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Edited Transcript of DIIb.TO earnings conference call or presentation 6-Nov-20 6:00pm GMT

·20 min read

Q3 2020 Dorel Industries Inc Earnings Call Montreal Nov 6, 2020 (Thomson StreetEvents) -- Edited Transcript of Dorel Industries Inc earnings conference call or presentation Friday, November 6, 2020 at 6:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Jeffrey Schwartz Dorel Industries Inc. - Executive VP, CFO, Secretary & Director * Martin Schwartz Dorel Industries Inc. - President, CEO & Director ================================================================================ Conference Call Participants ================================================================================ * Derek J. Lessard TD Securities Equity Research - Research Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Dorel Industries' Third Quarter 2020 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, November 6, 2020. I'll now turn the conference over to Martin Schwartz, President and CEO. Please go ahead. -------------------------------------------------------------------------------- Martin Schwartz, Dorel Industries Inc. - President, CEO & Director [2] -------------------------------------------------------------------------------- Thank you. Good afternoon, and thank you for joining us for Dorel's third quarter earnings call for the period ended September 30. Joining me are Jeffrey Schwartz, CFO; and Frank Rana, VP of Finance. We will take your questions following our comments. As I'm sure you know, on Monday, November 2, before the opening of the markets, Dorel issued a press release announcing an agreement in principle for a proposed going private transaction. The press release is available on Dorel's website and on SEDAR. As set out in the press release, Dorel does not intend to make any further announcements or to provide any update with respect to the potential going private transaction, unless and until Dorel enters into a definitive agreement for the transaction. Today's presentation is meant to discuss Dorel's latest results and is not made in furtherance of the proposed going private transaction or to solicit proxy votes from shareholders in connection with the proposed transaction. Following the advice of the company's Securities Counsel, the company will not discuss the proposed going private transaction, our comments beyond the scope of its publicly filed materials. Q&A for this call will be limited to the same scope as well. Now as regards to our third quarter, I am pleased to say that all 3 of our businesses delivered solid performance, with Dorel Sports and Dorel Home, again, leading the way. The second quarter trend of increased demand for bicycles continued through the third quarter, but demand again outpaced product availability. What we saw in the quarter was the continuation of the COVID effect. As there was a high demand for bikes worldwide, there has not been the usual trend of discount. As we've also been doing all year, we scaled back normal marketing costs at sales events. Dorel Home had a solid quarter despite sales also being limited by a lack of supply in some of its product categories. Dorel Juvenile improved its earnings and recovered from the first half adjusted operating loss that was due to the negative impact of the COVID-19 pandemic. For -- now, a more detailed review. Dorel Sports experienced another quarter of revenue growth due to the continued demand for Cycling Sports Group and Pacific Cycle Bicycle. E-commerce POS was also low. In Europe, increased e-bike sales contributed to the strong results here. Despite this overall success, capacity, again, limited sales as consumer demand outstripped supply. Caloi's year-over-year revenue was down in U.S. converted dollars but increased in local currency and up considerably over the second quarter as stores began reopening after the spring COVID-related shutdown. Dorel Home had another good quarter, both in terms of revenue and in terms of operating profit. Sales in e-commerce and brick-and-mortar channels grew from last year, with a particularly solid performance of brick-and-mortar customers in most categories. Branded sales of Little Seeds, Cosmo Living and Novogratz maintained their upward trend. As with sports, sales would have been even higher, but supply could not fully satisfy consumer needs. This demand is expected to remain strong through the balance of the year, but ongoing issues could affect earnings. At Dorel Juvenile, third quarter revenue was down, but operating profits increased considerably due to reduced expenses. Retail stores reopened in most regions with the exception of certain company-owned outfits in Chile and Peru, resulting in lower sales in those markets and creating the quarter's overall revenue decline. E-commerce sales continued to grow in importance within Juvenile, growing to approximately 35% of all sales. As we look forward, there are a number of global situations that are a concern. The rising COVID cases in Europe have pushed governments into lockdown. Many retailers have been shut down. A large part of our European sales are to small stores, and we are watching the situation carefully. Ocean freight has become a tenuous situation. Container rates have risen sharply as well as there is a shortage of available space on vessels. As an example, with the rise of COVID, lots of shipping space is being used for the huge volume of PPE. As e-commerce continues to grow, shoppers move away from brick-and-mortar stars. Delivery systems are being pressed, resulting in the cost of domestic package delivery to rise. Both FedEx and UPS being overwhelmed have raised prices. The cost of raw materials, mainly in Asia has increased. The demand for steel, aluminum, rubber and packaging is leading to this increase. The worldwide demand for bikes has caused a shortage of parts as suppliers are struggling to increase their output in the near future. The parts suppliers are raising their prices as demand goes up. In general, the demand for products in our categories out of Asia have increased the point where suppliers are having hard times keeping up. This is causing shortages throughout the system. The Chinese RMB has become stronger over the last summer months, which could increase cost. We are working on mitigating these costs. We have been negotiating with our suppliers as well as finding new