Esprinet S.p.A.

Good morning and welcome everyone to the Esperanto Q1 2023 result presentation. Before starting, I remind everyone that the webinar is being recorded and after the call, the podcast will be posted on the Esperanto website in the investor section together with the presentation. All cameras and microphones are currently disabled. During the Q&A session, we will proceed to reactivate the microphone. Please note again that this presentation contains forward-looking statements, so I would like to draw your attention to the regulation note on page 2, which provides all details. I'm Giulia Perfetti, Investor Relations Manager of Espernet, and with me is Alessandro Cattani, CEO of Espernet. Now I leave the floor to Alessandro to present and comment with you the Q1 2023 results. Alessandro, over to you.

Thank you, Giulia, and thanks everybody for joining us today. Well, Giulia introduced the forward-looking statement. Let's jump straight into our Q1 results. Well, of course, it's been a challenge quarter, but what is worth noting is that we keep on moving in our transition to an added value business model. And the growth of gross profit margins on one side and the growth of the weight of business sales is a clear indication of this relentless transition to an added value business model. We are living in times of high inflation and definitely higher interest rates. And we had, I think, a remarkable result in transferring, pushing downstream inflation and to a large extent the interest rates. That can be measured in the growth of our gross profit margins, which stood at 534%, 29 basis points more than the 505% of Q1 2022. and 12 basis points up sequentially against the fiscal year 22. This increase is even higher if we consider the fact that within our gross profit margins, we factored the cost of the financial cost of factoring, which in Q1 23 was 23 basis points higher than in Q1 22, reflecting the higher interest rates that we measured during this last 12 months. So in a stable environment from an interest rate standpoint, our gross profit margin improvement would have been 52 basis points up almost 10%. And that's been made mostly because of our focus on high margin business lines. So solution and services, which now stand at 23% of total sales, 70% in Q1-22. And the business customer segment now 67% of total sales against 60% in Q1 2022. The second highlight is the pressure on rebuilding a standard level of working capital. And we have made good progress in decreasing our inventory levels, which is still a high priority for our group. We went down more than 120 million euros against the Q1 last year and sequentially close to 60 million against the end of the year. But still, there's room to go, and we're working on a strong MedDev reduction with the aim of keeping payments to suppliers almost stable and managing customer terms. We must consider that in our net financial position, we discount the fact that we have reduced the overall level of factoring utilization by more than 120 million euros. resulting from lower sales in the retail segment where we typically factor our receivables. We are adjusting terms to customers in the business segment to reflect the new environment with higher interest rates. And that's part of the ongoing work of bringing back the the overall working capital to manageable levels. In terms of sales, solutions and services outperformed the market, both in terms of product category in the market. The market was down, but the solution and services were sharply up. And we outperformed the market with a notable 23% growth in this area against 18% of the market. There's an ongoing phase of pressure in the market on screens and certain devices, notably consumer electronics. And there's a significant pressure in the market on retailers and retailers. The consumer spending has been under pressure, is still under pressure. And we are, as I said before, relentlessly phasing out those product-customers combinations that generate the low value. We're crossing a very long line a long desert of, in a sense, of shedding lower value combinations and increasing the weight of the product lines and customer combinations as well that provide higher value, managing inflation and managing the pressure on interest rates. And to a certain extent, I think we have done a remarkable job if we consider that our SG&A were up just 3%. But let's have a look at the profitability evolution. As I said, the world has been impacted year on year by high inflation and rising interest rates. And we have reacted with very strict cost control. SG&A are up 3% year on year. And we have been able to pass down most of, not only product inflation, we have moved it to downstream almost entirely, but we have been able to recover also what has been in the gross profit margin in terms of interest rates and grow margins as well. What has not yet happened is the reduction of the working capital, which is still very high for our standards and is up six days compared to Q4 or 19 days compared to Q1 2022. We'll dig a little bit more later into these details. And therefore the