Nelly Group AB (publ) (NELLY) Earnings Call Transcript & Summary

Welcome to Nelly Group 2022 Full Year Results. Today, I am pleased to present Acting CEO, Helena Karlinder-Ostlundh; and Interim CFO, Ola Wahlstrom. [Operator Instructions] Now I will hand over to Helena Karlinder-Ostlundh. Please go ahead.

Thank you very much, and welcome to the quarter 4 2022 call for Nelly Group. My name is Helena Karlinder-Ostlundh, and I'm hosting this call together with Ola Wahlstrom, Interim CFO for Nelly Group. Before we start, I would like to briefly outline what we will cover in today's presentation. We will start with a short overview of Nelly and what we do. Following that, we will outline the key activities we are focusing on as we continue to transform the business towards profitability. We will then look at the quarterly and financial updates, before sharing an update on our sustainability work. Finally, there will be time for questions. We have received some questions in advance, but you can also continue to submit written questions during this presentation. So to start off, let me briefly introduce Nelly and what we do. Nelly is an integral part of the young women's everyday life. The business was founded in 2004 in Boras and at the time, pioneered online fashion for young women in the Nordics. We still operate online only today. We have 1.1 million active customers, and we help them look and more importantly, feel fab every day. We have built a community of 2.4 million Nordic consumers who love fashion as much as we do. We have 1.3 million followers on social media, which is an ever-present source of inspiration for our target customer. And last year, our customers placed 2.3 million orders with us. Now let's move on to quarter 4 and 2022 as a whole. Nelly is on a transformation journey. And during the fourth quarter, we continued our focus on achieving profitability. We have made significant progress on this journey already, but there is more to do, and that is why we are particularly pleased with this morning's announcement that Nelly Group's Board of Directors has resolved to conduct a fully guaranteed rights issue. This is a very positive step for the business as it grants Nelly a reinforced financial position during our continued transformation journey. We are also delighted about the continued confidence shown by our 3 largest shareholders through this rights issue. During 2022, we have taken significant steps to improve the quality of our assortment on an ongoing basis. We have transformed processes and ways of working to ensure that we create a highly curated assortment built around clear big bets every season. This is key to driving volume and profitability. We have also strengthened our everyday fashion offer to complement our already strong position in party wear. This is an important lever for driving purchase frequency. Lastly, we have reviewed our portfolio of external brands and retained only the very best and most attractive and profitable brands. We have continued to drive optimization in our marketing activities and spend. We have seen a positive development in our organic share of total traffic, and this will continue to be a key objective. We have also focused our marketing spend on directly sales driving activations and leveraged these to build the Nelly brand at the same time. We are managing our marketing spend very closely and we'll continue to refine our tools and ways of working in this area during 2023. During 2022, we saw positive developments in the efficiency of our warehouse and logistics operations, principally through further improvements in cost per item handled, and we continue to increase our freight income. We also maintained a sharp focus on trimming our fixed cost base. A key part of achieving profitability for Nelly is continuing to lower our cost base. We have initiated work to overhaul our IT architecture to both remove cost and drive efficiency. We conducted a reorganization of our office-based team in quarter 3 of last year to reduce costs, but equally importantly, reshape core business processes and internal ways of working. We have driven simplification in all areas of the business to remove complexity where it just does not add value for our customers. We launched a clear plan for how to rebuild Nelly as a profitable business last year, and we will continue with the implementation of this plan during 2023. I will now hand over to Ola Wahlstrom to take us through the quarterly and financial update.

