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

Welcome to Pierce Group Q4 Report 2022. [Operator Instructions] Now I will hand the conference over to the speakers, acting CEO, Willem Vos; and CFO, Niclas Olsson. Please go ahead.

Thank you, and good morning, everyone, and welcome to the fourth quarter Pierce earnings call. My name is Willem Vos, I'm the acting CEO. And I have Niclas Olsson, our CFO, with me here in the office at Pierce. Before we go into the Q4 results, let me start by giving you a short introduction of myself. As I was recently appointed in the role of acting CEO after Henrik Zadig left the business in December to pursue other opportunities. Now I joined Pierce since September 2017 as the Chief Operations Officer. And that was at a time when the company was still about 1/3 of the size of what it is today. And as COO, I was primarily responsible for the backbone of our day-to-day commercial operations. That includes our supply chain, our customer service and our information technology teams. And over the last 5 years, I've also spent a significant amount of time driving key initiatives to streamline our processes and working routines in order to drive more scalability across the business. And that also required quite some investments in new technology capabilities such as e-commerce, product information management and CRM systems. And then I also work with the operational and commercial teams to professionalize the business and to further expand our operations across Europe. So all in all, I've been exposed to the various parts of the company and have really enjoyed working across both the commercial and the operational teams. Now prior to joining Pierce, I was actually responsible for the e-commerce platforms at Staples, the office supply retailer. And they, at the time, had a combined e-commerce platform turnover of SEK 10 billion, so quite a large e-commerce business already at that time. And then before Staples, I worked for 10 years in marketing agencies, where I actually led a team that was responsible for digital marketing at Ericsson globally, and they also happen to be headquartered here out of Stockholm. So I was no stranger to Sweden before I joined Pierce. So let's go to Page 3, please. In terms of the agenda, we'll start off with the Q4 summary, and Niclas will provide a financial update. And then I'll finish it off with some reflections on the way forward and then we can take any questions afterwards. So let's move to Page #4. So here's the summary for the fourth quarter. And let's start with the upper left box, the operations. The market continued to be challenging in Q4 as consumer demand was impacted by inflation and by high prices. And if the cost of normal living goes up, then this typically means that consumers have less money to spend on the nonessentials such as motorsports and motorcycle gear, accessories and spare parts. Since the middle of Q1 '22, we have seen a decline in the online market, and our assessment is that the online market is actually down versus last year also in the fourth quarter by more than 10%. At the same time, we are still faced with a general overstock situation in the market, and this impacts not only retailers but also distributors and manufacturers. So it's really hitting the entire supply chain. During the quarter, we were successful in driving sales to reduce inventory and to further improve our solid cash position. With this sales focus in a declining market and with high inventory levels led to continued margin pressure. Profitability was also further squeezed by a legacy of very high shipping prices and higher purchase costs. It is good to see, though, that the container shipping prices from Asia have continued to decrease during the recent months and they're now back to pre-pandemic levels. However, we expect that it will take another quarter or so until the impact starts to materialize in a more significant way in the P&L. The financial improvement program is progressing according to plan, and we expect to gradually see a more significant impact from the second half of the year. And the main focus of this program is to improve the gross margin, which is our biggest pain point, but also we aim to improve our overall cost efficiency as well as the working capital. As a result of this financial improvement program, performance marketing spend declined during Q4 and the direct costs were reduced by some 1.3 percentage points in relation to revenue in comparison to last year. We also did an additional push to negotiate commercial terms with nearly all product suppliers, and it was basically to preempt further price increases but also to lower the existing commercial terms and purchasing costs. These new commercial terms will gradually kick in over the coming quarters with a full impact estimated to show towards the end of the year. It will take some time until the effects are visible in the P&L. But there's typically some time involved in ordering new products and then these products will not show in the P&L until they're effectively sold. So that may take some time. Moving on to the next section with the financials. We entered Q4 with a focus to maintain a strong cash position and to further reduce our inventory levels. Revenues grew by 3% in krona but declined by 3% in local currencies. And keep in mind that this is against the backdrop of a market that is declining by more than 10%. So we estimate that on balance, we continue to gain share in this market. In order to stimulate sales, we extended the Black Friday campaign period over the entire month of November, thereby trading off some margin in favor of sales. We have been able to increase our customer prices since the start of the year, and we see that the prices in the market are slowly edging up but these increases are not compensating for cost increases. This explains why the adjusted EBIT is down SEK 29 million since last year and we reported a loss of SEK 23 million for the quarter. After the new share issue in July, the balance sheet is much stronger and net cash further improved to SEK 136 million at the end of the quarter. This stronger cash situation helps us to improve our long-term profitability as there's less pressure to drive sales volumes. But at the same time, we will continue to be cautious going into 2023, and we are taking a more conservative approach towards purchasing new products. So despite the big hit on adjusted EBIT for the quarter, we do see a few positive and let me try to summarize those. So first of all, we see some good effects on our variable cost as we have been able to improve marketing efficiency. We also expect that the additional push that we did to negotiate commercial terms with the suppliers will start to have an impact later in the year. Then if we look at the stock value, that has been heavily impacted by the shipping cost increases. But we now see that the stock has decreased in value by some 9% since the end of '21, and in units it's almost 30% lower in comparison to the start of the year. So the efforts to reduce the inventory are bearing fruit, which is something that we're obviously very pleased with. And the stock is also getting more balanced, which means that it has a better assortment composition. As a result of these efforts, our operating cash flow and net working capital have also improved. And then as mentioned before, we believe that we are gaining market share, in particular in the Onroad segment. So with that, let's move to Page 5, please. Now looking at the KPIs, the customer satisfaction scores continue to remain at the high level at around 3 -- sorry, at around 4.3 out of 5 on average across Europe. We're pleased to see that we continue to be able to provide a good customer experience. And the private brands, they show good revenue growth with a 7% CAGR in the last 2 years also when measured in local currencies. And with these private brands, we also have a compelling value proposition towards the more, I would say, price-sensitive customers that are especially now looking for some good value for money deals. Page 6, please. As you can see here from the chart on the left, the active customer base grew marginally. We have reduced our spending within performance marketing somewhat to increase marketing efficiency, and this, in turn, has had an impact on the traffic and slow down our customer acquisition a bit. As you can see on the right-hand side, the number of orders is on the same level or slightly increasing for the full year. And we are very happy to see that the AOV keeps growing over several years with a CAGR of about 4% since 2020, also again, in -- we mentioned that in local currency. So despite the fact that customers seem to have less money to spend, we have been able to keep the basket size up, and this really helps to drive efficiencies in the supply chain. I will now hand over to Niclas Olsson to do the financial update. So Page 8, please.

