

After the presentation, there will be a question-and-answer session. [Operator Instructions]. Now I will hand over to Helena Karlinder-Ostlundh. Please go ahead.

[Helena Karlinder-Ostlundh, executive]

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

Let's start with a brief look at what we will cover in today's presentation. The first part will be a short overview of the Nelly business and our customer base. Following that, we will provide an update on the key areas that form the basis of our transformation towards profitability. We will then look at the operational and financial summary for the second quarter before opening up for questions from you.

We have already received some questions in advance, but you can also send us your written questions any time throughout this presentation.

So before we go through the second quarter in more detail, I will briefly introduce the Nelly business and our customer base to you. Nelly was founded in Borås, where the company is still headquartered today, in 2004. And at the time, it was considered a pioneer in online fashion for young women in the Nordics. We continue to be primarily an e-commerce business to this day, albeit with our first flagship store opening in Stockholm later this year. We will come back to this point a little later in the presentation.

Today, we have 1.1 million active customers, and we take enormous pride in helping them look, and more importantly, feel their best every day whether they're off to a party or just going about their daily life. We do this through the 2.1 million orders we fulfill from our warehouse in Borås over the course of a year. We have 1.3 million followers on social media, and we have built a virtual community with 2.3 million enthusiastic Nelly members who love fashion as much as we do.

Now let's move on and take a closer look at the second quarter of 2023. A year ago, we launched a clear plan for how to rebuild Nelly as a profitable business, and we've been laser-focused on implementing this plan since. Pleasingly, we are now starting to see the first encouraging signs pointing in the right direction, and we delivered both a gross margin improvement and a small profit in the second quarter despite lower net revenues.

Strengthening our assortment has been one of the most central elements of our transformation strategy right from the start, and we saw several positive developments in this area during the second quarter. We continued to increase our own brand share, which landed on 41.2%, up from 38.8% in the previous year. And we also improved our position in several everyday categories, most notably pants, which delivered a strong season. Our overall category mix continued to progress towards a better balance between party and everyday fashion, something which also drove a lower return rate in the second quarter.

It is worth noting here that returns decreased both overall and within most categories compared to the previous year.

The strategic decision we made last year to narrow our assortment breadth, both to make it easier for our customers and to increase our focus on hero SKUs and big bets also generated first positive results. We sold significantly larger quantities of our top Nelly products this quarter than we did of the best-selling products in the same quarter last year. This is important as it demonstrates the potential in our assortment once we realize the full effects of our transformation work in this area.

We furthermore continued to optimize our marketing activities during the quarter, still with a firm focus on driving organic traffic and proactively managing our spend on paid traffic. This resulted in significantly lower marketing costs compared to last year, which is a solid result, given that we achieved traffic almost in line with expectations and helped conversion at the same level as last year.

Going forward, we will continue to prioritize customer activation activities that drive conversion and average order value while at the same time building and positioning the Nelly brand.

We continued to see a positive trend in our warehouse and logistics costs in absolute terms during the second quarter. Due to the lower order volumes, these costs constituted a larger percentage of net revenue compared to the same quarter last year. But in absolute terms, 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.

We now feel that we have a strong warehousing and logistics setup in place, which will scale well once our volumes increase again.

Our other operating costs also continued to decrease versus last year, in large part driven by the rightsizing of our office-based team, which we've been working towards for the past year. Going forward, we will further increase our focus on strengthening our core IT architecture, both to continue to remove cost and to drive efficiency.

Achieving a healthy cost base is key to achieving profitability for Nelly, and it has therefore been important to build a more cost-conscious organization over the past year, something which we now feel is in place and will help us drive further cost optimization over time.

A few weeks ago, we announced that we will be opening a Nelly flagship store in Central Stockholm later this year. We will continue to be primarily an e-commerce business going forward as well, but we are excited about all the new opportunities a physical store will now create for us, not only in terms of deepening our relationships with our existing customers, but also in terms of providing an inspiring physical space where we can showcase our products to new customers who may not yet be familiar with Nelly. We are looking forward to sharing more news about the store concept and format closer to opening.

So to summarize the quarter, we have seen clear progress in a number of areas and are pleased that we have today been able to post positive financial results despite the continued net revenue decline. However, as we go into the second half of the year, we are focused on continuing to implement those parts of our transformation plan that are not yet in place. We have a lot more work to do, and we feel encouraged by the improvements we have already achieved, most notably across our assortment and in our cost base.

I will now hand over to Ola Wahlström to take us through the operational and financial summary for the second quarter.

[Ola Wahlstrom, executive]

Thank you for the introduction, Helena. Please let me provide some more details on the Q2 financials.

Net revenue declined by 15% in the second quarter. The main driver was lower sales before returns, driven by a lower average order value and lower B2B sales. This was partly compensated by a lower return rate and higher freight income.

We saw a significant increase of the share of organic traffic while paid traffic was lower, which correlates with the lower spending on performance marketing in the quarter. We experienced a high activity in our markets, and the competition for customers was tough. The return rate decreased by 2.6 percentage points to 38% during the second quarter due to effects from sold product mix as well as improvements within product categories.

Gross margin increased by 1.4 percentage points to 49% in the quarter. The main reasons for the high gross margin were higher sold share of own brands, higher freight income, lower customs and freight costs. The high gross margin, combined with the lower net revenue, resulted in a SEK 20 million gross profit decrease in the second quarter.

