Dorel Industries Inc. (DIIB) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Dorel Industries' Second Quarter 2020 Results Conference Call. [Operator Instructions] Before turning the meeting over to management, please be advised that this conference will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded today, August 11, 2020. I will now turn the call over to Martin Schwartz, President and CEO. Please go ahead.

Thank you. Well, good morning, and thank you all for joining us for Dorel's earnings call for the second quarter ended June 30. Joining me are Jeffrey Schwartz, CFO; and Frank Rana, VP of Finance. We will take your questions following our comments. As always, all numbers mentioned will be in U.S. dollars. 2020 has been a year like none others for all of us. While it began quite normally, it quickly and dramatically deteriorated with the onslaught of COVID-19. I am pleased to report that Dorel's revenues have recovered sharply from the initial negative effects of the pandemic, with strong performances in 2 of our 3 segments. Both Dorel Sports and Dorel Home benefited from increased demand as consumers have chosen Dorel for its bicycle and home furnishing purchases, selecting our leading brands and outstanding value products. Our advanced capabilities in e-commerce have also allowed us to deliver reliably and efficiently. Increased sales of in-stock items allowed both businesses to reduce inventories to record low levels. It's been somewhat different at Dorel Juvenile, which remained challenged through the first half of the quarter, affected by continuing store closures in many markets, a situation which began reversing as more stores reopen. I applaud our divisions, which have done an excellent job of cutting costs and holding discretionary spending, resulting in a considerable decrease in selling expenses. I'm also pleased to say that our balance sheet has improved significantly with much lower inventories and overall debt. Looking now to our individual segments. Dorel Sports had its fifth consecutive quarter of revenue growth and posted record profits, a sharp reversal from Q1's COVID-related operating loss. Bike factories in Asia closed for 4 to 6 weeks during the first quarter, initially severely reduced supply. Then as the factories were ramping back up, demand for bikes took off to an extent never seen before. According to the NPD Group, which offers point-of-sale data, retail sales tracking and analytic research, U.S. bicycle sales through all retail channels grew 75% in April to about $1 billion in retail sales, marking the first time sales reached that level in a single month. Typically, April sales are between $550 million and $575 million. NPD noted that bikes for family use, neighborhood riding and lower price points showed the strongest year-over-year sale gains. There are many reasons for this surge. First and foremost, people want and need to get out after weeks of force lockdowns to be able to exercise. And with the good weather, huge numbers are out in an easy, safe ensuring social distancing. Many are still reluctant to get on a bus or subway and are also staying away from gyms, even though most have reopened. Cities almost everywhere are encouraging cycling with significant additions to their bicycle infrastructure, plus people are staying put and spending on bikes for family recreation. As a result, CSG and Pacific Cycle did very well with sales, particularly online, only limited by a lack of supply. In CSG, our U.S. IBD channel saw revenue growth strong double digits over last year. And in the U.K., revenue was up just over 100%. Clearly, we could have sold more bikes than we had them. Our third bike division, Caloi was hurt by sustained closures in Brazil and the April-May shutdown of their factory. But looking ahead, based on current trends, the demand for bicycles is expected to remain strong throughout the summer. Ongoing supply constraints will limit sales, but expectations are that Q3 revenues and operating profits will continue to be strong. Due to the current volatility in the bicycle industry because of the pandemic, longer-term visibility is difficult. Changes