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

Welcome to the Pierce Group Audiocast with Teleconference Q4 2021. [Operator Instructions] Just to remind you, the call is being recorded. I'll now hand the floor to Henrik Zadig, CEO. Please begin your meeting.

Good morning, everyone. And welcome to Pierce Fourth Quarter earnings call. I'm Henrik Zadig. I'm the CEO, and with me here in the office I have Tomas Ljunglof, our CFO. So let's move straight to the agenda on Page 3, Please. On the agenda today, I'll start by making a short introduction to Pierce, and then we'll cover the Q4 highlights and a financial update, and then we conclude with some comments about the future and Q&As. So let's move to Page 4, please. Pierce has become a European online leader within the fragmented motorcycle niche. We sell gear, parts and accessories for motorcycles in 16 European markets, and 2/3 of our sales come from outside the Nordics. What's unique about Pierce is our private brand products, which now represents 41% of the revenues. Pierce has had a strong growth trajectory historically. During 2021, the growth was 7% in local currencies, and the adjusted EBIT was SEK 58 million, down from SEK 97 million last year. The main reason for the margin decrease 2021 is the Asian container costs, which increased by SEK 27 million versus the year before. And also, as we've been saying repeatedly, when you look at the 2020 numbers, it is important to remember that 2020 was fueled by strong revenue growth due to corona, and we estimate that the adjusted EBIT in 2020 was impacted positively by around SEK 15 million from that. Page 6, please. Overall, the fourth quarter was characterized by a market with better product availability in general in the market and declining online traffic in the market. And this unbalanced situation led to an aggressive campaign period with pressured prices, especially during Black Week. Starting with the financials. In Q4, we reported revenues that grew 1% in local currencies. And we should remember that this is versus a strong Q4 2020, when the growth was 25% in local currencies. However, this 1% growth in the fourth quarter was lower than we expected as we had much better product availability compared to the year before. Due to the pandemic effects during both 2020 and 2021, it is useful to extend the perspective 2 years and compare Q4 2021 with the same quarter in 2019. And when we do that, the average annual growth or CAGR in local currencies was 13% compared to 14% in the third quarter. Adjusted EBIT of SEK 6 million during the quarter was weak as the gross margin declined significantly versus last year, that means the EBIT margin was down 8 percentage points. And there were a number of drivers behind this. High container shipping costs from Asia, as I said, continue to be a problem and reduced the margin by 2 points. FX effect impacted negatively by 1 point versus last year. Price adjustments and higher purchase prices impacted by 2 points. And in addition, we also increased our marketing investments to drive volume in a declining market during the quarter, and this impacted the margin by 2 points during the quarter. As we had expected higher growth that had built safety stock due to the ongoing supply chain turbulence, the stock grew and the working capital increased. And while the stock is fresh and of good quality, we now need to drive sales to get the stock level down. On the operational side, despite all the challenges due to restrictions, we were able to keep our operational performance stable during the campaign. In the Polish warehouse, we hired a lot of temporary workers, and we also took a number of measures to tune the systems to ensure operational stability during high load times. And the campaign worked out very well, and the customer satisfaction reached an all-time high during the quarter. Page 7, please. So let me share some comments on the market, which was indeed challenging in the fourth quarter. First, we observed better product availability, again, overall in the market and also for Pierce after around 18 months with weak availability due to the global supply chain disruptions. The situation is not perfect, and there are still areas where the availability is not satisfactory. But overall, it is improving. Second, some comments on the traffic. At the start of the quarter, we observed some traffic growth again in the market. However, as the quarter progressed, the traffic growth in the market slowed down, and it even declined versus last year during the Black Week. For the quarter as a whole, the traffic declined marginally in the market and also for Pierce. And this unbalanced situation with higher supply in the sense of more products available in the market and lower demand in the sense of lower traffic in the market led to an intense competitive situation during the campaign period when large volumes were shifted. And most players that we could observe ran extensive and aggressive campaigns. So there was high price pressure in the market during