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

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Dorel Industries Third Quarter 2022 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 recorded today, November 4, 2022. And I would like to turn the conference over to Martin Schwartz, President and CEO. Please go ahead, sir.

Thank you. Good afternoon, and thank you all for joining us for Dorel's third quarter earnings call for the period ended September 30. With me are Jeffrey Schwartz, CFO; and Frank Rana, VP of Finance. We will take your questions following our comments. And again, all figures mentioned during this call are in U.S. dollars. It was another difficult quarter as retailers continue to grapple with the ongoing supply chain [ follow-ups ] and as well as foreign exchange hit our earnings. As was the case last quarter, the dynamics have changed previously. Not enough products to currently -- from far too much now. Moving into Q3, the supply chain bottlenecks eased, creating a considerable influx of merchandise. However, consumer sentiment turned negative, as goods piled up across many product categories, including ours, creating a significant drop in orders from our U.S. brick-and-mortar partners as they rightsize their inventory. As well, retailers did not have the ability to stock shelves and shoppers were and still are finding less of a choice on the floor. The operating environment remains challenging with high inflation in the surging U.S. dollar, factors beyond our control, having a definite impact on the performance of our 2 businesses. Consumers are being forced to make some tough choices as they put food on their table and gas in their vehicle or buy hardgoods. More often than not, purchases are for staples rather than products and that has hurt us. At Dorel Home, issues experienced last quarter persisted and sales decreased further from Q2 levels. It's noteworthy, while brick-and-mortar took a significant hit, Internet sales held their own. Important category for Dorel Home is traditionally an opening price point furniture, but recently, consumers struggling to make ends meet don't have disposable income for even these budget-priced items. Branded sales continued to perform well, reinforcing this segment's strategy to differentiate product through key partnerships with a growing number of well-known names. Dorel Home participated in the October High Point market on building its newly relined showroom, which accentuates its many brands. Several new products were on display, many of them from the branded collection, which generated considerable excitement. Some of Dorel Home brands are being introduced in Europe over the coming months. Dorel Home is also expanding the DIY business, which is attracting an additional category of shoppers. This initiative has met with good success this year as these accounts are growing steadily. New website, DorelShowroom.com, was recently launched which attract smaller retailers to easily order smaller quantities. There are many hundreds of independent furniture stores in North America, and this is an excellent way to reach them, therefore, providing excellent potential for growth in this sector. Online purchasing is available 24 hours a day, 7 days a week year-round. Customers can browse by category or visiting the output section for extra discounted products, and new products are added daily. Promotional pricing at lower margins helped reduce inventory by $27 million from the end of Q2. This also lowered warehouse and distribution costs. Results at Dorel Juvenile were disappointing, particularly after last quarter, which recorded the highest revenue since 2019. Q3 decreases were driven mostly by key U.S. retail customers, practically reducing orders much more so than we had expected. Many had too much inventory on hand and did not reorder due to overstock and trouble getting goods out of the warehouse. Sales opportunities were minimized as many stores have a limited merchandise assortment due to out-of-stock positions. The other major factor which hurt Juvenile was the FX loss from the strong U.S. dollar and Jeff will discuss this shortly. Europe continues to feel the effects of ongoing geopolitical issues, including recent lockdowns in China and the war in Ukraine. While most of the world has largely moved on from COVID, 1,000 cities are still being shut down overnight in parts of China. Risk to the recent economic activity remain in Europe with continuing disruption expected in energy and inflation still moving up. Customers are even more cautious due to the continued instability and the acute fall in the value of the euro, which is a 20-year low. In September, the pound sterling hit a 37-year low but has recovered somewhat with the change in U.K.'s political leadership. To be clear, there are bright spots in a number of areas in Juvenile. Partially offsetting the sales decline were strong e-commerce sales and recent point-of-sale data indicating that there is continuing demand for Dorel Juvenile products. The POS is normalizing. Positive contributions to revenue in the quarter came from Brazil, Canada and Mexico, with all 3 regions performing well. Ocean freight costs are coming down and the procurement landscape in Asia is now showing a positive trend, all of which bodes well for smoother operations and an improvement in margins going forward. As for our outlook, Dorel Home reduced inventory significantly in the quarter, despite our retail partners also reducing their inventories. This effort by the segment will continue through Q4. This is also a priority at Dorel Juvenile where inventory levels are higher than needed due to the unexpected drop in Q3 orders by retailers. E-commerce sales and point-of-sale data is encouraging. Therefore, we believe this phenomenon cannot continue indefinitely and there is demand for our products from our consumers. As of now, however, we expect this trend to continue through the balance of the year and we remain focused on reducing inventories in preparation for 2023. With no real change in the value of the U.S. dollar versus other currencies, continuing -- continued lower sales in the U.S. in the short term and ongoing challenges in Europe, we do not expect an improvement in Q4. Both segments are reducing costs across the board to offset lower revenues. As we look to 2023, better margins are expected. And as mentioned last quarter, we have also secured new listings for 2023 with many of our major accounts. I'll now ask Jeffrey to review the numbers.