Thank you for the introduction, Helena. Please let me provide some more details, but first, a short summary on the Q4 2022. First of all, we had a 4.9% net revenue decline in a competitive market. Secondly, an assortment reduction to drive profitability. Thirdly, lower marketing and warehousing costs. And last but not least, cost saving program is progressing well. Now please let me provide some more details on the Q4 financials on Slide 7. Net revenue declined by 4.9% in the fourth quarter. The main driver was lower sales before returns, which was partly compensated by a higher order value, a lower return rate and higher freight income. We saw a continued increase in organic traffic, while paid traffic was lower, which correlates with the lower spending on performance marketing in the quarter. Sales fell less than orders as the average order value increased. The campaign activity was high in our markets and the competition for customers continued to be tough. The return rate fell by 3.2 percentage points to 32% during the fourth quarter mainly due to mix effects, and for the full year, a return to historically more normal return behavior from lower levels in 2021. Now let's move on to the gross margin. The gross margin decreased by 2.3 percentage points to 41.1% in the Q4. The main reasons for the lower gross margin were, firstly, lower margins due to a strategic choice to discount prices; and secondly, a lower share of own brands in the quarter. The higher freight income partially offset this effect. The lower gross margin combined with the lower net revenue resulted in a SEK 17 million gross profit decrease in the quarter. Let's then take a look at the cost side of the P&L. In total, the fulfillment and distribution costs was SEK 7 million lower than last year, where we are happy to see high efficiency despite the low volumes. Our automation solution is running smoothly and the work to realize targeted cost savings during the past year have been accomplished. The distribution costs fell largely in line with the lower volumes shipped in the quarter. Marketing costs amounted to SEK 41 million in the quarter compared to SEK 44 million a year ago. The main reason for the lower marketing spend was the lower volumes of paid traffic. 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 8 million compared to last year. The decrease in the costs were mainly driven by lower payroll costs. All in all, EBIT in the quarter was SEK 1 million improvement compared to Q4 last year. To summarize, while operating costs were markedly lower than last year, the SEK 17 million lower gross profit implied a negative SEK 2 million EBIT. Now let's move on to Slide 8. So let us look on a few other aspects of the quarter we just closed. Fewer orders, a positive highlight is that the organic traffic to Nelly's sites increased for the third consecutive quarter. The lower spend on performance marketing has led to lower volumes of paid traffic to our sites. In the Nordic, traffic declined by about 8%. The lower traffic combined with a slightly lower conversion rate implied that the number of orders fell by 12% in the Nordics. The average order value saw a small increase in average order value of 1% in the quarter. The average order value is the product of the average number of items per parcel and the average value of these items. And we have seen a positive average order value trend since early 2021, and it's mainly driven by the higher average item value. Additionally, we want to comment on the lower returns. Our return rate for the quarter was reduced by 3 percentage points compared to 21% and was an effect of the product mix. Lower operating costs. Moving on to our operating costs. Operating costs were down by more than SEK 19 million in the quarter, and it is evident that the cost base for Nelly has come down. We are progressing well with the main drivers of the SEK 40 million to SEK 50 million cost saving reduction program that we announced in August 2022. While we have started to see costs come down as a consequence of this initiative, we expect the full annual run rate to be realized by Q2 2023. Working capital changes. Much like second quarter, the fourth quarter is recognized by strong seasonal sales, where we build up our cash position. Changes in working capital was SEK 51 million compared to SEK 65 million in Q4 2021. The changes in working capital are primarily linked to higher inventory balance, while cash flow from operations was higher than previous year. Net cash flow amounted to SEK 56 million, similar to last year's SEK 57 million. We did not draw anything on our short-term credit line. After now having been through the seasonal cash high point of the second half year, we build up inventory through the course of Q1. Cash at the end of the quarter amounted to SEK 97 million and did not use our short-term credit lines at all. And finally, it's worth noting that Nelly has no interest-bearing debt apart from government tax credits. And to summarize, due to a weaker cash flow position compared to previous year, we appreciate the Board has proposed a fully guaranteed rights issue to strengthen Nelly's financial position. Having been through the financials, I'd like to hand back over to Helena to comment on our sustainability work.

Thank you very much, Ola. Before we move on to answer questions, I would like to take you through a selection of sustainability highlights from 2022. We exceeded our goal for Better Cotton with over 60% of the cotton purchased for our own production being more sustainable cotton from Better Cotton. As a step to reduce CO2 emissions, we also replaced all the washing instructions, labels and hang tags on garments from our own production during 2022 to 100% recycled materials. We also continued our close collaboration control and follow-up with suppliers, which resulted in no products being disrupted during 2022. And finally, we continued the close collaboration with our Turkish suppliers to set goals for progress on climate and energy issues. A majority of our Turkish suppliers are now working actively towards using renewable energy. This concludes our presentation for today's call, and we will now open up for questions.

Thank you, Helena, and thank you for the submitted questions. We have received questions in advance and during the presentation, and we'll not be able to answer every question received during the length of this call. Therefore, we have, in some cases, grouped similar questions with the ambition to cover all areas of interest. Moving on to the first question. Is there a plan to collaborate with [indiscernible] in some form?

Well, Nelly is an independent entity and business. And we are, of course, as, hopefully, we have managed to convey today, fully focused on our own transformation journey towards profitability.

Moving on to the next question. There has been some talk about reducing the width of the range and instead work with targeted depth on the right products. At the time of this question, there are over 11,000 products on Nelly's websites. How much should this be reduced?

So we know that reducing the breadth of our assortment is critical to having an attractive offer, and it also is important to have an offer that customers can easily navigate to find what they're looking for. So having a more curated assortment is very important to enable us to focus on our big bets, where we can buy deeply and really put the whole organization's efforts behind each and every product we offer. So having a small assortment reduces complexity for the customer and for our organization as well, which is key to becoming profitable. This is a different strategy to the one we have pursued traditionally. So we aim to reduce our assortment breadth significantly, but we can't comment on the exact number today.

Thank you for that clarification. We have received questions about the change of our CEO. How come we changed CEO at this time?

So Ludvig Anderberg decided to resign, and, of course, I can't comment any further on that. If there are, of course, further questions regarding the appointment of a new permanent CEO, I would like to please refer those to Mathias Pedersen, Chairman of the Board.

We are moving on to some questions from our next questionnaire. The following question comes from Nicklas Fharm from SEB Equities. Starting with, could you walk us through the gross margin bridge in Q4, commenting on the impact from markdowns, the UDS impacting margins and the P&L shares as well as provide some comments on your expectations for these gross margin drivers in half 1, 2023, please?