Nelly Group AB (publ)

STO:NELLY

Earnings Call Transcript 2022-Q3

[Operator]

Welcome to Nelly Group Q3 Report 2022. Today, I am pleased to present CEO, Ludvig Anderberg; and CFO, John Afzelius. [Operator Instructions]

Now I will hand the conference over to Ludvig Anderberg. Please go ahead.

[Ludvig Anderberg, executive]

Good morning, ladies and gentlemen, and welcome to this presentation of our Q3 report for Nelly Group. My name is Ludvig Anderberg, and I am since 2 months back, the CEO of Nelly. I'm here with John Afzelius, our CFO, and we will present to you the Q3 report and financials for Nelly Group.

First of all, I would like to say that I'm really, really happy to be back at Nelly. For those of you who don't know me, I worked at Nelly Group between 2015 and 2018 in various positions. I started up as CFO. And I also had held the position of as acting CEO for a period of time.

Even though a lot of things has happened on the e-commerce market, I do recognize a lot of the questions and issues that we're dealing with at the moment within Nelly.

John and I will today present the presentation of Nelly for those of you who are new to our company. We'll give you a quarterly update of what's been happening during the quarter. We'll give you a financial update and talk about our sustainability work. And in the end, we will also open up for questions for those who have registered to do so. So if you want to ask a question, please register well ahead of the Q&A session.

I am standing here in the beautiful city of Boras, which is also considered to be the e-commerce capital in Sweden. Nelly started here in 2004, and we have always been a provider of trendy fashion for young women, mainly focusing on the Nordic countries. We provide a great mix of Nelly branded products together with the best external brands. We are an online pure player, and we have pioneered in digital marketing and social media.

Our member base on our site is some 2.3 million, and we have 1.1 million active customers who yearly place approximately 2.4 million orders with us every year. And together with our 1.3 million followers on social media, we play a major role in providing our customers with daily fashion inspiration.

As previously communicated, we're working with a number of actions during the quarter. We have a strong profitability focus in everything we do with Nelly at the moment. And our top priority is to increase our assortment efficiency. We are working with creating a clear assortment and an improved customer journey and customer experience through a tighter and more condensed assortment.

We will also improve the structure of our assortment, focusing our Nelly brand towards products where we see a high volume and profit driving possibilities. And we will also use Nelly brand to -- with an extension of high-fashion products to drive brand and awareness. External brands will be invested in selectively where we see an opportunity to drive demand and profitability.

During the quarter, we have worked a lot with marketing optimization, and we will continue to do so in the time to come. We will focus our market activities on micro influencers activities rather than larger influencers collabs and events. Marketing would also be focused on directly sales driving activities, where we will also integrate our brand marketing in all our channels rather than driving specific brand activities.

Since investing and implementing our new and automated warehouse last fall, we have been focusing on realizing our targeted cost savings. We will continue to do so, and we are on plan with this, and we will reach our targeted cost savings during 2023. We will also look at improving our freight to income cost ratio on the logistics side.

During the quarter, we have launched our updated nelly.com site, a modern and API-based front-end solution that will improve performance and maintenance. We will also move forward with evaluating our IT structure to remove cost and drive efficiency.

As communicated during the summer, we have implemented a smaller and more direct organization, and it has been launched during the quarter with good results. And we have also appointed new business -- key business leaders to drive our transformation.

A little bit about the performance of Nelly during the quarter. During the quarter, we saw a weak online market in our segment, and we saw a 9% reduction in our net revenue. And -- but despite this decline in revenue, we have already now seen efficiency improvement [Technical Difficulty] costs. And our previously communicated cost savings program is progressing well and running according to plan.

I will now hand over to John to give you the details of the financial results for the quarter.

[John Afzelius-Jenevall, executive]

Thank you very much, Ludvig. Please let me provide some more details then on the Q3 financials. So if we start on Slide 7. Net revenue declined, as Ludvig said, by 9% in the third quarter. And while we saw a continued increase in organic traffic, paid traffic was lower. And as I will return to, we spent significantly less on performance marketing in the quarter and paid sessions were consequently down compared to last year.

So with the largely flat conversion rates, orders were down in line with sessions, but sales then fell less than orders as the average order value increased. And during the quarter, campaign activity was high in our markets, as Ludvig alluded to, and customer acquisition competition continued to be tough.