net financial position by the impacted by 120 million euros of lower factoring utilization is up because of this and therefore also the interest costs are up both for interest rate increase as well as higher utilization. But we do believe that all the investments in The higher value lines that we have been doing and we keep on doing should pave the way for an accelerated value creation journey. Let's look at this journey. And as you know, since a few quarters, we report our product lines in five pillars, screens, devices, solutions, services, and our own brands. What is remarkable, I think, is that solution and services now represent 23% of total sales and 60% of total with a stronger combined 3.8 EBITDA margin. We have room to go to both improve the EBITDA margin of everything else, which of course has been impacted not so much by the gross profit reduction, but rather by the lower volumes that provided lower absorption of fixed costs. But still, we have a clear path marked ahead with a strong commitment to grow solutions and services on one side and focus our activities in the screens and devices more and more only on those areas where we can squeeze either higher EBITDA margins or better return on capital employed, meaning accepting lower margin products, but with disproportionately lower absorption of working capital. If we look at the P&L summary, I think most of the comments made before have clearly highlighted what is here. I want to stress that even with an acquisition and in a year of high inflation, we grew our GNA by just 3%. We have very aggressive cost control processes in place. What is worth noting is that the variable costs are stable. So we have been able to absorb fully year on year the changes in pricing for the variable costs and fixed costs are under control. despite the acquisition of Bluedis, which brought roughly 700K of additional costs, the overall cost is up 1.1 million. So really, we were able to manage pretty well our cost structure. We had... We had an opportunity in the foreign exchange gain and losses. We had the gains against losses last year. But the weight of the combined absorption of higher working capital as well as higher interest rates brought a significant increase in the other financial income and expenses, well, in the interest costs. income taxes as a proportion, as a percentage of profit before taxes, so the tax rate is essentially unchanged. If we look at the balance sheet, no real big changes from the end of the year in terms of fixed assets. As usual, we We witnessed big swings in our working capital due to seasonality. So it's probably worth looking at what happened in Q1 last year in terms of working capital. And you see that last year we already had absorbed a big hit in terms of inventory growth. End of the year, it was slightly down and further down in Q1. We are, we think, in a good trajectory. Short term, of course, we will have an impact on trade payables because one way of reducing inventory is not buying. And as long as we're not buying, we are not generating trade payables, or at least we are not generating enough trade payables. It's good to know that the terms that we got from vendors are stable and to a certain extent even improving. So once the inventory will be back to normal levels and we will have restored the usual flow of purchases, trade payable days should stay at a healthy level. We have, as I said, witnessed 120 million euros of lower factoring utilization against March last year, and we are not yet measuring a big impact on customer delinquencies. Of course, it's a worry that we see on On all the financial papers and newspapers, it's something that we keep a keen eye on. But so far, the situation is still absolutely manageable and we have not yet had significant credit losses. THE GROUP IS REDUCING ITS EXPOSURE TO CERTAIN CUSTOMERS AS WELL AS GENERALLY SPEAKING HAVING PROGRESSIVELY LOWER EXPOSURE TO THE RETAIL SEGMENT WHICH IN THIS MOMENT IS THE ONE WITHIN SEEING A HIGHER PRESSURE IN TERMS OF IMPACT OF THE DOWNTURN OF THE MARKET. SO, HERE THE forecast is of progressing with our work of inventory reduction. At a certain moment in time, trade payables will start balancing again. And in terms of trade receivables, business customers do have nominal payment terms that are lower, generally speaking, than those of retailers, but we don't typically factor them. So we should in time have a probably a different balance between factoring and trade receivables. So that's for the balance sheet. If we look at the working capital metrics on the four quarter average, Of course, you see a first sign of decline in the inventory after having spiked at 59 days. But the increase in the average DSOs has been driven by the results of the Q1, just the Q1, which we'll see in a second. more or less stable, a little bit down from the peak of Q3 2022, the payment terms of two suppliers, but mostly driven by a technical aspect of lower purchases because we're shedding inventory. But the nominal terms are stable, if not slightly improving. You see better in the following slide where you see not the moving average, but