Dorel Industries Inc.

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the REL Industries third quarter 2022 results conference call. At this time, all participant lines 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 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 4th, 2022. And I would like to turn the conference over to Martin Schwartz, President and CEO. Please go ahead, sir.

Martin Schwartz Thank you. Good afternoon, and thank you all for joining us for Darrell's third quarter earnings call for the period ended September 30th. With me are Jeffrey Schwartz, CFO, and Frank Rana, VP 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 continued to grapple with the ongoing supply chain fallout. And as well, foreign exchange hit our earnings. As was the case last quarter, the dynamics have changed previously. Not enough product to currently, okay, from far too much now. Moving into Q3, the supply chain bottlenecks eased, creating a considerable influx of merchandise. However, consumer sentiment turned negative, and 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 right-sized 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 and the surging U.S. dollar, factors beyond our control, having a definite impact on the performance of our two businesses. Consumers are being forced to make some tough choices. Do they put food on their table and gas in their vehicles or buy hard goods? More often than not, purchases are for staples rather than products, and that has hurt us. At the rail home, issues experienced last quarter persisted, and sales decreased further from Q2 levels. It's noteworthy that while brick and mortar took a significant hit, Internet sales held their own. An important category for Terrell Home has traditionally been opening price point furniture, but recently consumers struggling to make ends meet don't have the disposable income for even these budget-priced items. Branded sales continue to perform well, reinforcing the segment's strategy to differentiate product through key partnerships with a growing number of well-known names. The REL Home participated in the October High Point Market, unveiling its newly redesigned 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 the REL Home brands are being introduced in Europe over the coming months. The REL Home is also expanding its 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. A new website, durellshowroom.com, was recently launched, which allows 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, seven days a week, year-round. Customers can browse by category or visit the output section for extra discounted products. And new products are added daily. Promotional pricing at lower margins helped reduce inventories by $27 million from the end of Q2. This also lowered warehouse and distribution costs. Results of the real juvenile were disappointing, particularly after the last quarter, which recorded the highest revenue since 2019. U3's decreases were driven mostly by key U.S. retail customers, drastically 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 Jeffrey 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, towns and cities are still being shut down overnight in parts of China. Risks to economic activity remain in Europe, with continuing disruptions 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 hit a 20-year low. 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 the 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 normalized. Positive contributions to revenue in the quarter came from Brazil, Canada, and Mexico, with all three regions performing well. Ocean freight costs are coming down, and the procurement landscape in Asia is now showing a positive trend, all of which augurs well for smoother operations and an improvement in margins going forward. As for our outlook, Dorel Home reduced inventories 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 Doral 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 currency, 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. Jeffrey?