Difficult quarter indeed from a financial statement. I'll talk quickly about the Q and then talk a little bit about where we see the future. So third quarter, Dorel's revenue decreased by $63 million or 14.4%. Adjusted organic revenue declined by 12.7% after removing the impact of various foreign exchange and the current year revenue from Notio Living, which was acquired in November 2021. The adjusted organic revenue declines that were both in Home and in Juvenile. In Home, the revenue and the adjusted organic revenue declines were due to the reduced sales primarily brick-and-mortar channel in the U.S. and a little bit at the online in Europe. Dorel Juvenile revenue and organic revenue declines were mainly in the U.S. due to the high inventory levels at key retailers, brick-and-mortar retailers, and in Europe, where we're seeing a much bigger impact on our business because of inflation and the continuing war in Ukraine and all of the things that are affected around it, like heating issues and other issues that have grabbed people's attention. From the gross profit, I mean, this is really where we're getting hit right now is gross profit decreased by $35.3 million. The margin in the quarter decreased 650 basis points, and that's really again happening in both segments in Dorel Home. The gross profit margins came down, increased promotional incentives to get rid of the recurrent inventories that we have. And then just higher costs. I mean, even though today, freight costs might be down, the freight costs that we incurred in Q3 were record cost and the same with cost of raw materials and goods from Asian suppliers. The goods that came in and were sold were at higher cost. Similarly, in the Juvenile, the same thing, costs are very -- were very high in Q3, the inventory that was purchased. And on top of that, the exchange rates and the U.S. dollar was significant and caused a lot of pain. Finance expenses, that did decrease because of the huge drop in the amount of assets that were versus last year. We're down by almost $11 million to $5 million, just over $5 million from $16 million last year. Overall, for the quarter, Dorel reported an operating loss of $9.1 million compared to a profit of $8.1 million last year. And then excluding restructuring and other adjustments, operating profit or adjusted operating profit decreased by $16 million to an operating loss of $6.9 million. If we look at the individual groups now, Dorel Home, the third quarter declined by $30.7 million or 14%. Adjusted organic revenue, like I said, after removing foreign exchange and the Notio Living acquisition, declined by approximately 16.4%. The decrease in revenue is primarily brick-and-mortar channel, a huge discrepancy between what we sold to the brick-and-mortar versus what we sold online, particularly in the U.S., where the online sales were holding up fairly recently. What's going on at the brick-and-mortar? They have -- on their books, they have a lot of inventory but it's not necessarily getting onto the floor in time and it's not necessarily getting through all the supply chain issues that our customers have had. It affected them significantly in Q3. And on top of that, it is a bit -- POS is not strong. We're seeing declines in POS partially because it's hard to get the goods. It's not on the floor and partially because people just aren't spending on furniture as they were in 2021. The gross profit decreased by $14 million. I mean, here's where the issues are. So the gross margin at 4.8% for the quarter is not something that we can continue to run at. So again, it's pretty simple what's happening is costs were going up and up and up all year. Q3, even if we were getting new quotes that were for less