in current demand levels and possibly in the seasonality of bicycle sales currently makes expectations for the fourth quarter and beyond unclear. Dorel Home did equally as well as it posted record revenues. As lockdowns took hold in mid-March and were maintained for several weeks, attention initially for needed home office furniture turned to home renovations and DIY projects in general. Purchases of desks and entertainment units were strong. As the weeks wore on, consumers turned to the segment's other categories, including beds, futons, and with all staying put outdoor recreational furniture. Folding furniture such as tables and chairs as well as step stools were soft earlier in Q2 but also sold well. Online sales have been driving much of the segment's revenue growth. Last Wednesday, one of the world's largest online furniture retailers, a significant Dorel Home customer, reported second quarter sales growth of 84% due to what they termed unprecedented demand. As with Sports, inventory was way down and created supply issues, which limited some sales. This is now coming back somewhat, but remains constrained as demand remains strong. Recent surveys indicate the work-from-home trend will be maintained for a while. Last week, a KPMG poll found that 54% of Canadians are afraid to return to the workplace, given how contagious the virus is. In the U.S., Global Workplace Analytics, a research firm that helps employers prepare for the future of work, say some 56% of the workforce holds a job that is compatible with remote work and estimates that as much as 30% will be working from home multiple days a week by the end of 2021. As we look ahead, obviously, this bodes well for the continuing sales of home office furniture. We anticipate this trend to continue with Q3 revenues and operating profits expected to be strong. At current demand levels, inventory shortages could constrain sales in the short term, but the outlook for Dorel Home remains positive. Dorel Juvenile had a rough first quarter, but saw recovery starting midway through Q2. Apart from the U.S., most of its markets were hurt by retail store closures, which was especially the case in Europe. Even some online purchases there could not be delivered as baby stores were deemed nonessential. As stores began to reopen in May after a very challenging April, things began to improve and this continued through the end of the quarter. At Dorel Juvenile Europe, back-to-business promotions initiated in June, is supporting our retail customers to drive sales and earnings. The core Juvenile category of car seats and strollers, which suffered earlier, have started to come back, the U.S. government's stimulus checks have allowed consumers to buy. Items such as thermometers and other safety-first items were sold out everywhere and factories were working at maximum capacity to meet demand. Chile and Peru have been slow to bounce back, as Dorel-owned stores were closed for most of Q2. Many are still closed today, and there are limited e-commerce options. Looking ahead to the current second half despite ongoing weakness in South America, Dorel Juvenile is expected to continue to improve its operating profit. In terms of our overall outlook in the short term, robust sales, particularly at Dorel Sports and Dorel Homes should continue, but there are many unknowns and risks going forward. The impact of the slowing economy and higher unemployment is difficult to measure at this time. The possibility of worsening economic conditions brought on by a second coronavirus wave, means current shopping habits could change again. While we are currently enjoying strong demand in many of our markets, we must be prudent going forward in our inventory purchases, keeping a proper balance and in our expenses in general. I'm extremely grateful to our employees worldwide who have demonstrated their clear commitment to Dorel, by directly contributing to our lower costs in the second quarter and who continued working in our facilities under enhanced safety protocols. Their safety and welfare remain our top priority. I will now ask Jeffrey to provide the financial perspectives. Jeffrey?

