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

Welcome to the Pierce's Group Audiocast with Teleconference Third Quarter 2022. Today, I am pleased to present Henrik Zadig, CEO; and Niclas Olsson, CFO. Please begin your meeting.

Thank you, and good morning, everyone, and very welcome to the Pierce Third Quarter Earnings Call. 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 into Page 3, please. In terms of agenda, we'll do as usual, we'll start with the Q3 summary and then provide a financial update by Niclas. And then I'll finish off with some reflections on the future and illustrate what the way back to profitability can look like for Pierce. And then, of course, we'll take any questions. Page 4, please. So in terms of a Q3 summary, if we start with operations, we saw similar macro challenges in the third quarter as we've done in the recent quarters. And if anything, the uncertainty has increased with high inflation, energy shocks and rising interest rates that all impact the customers' purchase power. Since the middle of the first quarter, we have seen a decline in the online market. And even if the traffic now holds up quite well, the new macroeconomic situation affects our customers' willingness to buy. And our assessment is that the online market is slightly down versus last year in the third quarter. The gross margin continued to be squeezed by very high shipping costs, substantially higher purchase prices from raw material and supplies and the stronger U.S. dollar made our purchases more expensive. It is good to see that the container shipping prices from Asia have decreased a lot during the recent month. But it will take a couple of quarters before this is visible in the results. What's also good is that the market prices for raw materials like steel and aluminum are going down, and we expect that to be translated in lower COGS over time. We have continued during the quarter to execute our program to improve the financial performance. The main focus of this program is to restore the gross margin, which is the biggest pain point right now, but also, we aim to improve the overall cost efficiency and the working capital. And so far, the work is progressing as planned. And in the third quarter, we saw a positive effect in the P&L on the marketing spend. The bulk of the positive effect is expected to come from COGS negotiations with suppliers, which are ongoing as we speak. And we also expect some impact from better customer pricing, but the full impact -- the full effect from these efforts is expected to kick in during the second half of 2023. Moving to financials. We entered the third quarter with a focus to maintain a strong cash position. And even if the cash position is solid after the new share issue, the near-term market outlook is highly uncertain, and that is why we continue building as much cash as possible, so we are prepared before going into a recession. So we report revenues that grew 3% or flat in local currencies and remember, this has been done in a declining market. We have been able to increase our customer prices by some 5% since the start of the year, and we do see that the prices in the market are going up, but this increase is not yet compensating for all the cost increases. The price increases are being held back by the general financial situation, a high price sensitivity among customers and the general overstock situation in the market, and that explains fully why the adjusted EBIT is down SEK 11 million since last year, and we reported a loss of SEK 9 million. After the new share issue, the balance sheet is clearly stronger. The company is debt-free with a net cash position of SEK 115 million. And this stronger cash situation helps us to continue our work to improve the longer-term profitability. Having said that, given a looming recession, we will continue to prioritize sales at the cost of some gross margin points or as long as it's required to maintain a good cash position. On the positive side, we see good effects on our variable costs as we have been able to improve the marketing efficiency. The stock value has been heavily impacted by the cost increases, but we see that the stock in units is some 5% lower during the same -- than the same period last year and also a substantial 20% lower than at the start of this year. So all the efforts we've been pursuing to reduce the inventory are bearing fruit, which is very good to see. And a few words on Q4. As you all know, the last quarter of the year is highly dependent on the November and December campaigns. But for the month of October, that is before the start of the black month, we saw the same market development as during the third quarter. We do feel very well prepared for the campaigns in November, December. We have been preparing for this for a long time. We have a lot of new products and offers ready, and we are pleased to be serving up strong offers to our customers since November 1 when our campaign activities started. Let's move to Page 5, please. It is hard to compare revenues with recent years due to the pandemic effect. So that's why we extend the comparison until pre-pandemic times. And in the third quarter, we can see effects from the uncertain macroeconomic situation. Page 6, please. When we look at the KPIs, the customer satisfaction scores continue an upward trend, and they remain on our best-ever level on 4.3 out of 5 on average across Europe. And it is particularly good to see that we are able to provide a good customer experience despite all the turbulence. To the right, you see the private brands showing good revenue growth with an 11% CAGR over the last 2 years. We use private brand products to drive traffic and we see they are especially good to have in these times as they have low price points and workers' wallet openers. And private brands are important to us as they represent some 40% of the revenues. Page 7, please. The active customer base grew marginally. We have reduced our spending within performance marketing somewhat to increase marketing efficiency and that has slowed down the customer acquisition a bit. On the other hand, we have a stronger customer offering, especially within Onroad that counterbalances that. The number of orders is on the same level, and we are very happy to see that the average order value keeps growing over several years now. This is a focus area as it helps to drive efficiencies in the supply chain. And I'll hand over to Niclas to do the financial update. So let's turn to Page 9, please.