or talk about less cost of container freight, they were still very, very high in the quarter. And in order to move these goods, we've had to lower our pricing and promote some of these goods so we can get them out of our warehouse so we can get them out of our system. And I think the retailers are doing the same thing. They're looking to get the high-cost goods out of their system. So everybody is working to move these out so that we can bring in next year much lower-priced goods so that we can go back to making a normal margin like we used to make. So that's really what's going on that business. So overall, the operating profit declined $14.8 million in the quarter for an operating loss of about [ $8 million ]. In Juvenile, third quarter revenues were down $32.4 million or 14.8%. Organic revenues declined by about 9%. The declines in revenue were mainly in the U.S. and Europe and Chile. In the U.S., the decline, which was in most of the product categories, was primarily due to the retailers reducing inventories that -- I think Martin mentioned they were high. They're high across the board. They're not necessarily high in the Juvenile category. But nevertheless, our customers are dealing with their own supply chain issues and are looking to reduce the amount of inventory in general in their system and that affected us. Interesting enough, our POS was not that negatively affected. So they continue to sell goods, in fact, in Q3, we had a slight increase over last year at POS, and which means that people are still buying our products, there's just left in the system or was in Q3 left in the system. Hopefully, in Q4 and then certainly into next year, we expect to see a more balanced approach between the POS and what our customers are ordering. Europe, on the other hand, is being -- really is being impacted, both the POS and the amount of inventory that the customers are carrying. The inflation, the war, people's minds are on other things and spending money right now. So a little bit more concerned about what's going on over there. Then in the U.S., which we think will balance itself off shortly. In Chile, the high inflation and their currency was one of the worst hit in the world, and that's affected their demand, and we're hoping to see that leveling off as well, while we did see some bright spots in some parts of the world. Again, Brazil continues to be strong, both on the top and bottom line. Mexico, very small customer -- a very small country for us, but we are actually having record sales and profits right now. So -- and even Canada where we had massive product shortages earlier in the year, that has started to come back in Q3, so that's great. Gross profit in the quarter off by $21 million. Again, same thing, gross margin was 16%, a drop of 720 basis points. Again, foreign exchange, probably the biggest chunk of that, represented about $14 million, just the change in the strength of the U.S. dollar. And again, like I said in the other segment, costs, supply chain costs, were very, very high in Q3, both containers and input costs. So we have a lot of that to deal with. The operating loss in the segment was $18.4 million for the quarter versus a gain of $2.4 million last year. The only other thing I would consider major news for us that we did in order to enhance our liquidity, we did sell 1 of our factory building in Cornwall, Ontario and did a leaseback. So nothing really changes from an operating profit, but we do have more liquidity in the system, which makes us feel better and allows us to operate a little more comfortably. So that was done very recently within this week, but we've mentioned it in the financial statement. So with that, I'll pass it back to you, Martin.

