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

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Dorel Industries' Third Quarter 2021 Results Conference Call. [Operator Instructions] Before turning the meeting over to management, please be advised that this conference call 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, November 5, 2021. I will now turn the conference over to Martin Schwartz, President and CEO. Please go ahead.

Thank you. Good afternoon, and thank you all for joining us for Dorel's third quarter earnings call for the period ended September 30. On the line with me are Jeffrey Schwartz, CFO; and Frank Rana, VP of Finance. We will take your questions following our comments. Again, all figures discussed are in U.S. dollars. Major accomplishment during the quarter was the agreement reached to sell Dorel Sports. Acting on feedback from our shareholders earlier this year, we embarked on a thorough review of strategic alternatives. We are pleased that this transaction has accomplished our objective of unlocking shareholder value. We have been able to monetize Dorel Sports at a time when the demand for bicycles remains very strong. Investor interest in Dorel has certainly picked up since the announcement. A main question being how the net proceeds of over $700 million will be used? We are looking at various scenarios. And as we have said, we will provide details once the deal closes, which is expected before the end of Q1 next year. Our focus now is on Dorel Home and Dorel Juvenile. The aim is to replicate the success achieved in our Sports business, but there is work to do. To this end, last month, we announced initiatives to strengthen Dorel Home, which I will elaborate on shortly. An unpleasant surprise last week was the judgment from the Luxembourg Administrative Court. Jeffrey will get into the details when he summarizes the financials. Turning now to our segments. The main concern as with most industries is the continuing supply chain disruptions, which do not appear to be going away any time soon. While demand for our products remain strong, and we have not lost market share, the situation has become overwhelming and it is difficult to predict when it will end. At the outset, the concern was the high cost of containers. This is still the case, but the ramifications are now far more wide-ranging with a snowball effect. Now it is difficult to even get containers. The loading process is slow, ships offshore are waiting to enter ports because of delays on loading trucks are hard to find and trucks are hard to find. And once finally at the destination, warehousing and handling for both us and our customers is more complicated and more expensive. This is presenting challenges to meet the continuing consumer demand for Dorel's products, but we are actively working on the solutions. Dorel Home has had a tough quarter due to the supply chain chaos, the continuing pandemic and a series of related operational challenges. COVID forced the shutdown of several of the segment's large suppliers in Southeast Asia for several months, some of which have reopened or are in the process of reopening. And COVID also closed important Chinese ports. COVID-related labor shortages at Dorel Home's U.S. distribution centers compounded the problems resulting in additional detention and demurrage charges, as we couldn't empty containers on time. This all combines to cancel or delay shipments, materially limiting product availability, thus reducing Q3 sales, both online and in-store. Domestic production in our factories was also affected due to a lack of availability of board and hardware, which impacted manufacturing and factory throughput. The situation is now improving. The segment increased the price of its products with continuing cost hikes, plus the lag time of implementation did not fully compensate for the situation. The good news is that many of Dorel's internal issues, such as stopping, turnaround fines and congestion began to ease in September and continued to improve through October. As well, Home has good inventory going into Q4 to meet the increasing demand. To bolster Dorel Home's growth prospects, we announced $29 million in investments. $10 million is for new factory equipment at the segment's 3 factories that will bring back some production from Asia, allow for manufacture of value-added, innovative new products and better serve our e-commerce partners with on trend products made in North America. New machinery in Dorel Home products, in Montreal, will permit the manufacturing of coiled spring mattresses previously imported from Asia. All equipment should be up and running in the first quarter of 2022. The $19 million acquisition of Danish-based Notio Living, an e-commerce whole furnishing firm provides an important advantage for further European expansion. The combination of Dorel Home's portfolio of products and brands with Notio's strong mainland Europe distribution capabilities are expected to significantly augment Dorel Home's European business. Dorel remains fully committed to taking a disciplined approach to value creation as it sees significant upside in its Dorel Home business. At Dorel Juvenile, markets in North and South America all reported higher revenue. Europe was the issue as it was most negatively impacted by the supply chain problems, partially offsetting revenue increases gained elsewhere. The disruption has caused a backlog of hundreds of containers in Asia, resulting in product shortages and out-of-stock conditions of certain key items. While some of these conditions have started to ease in Europe, product shortages are expected through Q4. While Dorel Sports had a solid quarter as consumer demand remained high, supply chain disruptions and a shortage of components impacted sales. Turning to our outlook. The risks and rising costs associated with supply chain disruptions that we referenced at the end of Q2 impacted our third quarter more than anticipated. Situation is not yet easing, and therefore, our expectations for Q4 are now lower than previously projected. Despite Dorel Home's disappointing third quarter for the reasons outlined, we are currently in a favorable inventory position and experienced uptick in demand in both September and October. Q4 earnings from operations are expected to improve from the third quarter. But given the higher costs we are experiencing, earnings from operations will not reach last year's levels. Our gross margins will remain under pressure in the short term as we continue to implement strategic price increases to offset the higher costs. The challenges in Juvenile and Europe persist, and while previously, we expected this to be a short-term issue is now a continuing reality. Container backlog is being reduced, but it's taking time and is costing more. In addition, passing on higher costs to our customers will only begin to materially impact our earnings early in 2022. As such, Q4 gains in other markets are going to be offset by losses in Europe, and we now expect the quarter to be approximately breakeven. With Dorel Sports now classified as a discontinued operation, given its impending sale, we continue to see strong demand while navigating the same issues as our other segments. The sale is on-track for closure in the first quarter of 2022. I want to take this opportunity to thank the Sports segment employees for their contributions to Dorel and for their ongoing support of the sale process. I will now ask Jeffrey to review the numbers. Jeffrey?