the campaign period. Now 1 important question is what happens to the customer-facing price levels in the market given the increasing costs from freight and raw materials? And during the fourth quarter, we saw some early signs that customer prices at least started to adapt to the new higher cost levels. For example, we could see some of the recommended retail prices on external brands increasing, and we ourselves tried again to increase prices for selected products with high in-freight costs. However, in the end, these were only small isolated signs that could not change the total picture of a quarter with intense competition, particularly during the Black Week, when many players appeared to try to clear out stock through general price reductions. And prices are, of course, transparent in the online world. So being competitive is important. And if the market does not accept increased prices, we need to revert. So far, therefore, we've been able to forward only a limited part of our cost increases to the customers. And while it's not possible to say when, over time, I think that the industry simply needs to forward these increases to the customers. At times like this, it is important to keep perspectives. So while the Q4 was challenging, the long-term market drivers remain intact. Our category is well suited for online given the wide selection required for the large number of bikes out there and the convenience of online shopping. And it's still a category, which is underpenetrated online. The online penetration in this SEK 100 billion European market was only 14% 2 years ago, according to the market study we commissioned. It has grown a few points since then, but it's clearly, as a category, behind other nearby categories like fashion in terms of online penetration. There is still a lot of growth potential coming from the ongoing channel shift when sales is moving from physical stores to online. Now as to the start of the first quarter in 2022, although the visibility is still limited, and we're only 6 weeks in, we do see some signs of some traffic growth in the market again, and I'll come back with some more comments about the future towards the end. Page 8, please. When looking at the revenue growth in the last 3 quarters, we see that, in the second quarter, revenue declined 1% due to an exceptional growth in the second quarter of 2020 as well as low product availability, which we had back then. And in the third quarter, revenue grew 11%. Again, the quarter was characterized by product availability issues, in particular related to clearance deals, which held back the growth somewhat. And now in the fourth quarter, as I said, product availability improved and the average order value increased, but these effects were offset by negative traffic development in the market. Page 9, please. Since the pandemic distorts the figures, both the 2020 figures and 2021, it is useful to look back 2 years and compare the quarterly growth versus 2019. And when we do that, we can see that the growth rate, CAGR in local currencies during the first quarter was 19% and 17% in the second quarter, 14% in the third quarter and then now 13% in the fourth quarter. So even in the last couple of quarters with all the challenges we have faced, there is underlying growth when we compare to the situation 2 years ago. And for the full year of 2021, CAGR was 16% versus 2019. Page 10, please. The customer base continues to grow and it is positive to see that we can increase the base despite the high number of new customers acquired during the pandemic. During 2020, the lockdowns drove a high number of new customers, while some slowdown was expected during 2021. The number of orders is up 1% versus 2020, or up 17% versus 2019. And the average order value is growing steadily. We are working actively on different tactics to increase the size of the basket, which has paid off. And this also improves the freight efficiency in the P&L. Page 11, please. The private brand growth follows the overall revenue growth and shows a CAGR of 18% versus 2019. The customer satisfaction scores continued their upward trend and reached an all-time high of 4.3 out of 5 for a full quarter. And this is very good to see and as a result of a lot of work to improve and automate processes and systems. Page 12, please. The shipping costs from Asia continued to be in exceptionally high levels. In Q4, this affected the gross margin negatively by around 2 percentage points versus the year before. The cost decline that you can see here in the fourth quarter versus the third quarter is mainly related to changes in product mix. And as we've been saying, the increased shipping costs affect the P&L only when the products are sold. Since the majority of the products shipped during the last couple of months have not been sold yet, and they do have high shipping costs, we foresee that the high cost for in-freight will remain during the coming quarters. So I'll now hand over to our CFO, Tomas Ljunglof, to take you through the financial update on Page 14.