Good morning. This is Niclas Olsson, and I'm the CFO. During the fourth quarter, we, as Willem said, estimate that the online market declined by over 10%. Our revenue declined by 3% in local currencies, and we estimate that we have gained market shares during the quarter. Order volumes were negative, and the average order value was on par with last year in local currencies. The profit margin after variable costs decreased by approximately 5.5 percentage points in the fourth quarter. In line with previous quarters, we experienced significant cost increases that we were unable to compensate for -- by price increases to customers as we have continued to prioritize sales volumes. Our 2 main segments, Offroad and Onroad, both showed minor growth rates in the local currencies. The Other operations segment saw a significant decline in revenue during Q4. The segment focuses on snowmobile riders in the Nordics and accounted for around 10% of the total group revenue in the quarter. The decline within snow -- the snowmobile segment was significant as we were out of stock in some key private brand products as well as some external brands. Page 9, please. The EBIT margin decreased by nearly 7 percentage points compared with Q4 last year. The development was driven by gross margin, and I will come back to the details. The adjusted EBIT is SEK 8 million better than EBIT as we have costs in the quarter that we classify as extraordinary. These costs relate to external advisory fees for the financial improvement program, but also some costs related to the transition of CEO and CFO. Please turn to Page 10, please. When we look at EBIT margin bridge, I would like to highlight a few things. The higher shipping cost affected the margin negatively with 1.6 percentage points this quarter, and I will come back to the shipping cost. The other gross margin part of the waterfall includes purchasing price increases, driven by the cost inflation and significant cost increases from raw material after the pandemic. These cost increases have only, to a minor extent, being compensated by customer price adjustments leading to a lower margin. As in Q3, we saw FX from our financial improvement program on direct cost. The performance marketing efficiency improved, and the margin effect was positive with 1.3 percentage points compared with last year. And finally, the Other bucket that mainly includes overhead cost affected the EBIT margin negatively by 1.3 percentage points. The main driver for the cost increase was a general salary increases and retention costs for some key staff. Page 11, please. Compared with 2021, the shipping cost from Asia has affected us negatively with nearly SEK 30 million for the full year 2022. We expect a gradual cost decrease as the market prices for shipping containers has reduced significantly during Q4 and is now back to pre-pandemic levels. Despite the significantly lower prices on the market, the cost of shipping in our P&L was very high during the fourth quarter compared with levels before the pandemic. It will continue to be high in the short term as it will take some time to sell out the product that was shipped when prices still was high. But we expect some gradual cost reductions in the P&L during the coming quarters. Page 12, please. At the end of Q3, we had built stock ahead of the campaign season, and as we were able to successfully drive sales during the Q4 campaigns, our stock level decreased, and the working capital was reduced to SEK 246 million at the end of Q4. Compared with last year, we have been able to improve the net working capital driven by our sales focus and careful purchasing. As a result, the stock has decreased since December '21 by 9% in value. The value is inflated by cost increases and FX changes. In units, the stock has been reduced with nearly 30%. The stock has also a better composition compared to end of last year even if we have still more work to do to reach the optimal levels. Because of COVID and a very special market situation during the last year, it has been hard to analyze the seasonal effects for net working capital between the quarters. In general, the stock level should increase by end of Q1 and end of Q3 as we build stock ahead of the season start and the campaign period. Therefore, we expect some increased net working capital in relation to revenue at the end of Q1 2023. Page 13, please. The balance sheet and the cash situation was solid when we closed 2022, and we are well prepared for an uncertain market outlook regarding 2023. I will now hand over to Willem for the outlook section. Page 15, please.

