Dorel Industries Inc. (OTCPK:DIIBF) Q1 2022 Earnings Conference Call May 6, 2022 1:00 PM ET

Martin Schwartz – President and Chief Executive Officer

Jeffrey Schwartz – Chief Financial Officer

Stephen MacLeod – BMO Capital Markets

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Dorel Industries First 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 being recorded today, May 6, 2022.

I will now turn the conference over to Martin Schwartz, President and CEO. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining us for Dorel’s first quarter earnings call for the period ending March 31. On the line 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.

Our first quarter was affected by a continuation of the supply chain issues, which have plagued companies for the past two years. This continues to make it difficult to get sufficient products to meet demand that has increased the cost of goods. There is, nonetheless, optimism across the Dorel as we are doing the things we need to do to prepare for a better future. We are actively pursuing many projects and are strengthening customer relationships to get the business where it needs to be once the current environment improves.

So yes, many of the last quarter’s issues remained the same, but our employees are fully engaged and collectively, we are fairly optimistic about the process underway. Our fundamentals remain strong and our strategic plan in both segments remain on track. At Dorel Home, post-pandemic demand was down from the highs of last year due to COVID-prolonged stay-at-home period, plus the quarter’s lower sales were affected by the continued erratic supply chain, which did not allow all orders to be filled.

The reduced sales translated into lower profit, but other factors such as high freight, increased raw material prices and warehousing costs also aid into the bottom line. Nevertheless, it certainly is not all bad news. The machinery that we have previously mentioned is now fully installed and operational at the segments ready-to-assemble factories in Tiffin, Ohio and Cornwall, Ontario, and is already providing productivity efficiency as well as new mattress productions lines at Dorel Home Products in Montreal are now running. We’re pleased with the quality of these new mattresses being produced locally and will soon add more equipment to manufacture upscale products.

There are several benefits to having our own Canadian mattress operations, and controlling our own destiny. Major benefits include no tariffs and antidumping duties to deal with, no high freight cost to day as well as our ability to be faster to market with our products. The new machinery at all Dorel Home factories will not only augment our domestic production, but more importantly, will also help increase margins. Another encouraging sign was the important pickup in business at Dorel’s DIY retailers. Historically, these have been smaller accounts, but the growth in this category was significant this past quarter. Also on the bright side is the consistent growth of our branded furniture lines.

Dorel Juvenile’s Q1 revenue increased as demand was strong in most markets, although supply issues, which limited some available finished goods and components prevented an even better performance. The U.S. was the most significant contributor as travel system, strollers and infant health products were popular with consumers. This more than offset lower sales of car seats, which were hurt only by the lack of available components, notably cars seat covers, stemming from supply chain issues. As of late March, finally, with the arrival of the required components, production levels approved at the Columbus car seat factory.

In Europe, performance was considerably better compared to the second half of last year, even though the region was affected by a lack of chaos [ph]. Again, demand has been there, but getting the goods is still an issue. We’re encouraged in Europe as we’re seeing increased sell through at the consumer level. The team there is invigorated as new products has been introduced and several innovative programs are being launched to increase market share.

Dorel Juvenile goods are moving in stores, which is validating the many efforts that we have made. Sales in Chile and Peru grew by strong double digits in the retail and wholesale channels, although this had some negative impact on e-commerce sales. This was not unique to us, but across many industries as shoppers return to brick-and-mortar locations.

Turning now to our outlook. I must say that visibility is still difficult, volatility in earnings should continue giving rising inflation and its direct impact on input costs and the potential of slowing consumer demand. The war in Ukraine is also affecting the economy. Things in Eastern Europe are difficult. As an example, in Germany, people are nervous and have slowed down shopping for anything, but essential items. Russia’s invasion is adding to the increase in energy prices everywhere, further feeding record inflation. Right now, we are seeing some improvements in the supply chain situation out of Asia with better container availability and the stabilization of pricing, although still high.

