Dorel Industries Inc.

Welcome to Dorel Industries' second quarter 2022 results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star followed by zero for operator assistance at any time. 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 is being recorded today, August 9, 2022. I will now turn the conference over to Martin Schwartz, President and CEO. Please go ahead.

Thank you. Well, good morning and thank you for joining us for Darrell's second quarter earnings call for the period ended June 30th. With me are Jeffrey Schwartz, CFO, and Frank Rana, VP of Finance. We'll take your questions following our comments and a reminder that all figures are in U.S. dollars. It's safe to say that in most industries, things are difficult. I cannot remember when conditions were like this. First, the pandemic. And this year continued supply chain challenges, the war in Ukraine, high inflation and rising costs. It's next to impossible to plan properly as things are so unpredictable. We are working our way through the many issues and I'm confident that things will get back to normal. Dorel will prevail. I will now take you through each of our two segments, what we have been facing and how we are dealing with things and where we're going. At the rail home, the second quarter began with serious supply chain problems, from no available containers to logistics and unloading issues. However, as the quarter progressed, some of these matters eased to the extent that goods began flooding in at a time when consumer spending habits were changing dramatically. Furniture industry sales online and in-store decreased markedly from the peak pandemic periods. Consumers increasingly worried about high inflation, focused on food and gas purchases, and were traveling a lot more. This move away from furniture purchases created an inventory glut for us and also for our retail customers, who have slowed ordering. With lower volumes, price increases introduced during the quarter did not sufficiently offset high operating costs. The war in Ukraine also slowed the rail home's European expansion. As well, in Germany, the most important market, Sales there have been hurt. The segment is now dealing with these matters head on. An aggressive inventory reduction program is underway, and since the end of Q2, there has been progress. We expect levels to be more balanced by year's end. Part of the solution is a series of promotional programs, which will have short-term pressure on margins. Costs are at least stabilizing, and ocean freight rates, which have been off the charts, are also steadying. The first half reduction in sales has been at our major retail and online customers. But interesting, there have been significant increases this year in DIY and specialty stores. The rail home strategy of going wider with more accounts is paying off, even in this environment. Branded sales, which have grown steadily, will be expanded into Europe as soon as things start improving there. We are quite confident in the potential results. Our recent investments in domestic manufacturing and our factories will also serve us well as market conditions improve. We look forward to getting past this difficult period and returning Durrell home to its traditional growth. Durrell Juvenile posted its strongest second quarter revenue since 2019 with gains in their major markets. An excellent performance in the Americas offset the declines in Europe. For the second straight quarter, the most significant contributor was the U.S., with double-digit sales gains. Latin American markets all recorded solid organic revenue increases. In Brazil, both sales online and in the specialist channel showed strong growth, while in Chile and Peru, sales increased as all company-owned retail stores were open, unlike during last year's second quarter. It's much different in Europe, which sails down double digits. The real juvenile Europe has been facing a slowdown in consumer demand, particularly in Germany, Poland, and the Scandinavian markets, as these regions grapple with the high inflation and the indirect impact of the ongoing Ukraine war. Portugal and Spain, on the other hand, the westernmost part of Europe, and thus more removed from the war, experience double-digit growth. More than most companies, Dorrell relies on international markets, and the strong U.S. dollar took a significant toll on us this quarter. The main way to gauge U.S. dollar strength is by indexing it against a basket of currencies of major trading partners. By that measure, the dollar is at a 20-year high after gaining more than 10% this year, a huge move for an index that typically shifts by tiny fractions. But like the REL Home, Juvenile is seeing progress. According to a recent third party study, the REL Juvenile Europe is gaining market share in several key categories. This is highly encouraging as it comes at a time when overall Juvenile industry numbers are suffering. There has been positive reaction to newly launched Juvenile products with many new listings. Looking ahead, we expect a slight slowing of sales in the America as our retail customers are looking to reduce their high inventories. This should be a short-term issue as we have already increased listings for 2023 at key retailers. Europe remains our primary concern as consumers seem to be delaying purchases due to the difficult environment there. We know this cannot continue long-term given the essential nature of our product categories and expect sales to begin to increase by Q4. The US dollar continues to be strong, and this will pressure earnings, though not to the extent as in the second quarter. Should current currency levels continue long term, market prices will need to be adjusted. As economies have slowed in our markets, we are seeing a decrease in the cost of key commodities, especially in China. This might allow us for an easing of the very high cost environment in which we have been operating for well over a year. I will now ask Jeffrey to review the numbers.