Thank you, Martin. For the second quarter of 2020, Dorel's revenue increased by $54 million or 8.1%. Organic revenue improved by approximately 10.1% after removing the variations of foreign exchange year-over-year. Revenue and organic -- regular revenue and organic revenue improvements were in the Home and Sports section, partially offset by a decline of about 20% in the Juvenile. Gross profit for the quarter decreased 50 basis points to 20 from 20.5 in '19. SG&A. Selling expenses for the quarter declined by $14 million or 25%, a big number. Selling expenses were lower in all 3 segments due to spending cuts that were initiated in mid-March to mitigate the impact before we knew what demand would be. We did that through reducing the workforce temporarily in certain locations and reducing marketing spend and promotional activity as it wasn't needed in a number of categories. On the general and administrative expenses, they actually increased by 6% in the quarter. These were areas that were a little bit more difficult to pull back on during the time. Some other items from the income statement. We did have an impairment loss on accounts receivable of $3.5 million for the quarter. That was due to a filing for bankruptcy in Brazil of a bike share program, where we contributed the bikes for those primary reason for that. Finance expenses decreased slightly by $0.5 million from the last -- from the second quarter last year. And finally, the net income during the quarter -- net income was $11.1 million or $0.34 per share compared to $2.8 million or $0.09 last year. Then when we exclude restructuring costs, the adjusted net income for the quarter increased by $9 million to $15.6 million or $0.48 per share compared to $6.3 million or $0.19 last year. So now if we go to the individual segments. The Sports business had obviously tremendous quarter, with revenue up $44.6 million or 18.5% to $285.6 million. When we exclude the impact of varying foreign exchanges year-over-year, the actual organic revenue increased by 21.1%. The revenue growth was in all markets where stores were allowed to remain open. So what we saw was the U.S. was primarily open the entire time. And Europe gradually opened as the quarter went through. And as soon as it did open, sales grew substantially. Revenue down in Brazil at Caloi was impacted negatively due to the outbreak of the pandemic. Brazil is one of the worst hit countries in the world, and they did close a lot of doors, particularly early in the quarter. Gross profit for the quarter improved by 300 basis points to 23.6%. The increase was mainly due to less discounting, as we didn't need to do that during the quarter. Lower promotional incentive offerings and some favorable tariff exclusions granted in the U.S. On the other side, partially offsetting that, those gains were the impact of foreign currency in Brazil as well as some promotional activity in Brazil that we did to improve sales in the country. Ultimately, the operating profit in the quarter was $26.8 million compared to $10.1 million. The operating profit improved, as we said, mainly due to the increase in revenues and gross margin improvements as well as an overall reduced expenses, as we discussed before. Moving over to the Home division. Second quarter revenues increased by $53 million or 25%. Strong online sales in response to consumer needs during the pandemic. Stay-at-home period resulted in some record-setting revenues for the second quarter in all parts of that division. The gross profits were 13.3% and that declined by 90 basis points. However, we did do a small restructuring plan. So if you -- excluding the restructuring plan, the gross profit was 14.2%, which was flat with last year. The operating profit in the division improved by $4.5 million. However, when you exclude restructuring costs, operating profits improved by $7.3 million for the second quarter. And again, the reasons for that is improved revenues as well as some overall reduced expenses. If we move to Juvenile, much more things going on in the Juvenile. A bit of a tail of 2 stories during the quarter. I mean it started off quite, quite difficult with virtually all stores in Europe close and ended up in a strong June. So the net result of all that was we were down about almost 20%. We dropped sales from $221 million in '09 to about $177 million in 2020. Organic revenue declined by about 16.8%. Almost all the markets reported organic revenue declines because of the virus, with the most specific -- most significant being in areas where stores were closed, such as South America and Europe. As countries in the regions began reopening in the latter part of May and June, we definitely saw a rebound in those markets, but not enough to reverse the impact of the problems at the beginning of the quarter. Second quarter gross profit was 23.9%. This represented a decline of 230 basis points. If we exclude restructuring costs, the adjusted gross profit for the quarter was 24%, which represented a decline of 270 basis points. The decline in gross profits and adjusted gross profits were mainly due to lower volume absorption of the fixed overhead costs as well as higher promotional incentive offerings in certain markets in an effort to increase sales upon reopening. That did work. It did cost us some money, but we did see a boost in sales because of those efforts. The operating loss in the division was $1.2 million during the second quarter compared to a profit of $2.4 million. But if we exclude restructuring costs, operating profit declined by $5.6 million to $1 million from the $6.6 million last year. And I'm just going to talk a little bit about the long-term debt because there was a significant change there. So just a little bit of history here. So at the beginning of -- at the end of the first quarter, we increased our debt levels to maintain additional cash on hand and liquidity to meet our obligations during the downturn caused by the pandemic, while at the same time, ensuring we remain compliant with our amended borrowing covenants, which we got at the end of the first quarter. During the second quarter, consumer demand for bikes and home products led to increased sales generating higher cash on hand and therefore, improving our liquidity position. Accordingly, during the second quarter, we were able to reduce our debt level significantly. Our current -- our revolving credit facilities and term loans are due in -- right now at July 2021. And we're currently in discussions with our lenders to extend those dates. We're also looking at some other financing alternatives. But the net result of all this was the increase in demand reduced our inventory significantly. We were able to clear through a lot of the slower moving inventory. And we ultimately turn that to cash, which ultimately pay down debt. So today, we are comfortably under our all the covenants that we're supposed to be, and are looking forward to the future in a much less tight environment on our balance sheet than we've had over the last 1.5 years or so. So with that, I'm going to pass it back to Martin.