Dorel Home remains challenging, given the lower consumer demand for furniture overall and with the attitude toward COVID changing, purchases for the home have slowed. We continue to focus on what we term near sourcing with our newly installed machinery of branded furniture lines and the integration of our recently acquired European business, Notio, although it, too, has been affected by the war. This will put us in a leading position as demand for our product picks up in a more stable environment.

In Juvenile, the market most impacted by uncertainty is Europe. The devaluation of the euro to its lowest level in over five years relative to the U.S. dollars, and retailers ordering more cautiously means our outlook for the second quarter is less optimistic than it was. We will not allow the current challenges to detract from our long-term direction and we believe our strategy on recapturing market share remains valid. We are actively working with our retail partners on enhanced marketing, store investments and the rollout of our new products in Europe, but the positive impact of these actions may be delayed.

Now, I’ll ask Jeffrey to review the numbers.

Thank you, Mark and I go to some numbers quickly. For the first quarter of 2022, Dorel’s revenue declined by $10.5 million or 2.4%. Adjusted organic revenue declined by 1.4%. The revenue and adjusted organic revenue decline was in the Home section offset partially by improvements in Dorel Juvenile. The Dorel Juvenile revenue and adjusted organic revenue improvement was in virtually all the markets. So that’s the good news.

Looking at the gross profit for the company, it decreased by 13.4% – or $13.4 million or 15.6% compared to last year. Gross margins were 16.9% in the first quarter, declining by 260 basis points from 19.25% in 2021. The decline in the first quarter was in both the Home and the Juvenile segment.

Margins were negatively impacted by, particularly in the Juvenile, beside the regular cost that we’ve talked about, like freight and input costs, but the impact of component shortages that didn’t allow our manufacturing activity to be normal and therefore, increase our overhead costs.

Before we get into each segment, I want to make a note about financial expenses. So the financial expenses increased by $5.7 million to $12.6 million. But of that – $9.1 million of the $12.6 million is related to the extinguishing of the senior unsecured note, which happened after the transaction. So, I think it’s important to note that, that number is related not to the operations of the business, but to the transaction that happened at the beginning of the quarter, and of the $9.1 million, $6.4 million was a cash amount. The other was a noncash event. The cash amount was included when we discussed with the market and with the street, the difference between gross and net, $6.4 million was already accounted in that area. So, I just wanted to add that because I think it’s a significant number for the quarter.

We look at Home now, we move to Home. First quarter revenue declined by $17.2 million or 7.5%, adjusted organic revenue declined by 10.5%. If you remember, we did add the Notio Living acquisition to our business. Dorel Home’s revenue from the direct import business in the first quarter was lower as a result of supply chain disruptions that continue to persist. Last year’s revenue benefited from a strong demand created in response to consumer needs and a particular home office furniture during the prolonged stay-at-home period caused by COVID.

From a gross profit standpoint, gross profit for the first quarter decreased by $8.2 million or 26.1% compared to the first quarter. Gross margin at 11% in the first quarter declined by 270 basis points. The first quarter decline was due to higher warehousing costs, significant increase ocean freight costs and substantially increased board and overseas finished goods costs. Now we have raised prices, but we did not have the price increase go through on January 1. So by the end of the quarter, the margins were improving over where they were at the beginning of the quarter.

For profit, for Dorel Home’s operating profit declined by $9.3 million or 62.7% to $5.5 million this year. That declined again mainly due to lower revenues and lower gross margins as we discussed.

Moving over to Juvenile. The Juvenile first quarter revenues increased by $6.7 million or 3.2%. If we look at the organic revenue, it improved by 8.9% after we remove the impact of various foreign exchanges and prior year revenue that we had from the Chinese manufacturing facility, which was still in our books in the first quarter of 2021. The most significant contributor to the increase in the U.S. market, principally from the sale of travel system, strollers and infant health products, that more than offset lower cars seat sales, which were severely hampered by shortage of components coming from Asia.