Let me come back to the loss we incurred during the quarter and explain the key levers that will help us to improve the company's profitability over time. And please note that this is not an outlook or a forecast but more of a graphical and conceptual illustration of the key profitability drivers. And the starting point here in the chart that you can see is on the very left in the dark blue, which is the current situation with an EBIT loss in Q4. So the question is how do we get it up from here? First of all, we believe that several of the negative gross margin drivers are temporary in nature and the P&L will benefit from a normalization. We have already seen the shipping costs normalize, and we also expect growth to return in the online market on the back of the online channel shift. But in the short term, there's still quite some uncertainty hanging over the market, and the best thing we can do now is to focus on the things that we can control. So let's talk about purchasing. Now over the last quarter, we have made a significant effort in negotiating commercial terms across our supplier base. And we've done this additional push to preempt further purchase price increases and also to improve the existing commercial terms. And we've not only done this for our product suppliers, but we also revisited our outbound trade suppliers to renegotiate terms and to optimize the transport carrier network across Europe. And this is a transport network that we use to basically deliver the parcels to customers in the different countries. So these commercial improvements from product and freight suppliers will gradually add margin percent back into the P&L. Then let's proceed with pricing, and there's different ways to restore margin from pricing. First of all, if you look at our pricing, the way it has been set up historically has been very manual. And it's very complex and time-consuming and sometimes even a bit error-prone process given the large number of SKUs and all the different markets that are involved. And that is why the current setup has some limitations in how sophisticated we can be. But we've now deployed a new pricing engine and the algorithms are being tested in select markets before this new tool will be fully deployed and rolled out over the course of the next quarter. And this pricing tool allows us to be more surgical in optimizing consumer prices compared to the manual processes that we have had before. We also still expect when the overstock situation in the market further normalizes that we can pass on the cost increases more rapidly to our customers. And then we also launched an initiative to optimize the assortment and to cut the tail, where it should reduce the need for markdowns, improve our working capital and also drive some operational efficiencies across the teams. And then we have marketing. During the last couple of years, the marketing costs have increased as a share of revenue. But as part of our improvement program, we have trimmed the marketing machine and revised the ROI targets to improve the overall marketing efficiency. Also, the prices for key search terms have come down a bit more recently. And the positive impact of both of these factors, which we also already saw in Q3, also continued in the fourth quarter. Then we have the economies of scale. So over time, we expect to continue reducing our overhead costs in relation to revenue. We already have the organization and systems in place to handle larger volumes at low marginal cost. And we want to basically be prepared for when the market rebounds. And that's why we continue with initiatives to further improve the customer experience and also to lower our operating costs. And if we do this successfully, then it will add margin back to the P&L when growth resumes. And we believe that the long-term drivers for continued online growth are still in place, although the short-term outlook remains uncertain. Again, please note that this is a long-term illustration of our path back to profitability and not an outlook or forecast. I think in the here and now, there is still a high level of uncertainty, and we do expect 2023 to be challenging as well. And that is also why we will take a conservative approach to purchasing new products over the coming quarters. Page 16, please. Let me conclude this presentation by clarifying the 3 main priorities going forward. So the #1 priority in the short term is to maintain a strong cash position to mitigate the uncertainty in the market. And given our solid cash position, there is now less pressure to prioritize sales volumes, and we can gradually start shifting focus to improving our margins. And we will manage our working capital carefully and take a cautious approach to taking on new stock by adapting purchase volumes in line with the market reality. As mentioned, and this is point number two, our program to improve the financial performance, which has a strong focus on gross margin, is progressing according to plan. And it remains a key priority to ensure that all the actions that we have taken in Q4 and all the commercial improvements that we have negotiated, that they start landing in the P&L later this year. And then thirdly, we will continue with our daily work to improve the scalability of our fixed cost base by simplifying the business and improving processes and systems. We want to be well prepared when the market rebounds, and then we can also drive further scalability improvements in the P&L on the back of larger order volumes. So that concludes our presentation for today. So operator, let's open up for Q&A. And Page 17, please.