Okay. Thank you, Jeffrey. I'll now ask the operator to open the lines for questions. [Operator Instructions] Operator?

[Operator Instructions] Your first question comes from the line of Stephen MacLeod from BMO Capital Markets.

Just maybe starting with the Sports business. Could you just talk a little bit about where you see demand today versus the peaks in sort of March and April?

Demand, I mean, there's -- because of the worldwide shortage of bikes, demand is still pretty strong. There's very little inventory in stores today. So it's difficult to measure how deep it is. But today, again, everything we ship to the store seems to be moving through the system. So again, this is in a sense, unprecedented, so it's very difficult for anyone to truly be able to forecast on the bike side, where all of this is going. But right now, as we speak, demand is still very high and in-store inventory remains very low.

Okay. And is it possible -- like it sounds as though you saw revenue sort of -- like in the quarter, you didn't have Europe open the full quarter. So is it possible that you could actually see revenue in Q3 growth accelerating from where it was in Q2 on a year-over-year basis?

The problem that we have, let's address this now because I've got a lot of questions is on the supply constraints. So what that means is the time line to order bikes is anywhere from 90 to 150 days. So when we place -- started to place new orders for increased supply, we were getting all of our supply. There's been no problem getting the original supply. So I want to make that very clear. Whatever we were planning on getting, we're getting all of that plus more. But in order to increase supply for the increased demand, that -- there's a lag, and it takes a while to get there. So the limits we look at in Q3, if we were able to fulfill all the demand, yes, absolutely, you'd be right, Steve, we would be able to like match that number. But the stuff that's coming in, in, let's say, August, needed to have been ordered maybe in April. And April was just when we started seeing all of this demand. So the question is, when is this stuff going to come in, which time period and what's demand going to be like in that period, which is -- causes a lot of sort of uncertainty from our point of view. But where we have supply, where are we getting bikes in, I mean, they're going right out of the door.

Okay. That's good color. Maybe just one more, if I could, and then I'll get back into the queue. Just turning to the Home business. Can you talk a little bit about what you saw in terms of month-to-month progression through the quarter and into Q3? You talked a little bit about June sales sort of moderating slightly from higher levels early in the quarter. But can you talk a little bit about where you are now? And I guess, is it fair to read through the outlook that you talked about revenues and operating profit expected to be strong. I assume you mean continuing to be up year-over-year in Q3.

Yes. So we started off with both May and June with record sales -- not May and June, sorry, April and May, record sales. June came down slightly, but still very good. And that's the level we're continuing to see right now. Some of that is constrained by running out of inventory. So we are, again -- similarly we are getting more supply. It's not -- unfortunately, it's not 90 to 150 days. So we're able to get stuff in a little bit earlier than the bikes. But we're still running out of SKUs or running out of inventory on certain SKUs, which is limiting us. So it's difficult when you're in an online environment to understand the true demand because when you're out of stock, your product is not -- nobody is asking for it on an online site. So we're seeing lower than peak sales months now and probably will through the quarter. A lot of that again is constrained by demand, although it's a little more difficult, like I said, to know what true demand is. However, it is -- like you said, it is going to be a very good quarter again in Q3, as we see, again, sort of more of a stable environment compared to the bikes, which is far more volatile from a demand standpoint.

[Operator Instructions] Your next question comes from the line of Derek Lessard from Toronto-Dominion.