All right. Thank you, Jeffrey. Okay. I'll now ask the operator to open the lines for questions. But as always, I request you to limit first round to 2 questions. Operator?

[Operator Instructions] One moment please for the first question, and that will be from Stephen MacLeod at BMO Capital Markets.

Just a couple of questions. In terms of the top line, one of the things you talked about last quarter for the Juvenile business specifically was new listings, and that was meant to positively impact Q4. I think in the outlook section, you talked about new listings positively impacting next year. I was just curious, should we still expect some of those new listings to be positive for Q4? And is that -- when you talk about for the full year next year, is that for both segments? Or is that specifically around new listings for Juvenile?

So let's talk about Juvenile first. So yes, we continue to have a lot of new product coming through the channel. It is slipping a bit primarily because, like I said, the inventory issues that Dorel is encountering is not just Dorel, it's our retail partners as well. So everybody wants to move the goods that they have before buying a lot of new goods. So in some cases, some of that stuff is set. That's not to say that nothing has been launched in Q4. We certainly have some products being launched, but I don't think we'll see it affecting the financial statements until Q1. On the other side, again, similarly, we're moving -- we've got to move through the old inventory to both physically make room on -- in our warehouses, in the shelves of our store before we start bringing in a lot of the newer inventory. There is some new product coming in for sure. And that new stuff that comes in will probably be priced properly or cost-wise will be properly. But we are optimistic in the fact that we've seen the opportunity right now between freight and cost to get our margins back to where they should be. So what we've done is we've lowered our prices -- the retail prices are now kind of matching where the costs will be. But unfortunately, the inventory that we have today is higher priced than that. So that's the [ dilemma ] Dorel is in now, and we feel good looking forward that this will balance itself out, but we have to get there.

Okay. Okay. I see. And then just with EBITDA sort of going adjusted negative in the quarter, I'm just curious if there are any covenants issues or covenant restrictions that we should be aware of?

There's currently under the ABL agreement, we don't have like monthly or quarterly measurements for covenants like we used to. So based on that, the answer is no.

Next question will be from Derek Lessard of TD Securities.

Jeffrey, maybe I get it that there's a lot of moving parts right now. So I'm just going to add more of a qualitative question. Do you think you're past the worst?

Well, we don't see Q4 getting better because we still have to deal with the high cost inventory. The good news, and it's the really good news, is we've already got reduced costs for either the raw materials, finished goods, freight. All of that is not something we're hoping to see, but we are seeing today. But we're not buying heavily yet because we need to get through what we have. So exactly when does that point change, when does it like sort of saying we no longer have any of the old headaches, but we only have the good stuff going forward, I don't know exactly what month that is. I mean it's not that, that far away. It's certainly not Q4, it could be into the early part of next year. We're also a little bit cautious with what we believe is a recession coming. Historically, Juvenile does okay during recession. I mean the birth rate seems to be steady, a little more concern in Europe where it's not a normal recession, but less concerned in other parts of the world on the Juvenile. And then Home is something we've got to get through all of this stuff, and there's a lot of products in the system because a lot of people were jumping into inter-business. We are seeing bankruptcy. We are seeing people getting out. We are seeing importers not importing furniture anymore, and all of that has to wash through. So I'm a little less certain on demand next year for furniture, but we have great opportunities. We have -- retailers are looking to do new stuff. They're coming to us. We have a lot of new ideas, new products. We've got new channels. I mean, Martin touched on some of it before. We are addressing I'm going to call it the OPP level of furniture source. I mean they need -- with the recession coming, they need to have a lot of options for their customers. And then some of these stores are turning to us because we have some great value products. So there's a bunch of things that I'm excited about for next year. But we got to get there. We got to get through the sort of the anchors that we have and then things will be good.

Okay. That's helpful. The -- and then maybe just a follow up on that in terms of the inventory. I think in Q2, you had alluded to reducing them by about $50 million. You did about $27 million in the quarter. Is that $50 million still relevant? Or are you now thinking that, that number should be higher?

Yes. I mean I think it's still the appropriate number. We just want to replace the expensive inventory with normal price, I guess is the key. So it's less the number. Yes, the number will come down. We're still too high in many areas. But the important thing is we know that like we've already dropped selling prices off many items and now ahead of when we're actually going to be able to sort of make our normal margins on it. So we just got to get through the old stuff and then start bringing in the new stuff. And I mean, that's the real strategy here. If we have to put it in a small little compact statement, it's get through the old inventory so we can buy the new inventory, which will then give us the margins that we need to start going forward again.

Okay. That makes sense. And maybe if I could just follow up on that. So where do you -- where are you, I guess, in getting rid of the old in the line?