Europe continued to suffer slightly from the lack of items, but the situation is greatly improved from the second half of last year and revenues were slightly better than last year. We’re seeing pretty strong results as well in the Chile and Peru area. Brazil’s top line was also impacted a little bit in the quarter because of high end stock – out-of-stock levels. The same thing happened in Canada as well.

On the gross profit area, the first quarter, it decreased by $5.2 million or 9.6% compared to last year. First quarter gross margin was 22.6%, representing a decline of 320 basis points. The decline was mainly due to increased container freight costs and higher input costs overall. Additionally, margins were negatively impacted by the component shortages, as I mentioned, in the factory, leading to lower manufacturing activity. Price increases are in place in all the markets now, though timing limited their positive impact in the quarter.

Product liability costs increased by about $8.5 million for the quarter, as we had significantly more activity than is normal in that period. As anyone who has followed the company knows, we can go a long time without having anything significant. And in this quarter, we just had a number of cases coming to the end of the line. The good news looking forward the rest of the year, we see a lot less activity than normal. So certainly, more in the first quarter, but I think we’re not foreseeing anything to that level for the rest of the year.

The last area is corporate expenses, just pointing out that $2.2 million of the increase in – of the expenses is related to an unrealized FX impact because I know that, that stood out as significant.

And with that, I’ll turn it back to Martin.

Okay. Thank you, Jeffrey. Okay. I’ll now ask the operator to open the lines for questions. And as always I ask, okay, please keep your first round of questions to two. Operator?

Thank you. [Operator Instructions] Your first question comes from Derek Lessard from TD Securities. Please go ahead. Derek Lessard, your line is open.

Sorry about that. Good afternoon everybody. You mentioned that you were seeing some improvement in the supply chain. Just wondering if you can maybe talk more about that, what you’re seeing and maybe how container costs are trending?

I always tell people, supply chain is a huge category with lots of subsets underneath it. So if we’re talking about container availability, we are seeing definite improvements. We expect to be much more in stock by the second half of the second quarter. So that’s a good news. Pricing is down a little bit in the spot market, which is a good indication, but contract pricing is up significantly over last year, and that’s what we end up using. Contract pricing generally is lower than even spot pricing. So it’s looking like it’s getting a little softer, but we still have to deal with issues like the shutdown in the Shanghai region and all the ships that are there.

What’s going to happen when all those – when that opens up and all the ships get filled and they all start coming to ports on the West Coast of North America at the same time, I think that’s going to be another wave of delays. So it’s getting a little bit better there. But on the other side, if you look at Europe, you’ve got things like trucking is very difficult now in Europe. And there’s a lot of truck drivers work coming from the Eastern Block of the European countries and the wars sort of slowed that down. So there’s always seems to be other all sorts of issues that keep popping up and we have to deal with them.

Okay. And I guess – I mean, there seems to be a difference between the pressures that you’re seeing in Europe versus the U.S. And you – I guess you alluded to one of them being trucks. Is there anything else that’s making it more difficult from a...

Actually – the containers in Europe are actually a little bit easier right now. We are getting supply. We need to get it out of – but again, I think I’m talking about right now, I’m not talking about the first quarter, but right now, we’re getting the goods that we need to get so that we can fulfill the demand and really see the potential. It’s been extremely frustrating, particularly on the Juvenile side, where we think we’ve got increased listing, increased products, we’ve got better stuff happening, better relationships with our customers. And yes, we can’t get enough stock into the system to really see it’s working financially, if you know what I mean. So hopefully, we start to see some of that in the second half of Q2.

Okay. That’s good color. And congratulations on the start-up of the new machinery line. Just curious how much those two plants mean to its overall consolidated revenues in a Home.

Figure that out. Right now, what we’re seeing – let me tell you what we are saying what we’re not seeing yet. We are seeing significant increased efficiency. So our factories are putting out significantly more product per day than they had in the past. Demand is down a little bit. There’s a lot of inventory in the system depending on which product. So we’re not seeing the same demand as we’re seeing last year. So we can’t push the production to where we want to go. We hope to change that as we introduce more and more domestic products, which we’re in the process of doing throughout the year.