Good morning. After Q3 revenue growth of 11% in local currencies, the growth was 1% in Q4. We had a far better stock situation than last year, but we were surprised by the negative traffic development in the market. To drive growth, we took a hit on the contribution margin as we, around mid-Black Week, decided to reduce prices and also spend more on performance marketing to drive traffic. This, together with increased shipping costs from Asia, were the main drivers for the lower Q4 contribution margin versus last year. The main reason for the year-on-year margin change in 2021 was the increased freight costs from Asia that was pushing down contribution margin with 1.7 percentage points. Page 15, please. In Q4, the EBIT margin declined significantly, and I will walk you through the details on the next slide. During the full year 2021, the main reasons for the EBIT development were the increased shipping cost from Asia of SEK 27 million. And then also, as I just mentioned, we did increase the spending on performance marketing, especially in Q4. As I've mentioned a few times earlier, and also in conjunction with the IPO, we roughly estimate that the adjusted EBIT in 2020 was positively affected by pandemic related effects of SEK [ 15 ] million. Page 16 increase. If you look at the EBIT margin development from Q4 last year to Q4 this year, there are a couple of larger items. First of all, we had the shipping cost from Asia, which were increasing by SEK 8 million and pushing the margins down by 1.8%, as you can see in the bridge. And then we had other gross margin items, which mainly refer to the price adjustments that we made to stimulate growth in Q4 then. And another large item is the direct costs that did increase by SEK 7 million and was relating to the additional spend on performance marketing to drive traffic. So those are the 3 major items and also minor items also as well. Please proceed onto Page 17. If you look at the segments then, and here we have the off-road segment, which is around 2/3 of our top line in the company then in Q4, the track traffic went down, and it did so more within off-road and obviously affected traffic negatively. So it was down somewhat in local currencies. And if you look at the full year, off-road met harder comps than on-road, resulting in a relatively low year-on-year growth in 2021, but a CAGR of 18% if you look back to '19. The margin decrease in the quarter was caused by the same factors as for the total company and just the one that I went through on the previous page. Page 18, please. The on-road segment was meeting easier comps than off-road, and consequently, the growth was better, and it was around 10%, both in Q4 and for the full year. Growth was helped by an improved assortment, better product availability and more competitive pricing. Year-on-year, margin development and also during 2021 were similar to developments within off-road even if the general levels within on-road is lower. Page 19, please. Net working capital increased compared to recent quarters, mainly due to the increased inventory. And the inventory levels were adapted to higher sales growth and also included a safety buffer to cover up for supply chain disturbances that we saw earlier in the year. Page 20, please. As a consequence of the net working capital developments that I just mentioned, the cash conversion in 2021 was weak, especially if you compare to the strong developments in 2020. Page 21, please. Given the poor financial developments, partially in Q3, but especially in Q4, which, to a large extent, was most caused by external macro factors, the net debt-to-EBITDA leverage ratio was 2x at the end of Q4, which means that we were on par with our leverage target. On the other hand, we had a year-end liquidity buffer of SEK 140 million, and we also had a very strong equity position in excess of SEK 400 million at year-end. I will now hand back to Henrik for wrap up. Page 23, please.

