Pierce Group AB (publ) (PIERCE) Earnings Call Transcript & Summary

Good morning, and welcome to the Pierce Group Q2 2022 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Henrik Zadig. Please go ahead.

Yes. Good morning, everyone and welcome to the Pierce second quarter earnings call. I hope you're all feeling good. I'm Henrik Zadig, I'm the CEO. And I have Niclas Olsson, our acting CFO, with me here in the office. Let's move to Page 3, please. First, just allow me a few personal reflections on Tomas Ljunglöf, our CFO, who tragically passed away on June 3, following a terrible car accident here in the Stockholm area. To me, Tomas was a fantastic CFO, but he was also a close friend and a trusted partner who I've worked with closely in ups and downs for several years. And over time, we've got very close to each other. So this was a deeply painful and frankly, unimaginable for me and all of us here at Pierce. We had a great fortune to work with Tomas and benefit from his insights, his leadership and enthusiasm. And my thoughts still go out to Tomas and his family. In a way, it feels petty to talk about business when something like this happens, but the company and life needs to and will go on. And what is good is that Tomas has built a strong and experienced finance organization in Pierce. Niclas Olsson, our Chief Controller since 5 years, has taken on the role as acting CFO, and I'm confident in our finance team's ability to manage this transition and also build on and develop what Tomas set up. Now let's move to Page 5, please, for a summary of Q2. Starting with the operations. We saw the same macro challenges in the second quarter as we've done in the recent quarters. Since the war in Ukraine started, the traffic in the market has declined approximately minus 5% to minus 10% versus last year, both in the first and the second quarter. So far, in the third quarter, midway through, the traffic in the market shows a marginal improvement versus the most recent quarters. So we'll see whether that is temporary or holds true also for the full quarter. On the supply side, we see and we feel the inflation very clearly. We continue to face very high shipping costs and substantially higher purchase prices from raw material and supplies. The increased cost of fuel has now also increased our freight cost out to the customers somewhat. And the stronger U.S. dollar makes our purchases more expensive. What is positive is that the container shipping cost from Asia has decreased substantially during the recent months but it's expected to take a couple of quarters before this will be visible in the results. I am pleased we continue to see good traction within Onroad where we grew 10%. And this is driven, as in previous quarters by a stronger assortment, including several new external brands and the launch of new private brand products as well as more competitive prices. And I'm very pleased that amidst all this turbulence, the company continues to function very well operationally and deliver high service levels. And we see this also in the customer satisfaction, which remains on record levels. Moving to financials. As I said last time, we entered the second quarter with a focus to strengthen the cash situation. And we report revenues on par with last year, or a 3% decline in local currencies, but we estimate that the market has decreased somewhat more than that. In the beginning of the quarter, we implemented a broad price increase, particularly within Offroad but we did see that the growth was affected, more than expected, so we readjusted where needed. As a result, the sales development in Offroad improved during the second half of the quarter. In general, there are still high inventory levels in the market, not just at Pierce. It seems it will take a while for that overstock to wash through. And this makes it difficult to pass on all the cost increases to the customers in the short term. But consumer prices are now, and I should say, finally, slowly and cautiously increasing in the market, but not in level with the rapid major cost increases in the value chain, which, of course, puts pressure on the gross margin. But at least the upward journey has started, and I think more is needed. Despite this general overstock in the market, we do also suffer from some meaningful out-of-stock in pockets of our assortment coming from disruptions in the supply chain. And this relates to, in particular, the parts category and selected external brands and this impact sales. So there are indeed multiple challenges for us to handle at the same time here. On the positive side, the private brands are growing 9%, and we see progress on marketing. We have, for several quarters, experienced increasing marketing costs, and we have tried to tackle this in a number of ways. And now in the second quarter, the direct marketing cost share improved versus the second quarter last year, which is good. The result of all these factors is an adjusted EBIT, which landed on a loss of SEK 9 million. Importantly, our balance sheet and cash position was notably strengthened through the new share issue in June, July. And we will continue to closely monitor the cash situation, and we'll be careful about new purchases to continue to reduce the inventory. So let's move to Page 6 now, please. Given the uncertain macro environment and the pressure the company has been under for several quarters, we wanted to reduce the net debt and strengthen our financial capacity with a new share issue. By the end of the quarter, the new -- this share issue was completed. It was fully subscribed, which meant our equity increased by SEK 330 million net of transaction fees. I extend a thank you to all shareholders who showed confidence and support to the company. And as a result, we paid off outstanding loans and secured a considerable net cash position, which means we have a strong degree of resilience in the current very uncertain external environment. But this rights issue provides us with financial stamina. And it means that we can gradually now shift focus towards rebuilding margins and not only improving our cash situation, which has been the mantra over the last couple of quarters. During this quarter, we also welcomed a new shareholder of Verdane Capital, who has extensive competence and experience in owning e-commerce companies, and we look forward to working with them. Page 7, please. If we extend the perspective to prepandemic times, which would be 2019, we have a revenue CAGR of plus 10% in local currencies in the second quarter. Page 8, please. Looking at the KPIs, the customer satisfaction scores continued an upward trend, and they remain on our highest ever level of 4.3 out of 5 on average across all the markets in Europe. And it is good to see this evolution despite all the turbulence. The private brands to the right now show good growth. And overall, we now see better traction on the product development after all the COVID-related delays. Page 9, please. The active customer base grew marginally since last year. We see good customer acquisition, particularly within Onroad, where we had 11% more new customers this quarter versus the same quarter last year. I think this is a positive development despite the lower share of direct marketing. And it's coming from new pricing, better campaigns and a stronger assortment that is driving this positive development. The number of orders is up 10% since 2020 and 1% up versus 2021 in a declining market. The average order value, an important metric continues to increase, even if the progress in the second quarter slowed down somewhat. This is coming from a higher share of private brands within Onroad and some out-of-stock on high-priced products such as helmets that's impacting and driving this development. And I'll now hand over to Niclas Olsson to do the financial update on Page 11, please.