Thank you, Martin. First of all, it's a little bit tricky this year, but with the numbers, we're going to be talking mostly about continuing operations for the third quarter, which includes the financial results of Dorel Home and Dorel Juvenile as well as the existing corporate structure supporting these segments. But keep in mind that continuing operation should not be interpreted as representing the future results of Dorel and juvenile. For example, the interest, most of the interest that we had in the quarter is put into continuing operations. But when we closed this deal, we would have significantly less debt outstanding, and therefore, the interest rate will not be what you see today in continuing operations. So keep that in mind, it's not necessarily the best use forecasting. So if we look at the numbers, Dorel's, this will be for continuing operations. Revenue was down $10.6 million or 2.4% to $437 million. Organic revenue declined by approximately 1.1% after removing the variations of foreign exchange rate year-over-year and the impact on revenue of the sale of the Juvenile manufacturing facility in China. The revenue and adjusted organic revenue declines were in Dorel Home, partially offset by revenue growth in Dorel Juvenile. Dorel Home decrease in revenue is mainly explained by a small reduction in demand coming off of last year's record pandemic influence surge, but mostly supply chain issues in our direct import business as well as congestion in the ports and our warehouses. In Dorel Juvenile, all markets, except for Europe, had organic and adjusted organic revenue gains. From a gross profit standpoint, we decreased 390 basis points to 17% from 20.9% last year. The decline in the quarter was in both segments. The decline in Home was made up of higher warehousing cost, increased ocean freight costs, higher input costs and some reduced sales volume. And in Juvenile, it's mostly a decrease due to higher input costs. And within that, it's principally freight and resin used in car seat production. Selling expenses for the quarter increased $3.1 million or about 11%. The increase in selling expenses is mainly explained by an increased promotional and marketing activities and people costs, as last year, we saw a large reduction in these areas due to cost containment measures implemented to mitigate the impact of the COVID-19 pandemic. General and administrative expenses declined in the quarter by $4.7 million or 13%. The overall decrease was mainly due to lower people costs in Europe because of the restructuring programs. Finance expenses increased by $7.5 million to $16 million during the quarter, an increase of $8.5 million of that is mainly due to this judgment of the Luxembourg Administrative Court, and that's partially offset by a decrease of $400,000 in interest on long-term debt due to lower average interest borrowers. Overall, because of the judgment of the court and the tax loss, our net loss was $68 million or $2.09 per diluted share compared with a net income of $9.3 million or $0.28 last year. If we look at the segments now. If we look at Home, Dorel's third quarter revenue declined by $24 million or about 10%. The decrease in revenue is mainly explained by closures of Asian countries, such as Malaysia and Vietnam, which reduced our revenue from our direct import business. These countries were closed, Malaysia for most of the quarter, and I think Vietnam's only opened up in the last few weeks. And then the huge congestion of containers, both at the ports, domestic ports and within our warehouses, which delayed us from getting product that was demanded into the warehouse, so we would be able to ship it. So it affected our domestic shipping and it affected -- the supply chain also affected our direct import business. And as well, we did see a slowing down of demand a little bit because of the huge demand that we had last year, but we are seeing a fairly decent demand now, as Martin mentioned, September, October were good months. And as we get through the supply chain congestion, that's also adding to our ability to increase our sales. From a gross profit point of view, gross profit was only 10.6% in the quarter, a decline of 470 basis points. Again, as I mentioned before, higher warehousing costs, increased ocean freight costs, increased raw materials, increased overseas finished goods costs and reduced volume, all negatively impacted us. And while we did do a price increase to try and counter a lot of these increased costs, but they only took effect in the end of the quarter. So we expect to see some improvement in the fourth quarter in margin because of that. Operating profits declined $14 million to down to $6.8 million, which again was disappointing. As we mentioned, looking forward, things are getting better. There's a lot of challenges out there. If the price increases are in effect in Q4, our congestion has eased, but we still have the issues of raw material prices and difficulties in getting containers. If we move over to the Juvenile section. Revenue increased by $13.5 million or 6.6% to $219 million. Organic revenue increased by about 5.6%. So things are going well, virtually everywhere except for Europe, all the markets, like I said, are doing better, except for Europe. The markets in America continue to have strong sales. U.S., Brazil, Chile, Mexico, Canada, all having good quarters. The Dorel Juvenile USA increases came mainly from mobility categories. Those are starting to come back as people are traveling more. And Brazil, we've now taken a leading position in e-commerce. All of those things are going well. The problems we're having in Europe are primarily related to not having enough goods. As we go into this week, we have about 350 containers worth of goods sitting in China, and that's about a 6-week delay on what we'd like to have here. We have a lot of new products that are selling well, but we continue to run out of them. So the challenge in Europe becomes not just not having the goods for the current orders, but when you don't have the goods for the current orders, it's unlikely you get the second round of orders as well as it's difficult to plan any promotions or any sort of expansion or distribution of those products. So it really is, until we catch up, it's really weighing us down as far as getting the revenue to get to the level we want. If we look at the gross profit in the Juvenile, it was 23.3%, so a decline of 410 basis points. Again, reason for that, higher input costs, as we talked about freight, resin as well as lower production because of some parts shortages and just general overhead not being covered by the lower sales levels. Price increases have gone into effect in most markets. The one market that we really need to put them in will be in Europe, and that is effective January 1. So as Martin mentioned, we are expecting January, in the first quarter, to see a material improvement in our margins in Europe. Operating profit in the division was $2.4 million during the quarter compared to an operating profit of $7.6 million last year. I will talk briefly on Sports. It's now classified as discontinued operations, but their revenue line was down $2 million. We're just under 1% versus last year. Gross profit declined by 110 basis points. The decline was mainly due to just increased ocean freight and factory costs. When we look at the operating profit, so it's a little confusing here, the accounting is showing $43.1 million. But when you exclude the reversal of the prior year impairment losses on intangible assets and restructuring costs and the transaction costs related to the sales of Sports segment of $51 million, the adjusted profit declined $6.6 million from last year. And the adjusted profit decline was mainly due to reduced revenues relating to available inventory. As you know, the bike business is still showed significant amounts of inventory, particularly on the Cannondale side and then some increase in costs related to having the business back normally. With that, I will pass it back to Martin.