Good morning. My name is Niclas Olsson, and I'm the acting CFO. During the third quarter, we, as Henrik said, estimate that the online market declined slightly. Order volume was negative versus last year, but average order value grew with approximately 4% in local currencies. This led to a flat revenue growth in the quarter. The higher average order value was to some extent driven by price increases but also by some campaign adjustments. The profit of the variable cost has decreased with approximately 4 percentage points in the third quarter as we have not been able to fully increase customer prices to compensate for all the cost increases. Our 2 main segments, Offroad and Onroad, show both the same development during the quarter. We continue to Page 10, please. The EBIT margin decreased by around 3 percentage points compared with Q3 last year. The development is driven by gross margin, and I will come back to the details. Please note in the report that the adjusted EBIT is SEK 6 million better than EBIT as we have had costs for initiatives that in the quarter that we classify as extraordinary. And of this SEK 6 million in extraordinary costs, some relate to our program to improve the financial performance and some relate to other strategic initiatives. And on that point, in this market environment, there are several consolidation opportunities. We welcome that, as I've said several times, and in this quarter, we chose to invest in external advice to investigate some of these opportunities in more detail. So let's turn to Page 11, please. When we look at the EBIT margin bridge between Q3 '21 and Q3 '22, I would like to highlight a few things. The higher shipping costs from Asia are well known and decreased the margin by 1.4 percentage points this quarter. More about shipping will be explained later. The other gross margin part of the waterfall includes purchasing price increases that is mainly driven by higher costs for raw material and also the stronger U.S. dollar in relation to Europe. This relation affect us negatively and will continue to do so during coming quarters. In the third quarter, the effect on gross margin from FX was approximately minus SEK 2 million, excluding the negative effect from revaluation of working capital items, as already specified in the bridge. These cost increases have only to a minor part being compensated by customer price adjustment, leading to the negative margin development. As previously said, there is a general overstock situation on the market but customers also exhibit high price sensitivity. This, together with our focus to generate cash and drive sales, has held back the pace of price adjustments. On the positive side, direct costs was reduced with 1.1 percentage point, driven by lower performance marketing spending as part of our improvement program. And finally, the other bucket that mainly includes overhead cost was reduced with 0.7 percentage points. Some of the decrease relates to a temporary effect last year as we corrected cost capitalization. But we continue to keep very tight control of our overhead costs, and we have, for example, less white collar FTEs today than last year. Page 12, please. The market price for shipping containers from Asia has decreased with approximately 75% since peak level, and we expect the price to go down even further in the coming quarters. This is, of course, very welcome news for us. Despite this significantly lower prices on the market, the cost per shipping in our P&L was very high during the third quarter. That is because we still sell products that were shipped when the price were on a high level, and we expect the positive effect from the lower prices will take a few more quarters to materialize in the P&L. As a benchmark, you can see that when the container costs were around USD 3,000 as in 2020, the cost in relation to revenue was below 3% compared to over 6% the last quarter. Page 13, please. Compared to end of third quarter last year, both inventory value has increased and short-term liability has decreased. We have, since end of Q4 '21 had a strong focus on improving our working capital, especially by reducing the inventory, and I will explain the development on the next slide. So please -- Page 14, please. Comparing Q3 '22, with Q3 '21, the physical stock has increased in value by SEK 75 million or 21%. But if we measure in units, the stock is approximately 5% lower than last year. The average unit cost has increased due to both the cost inflation and the stronger U.S. dollar and euro. For example, the extreme shipping prices have not really affected the stock value in Q3 '21. In addition to the average cost increases, physical stock has also increased as we need to build stock for the November campaigns earlier this year as the black month started already 1st of November, compared with November 19 last year. And also during autumn last year, there were still disturbances in the production and supply chain, leading to inbound delays. The effect was that we received a larger share of campaign products during the fourth quarter '21. This year, we don't see those problems. It's worth mentioning that our store products are usually not trend-sensitive, while we will be able to sell the products even if the average coverage time has been too long. As you can see in the table, the short-term liabilities have decreased by SEK 58 million compared with the end of September last year. Main reason is that we have inbounded and therefore paid earlier for the campaign product this year. This we can see clearly in the line Goods in transit, that has decreased with SEK 50 million since Q3 '21. Page 15, please. Since the new share issue was finalized in July, we repaid our loans and are now cash positive and have a strong equity position. I will now hand over to Henrik to guide you through the looking-forward section, Page 17, please.