So let me then conclude with some remarks about the future. So although we clearly have a number of short-term challenges to tackle, we do see that the long-term strategic value drivers remain intact. Starting with the revenue, on the revenue side, we target 15% to 20% growth on average in the medium to long term. The online penetration of this category, as I said, is still low, and it's behind other nearby categories, so there is good potential for growth from the channel shift in the coming years. The market is highly fragmented on both the retail and supplier side. So it consists of a lot of small players. And in this European market, Pierce is the largest motorcycle focused online retailers with a unique assortment of -- with 40% private brand products and a large 1.6 million online social community. And while the Pierce online market share has been growing over the years, it's still only 10% in Europe. So there's a lot of shares still to be gained. So we believe that there is potential for the online market to continue to grow and for Pierce to continue to gain share. On the EBIT side, we target around 8% in the medium to long term. First, there is attractive unit economics coming from high average order value, strong gross margin and low returns. Going forward, as the on-road segment is expected to grow, there will likely be downward pressure on the contribution margin as on-road has a lower profitability than off-road. On the other hand, we estimate that these dramatic cost increases we've been hit by June 2021 are temporary. Over time, there should be an equilibrium between the cost increases and the price levels in the industry. And above with the margin improvement in percent is expected to come from OpEx scalability. We have built a scalable and efficient, well-proven distribution operation. We have newly launched a new IT setup, which should allow us to grow more contribution than OpEx and hence, drive scalability over time. Page 24, please. Now given this situation with a lot of the challenges to tackle, our main focus continues to be on the here and now. In the short term, the main objective is to drive sales to reduce the stock, while also keep trying to forward the cost increases to the customers as much as possible. And as you can understand, this is, of course, a balancing act. So how do we approach it? Well, the first is to ensure our prices are competitive. We have made a huge number of tactical price adjustments during Q4 and will continue to do so daily. Importantly here, we do not want to be the price leader and be the 1 to drive the price level down in the market. In fact, and let me be very clear, we want the price level to go up as the prices simply need to go up in the market to reflect the cost increases that everyone is facing. But in the end, prices are transparent online, and we need to be competitive to drive volume. So in the meantime, until there is a broad price adjustment upwards in the industry, we will continue to try to push through selective price increase for particular product types or in specific geographies. Sometimes, as we've seen this works, and then that's good and we stay on that level. But sometimes, the impact on volume is too big and then we adjust. We've also implemented a number of on-site tactics to increase the average order value in a bid to compensate the gross margin decrease with freight efficiency. And so far, we have seen good results from that. So that will continue. We have also adapted the campaign schedules. For example, we push, to a much lesser degree, products that our expensive to ship and instead favor higher margin products in our campaign. But there's also work to do to speed up time to market. Due to the pandemic, the product development has slowed down due to all the supply chain disruptions. We did manage to launch more new products in 2021 than during 2020. So the trend is improving, but we're not on target. So to accelerate this, we are taking a number of actions. We are canceling suppliers that don't perform. We are broadening our supplier network. We have invested in additional product development resources, and we have streamlined the product development process to enable products to go live faster. We have also implemented a specific speed line for parts extensions to accelerate that category. So there are several things we can do in the short term that are in our control. But overall, I should remember that we are still navigating in an uncertain market where both demand, supply and cost levels are impacted by continued pandemic effects. Looking further ahead in the medium to long term, the focus is to execute on the long-term growth strategy. And we continue to strengthen here the on-road assortment because growing within on-road is a strategic priority for us, and the assortment is an important lever for that. The on-road assortment has historically been built for Nordic riders, and we are in the process of making it more attractive also for Continental European riders, and we have seen progress on that. For example, during 2021, we signed a range of new brands that are relevant for Continental and Southern Europe, and we'll continue that during 2022. And on the product development side, most of our focus is to launch new products for on-road. We're also looking at investigating alternative sourcing routes to see if we can source cheaper and faster than from Asia. We've made some decisions to move parts of production to Europe, but it's still small volumes, and the lead times are long. So this is a longer-term play. And finally, driving OpEx scalability and improving the customer experience are key drivers for our long-term success. We have come some way in the last year, and I'm very pleased to see the all-time high customer satisfaction scores, but still, we have a lot of work to do to streamline and automate processes so that is very much part of our plans. So that concludes our presentation. Operator, let's move to Page 25 and open up for Q&As.

[Operator Instructions] Our first question comes from the line of Daniel Ovin of Nordea.

First question is on the price pressure in the market and also the higher input costs that apparently impacted your margin in Q4. So if you look at those drivers, and I calculate together, it's around 2 percentage point negative impact or more. Can you say anything of what you see of these drivers in the start of 2022? And perhaps also comment on what you expect for the first quarter in relation to Q4, i.e., do you expect a higher or lower impact from these drivers in Q1? That's the first question.