And margin-wise, again, we’re seeing the efficiency, improving the margin, but then we’ve got significant cost increases on particle board and all the other inputs and get raising prices again, but – that whole process. So we’re not seeing necessarily yet the benefit from all of that, but I think it’s all in place. So hopefully, we’ll be fine.

Okay, Jeffery. I’ll reach you. Thanks.

Your next question comes from Stephen MacLeod from BMO Capital Markets. Please go ahead.

Thank you. Good afternoon guys. Just wanted to follow up on the pricing. You talked about Juvenile and Home. In both situations or both segments, you put your price to offset some of the inflationary challenge that you’re seeing. It sounds like some of that you began to see in the quarter, but maybe not to the full extent. So I’m just curious, what it looks like with respect to when you might expect to see price coming through into margins.

Yes, that’s a big question, Steve. I mean when is inflation going to slow down? When is the next price increase going to stop? And then we can answer the question. I mean we’re just – we’re always in catch-up mode. We’re always – we can’t be any more proactive, if anything, sometimes we’re more proactive than our competitors. But we raised prices to cover the freight and now there’s other things happening out there. So it’s difficult to know when we’re actually going to finally see the impact in the gross margins. There’s just – there’s so much uncertainty out there.

In Europe, we’ve got exchange rates, right, around the world other than the U.S., exchange rates have moved significantly in the last month. Negatively by the way, to us. So are we going to price for that? Is it going to come back? We don’t know. It’s still early days, but extremely frustrating by all the different elements of pressure on the margins that we’re seeing.

Right. Okay. And then I just wanted to turn to one thing specifically with respect to the mattress manufacturing that Martin is referring to. You mentioned is high margin, and I’m just curious like how much higher margin is it than other Home type products.

It – we’re looking to be 800 to 1,000 margin points, I guess, higher. Again, not every – depending on what we’re doing, maybe doing some volume stuff, but it’s a low-margin business in general, right now, especially under all the pressure.

I mean, our standard margin should be a lot higher than our reported gross margins in that industry. But nevertheless, we think that we can put a program together with domestic manufacturing that is – gives us even higher margins than the average standard margin that we’re supposed to have.

I mean it’s quite a benefit for everybody because right now, just getting stuff out of Asia is difficult plus you’ve got all the cost to transportation, plus you’ve got just the uncertainty of having to order with lots of inventory, we can make it. And we believe we’re making a really good product. We’ve had some significant retailers in to see the manufacturing facility and they’re interested. So we’re pretty upbeat.

I mean we don’t have all of these people online yet as customers, but we’re talking to people that we can never talk to before because they weren’t interested in buying imported mattresses, but very interested in domestic. And again, a lot – these are all lower-priced mattresses than the names that we’re all familiar with. The market segment before.

Yes. Okay. And then maybe one more if I could, just with respect – you talked about normalized margins being – it should be a lot higher. Can you talk about where you think normalized margins would where you not – in both segments where you’re not seeing all this inflation and noise, just is there something that...

I think, I can just go back to history and say, can we be at 15%, 16%. Again, we’re talking gross margins here, we’re talking net margins. But certainly on the gross margin, I mean, that’s what this business is. It’s a business that should be averaging and definitely north of 15%, 16%. We’ve just been struggling in the last couple of years with all the changes and all the stuff that’s happening.

Yes. And then that – those are Home margins you’re talking about 15% to 16%.

Yes. Talking about Home margins. Juvenile actually think that moved quite a bit, but like – I always look at Juvenile as a business that is from an operating leverage point has a lot of upside. We can increase – we don’t need to increase, double the revenue, double the earnings, right? And we’re at that. We’re looking at that from our point of view, and we’re saying it’s not that much more with that operating leverage really kicks in and you really start to see increased profits quickly. So we’re fairly upbeat on the potential for Juvenile. Just need to get all the clouds out of it.

Okay, that’s great color. Thank you.