The return rate fell by 0.8 percentage point to 36.2% during the third quarter, mainly due to mix effects and our [Technical Difficulty]. As you may be aware of, mix, there is a large difference between return rates in different categories -- significant difference actually.

And we can see that LTM, last 12 months rolling return rates stabilized in Q3 at levels lower to those recorded prior to the pandemic. And as you're probably aware, we saw significant changes in the return rates during the pandemic.

So if I then turn our focus on gross margin. Gross margins decreased by 4.3 percentage points to 41.5% in Q3. And the main reasons for the lower gross margins were initially or firstly, lower margins due to higher level of campaign activity. As I mentioned, both internally as we activated our inventory more aggressively, but also in the market in general, we've seen a rather intense campaign -- pressure on our campaign activity. And secondly, also, we saw a lowest share of owned brands in the quarter. This also contributed negatively to the gross margin.

On the positive side, just as we saw in Q2, not enough though to counterbalance the negatives that I just mentioned, was the higher freight fees from customers that we received during the quarter. And this comes up as we have adjusted our freight terms previously during the year. So we see a better cost coverage there.

The low gross margin compared -- combined with a lower net revenue resulted in a SEK 25 million gross profit decrease in the quarter.

So let's take a look at the cost side of the P&L. And to be -- just to be clear, the pink bubbles are the delta compared to last year in absolute terms. And the gray bubbles illustrate the warehouse project, the cost that incurred last quarter. So to be perfectly clear, we have no warehouse project costs in this quarter, obviously, because that project was closed last year, but I wanted to include those for comparison as I will refer to those numbers several times during this presentation.

So firstly, fulfillment and distribution costs were SEK 22 million lower than last year, mainly then, of course, as we ran one warehouse instead of 2 warehouses as we operated last year in Q3, incurring project-related costs of SEK 12 million than in 2021.

And the first component, the fulfillment cost, they fell markedly mainly due to this. And while we didn't see the record low warehousing costs in Q3 as we did in the second quarter, the processes of the new automation solutions are running smoothly and the work to realize the targeted cost savings during the year is going according to plan.

The other part of this P&L line item, the distribution costs, they fell largely in line with the lower volume shift in the quarter.

Then moving on to marketing costs. They amounted to SEK 28 million in the quarter compared to SEK 41 million a year ago. And the main reason for the significantly lower marketing spend was that the lower volumes of paid traffic that was driven to our sites -- the Nelly sites.

In addition to this, more cost-efficient working methods within marketing and that we held back on PR and brand marketing activities also contributed positively to this development. And we were happy to see a lower marketing spend -- performance marketing spend per paid session in the year in spite of the increased competition that I mentioned and in spite that we see a more tight market in that domain.

And finally, admin and other operating costs, they amounted to SEK 58 million compared to SEK 64 million last year. So we decreased the cost by SEK 6 million, mainly due to lower payroll costs. But again, please note that the warehouse project-related costs in Q3 last year was SEK 6 million. So all in all, EBIT in the quarter was SEK 15 million higher than Q3 last year, a quarter that in turn totaled SEK 22 million of warehouse project-related costs.

So to summarize, while operating costs were markedly lower this year compared to last year, also considering the warehouse related costs that were recorded in 2021. The SEK 25 million lower gross profit implied a negative SEK 12 million EBIT in the quarter.

So moving on to Slide 8. Let's take a look at a few other aspects on the quarter that we just closed. A positive highlight, just like we saw in Q2, is that the organic traffic to Nelly site increased also in the third quarter. And as we have detailed in the past, this is the kind of traffic that you really want to have. It is because of the higher conversion and because of the -- that you don't need marketing to drive that traffic, at least not initially.

And as I mentioned on the last slide, we did, however, spend less on performance marketing, significantly less, which led to lower volumes of paid traffic to our sites and in the Nordic, traffic declined by about 13%. So the lower traffic combined with a slightly lower conversion rate implied that the number of orders fell by 16% in the Nordics.

Another highlight is the continued increase in AOV, average order value, that increased 8% in the quarter. And the AOV is the product of the average number of items per parcel and the average value of these items. And we have seen a positive AOV trends since early 2021, which has been driven both by more items in each order, but also a higher average item value.