Let's take a look at the cost side of the P&L. In total, the fulfillment and distribution costs were SEK 5 million lower than last year, again proving an efficient model despite the low volumes. The distribution costs fell, largely in line with the low volumes shipped in the quarter.

Marketing costs amounted to SEK 29 million in the quarter compared to SEK 43 million previous year. The decrease of SEK 14 million was mainly due to a more efficient marketing spend. In addition, more cost-efficient working methods and a reduction on PR and brand marketing activities also contributed.

Admin and other operating costs were down SEK 28 million compared to last year. The reduction compared with the second quarter of 2022 is mainly explained of lower wage costs where the second quarter 2022 was charged with provisions for former management. Incrementing cost-cutting programs also contributed strongly to the lower costs.

All in all, EBIT in the quarter was SEK 26 million higher compared to quarter 2 last year.

And to summarize, while net revenue was markedly lower than last year, the significantly lower costs in all areas resulted in a positive SEK 8 million EBIT.

Let us now look at a few other aspects of the quarter we disclosed. First steps in our profitability journey starting to pay off. Despite a reduction of orders by 13% in the Nordics, driven mostly by lower traffic, we are pleased to see multiple steps in the right direction in our profitability journey. Firstly, the sold share of own brands increases with 2.4 percentage points, which drives a higher margin.

Secondly, we saw the return rate decreased by 2.6 percentage points, an improvement connected to assortment strategy.

Thirdly, we are pleased to see improvements in our gross margin with 1.4 percentage points, which is, of course, key to our continued profitability.

Lower operating costs. Moving on to the operating costs. Operating costs were down significantly by more than SEK 46 million in the quarter, where roughly SEK 10 million of the improvement is from a nonrecurring cost during 2022 with -- connected to the previous management exchange.

In the second quarter 2023, we see a full annual run rate effect of the cost savings from the cost-reduction program that we announced in August 2022. In February, we announced the additional cost savings will be performed, and we are confident that the full effects will be seen latest Q4 2023.

Coming down to the working capital changes. Cash flow in the second quarter was plus SEK 77 million, which was mainly driven by improvements in the ongoing operations as well as a lower inventory, an improvement against last year from SEK 34 million. In seasonal terms, the second quarter is stronger than the first and we build our cash position ahead of the third quarter.

Cash at the end of the quarter amounted to SEK 150 million, and we did not tap into our credit facilities as per the 30th of June. And Nelly has no interest-bearing debt apart from government tax credits.

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. Let's get started with the first question. If the flagship store in Stockholm is successful, is the plan to open more stores and work more towards omnichannels?

[Helena Karlinder-Ostlundh, executive]

So at the moment, we are fully focused on getting our Stockholm store set up and ready for opening during the fall. We're really, really excited about the many opportunities that this physical store will offer us in terms of getting to know our customers in a new setting and also, of course, showcasing our fantastic products and potentially even to a new audience. So what happens beyond that? Time will tell.

[Unknown Executive]

Thank you, Helena. We are moving on with the next questions. Are there plans to develop the review system for the products to encourage customers to leave feedback, for example, about the size fit to reduce the returns.

[Helena Karlinder-Ostlundh, executive]

So we completely agree, of course, that reviews are a great way for customers to share their feedback on our products and especially in a way that also benefits other customers. So we see the potential in encouraging reviews to help our customers find the right product and size for them, which, of course, prevents unnecessary returns. Proactively managing our return rate is a prioritized area for us where work is ongoing and will continue for the coming quarters as well.

[Unknown Executive]

Thank you. The next question is for you, Ola. The questioner asked, could you provide a breakdown of the Q2 gross margin bridge year-on-year, USD impact, markdowns contribution from increased share of sales from private labels, et cetera.

[Ola Wahlstrom, executive]

Yes, of course. So we're very happy to see an increased gross margin and -- where we have a mix of the following effects. We have a positive impact from the increased share of sales of the Nelly-owned brands. Additionally, we have an overall positive impact from lower freight costs and customs in Norway. And lastly, we have a negative FX effect from the weak Swedish crown, and that is then mainly composed by the Norwegian crown on the sales side, but also the U.S. dollar connected to procurement.

[Unknown Executive]

Thank you, Ola. How would you review the strategic review of your operations so far after implementation? Are you on par with your own expectations in terms of sales development as well as in terms of gross margin developments. If not, what are the main drivers behind outperforming or underperforming versus your initial internal expectations, please.

[Helena Karlinder-Ostlundh, executive]

So we are, of course, very pleased with the positive results we achieved in this quarter and also the operational improvements that we have already delivered. But of course, we're not entirely satisfied with our net revenues just yet. However, as we have communicated as well, we are not yet done with that transformation of the business. So we continue to focus on implementing the remaining parts of our plan over the coming quarters.

[Unknown Executive]

Thank you. We would like to thank for all the questions, and we will wrap up this Q&A session with a final question.

When will NLYman go live with the updated website?

[Helena Karlinder-Ostlundh, executive]

Yes. So our new NLYman website is actually live already in Finland as of last week. And we're, of course, keen to launch as soon as possible in the other markets as well assuming that the site performs in line with expectations, of course. So we will evaluate the best time line for full rollout after the summer break.

Thank you very much for listening today. This concludes our results call, and we'll see you again next quarter. Thank you.

[Ola Wahlstrom, executive]

Thank you.

[Unknown Executive]

Thank you.