Thank you, Henrik. Good morning. During the second quarter, traffic on the market declined and our revenue growth in local currency was slightly negative. In the beginning of the period, as Henrik said, we increased the prices quite significantly to adjust for the cost increases we have had in the last quarters. This was done mainly within the Offroad segment. However, the market reacted negatively, and we saw a big drop in sales. So after some weeks, we adapted our prices to the prevailing market levels and saw one up improved sales trend. The intense campaigning, together with a higher cost level, including, for example, shipping, affected our profit level negative. Page 12, please. The EBIT margin decreased by around 9 percentage points versus last year and is in line with the development from previous quarters. We continue to the next page, where main deviations are listed. Please turn to Page 13, please. Higher shipping costs from Asia decreased the EBIT margin by 2.3 percentage points this quarter. I'll come back to this later. The campaigning in Q2 continued to be aggressive and the effect is included in the other gross margin part of the waterfall. This part also includes the purchasing price increases from suppliers driven by price inflation within raw material, but also negative FX development. The strongest U.S. dollar in relation to euro has affected us negatively and will continue to do so during the coming quarters. Direct costs increased by 0.7 percentage points, and this was driven by the higher fuel prices affecting the freight cost to our customers. Finally, the Other bucket. This bucket mainly includes overhead and increased with 1.6 percentage points. Last year in Q2, the overhead cost was positively affected by adjustments related to the variable salaries and capitalization on cost. In 2022, we have also have had higher IT costs as we have added some new licenses to the operations. The development year-to-date is more or less the same as for the quarter, except -- or is more or less the same as for the quarter, except for direct marketing, where the spending was higher in the first quarter compared to last year. During the second quarter, we have reduced the spending and the cost has been lower than both last year and previous quarter. Page 14, please. The shipping cost from Asia increased in Q4. Market fees for shipping containers from Asia are going down and are about 40% lower than peak level. Despite this decrease, we were heavily affected by the shipping costs in this second quarter. In general, the products we have sold were shipped during periods with high price level and we have a sales mix in Q2 with higher share of bulk items. As for example, our successful rate stands, this also drives up the cost. We continue to expect to see some high intake cost for some further quarters as we still will sell products that were inbounded during the high-price quarters. Page 15, please. The Offroad segment, where we are the clear market leader, is more affected by the negative market development than the Onroad segment where we still are a small player. We also believe that the warm weather in Europe has reduced the motocross activities on the tracks the last quarter. As earlier said, we increased price significantly within the segment during the beginning of the quarter to compensate for cost increases. The net revenue was negatively affected more than expected, while we after some time, adjusted price level again to stimulate sales. The margin development is same as we have outlined earlier. Please turn to Page 16, please. The Onroad segment continues to develop positively. And the improvement is driven by a stronger assortment, more competitive pricing and successful campaigns. The margin development is still weak and the reasons are the same as we have addressed earlier for the total company. Page 17, please. Since the end of Q4, we have focused on improving the working capital with more intensive campaigning and a careful purchasing approach. Stock value has been going down since that focus shift. And in Q2, the number of articles in stock was reduced by 13% compared with the end of last quarter. The stock value during the same period has only decreased with 4%, and the cost per product increased due to the higher cost for shipping of raw material, together with the continued stronger U.S. dollar and euro. In addition to that progress, we also see some good development of reducing our slow moves within the inventory. These are down over 20% since the peak level in February. In Q2, the net working capital increased some versus the end of Q1 as the positive development within stock was offset in the quarter mainly by lower short-term liabilities. Page 18, please. The operating cash flow was negative with SEK 30 million in the second quarter. Inventory level was reduced, but the other net working capital items developed negatively. The main reason was the short-term liabilities declining as we have been very conservative on purchases since many months. Over time, we expect the net working capital should be reduced as long as we will continue lowering the stock level. Please turn to Page 19, please. In the beginning of July, the financial position was changed and improved following the new share issue. After the new share issue, we are debt-free, cash positive and have a very strong equity position. I will now hand over to Henrik for the final section. Thank you. Operator, please turn to Page 21, please.