As I mentioned in Q3, the AOV continued to increase, but a slightly different underlying pattern because the high campaign activity that we saw and that we drove, drove more items per parcel, which was more than compensating for the AOV drag that was caused by the campaign-driven lower average item value in the quarter.

So moving on to the cost side. I'd like to comment on cost because operating costs were down by more than SEK 40 million year-on-year in the quarter. So even considering the SEK 18 million whereas project-related costs on the operating cost side that we saw last year and the lower volumes, it's evident that the cost base for Nelly has come down.

During the quarter, we executed on the notice. That is the main driver of the SEK 40 million to SEK 50 million cost reduction program that we announced in August. And while we have started to see costs come down as a consequence of this initiative, we expect full annual run rate of this program to be realized by Q2 next year, 2023.

Finally, commenting on the balance sheet, the cash flow and working capital changes. And much like the first quarter, the third quarter is burdened by the building up of inventory ahead of the next quarter, in this case Q4, in which sales are seasonally strong. And we saw a working capital buildup of SEK 57 million in the quarter, mainly due to higher inventory.

Net cash flow amounted to a negative SEK 43 million, similar to last year's SEK 45 million. But in Q3, unlike last year, we drew SEK 30 million on our short-term credit line. And after now having been through the seasonal cash flow, low point of the second half of the year, we expect to build cash through the course of Q4 as we seasonally typically do.

Cash at the end of the quarter amounted to SEK 41 million, and we drew SEK 30 million on the short-term credit lines. And finally, it's worth noting that Nelly has no interest-bearing debt apart from the government tax credits.

So having been through the financials, I'd like to hand back to Ludvig to comment on the progress of our sustainability work.

[Ludvig Anderberg, executive]

Thank you. Well, sustainability is an important and integral part of the work that we do at Nelly. We are working with a number of different aspects in our sustainability work internally.

First of all, we are increasing the use of user-generated content on our site and in social media to celebrate our customers show styles in a more diverse way and on any more natural situations.

We are, at the moment, participating in a project that are developing a tool for supporting and gathering analysis and insights on climate data and CO2 footprint. Our -- we have accelerated our work for a fair industry through our supply chain by joining the International Accord for Health and Safety in the Textile and Garment Industry.

And with that, we will open up for questions for those of you who have registered to do so.

[Operator]

[Operator Instructions] The next question comes from Nicklas Fharm from SEB Equities.

[Nicklas Fhärm, analyst]

My first question would be, if we could just discuss the balance sheet and the cash flow development in the quarter, and in particular, the negative change in working cap. And I guess we've already seen the numbers, which obviously adds up.

But my question would be, is there anything else -- is there like any timing issues with goods being booked on the balance sheet or anything else other than regular trading in the period, which explains the working cap build up to the end of this Q3 period?

[John Afzelius-Jenevall, executive]

Well, thank you, Nicklas. I'll take the liberty to answer that question. I think the short answer is no. I mean, the -- we entered Q3 with a higher inventory than we did the year before. It was about 18 -- 19% higher than Q2 -- outgoing stock Q2 in 2021. So going into this period of lower sales we saw higher in our stocks. So it's mainly inventory buildup. What we have done during the quarter, though, is that we're growing the inventory slightly less than going out of the quarter than we did going into the quarter.

So considering also that the market has been weak, we have pulled the break on inventories. But still, it takes a while before that break kicks in. So we did see that inventory buildup in Q3. But a lot of the effect of the pulling the brake on that is -- will be -- we expect to be more visible in Q4.

So I -- so the short answer is no, no special effects really. It's more a timing issue because it's -- I think it's pretty apparent that we had planned for higher sales than we saw this quarter. And I think we're not alone in the market to have done so. So that's a comment on the quarter and a teaser for the next in a way.

[Nicklas Fhärm, analyst]

Also, looking at the actual operating performance in the period, how do you -- how would you like to -- I would like for us to look at the fact that you have a 440 basis point decrease in gross margins at the same time as local currency sales are down 12% from the context of typically when you do markdown activities or campaign management, you would expect to have a slightly better, I would assume, effect on sales. Are you happy with the campaign work and markdown management in this period? Or is this merely a reflection of the market situation?