Yes, by category, I mean, certainly, Q4 is going to be like a transitional period where we're -- whatever comes in, in November-December, we'll probably be at new costing levels. And we're still -- what we're selling today is still stuck up in inventory at a higher cost than that. So I'm hoping to see a noticeable change in Q1. But again, depends on how much we get out. And it's also which categories, certain categories we're already -- we don't have a ton of inventory. And we are bringing in other categories we might be sitting on for some time, so it really is depending on where [indiscernible].

Okay. And if you look back or as you're looking through your portfolio and you did the sale leaseback of the Cornwall property, do you have any more of those type assets lying around that you can -- that you'll be able to do similar transactions and generate more cash or any potential noncore assets that you may have?

Right. Yes, we actually do have some more real estate. Some of it is very small, some of it is larger. So certainly, yes, we are looking into the values and if we needed to monetize them, can we -- all of that, I'm not going to give you any numbers, and I'm not going to talk about value. But yes, there is some inventory of both types of assets.

Okay. And maybe just a final 1 for me. Thanks for giving us the impact -- foreign exchange impact on EBITDA. I was curious if you had the impact on revenues.

Well, I think maybe [indiscernible] is working right now.

We do, but I don't have it handy, Jeff.

Yes. [Technical Difficulty] interesting. So we took, obviously, a really large Q3. The U.S. dollar hasn't really gotten stronger very much since Q3. So there would still be an impact versus last year, but that's sort of no ball effect of just like every month and every week, taking another write-down on balance sheet items. It seems to have slowed. And I'm hoping this is maybe the bottom or the top of the U.S. dollar strike because if we see it coming back to the other direction, we will see some nice tailwinds for a change behind us because it's been brutal. I mean, some of the currencies that -- like I said, I think the Chilean currency is one of the worst hit in the world as far as the fall that it had. So I'm hoping that this is the worst it gets and that we only pick up from here. But I'm not putting any money on that.

Okay. All right. One final 1 for me. I noticed CapEx did tick up a little bit, I think $2 million versus last quarter. So I think it was $6 million in total in Q3. Just curious about what was driving that, if you have any sort of early outlook for 2023 in terms of CapEx?

Yes. I mean we want to get through this period before we get back to spending a lot, hopefully. I mean I don't know the answer to Q3 can be a project that was being finished. I know we have some important car seats coming through the system. But no, I don't have. It's still a little early to give you any outlook on CapEx because we haven't finalized anything.

And at this time, I would like to introduce with a follow up, Stephen MacLeod.

One follow-up question. Just as you talked a lot about the inventory, you got to work with the bad stuff here of your aged stuff to -- before you can introduce the higher full margin product. I'm just curious, if you think about 2023 and if you do get through that into the Q1 period, let's say, do you think you could be in a position where you're getting back to historical margin levels in both the Home and Juvenile business?

Yes, volume is going to be a big part of that, and I don't know the impact of the coming slowdown. I think we will be hurt less than other businesses. That's traditionally been the case. And I said this 2 years ago, Dorel did better in a recession than an inflationary time like 2022. It's not good for Dorel to have prices going up constantly and having to go get price increases and then having our customers having to pay more for the things that they -- it just doesn't work well for us. It works a lot better when even if demand is slower and our costs come down, we were able to get normal margins again. And people tend to move downwards, and we do have a lot of the opening price point, mid-price point products. So I do feel like Dorel isn't that scary if we can get our costs under control, and we can get back. I don't know what historical is anymore. It's been a while to the furniture side, we knew what historical was. But we can get back to a good place next year -- run rate, certainly next year. I don't see that being an issue unless demand is just -- is really, really terrible. But if it's less than ideal, I think we'll still be fine.

At this time, I would like to turn the meeting back over to Mr. Schwartz. Please proceed with closing remarks.

Okay. Well, I want to thank all of you for joining us this afternoon and wish you all a pleasant weekend.

Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a good weekend.