Welcome to the Pierce Group audiocast with teleconference third quarter 2022. Today, I'm pleased to present Henrik Zadig, CEO, and Niclas Olsson, CFO. Please begin your meeting.
Thank you. 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 three, please. In terms of agenda, we'll do as usual.
We'll start with a 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. Then, of course, we'll take any questions. Page four, please. 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.
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.
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 US dollar made our purchases more expensive. It is good to see that container shipping prices from Asia have decreased a lot during the recent months, 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 into 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.
So far the work is progressing as planned. 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. We also expect some impact from better customer pricing.
The full impact, the full effect from these efforts is expected to kick in during the second half of 2023. Moving to financials, we enter 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.
We report revenues that grew 3% or flat in local currencies. 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 markets are going up.
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 a general overstock situation in the market. That explains fully why the adjusted EBIT is down SEK 11 million since last year, and we report a loss of SEK nine 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. 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 for 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've 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.
All the efforts we've been pursuing to reduce the inventory are bearing fruit, which is very good to see. A few words on Q4. As you all know, the last quarter of the year is highly dependent on the November and December campaigns. For the month of October, that is before the start of the Black Month, we saw the same market developments as during the third quarter.
We do feel very well prepared for the campaigns in November, December. We've been preparing for this for a long time, and we have a lot of new products and offers ready. We are pleased to be serving up strong offers to our customers since November first, when our campaign activities started. Let's move to page five, 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. In the third quarter, we can see effects from the uncertain macroeconomic situation. Page six, 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 five on average across Europe.
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 the last two 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 work as wallet openers. 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 on-road, 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. I'll hand over to Niclas to do the financial update. Let's turn to page nine, please.
Good morning. My name is Niclas Olsson, and I'm the acting CFO. During the third quarter, we, as Henrik said, estimated 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 four 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 two main segments, off road and on road, show both the same development during the quarter. We continue to page ten, please. The EBIT margin decreased by around three 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 adjusted EBIT is SEK six million better than EBIT, as we have had costs for initiatives that in the quarter that we classify as extraordinary.
Of this SEK six million in extraordinary costs, some relate to our program to improve the financial performance and some relate to other strategic initiatives. On that point, in this market environment, there are several consolidation opportunities. We welcome that, as I've said several times. In this quarter, we chose to invest in external advice to investigate some of these opportunities in more detail. Let's turn to page 11, please.
When we look at the EBIT margin bridge between Q3 2021 and Q3 2022, 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 the shipping will be explained later. The other gross margin part of the waterfall includes purchasing price increases that is mainly driven by higher cost for raw material, and also the stronger US dollar in relation to euro.
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 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 been 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 a 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 cost was reduced with 1.1 percentage points, driven by lower performance marketing spending as part of our improvement program. 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. We continue to keep very tight control over 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 the coming quarters. This is, of course, very welcome news for us. Despite these significantly lower prices on the market, the cost for 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 $3,000, as in 2020, the cost in relation to revenue was below 3% compared to over 6% the last quarters. 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 2021, had a strong focus on improving our working capital, especially by reducing the inventory, and I will explain the development on the next slide. Please, page 14, please.
Comparing Q3 2022 with Q3 2021, the physical stock has increased in value by SEK 75 million or 21%. 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 US dollar and euro. For example, the extreme shipping prices had not really affected the stock value in Q3 2021.
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 first of November, compared with November 19 last year. 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 2021. 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 by SEK 50 million since Q3 2021. 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. Let me now spend some time talking about how we see a way back to profits for Pierce. 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 two 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.
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. In Q3 now, the stronger US dollar also started to impact the gross margin negatively as we buy quite a lot in US dollars.
When you add to this, then the geopolitical and financial environment with war, 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. We have been doing our very best to navigate through these extremely challenging times by prioritizing sales to secure a good cash position. I would say, so far so good on that point, and we do see a way back to profitability.
To give more substance to that, you have to dig deeper and understand the different drivers of the gross margin. Let's turn to that on page 18, please. Let me walk through an illustration of the key levers for restoring the profitability. You should note that this is not an outlook or forecast. The starting point to the very left in dark blue is the current situation with a marginal EBIT loss in the third quarter. 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.
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. 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. Wouldn't it be logical that if our purchase prices went up when the market prices for raw material increased, that there is an opportunities for us to negotiate them back down again now when the raw material prices are decreasing?
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 a 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. Then we have marketing. During the last couple of years, the marketing costs have increased as a share of revenues. 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. Finally, 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. You've heard me say before that the number of employees has decreased by approximately 10% compared to three years ago, despite all the volume increases since then. That has improved the overhead cost share of revenue from 19% in 2019 to 15% now. If we continue to be successful here, that will add margin back to the P&L when growth resumes.