the quarter and the metrics. you see that the payment terms are more or less stable at 72, 73 days. Inventory at 53 days is down against the 57 days of Q1 2022 is still very, very high. But if we go back to pre-pandemic levels, we are trading in line, if not slightly below those levels, and we expect to have a better situation moving forward. We had this spike at the end of Q1 because of mostly this lower utilization of factoring. So Moving forward, we're really keen to have a better picture during the year in terms of working capital metrics, which of course reflect on our return on capital employed, which has been heavily impacted by not so much by the profitability, but rather by the higher level of capital employed linked entirely to the working capital. Now, we had a tax issue. Well, we are discussing a possible tax issue settlement. I expect a lot of questions here. Let me give a little bit more of color. First of all, it has not yet been closed. We're still in discussion with Italian tax authorities. Of course, as long as we have provided numbers, we have a certain level of confidence drawn by the discussions with the authority. that the settlement could be finalized by the end of this month. And if that will eventually happen, we will provide... We will provide... We will inform the market with ad hoc information. What happened is that As described in the annual financial report 2022, at the end of 2022, the Italian tax authorities gave us four tax assessments for the taxable years 2013, 2016, and one for the taxable year 2017. The point is that according to the Italian law, There are customers that are considered usual or habitual exporters. So customers that typically pay VAT on their purchases and as long as they are exporting, they are not collecting VAT. So they generate a huge credit against the financial authorities. The financial authorities, instead of reimbursing this credit, gave options since many years to these habitual exporters to issue a self-declaration to their suppliers claiming them to be habitual exporters and allowing them to purchase without VAT. The Italian tax authorities, we have sold to some of them. It's a really minor portion of our total sales, probably something like 1% of our total sales during those years. And it's a few tens of customers. that were audited, and after longer investigations, the Italian tax authorities claimed that not only they do not qualify as habitual exporters, but some of them even took part in tax evasion. We have never been considered part of this mechanism, but the tax authority said, you should have made the sort of trying to understand if they were really habitual exporters. This is really peculiar because this is not written in the law and it's the result of retroactive decisions made many years after we sold. Luckily, we had performed controls. So we feel confident that we could win. Unfortunately, the Italian tax authorities challenge 77 million euros of VAT, which we think we should win. But given the Italian regulations, the penalties and interest amount to a staggering 140, roughly 140 million euros of additional penalties and interest for a total of more than 220 million euros. That's the standard numbers. Whenever you see a challenge number on VAT, or for what I understand, traditional taxes as well, income taxes as well, penalties and interest very often are two, if not three times the amount of challenge. And what happened under the Italian regulations is that the tax litigation typically goes through three levels of judgment up to the Supreme Court and normally lasts more than 10 years. And so the litigation will start this year. And unfortunately, pending the litigation, there's a chance that the authority may claim these 220 million euros in advance, pending the final decision. So our board had to face the dilemma in terms of risking of potentially freeze up to 220 million euros in the next two, three years, probably, or to start a potential settlement. The idea, after long and painful internal discussions, has been the a risk for the company of having to give an advance to the government of up to 220 million euros and then waiting up to 10 years to get them back after the Supreme Court's judgment, which we have plenty of leading law firms' opinions. that say that clearly this is illegal for many reasons was too high, was deemed too high. And so in order to reduce the risk for the company, we entered the negotiation with the authorities. The authorities, and I think the percentage is a clear indication of the level of confidence the authorities themselves have in the possibility of winning is 14 percent a little bit less than 14 percent of the total claim which we can pay in up to five years so we are talking about 6.2 million euros of taxes per year but for the next five years roughly eight nine percent higher tax rate even if the entire cost will be booked as a non-recurring charge on this year results. Discussions are still open and ongoing. And as I said, if the settlement procedure will be finalized by the end of the current month, as we think it's possible, we will inform