Could you -- when it comes to the price pressure, it's -- we see -- we saw it especially during Black Week. And -- but since then, it has been stabilizing. But from an overall perspective, I think it's fair to assume the same.

We don't see any dramatic changes when it comes to the overall price situations. We don't see big signs that the industry is yet absorbing all these cost increases. We see some signs, as I mentioned, but not as much as I would have expected.

Okay. So it sounds like the -- it's fair to assume a similar kind of pressure in Q1 as you saw in Q4 it sounds like. Okay. And then moving on to the next question and then looking at the inventory levels. And it sounds like your main priority here is to get down the inventory levels in the beginning of the year. And what kind of -- just to understand what kind of margin pressure can you tolerate to achieve this? Can you perhaps elaborate a little bit on how you think around the tradeoff between getting the inventory levels down and an impact on the margin side? That's the second question.

Yes. First of all, we are working and it is a priority -- very, very high priority. But in order to not push the margins down too much, so to say, we're taking a 6-month view upon this, right? So we will try to do it under -- in a controlled way to not push the margins down too much. But then there is this trade-off between growth and margins, right? And we can see here that when we have lowered the prices, we get better traction in the market. And we did the adjustment around mid-Black Week and since then the growth numbers are better. And what we are trying to optimize then is the marginal contribution in SEK. So one should not be looking too much at the percentage points. In the end, it's the SEK that we want and the SEK is kind of coming from then the growth numbers and the margin. So that's what we're trying to optimize. And as I just said, we're lowering the prices, hence lowering the margins, we could see top line growing. So that's how we try to play it.

The pricing here is a very dynamic play. Obviously, it's a daily game to be competitive, but not more competitive than we need to. We don't want to be the ones to drive the price levels down in the industry, as I said. So what we are doing, we're tweaking on a daily basis to try and see where -- what can we -- what can we push away, what can the market tolerate? And there are -- so we are able to push through certain price increases for specific product types or in specific geographies. But sometimes, when we make those pushes, we could see that the market doesn't tolerate it, the market is not ready, and then we need to revert back. So it is a daily game, as Tomas said, to try and optimize for the contributions sake.

Okay. Great. And then on the freight cost side. So as we talked about before, the lead time here is, if I remember correctly, 3 to 4 months. So that means that for Q1, the freight cost impact is more or less already set. And if I look a few months back, there seems to have been some volatility, but relatively flat numbers it looks like on my input factors here. So could you please -- can you perhaps comment on if that is correct assessment, that the freight cost should be around the same kind of pressure in Q1 as in Q4, or could they perhaps be even higher, even a more negative impact during Q4? That's the third question.

Yes. If you look at the container cost themselves, it is true, as you said, that those have been stable here for a while now. And it's also true that we do have this delay, whether it's 3 or 4 markets, but we do have a delay since we take the -- we include that in the inventory when we take it in, so to say, and it hits the P&L when we outbound to the customers. And due to this delay then of 3 to 4 months, it is -- as you said, it is going to be on a similar level as we did have in Q4. As you probably noticed, it actually went down a little bit as a percentage of revenue in Q4. And that -- as I said had to do with the product mix. So if you go back and look at our presentation in detail, you can see that the freight uplift, as a percentage of inventory, has actually gone up a little bit, right? So it could indicate that it could go up actually a little bit in Q1 and Q2, but it has to do with the product mix. Is that clear?

Yes, yes, absolutely. And then just the last question also a bit on how you think about your leverage level here because now you are in line with your target or your higher end not to be above. And I think that we talked about bank covenants being much higher around 3.5x. But what kind of level would you -- at what kind of level would you see a need to strengthen the balance sheet here? How do you think around those factors that would be interesting to know.

Yes, obviously, we're looking at close into this on a recurring basis, and we don't foresee it to break any covenants. And as you said yourself the covenant, which is by the way stated in reporting the risk section there is 3.5, and now we are at 2 down. So we don't foresee to break any covenants.