[John Afzelius-Jenevall, executive]

I think I can say both. I mean we have been -- it's really a balancing act when it comes to in the short term to balance profitability, which is, of course, the longer-term goal, not the long term, we're always working to the main priority for us is profitability. But in a situation where we see slower sales and going in with higher incoming stock, we need to be more aggressive on campaign activity. So -- and that has that in a market which is -- which has seen a lot of campaign activity also from other players that then you see a big toll taken on the gross margin.

And that's also another effect when we are more aggressive on the campaign with the campaign levers, it also has an effect on the own brand shares typically which also burdens the gross margins. So in this quarter, it's really us being proactive and aggressive when it comes to campaign activity, coupled with a weak market I don't know if that -- if you want to add Ludvig or if that makes sense to you Nicklas.

[Ludvig Anderberg, executive]

I think you described it meaningfully.

[Nicklas Fhärm, analyst]

All right. There's a little bit of a lag between the visual and the conference call. So I'm sorry if I interrupted you, Ludvig.

[Ludvig Anderberg, executive]

Not at all.

[John Afzelius-Jenevall, executive]

No, no, not at all. Not at all.

[Nicklas Fhärm, analyst]

All right. So if this is merely a market reflection, I mean the reality is quite harsh, right? How do you explain the decrease in private label sales, negative 12 percentage points year-on-year to 34% of sales. Are you happy with your assortment under those conditions?

[Ludvig Anderberg, executive]

Well, we are, as we have said, I mean, we are in the middle of our large transition of our assortment. We are not, I mean, satisfied with the mix of the assortment that we're having at the moment. But I also think that in a situation, in a market situation where we have chosen to also decrease on our marketing activities. And also, as I said, we are changing a lot of how we are working with our internal brands. As we go through this transition phase, we will -- we are not, of course, happy with the situation, but maybe not, I would say, not surprised with the development that we see at the moment.

[John Afzelius-Jenevall, executive]

And I can also add just a few. In general, that's absolutely true. And in the third quarter, especially, we can also highlight that. We -- the -- we have seen a shift back, if you may, or away from some of the occasion where that the -- our own brands are strong in. And also last year, we had a big impact with the campaign. You may remember the Bianca Ingrosso campaign that we did in Q3 of last year, which was entirely our own brands, which had a large impact on sales, so that also adds to the lower share of own brands in the quarter. So in addition to what Ludvig said, I think those 2 factors should be taken into account as well.

[Nicklas Fhärm, analyst]

Okay. It makes, obviously, a lot of sense. And importantly, if I understand you correctly, you're quite happy with your own assortment, but obviously from a substantial cut to marketing. And as you also pointed to other impacts, we see the change in private label sales as reported. Is that correct? It's not the assortment as such, you would say?

[John Afzelius-Jenevall, executive]

I think that's a correct summary.

[Ludvig Anderberg, executive]

As we have said, I mean, we are working towards a narrower and more clear assortment. That also means that we will work a lot more with depth in our assortment than we have done previously. And of course, this is a shift for Nelly, and it's a shift for our customers to get to know. But we are very convinced that this will, in the long run, provide us with a much better situation and a much -- well, a better customer offer that also has the possibility of driving profitability in a better way than we have seen in the past.

[Nicklas Fhärm, analyst]

Right. My last question, and then I'll be quiet for now and then maybe I can come back into the call later on, but that would be -- so if private label sales are down 12 percentage points year-on-year, why aren't return rates down at least nearly at the same level, but only 0.8 percentage points, assuming that return rates on private label sales are higher than brand sales?

[John Afzelius-Jenevall, executive]

Well, the direction is correct. I mean we lower own brand sales imply lower return rates as we have seen in the quarter. So what you're implying is that you had expected a larger effect on that. Well, what we have seen in the past that we -- during the COVID years, we saw -- if I just back up the tape a bit. Going into the pandemic, we saw higher than return rates than we're seeing now. Then, of course, going into the pandemic, we saw drastically lower return rates, both from a mix perspective, but also from a customer behavior perspective, in addition to us also pulling the brakes and shutting down customers.