Thank you, Martin. I'll do this fairly quickly. You know, for the second quarter, revenue was down almost $20 million or 4.4 percent to $427.8 million. Adjusted organic revenue declined by 3.6 percent after removing the impact of foreign exchange rates year-over-year, and the current revenue from no-till living, which was acquired in November of 21. The revenue and organic revenue declines were in Doral Home, and they were offset by partial and partially by improvements in the juvenile segment. Our gross profit for the quarter decreased 20 million, or 24 percent to 65 million. The gross margin for the quarter decreased 390 basis points to 15.3. The decline was in both sides. As you mentioned, the Durrell Home, the gross profit was due to higher costs through the system. And for the juvenile, it was higher overall input costs and a large net negative impact of foreign exchange of approximately $6.5 million. versus the very strong surging U.S. dollar. If we move over to the home business, the sector declined by 27 million or 11.4%. And then, again, if you add foreign exchange changes and no-deal living, the actual organic decline was 13.8%. A dramatic rise in inflation has caused prices for everyday consumer goods to increase significantly. And we've seen since, you know, late first quarter until now a noticeable reduction in demand in furniture across the board. And it seems to be in all industries, online, not online. All parts of the furniture industry has been hit. We believe it's a combination of, like I said, less disposable income because of inflation, the fact that many people have bought a lot of product during the pandemic, and also the fact that as we come into this summer season, people were traveling and they were doing more things than just buying products. And we're seeing that currently right now. So overall in the home, our profits declined by $12.1 million to $2.2 million from last year. And again, as we said, it was mainly due to lower revenues and lower gross margins. On the juvenile side, second quarter revenue increased by $7 million, or 3.4% to $218 million. Organic revenue, however, was up by almost 8%. after moving the impact of foreign exchange year over year. You know, Europe was impacted by higher inflation, and the war is really, really having an impact on markets that are very close to it, like Martin mentioned, Germany. And that is definitely reducing demand. However, over in the Americas, particularly in the U.S., Brazil, very, very strong performance. We're continuing to pick up market share in those markets. In fact, one of the odd parts is we believe, according to third-party studies in Europe, that we've actually increased market share despite the sales being really struggling. And according to the statistics that we saw, the market has dropped double digits in the juvenile industry when you look at places like Germany, and much less so as you move West from there. So, you know, the UK was down low single digits in the market size in the quarter. So, you know, we do believe that that is something that is not sustainable, that at some point people are going to need to buy more products. They're putting it off now. They're borrowing or whatever. But at some point we do believe that those numbers will get back up. And, again, given that we have been gaining some market share, We are confident that at some point soon, hopefully the fourth quarter, we'll be able to see that coming in on the revenue side. If we look at gross profits for the quarter, they decreased 15 percent from a year ago. The gross margin was 21.3 percent. That represented a decline of 460 basis points. Again, we talked about it, higher input costs and the negative, the big one was the negative impact of the foreign exchange, which we had through most of the markets in the world. We ended up, you know, with an operating loss of 4.7 during the quarter compared to an operating profit last year of 2.1 million. And again, the bulk of you know the change right there's just the foreign exchange with that I will pocket back to Martin although I before I go there is one obviously the elephant in the room is our inventory or inventory went up about eighty million in the quarter you know what happened was you know people were talking we we we would talk to them to our investors for, let's say, at least nine months about how the lack of inventory was hampering our business and we couldn't get goods and goods were sitting in China or we couldn't get containers or the containers couldn't get unloaded. And it all kind of cleared up all at the same time in Q2. And we literally had a massive flood of goods into our warehouses. on both the juvenile and the home side. Unfortunately, on the home side, demand slowed down. So, you know, we were stuck with, you know, increasing supply, decreasing demand. And this is, you know, like Martin said, this is not a Dorel problem. This is an industry problem. And everyone at this point is going through and clearing, you know, reducing ordering, clearing through inventories so we can get back to normal times. On the juvenile, we do have more goods than we need, but the market is fairly good and steady. We're reducing our orders to sort of match the supply chain, but we feel that, you know, the inventory that we have is good. It's just we got too much of it at once, and we have to wait for, you know, the normal flow of inventory. But we're focused, you know, that's $80 million of inventory excess cash taken out of our system. So we're focused now on reducing that inventory and, you know, increasing, you know, our cash flow. We had a fairly negative cash flow in the quarter. That should change fairly quickly as our, you know, as our ordering has gotten much slower. and we go through the inventory that we have, and we're hoping by Q4 to be down to a normal period, a normal level. Normal level is a bit higher than it was last year. We were short inventory at the end of last year, so we're not looking to get down to necessarily last year's level, but we are certainly in excess of $50 million for sure that we're going to tackle this year. And we are on track. June was actually down a little bit from May, but July was a good month for reducing inventory. We're going to see that again in August. And we're pretty confident we'll get through it. Most of the inventory, you know, the vast majority of inventory is very good inventory. There might be a commodity here or a commodity there that perhaps we have a lot more than we need. That's going to take more than six months to clear, but there's not a lot of those categories out there. Things are just moving. They're just moving slowly, and we've readjusted everything for that. So with that, I'll pass it back to Martin.