the market. And that's for the tax issues settlement. With this, the risks of further payments for taxes up to 2017 for our group on the Italian operations are closed, fully closed. And we have reduced significantly the risk. And that's for the tax settlement. Guidance. Well, The backdrop, we, as everybody, are facing headwinds. There's a geopolitical tension. There's high inflation, interest rate. But forward-looking indicators suggest this inflation in the second half. But negative short-term momentum is still very strong. First half of the year has been very challenging, even if we start seeing hopefully some signs of improvement. Opportunities. Well, short-term public investments in digitalization are still strong. And mid-term, the product refresh on a large installed base of users is a tremendous mid-term opportunity. Not to mention, of course, the overall opportunities given by the overall higher level of IT utilization fueled by innovation on one side, but from the major wave of IT purchases made during the pandemic. What to watch? Of course, the economic outlook, risk of recession or GDP recovery. There's a sort of strong separation between what the numbers apparently are telling us and what is the feeling of people feeling when you talk about What's happening in the market? There's a lot of worry and uncertainty. On the other side, apparently the numbers speak for a much better picture. And then, are we shifting from energy risk to credit financial risk? We have put a lot of attention into reducing our exposure to certain customers and certain segments, especially the consumer one. because we are afraid this pressure might create the troubles in that area. What are our key priorities? Well, first and foremost, moving forward again and again on our transformation into a value-add distribution model will be relentlessly phase out of the lowest value-add combination of products and customers. And so we are accepting some market share losses because we want to improve our gross profit margins and pave the way from an accelerated growth in value creation in the next years. Of course, this will drive the pressure on changing our cost structure and some of our people, of course. And we are telling clearly to our people, to our vendors, and to customers as well, that we are looking for value also in lower profitability lines, such as telephones or PCs, which we call that, what we call screens. but only when optimal management working capital levels is achievable. And I would add in a structural way. And of course, we keep on looking at new growth opportunities also through M&A in the solution and services segment. And we keep on looking at opportunities. We are actively working on some opportunities. We'll see if we will be able to translate them into reality. And last but not least, we have already spoken at length about that. Another key priority is finishing the hard work of bringing back and networking capital absorption to the standard levels, which were severely impaired by the post-COVID changes, especially in the supply chains, and therefore returning to higher levels of policy. All in all, if we look at our guidance, well, digital transformation is driving strong IT spending and will drive strong IT spending. And we have a clear and consistent strategy in the high value add product and customer segments of the industry. We have more than doubled our profitability. We have doubled our profitability and more in these last five years. And our guidance is based on our feeling and the almost unanimous feeling of industry analysts that during the 2023, we should expect in the groups reference countries, a low single digit increase in demand. There's agreement that the strongest growth is expected in software and infrastructure spending, and that consumer demand will continue to be under pressure, albeit less than what we experienced in the first part of the year. So, in consideration of this challenging backdrop, as well as the results obtained in the first quarter, the guidance is of an EBITDA adjusted expected between 85 and 95 million euros. It's all boils down. We are pretty confident on our cost control capabilities as well as on the gross profit performance. It's mostly a matter of understanding market performance will be as analysts and as we as well believe a good recovery, especially in the second half of the year or will still be challenges in demand driven by worsening macro scenario. Numbers speak for a better performance of the market. We, of course, are driving a shift, leaving on the table certain lower value portions of the market. But nevertheless, we expect 85 to 95 at the moment as a reasonable number. Of course, being adjusted, the roughly 31 million euros of the tax settlement, if we will find the agreement with the government, will be adjusted in these numbers. So the end number, the as reported number, will be 31 million less. with the cash disbursement will be spread in five years at 6.2 million plus interest per year, roughly. And that's all. Thanks for the interest. And now I give back the floor to Giulia for the Q&A session.

