Dorel Industries Inc. (OTCPK:DIIBF) Q2 2022 Earnings Conference Call August 9, 2022 11:00 AM ET
Company Participants
Martin Schwartz – President and Chief Executive Officer
Jeffrey Schwartz – Executive Vice President, Chief Financial Officer and Secretary
Conference Call Participants
Stephen MacLeod – BMO Capital Markets
Derek Lessard – TD Securities
Operator
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Dorel Industries’ Second Quarter 2022 Results Conference Call. At this time all aprticipants’ are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. [Operator Instructions]
Before turning the meeting over to management, please be advised that this conference will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference is being recorded today, August 9, 2022.
I will now turn the conference over to Martin Schwartz, President and CEO. Please go ahead.
Martin Schwartz
Thank you. Well, good morning, and thank you for joining us for Dorel’s second quarter earnings call for the period ended June 30th. With me are Jeffrey Schwartz, CFO; and Frank Rana, VP of Finance. We will 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 Dorel 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 period. Consumers increasingly worried about high inflation, focused on food and gas purchases, and we’re 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 Dorel 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 — on our major retail and online customers. But interesting, there have been significant increases this year in DIY and specialty stores. Dorel 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 in our factories will also serve us well as market conditions improve. We look forward to getting past this difficult period and returning Dorel Home to its traditional growth. Dorel 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 with sales down double-digits. Dorel 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 remove from the war experienced double-digit growth.
More than most companies, Dorel 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 the 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 Dorel Home, Juvenile is seeing progress. According to a recent third-party study, Dorel 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 U.S. dollar continues to be strong, and this will pressure earnings, but 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.
Jeffrey Schwartz
Thank you, Martin. I’ll do this fairly quickly. For the second quarter, revenue was down almost $20 million or 4.4% to $427.8 million. Adjusted organic revenue declined by 3.6% after removing the impact of foreign exchange rates year-over-year and the current revenue from Notio Living, which was acquired in November of ’21. The revenue and organic revenue declines were in Dorel Home and they were offset by partially by improvements in the Juvenile segment.
Our gross profit for the quarter decreased $20 million or 24% to $65 million. The gross margin for the quarter decreased 390 basis points to 15.3%. The decline was in both sides. As we mentioned, at Dorel Home, the gross profit was due to higher cost 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 Notio 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 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 the summer season, people were traveling and they were doing more things than just buying products, and we are 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. Europe was impacted by higher inflation, and the war is 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 the U.K. was down low single-digits in the market size in the quarter.
So 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% from a year ago. The gross margin was 21.3%, that represented a decline of 460 basis points. And 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 with an operating loss of $4.7 million during the quarter, compared to an operating profit last year of $2.1 million. And again, the bulk of the change right there is just the foreign exchange.
With that, I will pass it back to Martin. Although before I go, there is one — obviously, the elephant in the room is our inventory. Our inventory went up about $80 million in the quarter. What happened was as people were talking — 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 where 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 we were stuck with increasing supply, decreasing demand. And this is — like Martin said, this is not a Dorel problem, this is an industry problem. And everyone at this point is going through and clearing — 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 the inventory that we have is good. It’s just — we got too much of it at once, and we have to wait for the normal flow of inventory. But we’re focused — that’s $80 million of excess cash taken out of our system. So we’re focused now on reducing that inventory and increasing our cash flow.
We had a fairly negative cash flow in the quarter. That should change fairly quickly as our ordering has gotten much slower, and we go through the inventory that we have. And we’re helping by Q4 to be down to a normal period — 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 necessary 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.
July — 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 — the vast majority of the 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 Schwartz
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?
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. [Operator Instructions] Your first question comes from Stephen MacLeod, BMO Capital Markets. Please go ahead.
Stephen MacLeod
Thank you. Good afternoon — good monring, guys. Just a couple of questions on the outlook here. You seem to have — you’d 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?
Jeffrey Schwartz
The 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. We’re not overstocked at the retail level in Juvenile, but yet we’re — 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 will 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. And 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, our — in North America, our products are opening price points at apt. So we are catching a lot of people that are trading down in price points, and with — what I think is a coming recession, I think we’re well placed in North America to capture those customers. So we’re 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 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 is going to come back. We look at this as a transition period where we’re going from 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 lower — we’ll have either better margins or lower sales — lower price points in the marketplace. That’s probably a Q4 thing.