Yes. I've repeatedly said that during turbulent times like this, one needs to have the feet on the ground to focus on the here and now, but also to have the eyes on the horizon, so you can steer in the right direction. Short term, there's no doubt the situation is clearly very uncertain, but it will allow ourselves to -- and lift ourselves from the daily grinding and look towards the horizon. We see a lot of growth potential for this business. There is a structural online channel shift that has been going on for many years when sales move from physical shops to online. We don't -- I don't see that stopping. I believe that will continue to fuel and grow our online market in the long term once we are through this current turbulence. The online penetration in this industry is still weak at 19%. So there's a lot of room to grow when we compare to nearby verticals. In fact, during the spring, we asked PwC to refresh the market study to better understand the current trends. They assessed that the online market for motorcycle gear, parts and accessories will grow by 11% per year on average between 2021 and 2026, primarily through the structural sales channel shift. And they expect the total market, including physical shops to grow by 4%. So mathematically, that means the online penetration will rise from 19% to 26% by 2026. So however we look at this, there is plenty of long-term growth to fight for in this market, which is very fragmented and which is dominated by a lot of small physical shops. And Pierce has indeed a terrific track record of beating the market growth. Page 22, please. As I said last time, the main objective now is to position Pierce well for a strong rebound when the headwinds in the market ease. So we focus on 2 areas that we can control. The first was to strengthen the balance sheet. In addition to pushing sales that we've been doing for the last couple of months, we took a decisive step forward with the new share issue. We are now debt-free, cash positive and have a very strong equity position. And we are, as a result, a much stronger company. And that means we can gradually shift our focus to also improving margins. And that leads me to the second focus area, which is a program to improve financial performance. During the second quarter, we have prepared the next major stage in our ongoing efficiency improvement work where we will now proceed with focused initiatives within 3 areas: in sourcing where we believe the largest opportunity sits, we have a number of initiatives. We have one ongoing project to realize savings from the supply of both external and private brands. And this would include both renegotiations of contracts as well as consolidating -- consolidation of suppliers, for example. We have also one project to drive outbound freight savings. Within pricing, we are in the final stages of implementing a new pricing tool, which will allow us to become more sophisticated in how we price individual items automatically based on rules and algorithms rather than the fairly complex and manual processes we've used so far. And within overheads, we will continue to streamline systems and processes to reduce complexity and become more efficient. And this is something we've been working on for several years and that has worked well so far. As an example, the number of employees, excluding warehouse personnel decreased by 9% compared with the end of the Q2 last year. And we are having, in fact, still somewhat fewer employees than we had back in 2019 despite the volume growth since that time of 50%. So thanks to that, the overhead cost share of revenue has gone down from 19% in 2019 to 15% now, and it shows the business is very scalable. In terms of new actions within overhead, we are now going to implement a return portal, which will much simplify the returns process for customers as well as for ourselves internally. And we have also launched an initiative to reduce selected parts of the assortment, in particular, the low value, long tail, which will also reduce complexity and streamline our way of working and improve the working capital. And we do expect that these initiatives together will positively impact the gross margin, EBIT and working capital will fully impact in the second half of next year. And this is obviously an overriding priority for us to improve the financial performance. Page 23, please. So to summarize, this was a quarter where we focused on driving sales to reduce inventory in a market with declining traffic and rapidly rising costs, and this affected the EBIT negatively. We significantly strengthened the financial position of the company with a new share issue, which means we can gradually extend our focus to also improving margins. And the immediate priority now is to get full traction on our program to improve financial performance. This program focuses on sourcing, pricing and overheads, and we expect this program will improve gross margin, EBITDA and working capital, to the full effect in the second half of 2023. And that concludes our presentation of the second quarter report. So operator, let's open up for Q&As and turn to page 24, please.

[Operator Instructions] The first question is from Carl Deijenberg from Carnegie.

So a couple of questions from my side. First, on the organic sales decline here in Q2. If you could quantify the mix here between volume and price because you talked about some price hikes here in Q2, out of the decline of 3% on group on organic, how -- approximately, how much is positive price effects, just to understand sort of the volume development?

I would say that the price effects maybe is a couple of percentage points -- percent of this.

Okay. So between 0 and 5%, is that a fair assumption, or 3 to 5?

Yes.

Yes. Yes. Okay. Yes. And maybe on the -- because you elaborated on the price hikes here in Q2, I'm just curious what you see on -- because your inventory levels are down here in Q2 quarter-on-quarter. And I'm just curious, do you see any incremental improvement in the availability of operating prices here going into Q3 versus Q2? And is your general impression that inventories have started to come down a bit going into Q3 in the overall market?

Yes. We believe that as for us, the general stock is going down, but there is still an overstock. And we think that this will not end in Q3 year either.