Thanks, Niclas. So let me now spend some time talking about how we see a way back to profits for Pierce. So the margin development the last couple of quarters has, of course, been disappointing. In this graph, which shows the adjusted EBIT Q3 year-to-date last year versus this year, it's clear that the problem sits in the gross margin. And that is being squeezed by several forces, in particular, the higher shipping costs for Asian containers. In fact, this factor alone has cost us SEK 45 million more year-to-date this year compared to 2 years ago 2020. We also have higher purchasing prices for, in particular, our private brand products, which is driven by higher costs for raw material, energy and labor. And then there is the generally high stock levels in the market, which drives markdowns and slows down the process of passing on these cost increases to the customers. And in Q3 now, the stronger U.S. dollar also started to impact the gross margin negatively as we buy quite a lot in U.S. dollars. And when you add to this, then the geopolitical and financial environment with more high inflation, energy shock and rising interest rates, which together slow down the customer demand, well, then you have a quite demanding cocktail to manage. And we have been doing our very best to navigate through these extremely challenging times by prioritizing sales to secure a good cash position. And I would say, so far so good on that point, and we do see a way back to profitability. But to give more substance to that, you have to dig deeper and understand the different drivers of the gross margin. So let's turn to that on Page 18, please. So let me walk through an illustration of the key levers for restoring the profitability. And you should note that this is not an outlook or forecast. The starting point at the very left in dark blue is the current situation with a marginal EBIT loss in the third quarter. So how do we get it up from here? Well, we believe several of these negative gross margin drivers on the previous page are temporary in nature and the P&L will benefit from a normalization. And on top of that, then we have our program to improve financial performance. As you go through the different levers, we first have the shipping costs for the Asian containers which has hit in particular, our private brand products. As we showed earlier, this on a couple of pages ago, since before the container crisis, our shipping cost has increased by some 3.5 percentage points in the P&L. Recently, the market price for containers has gone down sharply and are now close to the level before the crisis. And if this normalization continues, it will add back important margin points to the P&L. Moving to the next item, the purchasing prices. We can now see that the market prices for raw materials are going down again since a very sharp increase during COVID, that's true for steel, aluminum, cotton, oil, to name a few that are important to us. We also know that factories in Asia are running more idle lately. So wouldn't it be logical but if our purchase prices went up where the market prices for raw material increased, but there is an opportunity for us to negotiate them back down again now and the raw material prices are decreasing. And that is exactly the negotiation we have now with all our suppliers as we speak. If we are successful here, that will add back margin to the P&L. Proceeding to pricing, there are several ways to restore margin from pricing. First, our pricing has historically been done manually to a large extent. It is a complex and quite error-prone process, given the large number of SKUs and markets. We are now in the final stages of a long project to implement the tool that will automate our pricing based on rules and algorithms. And if executed well, this should improve margins. Also, as and when the overstock situation in the market is normalized, one would expect the market to pass on the cost increases even more rapidly to the customers than we have seen lately. We have also now launched an initiative to optimize the assortment by reducing selected parts of it, in particular, the low-value long tail, and this should reduce the need for markdowns and improve working capital. And then we have marketing. During the last couple of years, the marketing costs have increased as a share of revenues. And as part of our improvement program, we have trimmed the machine, and we have revised the ROI targets to improve the marketing efficiency. At the same time, the price levels in the search markets have declined a bit lately, and we see a positive impact of both these factors now in the third quarter. And then finally, then we have the economies of scale. Over time, we expect to continue reducing our overhead costs in relation to revenue. We have the base organization and systems in place. It is built to handle growth at a low marginal cost. And you've heard me say before that the number of employees has decreased by approximately 10% compared to 3 years ago, despite all the volume increases since then. And that has improved the overhead cost share of revenue from 19% in 2019 to 15% now. And if we continue to be successful here, that will add margin back to the P&L when growth resumes. And we believe the long-term drivers for continued online growth are still there as this industry is still lagging behind in online penetration. And that sums up our view on how to restore profitability for Pierce. But again, note that this is a long-term illustration. And even if we believe that all of this is possible, a number of factors currently working against us, such as the market development, the stronger U.S. dollar and the fact that as long as there is such a high level of uncertainty, we need to work towards quite some large cash buffer, which means we need to prioritize sales and reduce risks. And we do expect the next couple of quarters going into 2023 to be challenging. Page 19, please. So let me conclude by clarifying our 3 main priorities during the next couple of quarters. The #1 priority in the very short term is to maintain a strong cash position. We will continue to prioritize sales at the cost of some gross margin points for as long as required. We'll also adapt our purchasing volumes through the market developments to balance out the working capital. Secondly, as I just explained, we are now in the midst of the execution of our program to improve the financial performance with a strong focus on the gross margin, that remains a key priority. And thirdly, we will continue with our daily work to improve the scalability of our fixed costs by simplifying the business and improving processes and systems. And that concludes our presentation. So operator, let's open up for Q&A if there are any and turn to Page 20, please.