Yes. I was just wondering in terms of the strong demand. If you have -- what -- how do you intend to keep, I guess, the momentum up once the COVID impact begins to recede. I mean you're going to be coming up against some pretty tough comps in 2021 as we start to lap these quarters, just wondering what your thoughts are there.

Yes. So going into the year, we were looking at increasing market share. And that was our strategy. And that's what we were doing pre-pandemic and again, very short sample, but we thought, particularly on bikes that we were doing a good job there. Then the pandemic hit and sort of all data points don't make a lot of sense. We do believe next year that supply will catch up to demand. So this unprecedented sort of whatever you have sales probably won't be there next year. But again, our strategy of increasing market share of the pie is still there, and that's still what we're working on. We do believe the pie will be bigger. And therefore, give us an opportunity to do that. But you're right, it's going to be a little more challenging, given what happened this year. Our costs are probably going to go up. We didn't do a lot of marketing this year. We didn't do a lot of event planning and all of that stuff that you normally do. So there was some savings there, which will probably come back next year. But again, we do think the pie will be bigger, and we do believe what we're doing will allow us to increase our market share within the pie.

Okay. And I guess maybe if you could just highlight some of the mitigation efforts that you have in place for Juvenile. It's obviously -- the segment is facing some pretty tough challenges. And obviously, some of the markets are still opening up. Just wondering if you've thought about is there still cost-cutting going on, layoffs or...

Yes. Well, certainly, in places that are more challenging, such as South America, particularly Chile and Peru that are per capita, one of the worst countries in the world for the virus. So a lot of stores are not opened. However, this is baby products. So people do have to buy. We are looking at trying to continuously reduce our footprint in those markets. So that's probably the area of the biggest continual cost reductions. Things in U.S. and Europe are somewhat back to normal by now. So as you know, we've already done quite a bit of cost cutting in Europe, and that's working out well. And -- so there's not -- we started off in a bad place, but we finished the quarter with a much better run rate. So where it's going well, we're fine. And then where it's not, we're looking at additional cost cutting.

Okay. And maybe just a couple of housekeeping for me. Just on -- I think last quarter, you had mentioned a CapEx number of around $25 million to $35 million. Is that still the right number for this year? And I guess, how do you see that playing out in 2021 and '22?

Yes. I would think that, that's probably still a good number, maybe to the higher side of it now that things are coming back. We certainly push stuff back a bit. But as I said, with business getting back to somewhat normal for us, even in the Juvenile business, we're coming back. But we are definitely going to -- if we look forward, we're going to try and spend less than we have in the past through a better R&D system, particularly on the Juvenile side, where we think we can get more product out of the system with spending less money. So I think you're going to see us down from our peaks, but we don't have the final budgets ready for the next few. But the goal is to get the CapEx down, not up.

Okay. Okay. And 1 last 1 for me is on the corporate expense line. It was back up in the quarter. Just wondering if that's still stock-based comp. And I guess what's the right level we should be looking at? It's typically run around $6 million a quarter. That was $2.5 million in Q1. Just get your thoughts there?

Yes. I think it's $6 million a quarter still probably a pretty good number. I mean, a lot happened between cost cutting, and I'm sure all compensation bonuses were removed from everything in Q1. And now that we're actually doing well, we've put them back in and so there's some of that going on there. But overall, I think at the end of the day, $6 million is probably still the right number. I don't see much growth from that.

Your next question comes from the line of Stephen MacLeod from BMO Capital Markets.

Just a couple of follow-up questions for me. Just on the Juvenile business, you talked a little bit about some of the improvements as you moved sequentially through the quarter. Do you feel as though you're in a position to have -- when you talked about improvements in EBIT, are you talking about improvements in the back half of the year being sort of up year-over-year? Or are you talking more improvements sequentially?

Everything we're looking at is year-over-year. So that's what I've been talking about.