After that period and that shock, if you may, we've seen as we saw in H1, we saw an underlying increase in return rates, mainly due to a normalization of behavior. So I think if you see a lower effect than you had expected, that's, I mean, the combination of a lower own brand sales, combined with, I mean, a normalization, if you may, in return rates. But it's also important to see that we are still lower than we were prior to the pandemic -- does that make sense? It either doesn't make sense, or you fell out.

[Operator]

[Operator Instructions] The next question comes from Nicklas Fharm from SEB Equities.

[Nicklas Fhärm, analyst]

Just a few follow-up questions then. So could you just elaborate a little bit on the gross margin bridge in Q3, please? Discussing the FX impact, markdown impact, any other stuff that you want to say is more or less important to explain the total deviation, please?

[John Afzelius-Jenevall, executive]

Yes, I'll walk you through that. It sounds like a John question. The main and the dominant factor in the quarter was the markdown activity and the campaign activity. The B2C, what we call customer margin was down markedly as a consequence of that, of this activity, us being more aggressive in a weak market. That was the main impact. The second impact was the own brand share as our own brands have a significantly higher purchasing ingoing margin and purchasing margin. So that was the second factor.

On the FX side that you mentioned. And lastly, I'd like to mention also the positive effect of the freight net, i.e., that the conditions to the customers, we've always taken out freight fees and return fees, we've actually increased these during the year. And this gives a positive effect on the cost side. So we have got a better cost coverage, which goes into the gross margin. It also, of course, has an effect on sales, but our -- I mean we're driving towards profitability and then this is a natural stand.

And then to comment on the FX side. We are short U.S. dollars. So obviously, that hurts, but we're also very long Norwegian kroners, which we've had a strong year-on-year development in. So the net effect is a negative, but it's not that -- it doesn't pop up as one of the major gross margin impact, thanks to the strong Norwegian kroners. And I think those were the -- did you mention another one? Or did I cover the ones that you asked for? I think those are the main ones.

[Nicklas Fhärm, analyst]

Absolutely. Thanks, John. Now turning to the cost side. I think if you take out the SEK 22 million reported as non-recurring items last year in Q3. The underlying development suggests a decline of 3%, which is quite good on cost management. And I was just wondering if you could give us any thoughts on have you -- are there any savings included in Q3 adjusted SG&A costs this year already? Or has that yet to come through in Q4 onwards towards Q2 next year?

[John Afzelius-Jenevall, executive]

We are -- as I mentioned on the call, we're starting to see the effect of that, and that's typically because we've -- when in practice doing this kind of cost reduction program, especially on the employee side, it's not as digital as every -- all the effects come on one date.

So in practice, you will see a sliding effect of that. So there is some of that. I don't want to put a number on it, but we have seen somewhat lower admin and other operating costs already. So we will see a gradual decline until we see the full run rate by Q2 2023.

And I can say that we expect to see -- I mean the most clear effect come -- is expected to come in the last month in December of 2023 since we initiated this in all, its typically a few months lag until we see the effect.

[Nicklas Fhärm, analyst]

Final question. Have you already started and have we witnessed some effects of your sort of changes to assortments that you're planning for the future to change the customer proposition. Have we seen anything of that work in this quarter that you just reported?

[John Afzelius-Jenevall, executive]

If you want to comment on that?

[Ludvig Anderberg, executive]

No, I would say no, actually, in not in any significantly. So these are changes that are planned for and going into spring season of '23. Of course, we are doing what we can do in the short term with our assortment management, but the larger effects will be seen during the -- starting of the '23 season.

[Operator]

There are no more questions at this time. So I hand the conference back to the speakers for any closing comments.

[Nicklas Fhärm, analyst]

Thank you, and thank you for listening in on our conference call this morning. I will end by saying that the -- what we are on our way of creating is a much more stable and profitable Nelly going forward.

With the investments that we have made in our logistical solution that was implemented last year, together with the cost saving program that was communicated earliest this year, we have created a structure of the company that is set up for profitability.

This, together with the changes that we are doing in our assortment that will create a much clearer customer offer and customer structure with the possibility of raising gross margin going forward will be the basis for a profitable and then also growing Nelly in the future.

Well, once again, I would just like to say that I'm really happy to be back at Nelly and to meet all the amazing people that work in this company. And with their dedication that we see every day, we will make this a very fun journey going forward. Thank you very much for listening.

[John Afzelius-Jenevall, executive]

Thank you.