Martin Blaser All right. Thanks, Jeffrey. I'll now ask the operator to open the lines for questions, and I ask, as always, that you limit your first round to two questions. Operator?

Thank you. Ladies and gentlemen, we will now conduct the question and answer session. If you have a question, please press the star followed by the 1 on your touchtone phone. You will hear a tone acknowledging your request. Your question will be pulled in the order they are received. Please ensure you lift your handset if you are using a speakerphone before pressing any keys. One bone, please, for your first question. Your first question comes from Steven McLeod BMO Capital Markets. Please go ahead.

Thank you. Good morning, guys. Just a couple of questions on the outlook here. You seem to be guiding or sort of outlook is for on the juvenile business for sales to increase by Q4. So I was just curious sort of how much visibility do you have into that? And then secondly, as it relates to the home business, You're talking about sales continuing to be lower year over year. Just curious, is that something you expect just for Q3 or is that for the full year? And what kind of visibility do you have into the home business top line sort of recovering?

Visibility is really, really tough now. It's been tough for a while. It's certainly no better. What we're seeing in juvenile, we're seeing a slowdown at the retail level where large retailers are actually holding inventory purchases, even in areas where they actually need inventory. So we're not overstocked at the retail level in juvenile, but yet the orders are being reduced just so the retailers can bring down their overall general inventory. So we know that's going to affect Q3. We don't think that'll continue into Q4 because the goods are still selling, and at some point they'll have to buy the stuff that they need to buy. So we're thinking that's more of a Q3 issue. We also have new listings for the 2023 year, and a lot of those, not all of them, but a lot of them do ship in Q4. So given the growth in listings, we're expecting that. We're continuing to see... gains in market share in Europe, and like I said, I don't see how through everything people could reduce purchases double-digit in things like car seats. Perhaps they're trading down, and we're certainly introducing more lower-priced goods in Europe, and those are doing well to try and catch those customers as well. As you know, in North America, our products are you know, opening price points and up. So we are catching a lot of people that are trading down in price points. And, you know, with what I think is a coming recession, I think we're well placed in North America to capture those customers. So we're, you know, not too worried about a recession, particularly on the juvenile side. So that's sort of the juvenile, while we feel like we do have the right products and You know, demand in America, again, North America and South America is solid. In Europe, it seems to be light, particularly on sort of the German side of the continent there. On home, it's a little different. We don't have visibility as to when the market's going to come back. We look at this as a transition period where we're going from, you know, high demand, high prices, High inventories, we've got to get through those inventories, reduce those inventories, turn them to cash, and then hopefully by when we start to buy again seriously, we could be buying with lower costs, which means we'll have either better margins or lower price points in the marketplace. That's probably a Q4 thing. And hopefully, you know, we'll get through this whole mess. Inventories will normalize. Nobody in the industry is panicking because it's just an adjustment period. And how long it is, I don't know. It's certainly Q3. We're hoping to see an improvement in Q4 from Q3. But, you know, we don't know yet. We don't know how long it's going to be until people come home and say, hey – I need a new desk, I need a new sofa, I need a new whatever, and we'll see a pickup in sales again. But we know it's coming. There's no fundamental issue with the industry. It's just had too much in the system at the same time.