supply lines. We have started to raise prices, which is a process over a few months. Our teams have done an exceptional job on their ongoing less-than-ideal circumstances. Senior management thanks them sincerely for their efforts and continued dedication to Dorel. Their safety and welfare remain our top priority. I will now ask Jeffrey to provide the outlook and financial perspective. Jeffrey? -------------------------------------------------------------------------------- Jeffrey Schwartz, Dorel Industries Inc. - Executive VP, CFO, Secretary & Director [3] -------------------------------------------------------------------------------- Thank you, Martin. So what I'm going to do is I'm going to expand on our Q3 numbers a little bit as well as expand a little bit on our Q4 outlook, giving a little bit more details as to -- in both cases, how we got to where we're going here. So for Q3, Dorel's revenue increased by $67 million or just under 10% to $753 million. Organic revenue improved by approximately 10.7% after removing the variation of foreign exchange rates year-over-year. Revenue and organic revenue improvements were in Dorel Home and Dorel Sports, and they were offset by revenue declines in Dorel Juvenile. Dorel Home revenue increased due to strong online sales and improved brick-and-mortar sales as much of the country reopened post-COVID-19 restrictions in the United States. Dorel Sports revenue improved for the sixth consecutive quarter as Pacific Cycle and Cycling Sports Group benefited from increased demand due to the COVID-19 pandemic. Dorel Juvenile saw -- several markets saw revenue improvements, which were more than offset by declines in countries that continue to impose lockdowns and store closures to limit the spread of COVID-19. Gross profit for the third quarter increased 210 basis points to 21.9% compared to 19.8% last year. The improvement in gross profit and adjusted gross profit in the quarter was mainly attributable to Dorel Juvenile and Dorel Sports, while Doral Homes gross profit was flat with prior year. Dorel Juvenile's margin improvement was mainly due to favorable exchange rates, cost savings initiatives and lower commodity prices. And Dorel Sports' margin improvement was due to less discounting, favorable tariff exclusions granted in the U.S. and lower warranty costs. Selling expenses for the third quarter declined by $6.8 million or 11.8% to $50.4 million, a decrease of 160 basis points as a percent of revenue. Selling expenses were lower in all 3 segments, and spending cuts were initiated in mid-March to mitigate the impact of the pandemic such as reducing the workforce temporarily in certain locations and reducing marketing spending and promotional activity. General and administrative expenses increased in the quarter by $8.4 million or 17% and an increase of 50 basis points as a percentage of revenue. The dollar increase in the quarter was driven by higher people costs, higher product liability costs, and it was offset in part by cost containment measures across Dorel. Financial expenses decreased by $1.9 million to $10.9 million during the third quarter compared to $12.8 million. The decrease is mainly explained by a decrease of $1.6 million in interest on the long-term debt due to lower average debt balances year-over-year. And of course, I will move on to the Sports section now. For the third quarter of 2020, Dorel Sports revenue increased by $55.3 million or 22% to $305.6 million from $250.3 million. When excluding the impact of varying foreign exchange year-over-year, the revenue improvement was about 23.8%. So Dorel's revenue and organic revenue improved for the sixth consecutive quarter. CSG and Pacific Cycle revenue continued to grow due to, again, consumer demand for bikes across the globe as families were looking for outdoor activities and transportation methods that are safe and respect social distancing guidelines. The revenue growth at CSG was mainly in the key accounts due to an increase in online sales and curbside pickups as well as in Europe, where demand is even stronger than it is in North America. Pacific Cycles' revenue growth were, again, due to strong POS demand throughout the summer. We also -- in addition to that filling of the pipelines, we came into Q3 with practically no bikes at the retail level. That did improve significantly by the end of the quarter where there is some inventory in the stores. It's not 100% where it should be, but we definitely increased filling the pipeline. For gross profit, during the quarter, gross profit improved by 470 basis points to 23.4%. The increase in gross profit was mainly due to less discounting of prior year models compared to last year. And that's because the demand is basically taking any and all bikes, favorable tariff exclusions granted in the United States and lower warranty expenses. In the SG&A, expenses increased by $3.2 million. That was mainly due to increased commissions from higher sales, increased spending on e-commerce, higher product liability due to increased sales, which was partly offset by containment measures to mitigate the impact as well as significant reductions in both travel and marketing for the year. The result was operating profits in the third quarter of $24.2 million compared to $6 million last year. Operating profits improved for both periods, mainly due to the increased revenue and gross margin improvements and offset again by higher overall expenses, as we discussed. If we look over at the Home business, third quarter revenue increased by 29.7% or 14 -- $29.7 million or 14%, and the increase is explained by strong POS in most categories in the brick-and-mortar as stay-at-home orders eased in the United States, more people went shopping in stores, the actual brick and mortars. And online continued to be very strong in the home furnishing area as well. Gross profit of $15.3 million was relatively flat with last year. And our overall profit increased by $5.2 million or 33% for the quarter to $20.9 million from $15.7 million last year. Moving over to Juvenile. Dorel Juvenile's third quarter declined $17 million or 7.8%. The organic decline was 7.1% after removing the impact of varying foreign exchange. Several markets, including the United States, Europe, Australia and Brazil, saw organic growth. However, revenue declines in Chile and Peru were significant, as well in China domestic where we sell to consumers, not