Jeffrey, I'm mute. Thank you. Sorry about that. Difficult quarter, indeed, from a financial statement. I'll talk quickly about the queue and then talk a little bit about where we see the future. So, third quarter, Durrell's revenue decreased by $63 million, or 14.4 percent. Adjusted organic revenue declined by 12.7 percent after removing the impact of various foreign exchange. and the current year revenue from Nodeo Living, which was acquired in November of 2021. The adjusted organic revenue declines were both in home and in juvenile. In home, the revenue and the adjusted organic revenue declines were due to the reduced sales, primarily at brick-and-mortar channel in the U.S., and a little bit online in Europe. uh, Doral juvenile revenue, uh, and organic revenue declines were mainly in the U S due to the high inventory levels at key retailers, uh, brick and mortar retailers. And in Europe where we're seeing, uh, a much bigger impact, um, on, uh, our business because of inflation and the continuing war in Ukraine and all of the things that are, uh, affected around it, uh, like, uh, you know, heating issues and, uh, 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 and the quarter decreased 660 basis points. And that's really, again, happening in both segments. In Durrell Home, the gross profit margins came down Increased promotional incentives to get rid of the current 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 costs. And the same with cost of raw materials and goods from Asian suppliers. The goods that came in and were sold were at higher costs. Similarly, in the juvenile, the same thing. Costs 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, you know, that did decrease because of the huge drop in the amount of debt that Sorrel has versus last year. You know, we're down by almost $11 million to $5 million, just over $5 million from $16 million last year. You know, overall for the quarter, Durrell reported an operating loss of $9.1 million compared to a profit of $8.1 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. As we look at the individual groups now, Darrell Holmes, the third quarter declined by 30.7 million, or 14 percent. Adjusted organic revenue, like I said, after removing foreign exchange and the no deal living acquisition, declined by approximately 16.4 percent. 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 decently. You know, what's going on at the brick and mortars? 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, you know, through all the supply chain issues that our customers have had. uh you know it affected them significantly in q3 um and on top of that you know it is a bit you know pos is not strong uh you know we're seeing declines in pos partially because it's um hard to get the goods it's not on the floor and partially because people just aren't spending on furniture like they were uh in 2021. uh the gross profit decreased by 14 million i mean here's where So a gross margin at 4.8 for the quarter, you know, is not something that we can continue to run at. So, again, you know, it's pretty simple what's happening is, you know, costs were going up and up and up all year. You know, Q3, even if we were getting new quotes that were for less or there was talk about less costs of, you container freight they they were still very very high in the quarter and in order to move these goods we've had to you know lower our our pricing uh and promote some of these goods so we can get them out of our warehouse so we can get them you know out of our system um 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's working to 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 in that business. So overall, the operating profit declined $14.8 million in the quarter for an operating loss of about $8 million. In juveniles, third-quarter revenues are down $32.4 million or 40.8%. 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, you know, I think Martin mentioned they were high. They're high across the board. They're not necessarily high in the juvenile categories. 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 in POS, which means that people are still buying our products. there's just less in the system, or was in Q3, less 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, really is being impacted, both the POS and the amount of inventory that our customers are carrying. The inflation, the war, people's minds are on other things than spending money right now. So a little bit more concerned about what's going on over there than in the U.S., which we think will balance itself off shortly. In Chile, you know, the high inflation and their currency was one of the worst hits in the world, and that's affected their demand, and we're hoping to see You know, that's leveling off as well. 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 country for us, but we are actually having record sales and profits right now. And even Canada, where we had massive product shortages earlier in the year, Canada started to come back in Q3, so that's great. Gross profit in the quarter, off by $21 million. Again, same thing. Gross margins were 16%, drop of 720 basis points. Again, foreign exchange, probably the biggest chunk of that, represented by $14 million, just the change in the strength of the U.S. dollar. And again, like I said in the other segment, supply chain costs, were very, very high in Q3, both containers and input costs. You know, so we have a lot of that to deal with. You know, 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 one of our factory buildings in Cornwall, Ontario, and did a lease back. 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. It was done this week. but we've mentioned it in the financial statements. So with that, I'll pass it back to you, Mark.

All right, thank you, Jeffrey. Okay, I'll now ask the operator to open the line for questions.

Thank you, sir.

As always, I request that you limit the first round to questions. Operator?

Certainly. Ladies and gentlemen, we will now conduct a question-and-answer session. If you do have a question, please press star followed by one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request. Your questions will be pulled in the order they are received. Please ensure you lift the handset if you are using a speakerphone before pressing any keys. One moment, please, for the first question. And that will be from Stephen McLeod at BMO Capital Markets. Please go ahead.

Thank you. Good morning, guys. 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 channels. 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 through the goods that they have before buying a lot of new goods. So in some cases, some of that stuff has slipped. That's not to say that nothing is being 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've got to move through the old inventory to both physically make room 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. You know, 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. You know, the retail prices are now kind of matching where the costs will be. But unfortunately, the inventory that we have today is a higher price than that. So that's the dilemma that they're all in now and we feel good looking forward that, you know, this will balance itself out, but we, you know, we have to get there.

Okay.

Okay. I see. Thank you.

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

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

Okay. Okay, that's great. I'll go back online. Thank you.

Thank you. Next question will be from Derek Lessard at TD Securities. Please go ahead.

