Good morning and welcome to the Pierce Group Q2 2022 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing Star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star then one on your telephone keypad. To withdraw your question, please press Star then two. 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. 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 three, please. First, just allow me a few personal reflections on Tomas Ljunglöf, our CFO, who tragically passed away on June the third 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 worked with closely in ups and downs for several years. Over time, we got very close to each other.
This was deeply painful and frankly unimaginable for me and all of us here at Pierce, who had the great fortune to work with Tomas and benefit from his insights, his leadership and enthusiasm. 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. What is good is that Tomas has built a strong and experienced finance organization in Pierce. Niclas Olsson, our chief controller since five 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. Let's move to page five, 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 -5% to -10% versus last year, both in the first and the second quarter. 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 US dollars 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 on-road, 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. I'm very pleased that amidst all this turbulence, the company continues to function very well operationally and deliver high service levels. We see this also in the customer satisfaction, which remains on record levels.
Moving to financials, as I said last time, we enter the second quarter with a focus to strengthen the cash flow situation. 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 off-road, but we did see that the growth was affected more than expected, so we readjusted where needed. As a result, the sales development in off-road 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.
Consumer prices are now, and I should say finally, slowly and cautiously increasing in the market, but not on level with the rapid major cost increases in the value chain, which of course puts pressure on the gross margin. 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. This relates to, in particular, the parts category and selected external brands, and this impacts sales. 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. 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. We will continue to closely monitor the cash situation, and we'll be careful about new purchases to continue to reduce the inventory. Let's move to page six 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, this share issue was completed. It was fully subscribed, which meant our records 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. 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. 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, Verdane Capital, who has extensive competence and experience in owning e-commerce companies, and we look forward to working with them. Page seven, please. If we extend the perspective to pre-pandemic times, which would be 2019, we have a revenue CAGR of +10% in local currencies in the second quarter. Page eight, please. Looking at the KPIs, the customer satisfaction scores continue 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. It is good to see this evolution despite all the turbulence. The private brands to the right now show good growth. Overall, we now see better traction on the private brand product development after all the COVID-related delays. Page nine, please.
The active customer base grew marginally since last year. We see good customer acquisition, particularly within on-road, 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 on-road and some out of stock on high-priced products such as helmets that's impacting and driving this development.
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 for the last quarters. This was done mainly within the off-road segment. However, the market reacted negatively and we saw a big drop in sales. After some weeks, we adapted our prices to the prevailing market levels and saw an improved sales trend. The intense campaigning together with a higher cost level, including, for example, shipping, affected our profit level negatively. 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 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 will 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 stronger US dollar in relation to Euro has affected us negatively and will continue to do so during the coming quarters. Direct cost 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 also 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 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 the peak level.
Despite this decrease, we were heavily affected by the shipping cost 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 bulky items, as, for example, our successful Race Tent. This also drives up the cost. We continue to expect to see high intake costs for some further quarters as we still will sell products that were inbound during the high-price quarters. Page 15, please. The off-road segment, where we are the clear market leader, is more affected by the negative market development than the on-road 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, why 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 on-road segment continues to redevelop 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.
Top 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% as the cost per product increases due to the higher cost for shipping a 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 movers 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 in many months. Over time, we expect the net working capital to 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.
Yeah, 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. If we 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. 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. They expect the total market, including physical shops, to grow by 4%. Mathematically, that means the online penetration will rise from 19% to 26% by 2026. 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.
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. We focus on two areas that we can control. The first was the strength of 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. We are, as a result, a much stronger company. That means we can gradually shift our focus to also improving margins. 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.
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. Within overheads, we'll continue to streamline systems and processes to reduce complexity and become more efficient. 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. We have in fact still somewhat fewer employees than we had back in 2019, despite the volume growth since that time of 50%.
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're now going to implement a return portal, which will much simplify the returns process for customers as well as for ourselves internally. 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. 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. This is obviously an overriding priority for us to improve the financial performance. Page 23, please.
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. 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 with full effect in the second half of 2023. That concludes our presentation of this second quarter report. Operator, let's open up for Q&As and turn to page 24, please.
We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question is from Carl Fredrik Berg from Carnegie. Please go ahead.
Thank you. Good morning, Henrik and Niclas. 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, 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. Between zero and five, is that a fair assumption?
Yeah.
Three-five? Yeah. Yeah. Okay. Fair enough.
Zero.
Maybe on the FX because you elaborated on the price hikes here in Q2. I'm just curious what you see on FX because your inventory levels are down here in Q2 quarter-over-quarter. I'm just curious, do you see any incremental improvements in the availability of operating price here going into Q3 versus Q2? It's 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 an overstock, and we think that this will not end in Q3 either.
Yeah.
Okay.
Quite some overstock, exactly as Niclas said in the market overall. It is going down, but this is gonna take a couple of quarters, I think, for this to really wash through the system.
Okay. Fair enough. Maybe on the outlook a bit, you seem a bit cautiously optimistic here going into Q3 on sort of the market development, and you talk about the contraction in Q2 volume or maybe sort of traffic of 5%-10% in Q2. Could you elaborate a bit what you see here going into Q3? Are we talking about a flat to -5% development or just to understand sort of the magnitude of these first two months into Q3.
Yeah. I mean, as you said, we have negative traffic development in Q1, Q2 of sort of -5%,-10% on average versus last year. In the first couple of weeks in Q3, that would mean maybe the first six weeks, we do see the traffic marginally improving versus that trend. It's about flattish versus last year now.
Okay. Fair enough. Okay. That's good. Then I had a question on the gross margin and the contraction and the freight rates. Maybe if you could remind us a bit of the sort of monthly lag before the purchase that you're making now on this freight rates before they reach the cost of goods sold. I think it was said previously that that takes roughly on group level between six to eight months. Is that still a fair assumption or what is usually the timing there? Just to understand when these lower freight rates will start impacting.
It's mainly the private brands that are affected by the inflation. In general, over a long time, we usually maybe have a four month period until we see it. As we now have this sticky rate, I would say that six months is the best guess we have at the moment or estimate.
Okay, great. Then I had a final question on the balance sheet. As you've now completed the rights issue, you are quite not overcapitalized, but you have a clear net cash position at the end of this year. I'm just curious, because I know we've been discussing M&A a bit in the IPO process and obviously that hasn't been a focus now in the recent quarters. If you could just say a bit of your gut setting of how your competitors are doing. Are you still looking at M&A or is that the focus when sort of your core operations have improved? Or maybe if you could give a bit of granularity on what you see there.
Yeah, no, we think that M&A is still a very viable growth path for this company. With the look across the industry, I would say it is in need of consolidation. Obviously we have a view on the competitors and I would say for most it is challenging right now. If anything that should open up the possibilities for M&As. The company, we need to be ready and they need to be ready. Of course it's a better position now with the rights issue than it was, you know, a couple of quarters ago. I think the industry is in need of consolidation. As Pierce, we'd love to play a leading role in making that happen.
Obviously it's not something I can guarantee here and now, but it's something we're looking at.
Okay, perfect. I think that was all my questions, so thank you very much.
Thank you.
Thank you.
Any further questions, please press star and one. There are no more questions at this time.
Okay. I say, thank you very much for listening in to the second quarter earnings call, and we will be back in November then with the third quarter earnings call, if not before. Thank you very much and have a good rest of the day.
Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.