[Operator Instructions] Your first question comes from Daniel Ovin from Nordea.

Yes. First question is on the market development during Q3. And I noticed that you mentioned that traffic now was flattish year-over-year. I think you said in Q2, that was down slightly. So I just wonder, is there a small gradual improvement perhaps in the market from higher interest from clients? And is that also something that seems to have continued in Q4? That's my first question.

I would say it continues on about the same level. What we've seen is that the conversion rate are a bit impacted because customers seem to have a bit less inclination to buy than before. So while the traffic has been holding up well, maybe increased slightly, slightly then the conversion rate is down versus last year. So that means the total value continues on roughly the same pattern as in the second quarter.

Okay. And then on the -- when it comes to price increases, I don't think that you talked about that before. So that seems to be something that has started to come down during Q3. Is that also a trend that you see continuing into Q4? That's the second question.

Yes. No, on prices, we have said that we have expected -- actually, I started talking about this a year ago that we expect the price increases to happen in the market. And it took a long time for it to kick in. I think I mentioned in the first quarter that we started to see some emerging signs that the prices increased by the low single digits, and that has continued in sort of in that pattern. So right now, it's up to 5% increase versus the beginning of the year. So it is a slow gradual increase, which is good. We wish it were a bit faster and more pronounced, but still 5%, it's a better situation now than 9 months.

Okay. And then finally, on the freight cost situation. So down massively, of course, since the peak, but it seems like there's still some few quarters here until it's -- until you noticed it in the number. And I think that we talked previously about 6 to 9 months. So according to my calculation, it's almost should starting to have an impact now. But then also I understand that inventory levels has been higher and longer time to work off -- work that off. So perhaps you can give some indication when -- what quarter do you think that what we see right now should start to actually benefit the margin on a year-over-year basis. That's the third question.

It's -- I would say that has to do also with the sales mix and so on. But I would say that we expect at least 2 more quarters with high levels of this in freight cost, and then we expect a decline.