Yes, we can start with the Q&A session. I remind you that to ask questions, you should kindly book your speech. The first question comes from Mr. Storer. Mr. Storer, I give you the floor.

Please remember to activate your microphone.

Can you hear me now?

Yes, very well.

OK, perfect. Thank you. Good morning. Thanks for the presentation. I have maybe a couple of questions. The first one is on your underperformance compared to market in Q1. So if you can maybe give us some more color on why such a significant underperformance. You spoke about maybe the fact that you keep shedding most unprofitable business, but I'm wondering whether this could alone explain the big gap versus the market and also was surprised in seeing this gap also in the business segment. The second question is on cash conversion cycle. we are understanding that basically the business segment entails a lower level of factoring versus the commercial, the community consumer one. So in light of that and in light of the shift that we are seeing in the mix, should we think of a different target in terms of cash conversion cycle and so working capital level at target, let's say level compared to the past? Thank you.

OK, thank you. Well, on the performance against the market, let's say, no, we are not really losing opportunities. We have a very firm grip on the market. That's our perception, at least, also speaking with customers and vendors. The point is that, especially on... on PCs and smartphones. And to a lesser extent, certain consumer electronics products, such as TVs, we simply have walked away from really underperforming customers and vendors and deals, generally speaking. I said this many times in the last two years. When we embarked into this journey, I said that it would have happened sooner or later that the pace of growth in the higher margin and higher value-add business, such as solution and services, would have probably been outpaced by the reduction that we are performing of the lower margin businesses. Sometimes we have been able to balance them in a better way. Sometimes the acceleration in the, let's say, shedding of unprofitable business has been a bit too fast. But that's basically what we're doing. We have progressively, and we will keep on progressively discussing with our customers and our vendors. And if there's not enough value in terms of margins against the working capital, we will slowly or quickly walk away from them. So the underperformance is mostly driven by this. And it's also a force that we are exerting on our people. They have to understand that we are becoming something different and whoever is involved in low margin businesses is forced to work hard to change this underperforming business into a better performing one or they will be moved to other departments or potentially left home. That's for the market. On the cash conversion cycle, well, so far we have not changed our targets. It is true that we are in the middle of a big transition. Anyhow, the impact on DSOs on the business segment is normally counterbalanced by the fact that most of the solutions run with the lower inventory levels. So what might happen probably in the future is that we will have lower levels of inventory and slightly higher levels of DSOs, but the overall target of running around or below 18 and 19 days of the cash cycle is something that we keep in mind as our guiding light. Of course, we are far away from there because we are transitioning from, let's say, a steady state situation to a really post-pandemic mess, which we are sorting out and not only us, but but it will take some time. And unfortunately, the fact that the PC market is so under pressure, minus 20%, is something that is creating further complexities into the process of reducing the inventory because the vendors are truly desperate about the market performance. And on top of that, we collectively as distributors are working to reduce the level of inventory. It is taking more time than what we would have expected and loved. But so far, the target is still is still confirmed we'll see by the end of the year if when we'll most probably will release a new focus for the next three years we will we will work on on new numbers but so far i don't expect big changes okay so another call question comes from mr nargi mr nargi please remember to activate your microphone

Hello everyone and thanks for taking my question. I have three questions. The first one is on the tax litigation you received from the Italian Tax Authority. My question is about these unfair customers. So if you are still in touch with this customer and if they had some contribution to your revenues in 2018 and 2022 period. The second question is about the rental business. may provide some update on this business or if you can give us some indication for the year. And the third question is about your M&A strategy. So if your M&A strategy is still ongoing, so if you you expect to continue acquiring new firms? Thanks.

Okay. Well, on the first question, tax litigation, it was a really small amount of our overall sales. it's considered that they challenge 77 millions of VAT on a period of four years. And in that period of time, we made probably eight, nine billion in Italy alone. And then, no, we have not sold anything to those customers. As a matter of fact, We have basically brought to zero sales to all customers in exempt, in exemption, in habitual exporters as a result of this investigation years ago. So we have lost the sales on many other customers since 2017. Because it's not yet clear, even now from the government, which kind of controls are deemed as okay for the tax authorities. The tax authorities challenge us, but they didn't say what we should have made as controls. That's the point. They didn't say. They simply said that we didn't make enough controls. That's it. And so we quit selling to these customers. We still have some minor sales to few long-term customers of ours, as some of these customers were as well, frankly speaking. And so sales are zero, not only on those customers that were challenged, but on many, many others as well. On the rental business, it's progressing slower than expected. We are close to six millions of contracts either signed or under discussion in Italy alone as of today. We are kicking off seriously the activities in Spain. So eventually Spain will become a contributor. So the project is moving forward. It's lower than expected, frankly speaking. So we have not yet the targets for this year. As I said, we would expect to be in double digit in terms of millions of euros of the cost of contracts for the full year. And we have a good trajectory here. Let's see if we will succeed. But the project is moving forward. And in terms of M&A, yes, we keep on exploring opportunities. As I said, we have a double-folded strategy. In Italy, Spain, and Portugal, we are looking at smaller companies. Typically, they are small, a few tens of millions in revenues, perhaps a million, two million, or slightly more in terms of EBITDA, as add-ons to especially the solution or services segment. And we have some deals that are under discussion. I don't know if, as always in this kind of deals, we will close them or not, but yes, we are discussing. We are also looking at opportunities in Western Europe. In this case, we are looking at bigger entities that would act, let's say, as a sort of portfolio company on which to provide the later on add-ons with further acquisitions once in that country. It's a longer process. We must be More careful here because we don't yet know these markets, so we must be really careful in selecting the targets. But we are discussing with multiple M&A firms that are providing targets and we are looking at the targets in this moment. It will take some time, probably. Here we need, as I said, to be really spot on in terms of choice of the target. But yes, we are working on this. The M&A trajectory that we designed is of paramount importance for our development. And so, yes, we keep on running it.