Your next question comes from Derek Lessard from TD Securities. Please go ahead. Derek, your line is now open.

Yes, I keep muting myself, but just a few more for me. You did mentioned, some of the increased liability costs that you took in the quarter. Curious on, how much visibility that you guys have. I know you said you don’t have any major, I guess, costs coming up for the year, but how much visibility or advance warning do you have about these things?

I mean we could see the calendar as to which cases are actually going to come to – I don’t know what the right word is, like a – resolve, resolvement, I guess, is the right way to say it. We can see what is on the calendar for the rest of the year. We can’t necessarily see into next year. I mean many places that we’re notified of don’t actually even end up being cases. Some of them just fade away. Some of them get settled quickly. Some of them will fight. I mean, depending on a whole bunch of things, and I don’t want to get into it now. So we know it’s on the sort of likely to be resolved for the rest of the year. And it is – it’s lighter than it’s been than the average would be.

Okay. And on the corporate expense side, there was a jump to $8.5 million, I think, from $3.8 million last quarter. What was driving that?

I think I mentioned before or maybe I missed it. 2.2% is a FX impact. I mean, corporate is not just a corporate end ups paying everything that doesn’t fit into a division, so including some hedges that we have between areas and corporate. So 2.2% of that is unrealized FX.

Okay. And maybe one final one for me and it might be a bit of a harder one to answer. I was just wondering how you guys view the macro environment and how that could potentially impact you from maybe unlocking more value from one or both of your businesses?

I mean the macro environment right now makes it unwise to try and do that. We – I don’t know that it impacts the value of these businesses, in the midterm or when we kind of unlock it. I mean, we’re very, very, very focused now on doing the things we need to do to create value. We also have to deal with the reality of the day-to-day operations. Somebody in our organization, I’m going to quote him, I like it. I feel it’s appropriate.

It’s like on a week-to-week basis, we’re seeing a lot of progress. But on a day-to-day basis, man, it’s tough, it’s really, really tough, like there’s always something popping up that we have to deal with. There’s another kind of curve ball and with component doesn’t show up because it’s stuck on a boat because there was a fire. I mean – or this port is on strike or all of those things are happening, all the time and they all go right immediately to your bottom line.

So we got to look past that and say we’re going to deal with it, but we also need to do the things that we needed to do. It’s an example, in home furnishing; we need to continue to expand our European business. I mean, right now, it’s suffering to the war. But that doesn’t mean we don’t go out and get new accounts, and we don’t start listing products all over the place, even if sales are down. So on one hand, we know that what the work we’re doing today is going to pay off. But when you look at the end of the month, you don’t see it.

So we’ve got to wait for the clouds to disappear and then see where we are. We want to come out running when things open up again. And then we’ll know timing. Like there’s no – we don’t even talk timing now. We don’t know. I mean we just have to do the things so that this business is going to be better when it’s back to normal.

Okay. And it hasn’t impacted, I guess, any other conversations that you might be having?

We’re not – like I said, we’re – we’ve been transparent with the market. It’s one day we’re going to do that, but today is not a day, it’s really not a day today. So there’s no point talking to anybody or anything. There’s nothing – we’ve got to fix the businesses. And while we’re fixing them, we have to deal with all of this day-to-day craziness that the world is in now. So that’s – it’s really two-pronged. We really have two-pronged approach dealing with day-to-day trying to get as much as we can in our quarters.

But – as important or more important is, are we doing the things for that next year, this business is going to be a much better spot. Do we have the right products listed with the right accounts? Do we have the relationship right? Is our marketing better? Is our branding better? All of those things aren’t necessarily been done for this quarter, but they’re being done for 2023 and 2024. So we’ll have to see. So there is no news on timing.

Thanks you so much guys.

Presenters, there are no further questions at this time. Please continue.

We’d like to thank everybody for being with us today. And we wish you all a pleasant weekend and special wishes for a great day Sunday to all the mothers out there. Thank you very much.

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect. Thank you.