Okay, that's great. Thank you.

Okay. Thank you. The next question comes from Derek Lessard of TD Securities. Please go ahead.

Yeah. Good morning, everybody. I just want to hit back on the inventory positions. I think, Jeffrey, you said that you were making some progress and you had anticipated, I think it was $50 million reduction this year. um like how confident are you in in that number and is it do you expect it to be an orderly um reduction and or should we be expecting um you know some some markdowns on on that as you try to clear clear through that and make room for your new products well i think i think we it's uh two different tales like again juvenile really no issue we just got

you know, six months' worth of inventory showed up in one month type of thing. It's good. It's selling, selling at a regular basis. You know, there's no issues there. I mean, we'll be able to react faster than we did before to orders, so hopefully that will help us. But, yeah, we're pretty confident on the juvenile side that everything will be normal. I mean, we'll probably finally have an opportunity to do some promotions. I mean, that's something we missed for the last nine months where we didn't have enough inventory to do, let's say, a maxi-cozy sale in the month of September or something like that. We didn't have that inventory, so we couldn't do any of that. We're back in sort of the game again and looking forward to it. So I'm going to say it's normal on the juvenile side. On the home side, we are trying to move goods We're doing a lot of promotions, not necessarily price cutting, but, you know, it still puts pressure on margins, hence why we think, you know, Q3 is not going to be much of an improvement to Q2 because we want to focus more on kind of clearing up that old inventory to get to a position where we can start bringing in newer inventory that's fresher, hopefully lower prices. I mean, you know, we're relying on things like You know, will freight come down a little bit by the fourth quarter? We know some of the factories in Asia are hungrier. You know, there's some commodities that are coming down. Certainly inflation is – we don't see inflation anymore in our – which I find very interesting because if you read most of the media, they still talk about, you know, runaway inflation. In our inputs now, we're not seeing almost anything going up. We don't see everything going down. Some stuff is not going down. It's holding. But we're not seeing any more inflation. So I think that's going to be interesting. And so I think we're going to see a number of months where margins aren't great, but A few months ago, we've already slowed down our purchases. So what we're seeing now is a real slowdown in input containers coming in into our yards and into our warehouses, which is giving us a chance to sort of clean up. And we still have orders, right? We're not sitting around waiting for the next order to come in. We were down 11%. during the year. That's not good, but that's not 20%, 30%. So we'll move through a lot of this inventory, and it's not, you know, I think the number on the home side that we want to hit is something like 25 to 30 million. I mean, that's not crazy, given that we're selling, you know, 75 to 80 million a month. So I don't see a lot of risk to bringing that inventory down. I mean, it's underway right now. It's happening, and it's happening on schedule, and we have it all mapped out to the end of the year.

And how close do you – like, I guess when – maybe if I ask it differently, like, how close are you or how much of that progress have you made? Are you 50% of the way through or – Well, no.