The next question comes from Carl Deijenberg from Carnegie.

Niclas and Henrik, thank you for a very well explained presentation. So a couple of questions from my side. First, on the inventory levels. And maybe more speaking about sort of your feeling of the inventory levels in the market and you're highlighting in the report that these are high and this has been the case for quite some time now or throughout this year that inventory levels have been very high in the market, which has been negative on the price adjustments for you. And I'm just curious, do you see any signs sort of maybe your competitors or what you hear from your suppliers that these are starting to come down? Or maybe you're feeling what you're seeing there and maybe the outlook there on '23 also, if you could share anything on that?

Yes. I think the -- obviously, our sort of suppliers and most of them are not listed right, so it's difficult to have a precise view. But -- the general feeling is that the inventory levels are still too high in the industry. It's gone gradually a bit better over the year, but still, the inventory levels are too high for it to be really healthy for the industry overall. And I think everyone now is looking for Q4 to see what happens during the black month, the black week period, which is a very important sales period. And I think that will be an important yardstick, not just for peers, but for the industry overall. And I think then after that, we shall know a bit more about what happens with the inventory levels as we go into next year. I think overall -- the industry overall thought the evolution of demand would be a bit better than it has been in the last couple of months.

Okay. Fair enough. That's very clear. And my second question is about these initiatives that you have started to implement on the marketing side and you're talking about an improved ROI on the marketing. And I'm just curious, if you could share a bit exactly what this imply or what you have done exactly? Is it mainly a result of reallocating your marketing efforts to regions and geographies where sort of the economic slowdown is less severe? Or -- yes, anything on that would be helpful.

Sure. No. And I think for competitive reasons, I don't want to go into all the level of detail. But clearly, we have been looking through our marketing spend. As we've seen over the last couple of years, it has been going up, partly as a share of revenue, partly because the price for the keywords has been increasing in the search engines and partly because we had historically invested. We have increased our investments also and relaxed some of the ROI targets. And what we have done now in this -- as part of this program, we have taken a deep look at how we invest the marketing spend, which markets, which segments, which stores and we have -- wanted to trim it to optimize the ROI, that is to improve the ROI on the marketing spend and notch. And so the good thing about that is that it improves the efficiency. If you do -- if you execute it well, it will improve the marketing efficiency, and we see results of that in the P&L. The flip side of that is that then, yes, then you will acquire a few -- some fewer customers, but we're hoping to go for better quality on the back of these decisions that we've taken.

Okay, very well. And then my final question was on this extraordinary costs here in Q3, you are giving us maybe a hint here that you've been looking at some sort of M&A targets. And I know that this has been a discussion since the IPO, but could you say anything on sort of what kinds of targets that you have been evaluating here in Q3? Are these primarily players within on-road? Or I know you haven't announced anything on it, but if you could say anything that would be very interesting.

Yes. I mean, I think what I can say in general here is that our market is very fragmented. The top line players represent some 15% or so only of the total market. So it is very fragmented. And we think the overall industry would benefit from some consolidation to be -- to get a better health long term. And we think Pierce should play a role in this consolidation effort. So when there is a target, and the conditions are right, and we are ready internally, this can be an option. And in the third quarter, we invested in an external advice to investigate some of these opportunities in more detail. And I think what I can -- as far as I can go is to say that when it comes to criteria for M&A targets, we look for targets that can strengthen our position within current segments or verticals. Secondly, they need to add something unique that can be a capability or geography. And thirdly, they need to be -- have a sound underlying business that can help peers to grow profits and revenues and scalability. And I think that is sort of as far as I can go at this stage.

[Operator Instructions] There are no more questions. Dear speakers, back to you.

Okay. Well, thank you very much, everyone, for joining in on the Third Quarter Earnings Call, and we will be back with a Q4 update in February. And until then, we wish you a good time. Have a good rest of the day. Thank you very much.

Thank you.

Ladies and gentlemen, this now concludes our conference call. Thank you all for attending. You may now disconnect your lines.