Nelly Group AB (publ)

STO:NELLY

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Welcome to Nelly Group's Third Quarter Report 2023. Today, I am pleased to present 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 2023 third 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 begin with a brief overview of what we will cover in today's presentation. We'll start with a short introduction to the Nelly business and our customer base. This will be followed by an update on the key areas that together form the basis of our transformation journey towards profitability. We will then go through the operational and financial summary for the third quarter, before opening up for questions from you. We have once again received some questions in advance, but you can also send us your questions in writing throughout today's presentation. So let's begin.

Before we go through the third quarter in more detail, let me briefly introduce you to the Nelly business. 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 now open on Drottninggatan in Stockholm.

We currently have 1 million active customers, and we take enormous pride in helping them look, and more importantly, feel their best every day, whether they are out to a party or just going about their daily life. We do this through the 2 million orders we fulfill from our warehouse in Borås over the course of the year. We have built a virtual community of 2.4 million amazing Nelly members who love fashion as much as we do, and we have a social media following of 1.2 million across our platforms.

Now let's look at the third quarter of 2023 in more detail. Pleasingly, we delivered both a gross margin improvement and a profit in the third quarter despite lower net revenues. Since we started our transformation journey last year, we have been clear that the strength of our assortment is key to our ability to achieve profitability. During the third quarter, we continued to optimize our assortment breadth as well as the depth to which we buy our top-selling products in particular. Our Autumn/Winter collection had a strong start, and we further solidified our position in everyday categories such as pants and jackets, which creates a better balance with our traditionally strong offering in party fashion.

Through this continued work to refine our assortment, we delivered several important improvements in the quarter. The full price share of our total sales increased. We achieved higher volumes than previously on our top-selling products, and our Nelly brands performed well. Additionally, we lowered our return rates, both overall and within several core categories. We have further potential to realize in the strength of our assortment going forward. But these are encouraging signs that our customer is responding well to the changes we have made so far and is willing to prioritize attractive and relevant products even in this prudent economic climate.

We also continue to further refine our marketing activities in the third quarter. As in previous quarters, we focused on driving organic traffic and we successfully increased our organic share of the total traffic to our sites. In parallel, we realized further efficiencies in our marketing spend to generate paid traffic. During the quarter, we also celebrated several successful product drops and capsule collection launches, and we will continue to develop this type of customer activation activity as another way to secure organic traffic and build the Nelly brand.

While we saw several positive developments in our marketing efficiency during the third quarter, it is also clear, however, that we will need to intensify our focus on driving total traffic as well as conversion going forward. In addition to building a truly attractive customer offering, having the right systems architecture is equally central to our success as an e-commerce business. We started preparing for a comprehensive overhaul of our technology enablement earlier in the year, and we really accelerated this work during the third quarter. This overhaul will be realized through several phases of change, and the initial focus is on those parts of our systems landscape that enable a better customer experience and simplified internal processes.

I'm also very pleased that we now have a new permanent Chief Technology Officer on board to lead and progress this work at pace going forward. As in previous quarters this year, we continue to reap the benefits of all the cost reduction measures we've taken so far since our transformation journey began. Our fulfillment and distribution costs improved further, and we also carried lower salary costs given that the business is now run by a significantly smaller organization than before. Disciplined cost control is essential for any retailer, and we are determined to maintain our focus on this going forward.

As I just mentioned, we welcomed a new Chief Technology Officer to Nelly in September. And we were also able to share further permanent additions to the management team during the third quarter. Our new permanent Chief Finance Officer will join the business in the first quarter of 2024, and we also announced that I was appointed permanently into the role of CEO for Nelly Group. I am deeply grateful for the trust placed in me to continue to lead our transformation work, and I'm very much looking forward to taking the next steps on this journey together with our amazing customers and, of course, our truly incredible Nelly team.

Before I hand over to Ola to take us through the operational and financial summary for the third quarter, we thought it worth sharing a few comments about Nelly's very first flagship store, which opened its stores at the end of September. The store is located on Drottninggatan in the heart of Central Stockholm and spans 3 floors over 500 square meters. After a successful launch a few weeks ago, which we celebrated together with our most loyal customers as well as many new customers, we are now looking forward to presenting the very best products from our Nelly assortment in new ways and getting to know our customers in a new setting.

So to summarize this quarter, we continue to see clear positive progress in many areas of the business, and we are pleased that we have today been able to post a second positive quarter this year despite the continued net revenue decline. However, it is important to emphasize that as we go into the last quarter of 2023, we continue to focus on implementing those parts of our transformation plan that are not yet in place. We still have more work to do, and we feel encouraged and energized by the clear progress we have already made.

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

[Ola Wahlstrom, executive]

Thank you for the introduction, Helena. Please let me provide some more details on Q3 financials. Net revenue declined by 17% in the third quarter. The main driver was lower sales before returns and lower B2B sales, which was partly compensated by a lower return rate. 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.

I also want to highlight a significantly higher share of sales of Nelly's own brand, where we also managed to increase the average item value in comparison to previous year. The return rate decreased by 1.9 percentage points to 34.3% during the third quarter due to effects from the sole product mix as well as improvements within product categories. Gross margin increased by 9.2 percentage points to 50.7% in Q3 2023. The main reasons for the higher gross margin were higher margins due to a lower level of campaign activity, lower customs and freight costs, as well as higher share of own brands in the quarter. The higher gross margin, combined with the lower net revenue resulted in a SEK 2 million gross profit increase 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 5 million lower than last year, again, proving an efficient model despite the low volumes. The distribution costs were largely in line with the lower volume shift in the quarter. Marketing costs amounted to SEK 21 million in the quarter compared to SEK 28 million a year ago. The decrease of SEK 7 million was mainly due to a more efficient marketing spend. In addition, more cost-efficient working methods and a reduction of PR and burn marketing activities also contributed.