Yes. Okay. Okay. Great. That's what I thought. And then can you talk a little bit about the SG&A level going forward? You talked about lower selling expenses, but do you have to ramp that selling expense back up into Q3 and beyond? Or do you feel as though the organic demand is still there and you can still ratchet that number -- have that number pull back a bit?

Yes. That's a really good question. So it's a bit of both. When I look at our Juvenile business, in Europe, we did get some relief from some government agencies to keep the employees on during the time that all the stores were closed. That has now gone away, given that the stores are open. But -- so we won't have that relief in Q3. And so our expenses will go up in Q3 in our Juvenile business because of that. On the flip side, in Sports right now I mean, to -- there's no need to be spending promotional dollars trying to sell a bicycle. So very little of that's happening. Also in the bicycle world, a lot of promotions are event-based, where you got to get out there and you're sponsoring some events. All those events, for the most part, are canceled. So I don't see that coming back this year. I think we'll be able to maintain lower SG&A. And then ultimately, in the selling world, we've learned a lot. I think a lot of companies have learned what they can and can't do with a reduced sort of spend. And I think as we look forward into next year, we'll be able to reduce some spending as well on a permanent basis. So it's a little bit of a mixed answer.

Right. Okay. And would you expect, like in the Home business, similar to Sports, there's no need to spend promotional dollars to drive home furnishings product sales?

We still -- we do still spend money there, but a little bit less. I mean, depending on the SKU. I mean, there are certain SKUs that are selling very, very well now. So we would likely spend a little less on those SKUs and other SKUs that we will spend on. I mean, that's the way that market works. It's a lot more -- promotions are done almost on a SKU level as opposed to a brand level that we have in other businesses. So that will be selective based on what inventories we have and what products we want to move and all of that.

Okay. Okay. That's helpful. And then in the Home business, can you quantify how much of your business is online versus in store?

I believe that's about 65% ballpark?

Yes, it is.

Yes, 65%.

65% online?

Yes.

Yes. Okay. And then just...

And then sold to online dealers, like online retailers, not dealers, right? Like people like the Amazons and stuff like that.

So would that include online sales at a large mass customer as well or no?

Yes, yes. So we would look at somebody like a Walmart and say there's Walmart stores and there's walmart.com. So we allocate what is sold at walmart.com, for instance, would be put into that 65%.

Right. Okay. Okay. And then maybe just finally for me. It might be a bit too premature to think about this, but with debt coming down and earnings coming up, how do you think about the dividend at this point?

Yes, it is a bit premature. We've had 1 great quarter. We think we're going to continue. It's a good discussion to have later. But right now, that's not on the table. We need to build a little bit more of the secure base. So it just feels good to at least get that sort of -- the way we look at it, there was $100 million of excess inventory that we shouldn't have been sitting on last year with the whole -- particularly in the U.S. with the whole tariff thing. And that ended up being $100 million more of debt, which really was a burden. And now that burden is gone, so we feel a lot less lighter. So I think 1 step at a time.

Your next question comes from the line of Derek Lessard from Toronto-Dominion.

Follow-up for me, gentlemen, is on the Juvenile side, I guess I wanted to get your thoughts on whether or not you think you're past the worst in terms of the sales environment? And secondly, I was wondering if you're expecting sales growth for the second half of the year?

Yes. Good question. Yes, I do think we are behind us. We are seeing -- I'm just trying to think -- we are definitely seeing improvement, particularly in our 2 largest markets, which is the U.S. and Europe. And we're having some success with new products in Europe. So I know the worst of our business was last year in Europe in Q3 and Q4, where things were really, really kind of going down and now that we have those as comps, I feel pretty good that we'll be able to beat that despite having some laggards like Chile and Peru that are just probably still going to be down from last year to help to able to beat last year, yes.

Mr. Schwartz, there are no further questions at this time. Please continue.

Okay. Well, thank you, everybody. This concludes today's call. I want to thank everybody for being with us. And just so everybody, please stay safe, stay healthy. Thank you.

Thank you.

This concludes today's conference call. You may now disconnect.