[Operator Instructions] The next question comes from Daniel Ovin from Nordea.

Yes. I'm starting on a question on the different segments here. I noticed that the Onroad division was relatively weak also if you compare to the Offroad. I also see the Other division being weak, but you did mention that a bit. But perhaps you can talk a little bit more about the relative weakness in the Onroad division and what is driving this? That's the first question.

Mostly, it has to do with the market situation right now that is driving the sales development for both the segments. And during the campaigning, we have been quite focused to reduce our stock levels as -- in Q4, as we said. And I would say that the stock situation for Offroad products had been a little bit worse during the year. So we have pushed a little bit harder in the Offroad during Q4.

Okay. And then I have one question also on this lower shipping costs. And you write here in the report that you expect that to support the gross margin by around 3 percentage points over the next few quarters. I'm a bit curious if you can elaborate a little bit more on -- a bit more specific. I mean, do you expect that to have a positive effect already in Q1? Or is it not until second half of the year that we will see the positive effect? If you could elaborate a little bit more there, that would be helpful.

It will be dependent on the -- a little bit of, of course, how the sales is going with the market, how fast we can sell out the old stock. But we expect it to start decreasing. But on -- the development will be quite slow. So I think we need a full year to at least clean out all the products that we have bought with higher shipping costs. So I would say a minor gradual improvement quarter-over-quarter, but then of course something the market situation and also if we sell a different kind of mix. But on the trend, it will be like that.

So I interpret that as it's going to be a negative impact also on a year-over-year basis in Q1 '23.

Maybe. We also start to meet quite high shipping cost comparison as these cost increases occurred already in the end of 2020 -- 2021.

Okay. Great. And then last question on -- you talked about price increases here in the quarter, that you managed to bring them up somewhat and also that you see some signs in the market that prices actually are starting to come up a bit here. So is it your impression that also the inventory levels now in the market overall is starting to be cleaned out? And is it reasonable to expect that we are going to see lower discounting and more pricing already in Q1 and going forward? Is that also a view? Perhaps you can talk a little bit around that. That's my last question.

So I think we said that the price -- consumer prices have edged up a bit in the beginning of the year but not by much, right? It's low single digits. And clearly, it did not offset all the cost increases that we have had. I think in Q4, we extended our Black Friday concept basically to the entire month and then we also had the Christmas campaign. So it's quite a long campaign season. So I don't think in Q4, consumer prices have gone up more than they had by the end of Q3 on balance. And we still see a high campaign activity in the market. So I wouldn't say that the high inventory levels have already cleared out of the system. I think that's still a situation.