Yeah, good afternoon. Jeffrey, maybe I get it that there's a lot of moving parts right now, so I'm just going to ask 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, you know, exactly when does that... change? When does it sort of say, okay, 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. It's not that far away. It's certainly not Q4. It's going to 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 the recession. I mean, the birth rate seems to be steady. A little more concerned 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 product in the system because a lot of people were jumping into the furniture business. We are seeing bankruptcies. We are seeing people getting out. We are seeing Importers not importing furniture anymore. And, you know, 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, you know, 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. um you know we are addressing i'm going to call it the uh opp level of furniture source i mean they they need you know 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 is 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 the anchors that we have, and then things will be good.

Okay, that's helpful. The and then maybe just to follow up on that in terms of the inventory that think in q2, you had alluded to reducing them by about $50 million, you did about 27 in the quarter. Is that 50 still relevant, or are you now thinking that that number should be higher?

Yeah, I mean, I think 50 is still the appropriate number. We just want to replace the expensive inventory with normal price inventory, I guess, is the key. So that's the number. Yeah, the number will come down. We're still too high in many areas, but uh the important thing is is you know we know that like we've already dropped selling prices on many items um and now ahead of when we're actually going to be able to you know 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 that's the real strategy here you know if we have to put it in a small little compact statement it's 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, uh, and maybe if I could just follow up on that. So where do you, where are you, I guess, in that, in, in, in getting rid of, um, the old inventory category, you know, I mean, certainly Q4 is going to be like a, you know,

transitional period where we're, you know, whatever comes in in November, December, we'll probably be at new costing levels. You know, and we're still, what we're selling today is still stuff that's in inventory at higher costing levels. So I'm hoping to see a noticeable change in Q1, but, you know, again, depends on how much we get out. And it's also which categories. Certain categories, we don't have a ton of inventory, and we are bringing in. Other categories, we might be sitting on for six months. So it really is depending on where I'm on the product point.

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

Right. Yeah, we actually do have some more real estate. Some of it's very small. Some of it's larger. So certainly, yeah, we are looking into the values and if we needed to monetize them, can we, you know, all of that, I'm not, you know, not going to give you any numbers and I'm not going to talk about, you know, um, value, but yeah, there is, there is some inventory of those types of facets.

Okay. Um, and maybe one, just final one for me. Um, you know, thanks for the, uh, for the, uh, giving us the impact, the foreign exchange impact on EBITDA. I was curious if you had the impact on revenues.

Well, maybe one of our guys is working on it now. We do, but I don't have it handy, Jeffrey. Okay. Yeah, you know, foreign exchange is interesting. So we took obviously a really large Q3. The US dollar hasn't really gotten stronger very much since Q3. So, you know, there would still be an impact versus last year, but that sort of snowball effect of just like every month and every week taking another right down on balance sheet items or It seems to have slowed, and, you know, 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 the other direction, we will see some nice, you know, 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 currencies in the world as far as the fall that it had. So I'm hoping this is the worst it gets and that we only pick up from here. But, you know, I'm not putting any money on that.

One final one for me. Notice CapEx did pick 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 and if you have any sort of early outlook for 2023 in terms of spending.

Yeah, I mean, you know, we want to get through this period before we, you know, get back to spending a lot, hopefully. I mean, I don't know the answer to Q3. It could be a project that was being finished. I know we have some, 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.

Okay, thank you. That's it for me, gentlemen. Thank you.

Thank you. And at this time, I would like to introduce with a follow-up, Stephen McLeod. Please go ahead.

Ted, one follow-up question. Just as you're thinking, you talked about the inventory, you got to work through the bad stuff here or the 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?

Yeah, 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. You know, and I said this two years ago, you know, Durrell does better in a recession than in an inflationary time like 2022. It's not good for Durrell to have prices going up constantly and having to go get price increases and then having you know our customer you know having to pay more for the same goods that they you know it just doesn't work well for us it works a lot better when even if demand is slower at our costs come down and we're able to get normal margins again and people tend to to to move downwards and we do have a lot of opening price point mid price point products so I do feel like a slowdown 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. I mean, it's been a while, particularly on the furniture side, since we knew what historical was. But we can get back to a good place next year, you know, a run rate certainly next year. I don't see that being an issue unless demand just, is really, really terrible. But if it's, you know, if it's less than ideal, I think we'll still be fine.

Okay. That's, that's great. Thanks Jeffrey.

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.

Thank you, sir. 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.