Yes, thank you, Jeffrey. I'll now ask the operator to open the lines for questions. [Operator Instructions] Operator, go ahead.

[Operator Instructions] Your first question comes from Derek Lessard of TD Securities.

I was wondering if you could maybe remind us how much of Home segments manufacturing is actually done domestically or in-house versus outsourced? And maybe as a follow-up to that, just maybe help us understand how your annual CapEx in that business is so low. I think it's hovered around $2 million before you announced the new CapEx spend.

Right. So the number right now is around 13% is domestic manufacturing. One of the reasons CapEx has always traditionally been low is it doesn't really -- we don't use the CapEx for product development, like we do in the other sectors, it's forged wood, whatever it is. So we don't capitalize any of that. It's generally machinery. And as we said in our last press release, we hadn't really spent much on the factories over the years. And hence, the large expenditure all at one-time here to do it. But I would expect, if you're looking for future, I think it will probably be more than 2 or 3, but it's not going to go up significantly from there.

And the 13% in-house, do you expect any, I guess, a boost to that after the $10 million CapEx? And I guess, maybe even the addition of the new acquisition in the U.K.?

Well, no, the acquisition in Europe is a distributor company. So that's only going to have actually reducing the manufactured number. Yes, the manufacture number will go up. We aren't necessarily bringing product back. We will be bringing some product back that is imported, but we will be expanding on products, higher margin, higher sales price, higher ticket items in the factories that we're not even importing today. So I expect that 13% number to go up, but it doesn't mean that it's not going to be importing items.