Admin and other operating costs amounted to SEK 52 million compared to SEK 58 million last year. The SEK 6 million decrease in costs was mainly driven by lower payroll costs and in line with previously communicated cost reductions. All in all, EBIT in the quarter was SEK 25 million higher than Q3 last year and resulting in a 5.4% operating margin. To summarize, while revenue was markedly lower than last year, we have seen an improvement in many of the underlying fundamentals in line with our profitability focus.

Moving on to the next slide. Let's look at a few other aspects of the quarter we just closed. The third quarter continues to show progress in line with improvements from the second quarter. So despite the reduction of orders by 17% in the Nordics, driven mostly by a lower traffic and a lower conversion rate, we are pleased to see multiple steps in the right direction in our profitability journey.

Firstly, the sole share of own brands increased with 5.2 percentage points, which drives a higher margin. Secondly, we saw the return rate decreased by 1.9 percentage points, an improvement connected to our assortment strategy. Thirdly, we are pleased to see improvements in our gross margin with 9.2 percentage points despite an increase in sales to our external outlet parties. Lower operating costs in line with our cost reductions.

Moving on to our operating costs. Operating costs were down significantly by more than SEK 23 million in the quarter. In the third quarter 2023, we again see the full annual rate effects of the cost savings from the cost reduction programs.

Working capital changes. Much like the first quarter, the third quarter is burdened by building up of inventory ahead of the next quarter, in which sales are seasonally strong. Cash flow from operations in Q3 was minus SEK 14 million, an improvement against last year from minus SEK 63 million. The change was mainly driven by improvements in ongoing operations as well as a lower inventory.

After now having been through the seasonal cash low point of the second half of the year, we expect to build up cash through the course of Q4. Cash at the end of the quarter amounted to SEK 120 million, excluding our credit facility, which we did not tap into per the 30th of September.

Lastly, Nelly has no interest-bearing debt apart from the government tax credit. 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 today's presentation, and we will now open up for your questions.

[Unknown Executive]

Thank you, Helena. And thank you for submitting questions. Let's get started with the first question. This 1 from Henrik at SEB. In terms of marketing, you mentioned less spending on brand building. Could you give a split on the costs for paid traffic and brand building, and perhaps how much the brand building activities declined year-on-year?

[Helena Karlinder-Ostlundh, executive]

Yes. Thank you so much for that question. So as we mentioned in the report as well, we have been heavily focused on building our organic traffic, but also, of course, optimizing our paid marketing to generate profitable traffic, so not traffic any cost, but profitable traffic. It is important, though, to clarify here that we are still focused on brand building, of course, but we do now set a different bar for ourselves, where all customer activation activity [Audio Gap].

[Unknown Executive]

Helena. Moving on to the next question. This 1 is from Niklas at SEB Equities. Could you give us -- could you update us on your pricing and average selling price strategies? I mean, the current high input cost inflations, but also consumer headwinds that in general could be expected to impact willingness to spend in the next year 2024, please?

[Helena Karlinder-Ostlundh, executive]

Yes. Of course. So it is a core part of our strategy to offer truly attractive and relevant products to our customers at the right price points. Of course, we are, like all other businesses, also impacted by inflation, but going forward as well -- as it is now and will be going forward, our pricing strategy is set by our customer and offering truly competitive prices for our great Nelly products.

[Unknown Executive]

Thank you. We will now answer a question from Henrik at SEB. There was a clear year-on-year increase in sales from own brands. Was this a conscious decision and part of the strategy? Should we expect own brands to continue to grow as a share of total sales?

[Helena Karlinder-Ostlundh, executive]

Yes, again. Own Nelly brands are a very important part of our strategy. It is [Audio Gap] offer our own very strong brands as well as the external brands that our customers are really looking for, the most attractive brands in the market. We have seen a very positive response so far to our Autumn and Winter collection, especially on our own brands. So yes, we will continue to invest in our own brands and continue to hopefully see this very positive response from our customers.

[Unknown Executive]

Thank you. The next question is from Niklas at SEB Equities. And he wants to know, could you remind us on where your target levels are with regards to PEO share of sales in Nelly over the coming years, please?

[Ola Wahlstrom, executive]

Yes. So I just want to remind our policy is not to give any forward-looking statements right now. But our goal and work is always aimed at increasing our own share of sales of Nelly brand. And this is to leverage our ability to understand our customer and also to design and produce an attractive assortment.

[Unknown Executive]

Thank you, Ola. We will wrap up this call with a final question. This 1 is from Niklas at SEB Equities. Typically, return rates increase with an increasing share of private label sales. But in Q3, gross margins benefited from both key metrics improving. One, can you elaborate on this outcome; and two, to what extent do you reckon this is going to be a sustained trend into Q4 and 2024?

[Helena Karlinder-Ostlundh, executive]

Yes. So as I mentioned before, we're very pleased that we've seen such a positive response from our customers to our Autumn and Winter collection. And this, of course, is also visible in the return rate. Again, though, it's important to understand that there are also seasonal effects in this return rate through the product mix that has primarily been the focus this quarter. So we have more work to do on our return rate, and we will continue to work on this going forward. But of course, we are happy to see this result in the third quarter.

[Unknown Executive]

Great. I think those were all the questions we received today. So thank you very much for listening, and we'll talk to you again next quarter. Thank you very much.

[Ola Wahlstrom, executive]

Thank you, everyone.

[Helena Karlinder-Ostlundh, executive]

Thank you.