The next question comes from Carl Deijenberg from Carnegie.

Yes. So I think most of my questions were already answered here. But I had one on the net financials development here in Q4. Quite a significant positive here, plus 8% in Q4, I think it was plus 3% in Q3. And I know that you're back on that cash now as well. But could you give any more color on that figure and why it's such a positive here in Q4? And also maybe a bit what we can think about there for going into '23.

I maybe missed your refer to the cash situation, I assume.

No, yes, I meant the net financials development in the P&L. I mean, you are debt free now. So I guess that you will not have significant negative there. But I'm just noting that it's plus 8% here in Q4, which is also quite a significant sequential uptick from plus 3% in Q3. So any color on that plus 8% figure would be very helpful.

Actually, it has to do with FX changes and the revaluation of different items within it. So it's very hard to make a prediction on these items. So it's also -- and it's also some hedges that give an effect. So it has been -- it's going quite up and down and it's also -- it's very depending on how the FX rates are going upwards. I don't know if I can give you anything better there.

I think I understand the underlying dynamic term. So that's fine. Actually, could I ask another question on the -- I think it was already touched upon here. But the gross margin development, I understand that it's going to be under pressure for quite some time here in the near to midterm. But I mean, for a conception here and looking a few years out in a more normalized market, let's say, 2, 3, 4, 5 years out. Do you think -- is it realistic that you will sort of return to your previous gross margins that you've been before at around 44%, 45%, 46%? Or sort of what was your longer-term ambition here if we overlook the short-term headwinds?

Yes. I think longer term, we still feel that the same drivers right behind the business are in place. And we expect margins to go up, maybe not to the levels that we were at in the past but definitely up. But also, you need to also take into account that there's a bit of a mix effect as we're pushing more now in the Onroad segment. That has slightly larger -- lower margin, right? So -- but I think it will definitely gravitate upwards, and that's what we're working hard on right now.

And also already before the pandemic, when we set our long-term targets, we expected some pressure -- some margin decrease due to this mix effect. So it's no change since before this market decline.

Yes. Well, understood. And maybe finally, I know that Daniel asked about it as well, sort of the inventory development in the market. I mean, it's fairly clear that you've been fairly successful reducing it here both quarter-over-quarter and also volume-wise comparing it to the end of last year, while it seems like there's still some overstocking in the market. But could you give any guidance of when do you expect that to be normalized from a market perspective? So just understanding some of the markdown pattern here going into the second half of '23, maybe. Do you think it was -- sort of the stock levels in the market will be normalized by then? Or is that a full year '23 issue as well in your book?

It's not so easy to predict and forecast that, right? So it's a little bit dependent on the demand in the market, how quickly you can clear out your inventories. So there is a level of uncertainty, I think, associated with that. But I would expect that it will continue at least into Q1, Q2.

The next question comes from [ Tommy Sorenen ] from [ Indirs ].

The first question is about the inventory and how it's distributed across the segments. So you had some availability issues in the other segments, and you said that in Offroad, you had still maybe some excess stocks. So how would you comment on the inventory levels in different segments? And maybe about if you're still taking more stock into the Other segment.

I think the inventory levels are still high, right, in the market across all the segments. I think we have some specific cases in the Other segment. So that's a snowmobile segment that put a bit of a brake on the sales there. But in general, I think there's no availability issue in the market. So stock levels are high. It's easy to get your hands on the products. Now we do take -- we are taking a conservative approach to purchasing. So over time, if the sales trend starts accelerating and the market becomes much better, that may then lead to availability challenges in the future. But for now, I wouldn't say we have any significant availability issues.

All right. And the other question is about the renegotiation about the commercial terms. So can you give any ballpark of how much would be renegotiate and impact on your gross margins in the '23?

I think that will be hard to answer because, of course, we expect an impact reducing cost. But the margin impact is so dependent on the marketing -- market situation, how the price pressure, et cetera. So it will be hard to give a figure for that one.

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

Well, thank you for listening into the Q4 earnings call. We'll be back with the Q1 update in May. And then for now, I wish you all a good rest of the day, and thank you very much for joining in.