I mean, it's really – Started in July where we saw some inventories coming down. But even, you know, we saw them coming down on one side. They continued. The containers continued to pour in on the other side. So really August is the first month that we're seeing less input, like less containers coming in. And, you know, sales is somewhat steady. But, you know, we know what's coming in. it's all about matching your you know incoming inventory with the projected outgoing inventory and we've already because this is coming from Asia so it's you can't press the button today and have the inventory stop tomorrow so we're already seeing the flow lesson like you know we push the button probably six weeks ago or eight weeks ago maybe so now we're finally seeing the you know, the efforts of that where we're having, you know, maybe 50% of containers that normally come in per week are coming in now. So I guess from that point is where we're really seeing it.

Okay. Are you guys, are you still having to, you said there was less inflation. I was just wondering if you're still passing on price or trying to.

At this point, no. At this point, no. We're, you know, we've got everything we needed. The only area of concern would be Europe for 2023, and we'll have to see where the euro is. If the euro stays where it is and there's no cost relief, we might have to raise prices again. But we'll see. It's a little early there, but we're not looking today to raise prices as we're seeing, you know, we're not seeing any more cost inflation.

Okay. You know, if there was one positive in the quarter, it was definitely, you know, excluding the foreign exchange hit, but it was your 8% organic growth in juvenile. Curious about the drivers there, and how should we be thinking about the sustainability of that number, that growth?

I mean, a lot of the growth came from North America. We've made some changes recently. at the beginning of the year. We're seeing the difference. We're seeing the products, the listings are getting better. Again, this year, this is not a normal year. I mean, if anybody tries to compare one quarter to another, there's nothing normal about any part of this year. So it's difficult even for us to gauge, you know, how we're doing quarter by quarter. Now, compared to last year, we're seeing the improvements. And we're seeing a lot more listings with the big customers for next year, which we're excited about. We're seeing the new products coming through the system. We're seeing a lot of new and really good stuff in our European operation as well. Unfortunately, we're not seeing any numbers there to sort of back that up. And it's just the market in general just seems to be down. Another area, just once I'm talking about Europe, we haven't talked about it, but Even in our home furnishing, I mean, the bulk of our sales in the new company that we bought was in Germany. And some of the customers, the customers, not just our sales, the customers are down 50% in Germany in online sales. So we're relying more on customers outside of Germany, but that's the minority. But, you know, we're making progress. We've got more products listed online. With our customers on home furnishing, we have more products listed in juvenile in our stores. The market share is growing, but none of the numbers look good in Europe today. I think it's just a matter of time. At some point, things will settle down, whether it's Q3, Q4, Q1 of next year. Sometime we think things will settle down in Europe, and we'll finally get the growth based on all of the work that we've done in the last year. you know, year, because we've done a lot of good stuff. It's showing up in the U.S. It's not showing up in Europe yet.

Okay. And then maybe just one final one for me. Last quarter, it did seem like you were getting some traction, and I'm talking about the home segment here, but from a number of the margin initiatives you had put in place. I know some of that's obviously being masked by the macro issue, challenges, but maybe if you could just give us an update on where you stand with those.

Yeah, it's difficult because if we're not running, you know, we've improved our production lines, we've taken costs out, we've gotten more efficient, but if we don't have enough orders to run the lines full, you don't see any of it. And again, it's not a market share thing, it's just our retailers saying, hey, I've got enough inventory now. I'm not going to order anything this month. I'll order again next month. At some point, you just slow down your facilities. Again, we did what we needed to do. The equipment's in. It's running really well. We know we're more efficient. We know we can do things faster and turns faster. We're just waiting for that period again where supply and demand balance out. I mean, we went through a couple of years where there was too much demand for supply, and then within a real short period of time, it just completely switched the other way, and there's way too much supply for demand. But, you know, we'll figure it out. We've seen it before. It's just this happened pretty quickly.

Okay. That's it for me. Thanks.

Okay.

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

Well, Darrell remains an important player in our two industries. We have great products, known brands, long-term satisfied customers, and most importantly, employees who care and give their all. We have always been strong in opening price point products. This will serve us well if sales continue to slow as consumers look for less expensive items, even if we experience a mild recession. We definitely will get through this environment and return to profitability. Thank you very much for joining us this morning.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.