And hopefully, 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 we don’t know yet. We don’t know how long it is 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.
Stephen MacLeod
Okay. That’s great. Thank you.
Operator
Thank you. The next question comes from Derek Lessard of TD Securities. Please go ahead.
Derek Lessard
Yes. Good morning, everybody. I just wanted to hit back on the inventory positions. I think Jeffrey, you said that you were making some progress than you had anticipated, I think it was $50 million reduction this year. Like how confident are you in that number? And is it — do you expect it to be an orderly reduction? And — or should we be expecting some markdowns on that as you try to clear through that and make room for your new products?
Jeffrey Schwartz
Well, I think we — it’s two different tails like again, Juvenile, really no issue. We just got six months’ worth of inventory showed up in one month type of thing. It’s good. It’s selling, selling at a regular basis. There’s no issues there, I mean we’ll be able to react faster than we did before to order. So hopefully, that will help us. But yes, 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-Cosi 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 it still puts pressure on margins, hence, why we think Q3 is not going to be much of an improvement to Q2, because we want to focus more on kind of clearing out that old inventory to get to a position where we can start bringing in newer inventory that’s fresher. Hopefully, lower prices. I mean we’re relying on things like will freight come down a little bit by the fourth quarter. Will — we know some of the factories in Asia are hungrier. There are 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 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 we’ve already — I mean a few months ago, we’ve already slowed down our purchases.
So what we’re seeing now is like 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. It’s — we were down 11%. And during the year, it’s not good, but that’s not 20%, 30%. So we’ll move through a lot of this inventory, and it’s not — I think the number on the Home side that we want to add is something like $25 million to $30 million. I mean that’s not crazy given that we’re selling $75 million 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 till the end of the year.
Derek Lessard
And how close do you — like I guess when — maybe if I ask it differently, how close are you or how much of that progress have you made? Are you 50% of the way through or —
Jeffrey Schwartz
Well, no. I mean it’s really started in July where we saw some inventories coming down. But even we saw them coming down on one side, they continue to — containers continue 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 sales is somewhat steady. So — but we know what’s coming in. It’s all about matching your incoming inventory with the projected outgoing inventory. And we’ve already — because this is coming from Asia. So it’s — you can’t press a button today and have the inventory stop tomorrow.
So we’re already seeing the flow lessen, like we pushed the button probably six weeks ago or eight weeks ago maybe. So now we’re finally seeing the efforts of that where we’re having 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.
Derek Lessard
Okay. Are you guys — are you still having to — you said there’s less inflation. I was just wondering if you’re still passing on price or trying to.
Jeffrey Schwartz
No. At this point, no. 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 — we’re not seeing any more cost inflation.
Derek Lessard
Okay. If there is one positive in the quarter, it’s definitely excluding the foreign exchange hit, what was your 8% organic growth in Juvenile. Curious about the drivers there, and how should we be thinking about the sustainability of that number for that growth?
Jeffrey Schwartz
I mean a lot of the growth came from North America. We’ve made some changes 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 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, but 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, it 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 we’re making progress. We’ve got more products listed 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.
And 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, 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.
Derek Lessard
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 Home — 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 challenges. But maybe if you could just give us an update on where you stand with those?
Jeffrey Schwartz
Yes. It’s difficult because if we’re not running — we’ve improved our production lines. We’ve taken cost 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. So — 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. And so at some point, you just slow down your facility.
So again, we did what we needed to do. The equipment is in. It’s running really well. We’ve — we know we’re more efficient. We know we can do things faster and turns faster. And we’re just waiting for that period again where sort of 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 to the other way, and there’s way too much supply for demand and — but we’ll figure it out. We’ve seen it before. It’s just — this happened pretty quickly.
Derek Lessard
Okay, that’s it from me. Thanks.
Jeffrey Schwartz
Okay.
Operator
Thank you. Mr. Schwartz, there are no further questions at this time. Please continue.
Martin Schwartz
Okay. Thank you. Well, Dorel 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.
Operator
Ladies and gentlemen, this concludes the conference call for today. Thank you for participating, and please disconnect your lines.
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