Okay. And the extra $10 million in capital spend. Over what period should we be modeling that?

Most likely would be first quarter. Am I right, Frank? The bulk of it?

Yes, the bulk of it will be in the first quarter of '22. There could be some of -- very little in Q4, but most of it will be Q1 next year.

Okay. That's helpful. Another question, just switching gears a little bit. Historically or last year, maybe you paid about $51 million in rent expense. Now with the Sports segment being sold, just wondering what that number comes down to? And maybe if -- I don't know if you have the split between Home and Juvenile?

Well, we'll give you -- I don't have the split right here. I think the number, correct me if I'm wrong, again, was 27%. Is that the right number, that the Sports segment represented of that?

Okay. Okay. And one last one for me before I re-queue. I know you said that you thought the pressure was more -- or the supply chain pressure is more transitory. Now that you think it's not, I was wondering how you guys are starting to think maybe about your free cash flow or your cash burn, I guess, against the backdrop of the current margin pressures that you're seeing?

Well, I mean, it's very difficult to look forward on the supply chain. What we're getting a handle on now, and where we're saying things are easing is sort of the internal issues. We had a lot of warehouse issues. We had one of our biggest warehouses got hit by COVID over the summer, which ended up giving us a huge backlog in unloading containers. We had hundreds of containers in our yard that we couldn't catch up. And that's starting to be caught up, and that means we can actually sell those items. So we had orders for items that we had in our yard, but couldn't get them out of the containers. So those are the internal issues that are easing. The external issues are not really easing. So it's very difficult to see down the road how it's going to impact us. As I mentioned, we passed on price increases, and it looks like we'll probably have to pass on some more price increases. Inflation is not slowing down. For our business, the main focus is container prices. That's probably the biggest input increase that we have. And they haven't really -- we're looking at next year and the rates look like they're going up. So we'll have to do another round of price increases at some point. And again, I don't have the timing on that. So that's making all of it as difficult to really get our hands on things. I will tell you from a cash flow standpoint that the inventory levels in the Home business are on a good place despite all the problems and everything, we're at a good place as far as owning inventory. I don't think we need to expand much on that. The Juvenile, on the other hand, is short inventory. They could certainly use another $20 million, I would say. And then on bike business, we don't have to worry about going forward. So that's sort of the cash that we're looking at. Once everything settles down, working capital, maybe another $20 million, but not much more than that.

Okay. And maybe one last one for me. Are there any, I guess, other legal proceedings that are going on that might result in a sort of like a large cash outlay? I know you guys had pointed out earlier in the year, this one related to tax. Just wondering if there's any other ones that are floating around.

That's the only outstanding large event that was out there, I bet.

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

A couple of questions. I just wanted to follow up, maybe one that's close to Derek's that he just asked. In the press release, you talked about the fact that some of these issues will continue in the short term around supply chain. But you're actively working on solutions to work through them. I guess, in addition to passing on price increases, and Jeffrey, you just mentioned around catching up on unloaded containers. Are there any other levers that you can pull on to get through some of these supply chain issues that are continuing to linger?

I mean, there's some, I think Martin was trying to show everybody, there's so many issues that, yes, we're solving some, but it's not a one-time thing. But yes, price increases are big, getting our own warehouses up to speed is a big deal. But we still have a lot of challenges outside trucking, getting our customers to pick up goods was a huge, huge issue in Q3. When we talk about direct import, what that often means is we design and buy a product and then have our customers pick it up in Asia. And they were not able to pick it up. But that was tens of millions of dollars of goods at any given point that was ready to be picked up, that wasn't. And hopefully, maybe with the Christmas season down and they're refocusing on other non-Christmas goods that will alleviate. But again, a lot of these things are outside of our control.

Okay. Okay. In the Juvenile segment, you quantified roughly $14 million in lost sales. I think was the number from European supply chain issues. Are you able to quantify what the lost sales could have been in the Dorel Home business because of some of the demand -- or sorry, supply disruptions?

Yes. No, it was a lot harder. We tried to do that. It was a lot harder to do because in some cases we owned the goods, but didn't have them accessible. But like I said, there's probably $20 million, is it $25 million of goods that were not picked up that could have been in normal times would have been picked up and delivered. So it's harder to do the profit, but I can comfortably say $25 million in the quarter was easily caused by supply chain issues.