We believe the long-term drivers for continued online growth are still there, as this industry is still lagging behind in online penetration. That sums up our view on how to restore profitability for Pierce Group. Again, note that this is a long-term illustration, and even if we believe that all this is possible, there are a number of factors currently working against us, such as the market development, the stronger US 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.
We do expect the next couple of quarters going into 2023 to be challenging. Page 19, please. Let me conclude by clarifying our three main priorities during the next couple of quarters. The number one priority in the very short term is to maintain a strong cash position. We'll continue to prioritize sales at the cost of some gross margin points for as long as required. We'll also adapt our purchasing volumes to 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. Thirdly, we will continue with our daily work to improve the scalability of our fixed cost by simplifying the business and improving processes and systems. That concludes our presentation. Operator, let's open up for Q&A, see if there are any, and turn to page 20, please.
Thank you. Ladies and gentlemen, if you do wish to ask a question, please press zero one on your telephone keypad. If you wish to withdraw your question, you may do so by pressing zero two to cancel. Your first question comes from Daniel Owen from Nordea. Please go ahead.
Yes. Good morning, Henrik and Niclas, and thank you for taking my questions. First question is on the market development during Q3. I noticed that you mentioned that the traffic now was flattish year-over-year. I think you said in Q2 that it was down slightly. I just wonder if there were a small gradual improvement, perhaps in the market, from high interest from clients. Is that also something that seems to have continued on in the Q4? That's my first question.
No, I would say it continues on about the same level. What we've seen is that the conversion rate is a bit impacted as customers seem to have a bit less inclination to buy than before. While the traffic has been holding up well, and maybe has increased slightly, then the conversion rate is down versus last year. That means the total value continues on roughly the same pattern as in the second quarter.
Okay. When it comes to price increases, I don't think that you talked about that before. 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.
Yeah, I know on prices, and we have said that we have expected. Actually, I started to talk 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 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. Right now it's up to 5% increase versus the beginning of the year. 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 nine months ago.
Okay. Then finally on the freight cost situation. Down massively of course since the peak, but it seems like there's still some few quarters here until you notice it in the number. I think that we talked previously about six to nine months.
According to my calculation it's almost should starting to have an impact now. Also I understand that, you know, inventory levels has been higher and, you know, longer time to work off work that off. 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. Thank you.
It's yeah. I would say that has to do also with the sales mix and so on. I would say that we expect at least two more quarters with high levels of these freight-in costs, and then we expect a decline.
Okay. Okay, perfect. That's all my questions. Thank you very much.
Thank you.
Thank you. The next question comes from Carl Deijenberg from Carnegie. Please go ahead.
Thank you and good morning, Niclas and Henrik, and thank you for a very well explained presentation. A couple of questions from my side. First, on the inventory levels, and maybe more speaking about the sort of your feeling of the inventory levels in the market. I mean, 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 a negative on the price adjustments for you.
I'm just curious, do you see any signs of 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 then maybe the outlook there on 2023 also? If you could share anything on that.
I think obviously our sort of suppliers, most of them are not listed, right? It's difficult to have a precise view. 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. I think everyone now is looking for Q4 to see what happens during the Black Month or Black Week period, which is a very important sales period. I think that'll be an important yardstick not just for peers, but for the industry overall.
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. 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. I'm just curious if you could share a bit exactly what you have done exactly. Is it mainly a result of reallocating your marketing efforts to regions and geographies where the sort of economic slowdown is less severe or yeah, anything on that would be helpful.
Sure. Now, 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. 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 a notch.
The good thing about that is that it improves the efficiency. 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 you will acquire 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. My final question was on this, the 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 of sort of what kinds of targets that you have been evaluating here in Q3? Are these primarily players within on-road? I know you haven't announced anything on it, but if you could say anything, that would be very interesting.
Yeah, I mean, I think what I can say in general here is that our market is very fragmented. The top nine 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. We think Pierce should play a role in this consolidation effort. When there is a target and the conditions are right and we are ready internally, this can be an option. In the third quarter we invested in external advice to investigate some of these opportunities in more detail.
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. Thirdly, they need to have a sound underlying business that can help Pierce to grow profits and revenues and scalability. I think that is sort of as far as I can go at this stage.
Okay, fair enough. I think that was all from me, so thank you for taking my questions.
Thank you.
Thank you very much, ladies and gentlemen. Let me remind you again, if you wish to ask a question, please press zero one on your telephone keypad. Thank you. 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. Until then, I 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 line.