And we currently have 1 further question in the queue. That's from the line of Niklas Ekman of Carnegie.

Yes, a couple of questions here. Firstly, when you talk about the outlook improving in H2, and I mean, at the same time, you're talking about very poor visibility. So what besides easy comparisons makes you confident that things will start to get restored in the second half?

Yes. I mean, as I mentioned, yes, limited visibility means that it's a short period and data is not sort of always real time, right? So it can lag a few weeks. But when we look at -- and we have a number of different tools. And when we look at the tools and make a total assessment, we can see that there is some growth in the overall on the traffic levels in the market. So it's based on that. Now we should know that in Q1, that's for the first sort of 5, 6 weeks, but the really important thing in Q1 is March. So in March, that's when the season -- motorcycle season starts in Continental and Southern Europe. In Sweden, it's a month later, or in the Nordic city in a month later. But March is the month that really matters. So that's why I say it's limited visibility. It's early days still in the quarter.

Okay. Okay. Fair enough. And just generally on the demand on the on-road side, can you elaborate a little bit here what you're seeing? Because off-road clearly benefited from the pandemic, but that does not appear to be the case in on-road. So what kind of -- do you have any insight into traffic levels on the on-road side? How far these are from being restored? And then particularly now with the restrictions being eased in a lot of markets?

Yes. No, we don't have any insights. So 1 report when it comes to Sweden, that the number of kilometers was [ ridden ] was increasing, but I was very isolated. It was a small survey for Sweden only, and we don't have any statistics for Europe as a whole. But our expectation is that riding and commuting will come back as and when the societies open up. We have also seen that there are more -- there was somewhat more bikes sold in 2021, new bikes than the year before. So there are signs that it's coming back, but I think it's still to be seen how that will then reflect in traffic patterns in the overall market and then, ultimately, in terms of sales. So the coming couple of quarters will be very interesting.

Yes, indeed. And you talked here about the availability of clearance deals as well, how that had dropped significantly here in the quarter. Is it right to assume that you've gone from exceptionally high levels to exceptionally low levels? Is that how we should view this? Or what -- is it merely just...

Yes, I wouldn't call that it was exceptionally high levels before, but it was high levels back in 2019 and '20, I think the early start of 2020 was also -- we also had high levels. But then in 2021, it was very low levels. And what's going to happen now in 2022, it's still difficult to see, but I still expect that there were -- since there were some supply chain disruptions, a lot of last year I'm not sure there's going to be so much clearance available in 2022 either, but that remains to be seen. I think that those discussions are starting now during early Q2.

Yes. Yes. Sounds reasonable. Can I also ask about your view on M&A as an efficient way to secure your leading position in Europe? Has your view changed in any way here? And I guess, particularly considering what we've seen now with the very tough competitive pressure at the moment, does that increase your urgency to kind of expand and strengthen your position in Europe?

Yes, I think there is -- as I've been saying repeatedly, there is -- this market is ripe and ready for M&A activity. There's a lot of small players, both on the -- it's very fragmented with a lot of small players on both the supply side and the retail side. So -- and as you mentioned now, there's a lot of high -- very high competition, especially during the Black Week period, right? So I think there's a lot of players sitting with high inventories. That's our interpretation, my interpretation about trying to clear stock. So yes, I think there is definitely an opportunity for M&As. At the same time then, you need to make sure that you're, as a company, are ready. And we are fighting a lot of short-term battles here to recover and regain the growth trajectory. So I think there is -- it's a timing question as to when these M&A activities will happen?

Yes.

We are -- it's definitely in our plans.

[Operator Instructions] There seems to be no further questions coming through. I'll hand back to our speakers for the closing comments.

Then thank you, everyone for listening into this fourth quarter earnings call, and we'll come back with the Q1 report in May. So thank you very much. Have a good rest of the day.