Okay. Okay. And then maybe just on both segments, you talked about price increases. Obviously, there's lots of input cost inflation. Is inflation continuing at such a rate that it's hard to see when price increases will potentially offset the cost inflation? Or is there a point in time maybe whether it's like next year, second half of next year, where you see maybe price increases beginning to catch up with some of the kind of the cost increases you've seen?

Yes. So it's a good question. Unfortunately, we don't have an answer because we do -- there's a lag time, 2 to 3 months, generally in North America is how it works. So we do the price increase to cover the inflation. And then by the time it's in, we're seeing more inflation. So I'm not sure when that's all going to stop. But yes, that definitely puts pressure. Not a lot of our business. But it is easier today to get those price increases. It's pretty obvious that everyone has them. So it's just a timing thing, right? It's just that lag. Hopefully, we won't have that lag all the times.

Right. Okay. Okay. And then maybe just finally, on the Juvenile business. I just wanted to maybe see if I -- I want to fully -- hoping to fully understand why in Europe, Europe was the market that was really uniquely impacted by supply chain, whereas some results performance in the Americas seem to do much better. So I was wondering if you could just explain what's unique about the European market with respect to that.

Yes. I think I'm going to pass the actual freight part over to Martin. But one of the things is we have a lot of new products that we've developed, in fact, 48% of our sales now is product that we've introduced in the last 2 years in Europe. So we're pretty proud of that. But a lot of that stuff is product that's made in Asia. And therefore, the high-demand stuff needs to be imported. And Martin, I'll let you talk about freight.

The problem with Europe is that getting goods out of Asia into Europe is much slower this year. There seems to be a lack of ships and containers available to bring the product over. And like we've said before, we've got something like 350 containers in of goods or goods to fill 350 containers waiting to be picked up, and it just isn't enough supply to start with empty containers. And there isn't enough supply routes to get them to Europe on time. So it's been much more difficult getting goods into Europe than it has been into North America.

Your next question comes from Derek Lessard of TD Securities.

Yes. I was wondering, Jeffrey, if you're able to talk about like how long is that lag on the price increases? And maybe I don't know if you've mentioned it, but the magnitude of the increases that you put through in both Home and Juvenile?

Yes, I'm not at liberty to discuss the magnitude. I will tell you, in some cases, we've done 3 price increases already and planning a fourth. So that in itself is -- I've never seen that. And as far -- what was the first -- I'm sorry, I forgot your first question.

While you didn't -- you weren't able to answer the magnitude, but I was just -- I was curious about the actual lag or how long is the lag.

The lag. Yes, I'm going to say 90 days, 90 days.

But in some cases, already, we've notified the customer that the prices are coming so.

Yes. But by the time they actually kicked in and the negotiations and then the -- it's about 90 days.

Okay. And I guess my final one is, as I guess we're sitting here November 5, what does the -- I guess, what is your -- what does the situation look like ahead of the upcoming holidays in terms of being able to get product to customers given the stronger seasonal demand?

I think, again, Martin, you might know this, but I believe that that seasonal demand is almost over now as far as delivery is concerned. Like if you don't have the stuff already in the warehouses, it's not getting on the shelves for Christmas. And given that we're not that -- we have some Christmas items, for sure, that it's maybe going to get easier for us, maybe we'll get a little more space. I mean, I know I've heard even some of the large retailers, they can't even process all the goods that are coming in, and they've pushed back even for stuff they need, they said we can't unload it. So don't bring it into our warehouses. And these are the big guys, so.

And in some cases, we have goods in our warehouse or our customers, like the big retailers just don't have the facilities to pick them up. They don't have enough trucks, drivers, and they don't have space in their warehouses to put it. The supply chain problems is not just between Asia and North America, it's within North America as well.

Our delivery of furniture directly to consumers is up now. And that's doing well because the retailers don't have to bring it into their place. So we deliver those items, and that's doing well. That was -- I mean, we were behind because of all of the issues we had within our warehouses, but that is improving every week now. So we're hoping that, that picks up some of the business.

Okay. And have a good weekend.

There are no further questions at this time. I will now turn the floor back over to Martin Schwartz for any closing remarks.

Yes. Thank you. A word of sincere thanks to our teams everywhere for their continuing effort to get through the supply chain and COVID challenges as well as the rising costs. It's tough and stressful, but our employees are clearly doing what's necessary to get things done. In fact, many of our customers have told us that Dorel is doing better than many of our competition. And that concludes today's call. Thank you for being with us, and have a pleasant weekend.

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation. Please disconnect your lines at this time.