OK.

OK, so another question come from Mr. Berti. Mr. Berti, please remember to activate your microphone.

Hi, good morning everyone. Thank you for the presentation. I was wondering what's what is the visibility you have on the guidance you provided? My understanding is that it incorporates the assumption of mild recovery in consumer demand in the second half of the year. Is that correct and what is the visibility on that? Second question, if you can provide a comment on the timing you expect for the stocking and therefore the return to a more normalized level of financial position.

Yeah, In terms of the visibility on the guidance, well, gross profit margins are growing, notwithstanding the increased interest rate costs there within the gross profit by the financial costs of the factoring. So in our guidance, we have incorporated higher gross profit margins very strict cost control. We do expect some growth in the overall SG&A, although we are exerting a tremendous pressure on our organization to keep a lead on costs. We are forcing holidays on our people. We are reducing significantly the turnover, so the substitution of people that leave uh autonomously the company uh we are renegotiating furthermore contracts with everybody we have reduced we have sub rented the portion of our italian offices we are putting a lead on travel so lots of activity over there good news is that the um the weight on revenues of variable cost is stable. So we have stabilized the inflation in this area as well after very strong and harsh negotiations with suppliers, as well as redesigning of certain processes. It all boils down to the volumes. So far, The visibility is that we could have an era of stable, if not slightly higher levels of revenues. That's the math incorporated in the best case scenario. And there's another hypothesis of low single digit decline in revenues that is incorporated in the lower level of the guidance. So we'll see what will happen in the next month. April has been a challenge month. May looks much better. The overall sentiment of business customers is fairly good. consumer retailers are struggling. And again, the point is more on the perception rather than truly the numbers as a scene. There's a bad mood out there, which apparently is not reflected in the hard figures that we get from from the government, from statistical entities. And especially in the consumer segment, we think that it's not so much an issue of crisis it's a rebalancing of the share of wallet after having been mostly devoted to indoor spending during the pandemic this sort of binge spending in outdoor activities and probably it will bounce back to a more normal situation so Those are the assumptions under the visibility of the guidance. And as long as the guidance has been issued yesterday night, it incorporates all the information that we have as of today. And therefore, so far, we have a good visibility. All analysts are unanimous in stating that there should be a mild year-on-year recovery in the distribution industry in the second half, especially driven by better performance on PCs. Smartphones are not doing bad. Consumer electronics is very challenged, especially in Italy. Last year, we had... government subsidies for TVs, so it will be a hard time for those that sell TVs this year. But apart from this, we have more uncertainty, so the range is higher than usual. But so far, we think it should turn out to be a good year, potentially another record year. we'll see in due time depending on the overall performance of the market and also on the timing of the stocking, which is your second question. The impact on gross profit margin is linked also to the speed of the stocking. We have been able to significantly destock without any impact on our gross profit margins. As a matter of fact, they grew. The timing is also linked here. We are patient and we are helping our customers, our suppliers to find the right timing to reduce the level of the stock because it's a painful journey for them especially and to a lesser extent for us. It really depends on the recovery, especially in the PC market. If the PC market will provide some signs of recovery before summer or earlier in September, I think by the end of the year we should have probably normalized the situation even earlier if possible. If not, it would probably be a more muted journey. But we'll see. It's really hard to have a strong prediction. We were more positive last year. And so we said probably by the end of the year, everything will be fixed. And we were wrong because the market turned down in Q4. And so we We have to be cautious in providing timing. Most probably by the end of the year, the situation should be over anyhow.

Thank you very much. You're welcome. Any other questions? Apparently not.

Well, thanks everybody for joining us today. We are on a journey and here we are. For further questions, as always, feel free to get in touch with us. We have an upcoming series of stock conferences. You can find them in our calendar on our investor relation website. and eager to see you soon at one of these meetings and hope you're all well and speak soon. Thanks.

Thank you and see you next time.