the factory, that had a large drop due to a change in distribution and a return of inventory from one of our distributors. Gross profit for the quarter was 27.4%. That represented an improvement of 220 basis points. Excluding restructuring costs, the adjusted gross profit was still $27.4 million, even though we're still going through the restructuring cost area. The improvement in gross profit and adjusted gross profit in the third quarter were mainly due to foreign exchange gains, cost savings initiatives and overall lower commodity costs. The SG&A in the quarter decreased -- or the selling expenses decreased by $4.5 million or 16.9%, representing a decrease of $1.2 million. General and administrative expenses, however, increased by $1.7 million to $19.8 million. The decrease in selling was mainly due to cost containment issues or measures initiated in the first quarter to mitigate the impact of the lower sales, mainly resulting from the COVID pandemic. And additional cost savings that were realized related to the restructuring activities that started in the first quarter of 2019. The increase in general administrative is mainly due to an event in the third quarter of '19, in which when we exited the LEGO business, we actually had a gain there and applied it there. So that's the reason for that increase. And operating profit was $7.6 million during the quarter compared to an operating loss of $4.6 million last year. And excluding restructuring costs, profit improved by $4.9 million to $7.5 million this year versus $2.6 million last year. Again, the improvement in the profit -- adjusted profit was mainly explained by better gross margin as well as a decrease in expenses that we talked about. A couple of other small areas. Cash flow provided by activities, $29.4 million compared to $48.8 million last year, a decrease of $19.4 million. We had a tremendous Q2, as you remember there, and this is slowing down a little bit as we increase our working capital, which had dropped significantly. Now I'm going to move over to an outlook for Q4. Q4 is looking like a difficult quarter. And I'll give you some background on what's impacting it. The sports business is likely to be the most negatively impacted of the 3 segments in the fourth quarter. Demand does remain strong. However, here are some of the issues that are impacting the business. In the mass side, container freight issues that Martin mentioned, both delayed shipments and have made those shipments that are coming in more costly. A shortage of bicycle components in the whole industry as well as an increase in their cost has impacted us in Q4 as factories have limitations on what they can make and costs from those factories have gone up as well. In order to deal with that, we are going to go to the market and get price increases. And we hope to have that done and impacted sometime early next year. But that hasn't been completed yet. On the higher end bicycles, we do have a mix issue in the quarter and which is depressing our margins. We are shipping a lot more lower priced, lower-margin products than we have in previous quarters. Most of the higher-margin products will be shipped at the beginning of Q1 as we've moved our model year in production from Q4 to Q1. Last year's quarter contained a large refund of tariffs that we had paid throughout the year, and then was refunded in Q4. So that one will not be repeated this year. So that makes it difficult to get our numbers back there. And as you can see, there's many issues that are really impacting this business and the forecast for the quarter. We do believe that with some price increases and a better mix that we can reverse this negative trend and be doing -- having a better business in 2021 than we're seeing in Q4. On the Home side, demand is still good. Supply is somewhat limited. The factories are very, very busy, and we're getting what we can, and we're looking -- as Martin said, we're looking for more factories. But a lot of the issues that Martin talked about are already actually affecting our business right now. Container freight, certainly on the -- right up there, adding cost. Domestic delivery is difficult, getting trucks. And again, the cost of doing online business delivery is going up as well. And on top of that, factory costs in China and all over Asia is on the rise. And all of that is putting pressure on our margins. We are, again, in this sector, going to need to have price increases to mitigate that. And we're in the process now of going out to try and get some of those price increases. A little bit different in the Juvenile when we're looking forward. The Juvenile in the fourth quarter is really being impacted by the shutdown of retail in Europe. Currently, many countries are going into a lockdown, and that's leading to a lot of softness in sales. And we know from the first wave back in March and April that our European business is highly correlated to the stores being open. On the other side, we're seeing improvements in South America as summer is arriving and more stores are able to open, and we're starting to see some improvement there. So we are definitely correlated to what's happening with COVID and shutdowns in this business. So although impacted by other issues like the freight and the currency and some of the other things, really, the COVID close lockdowns are really the main impact that we're having on Juvenile. And that will last as long as the lockdowns last. So we don't see a visibility as to exactly when we'll see a pickup in that business. So overall, when we're looking at our earnings right now, we're looking at about the same level as we had last year for the quarter. And we are hoping that we can tackle a lot of these issues, and we believe we can tackle them that we're looking to have a good 2021. So with that, I'll pass it back to Martin. -------------------------------------------------------------------------------- Martin Schwartz, Dorel Industries Inc. - President, CEO & Director [4] -------------------------------------------------------------------------------- Okay. Thank you, Jeffrey. I'll now ask the operator to open the lines for your questions. Operator, please? ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Your first question comes from Derek Lessard from TD Securities. -------------------------------------------------------------------------------- Derek J. Lessard, TD Securities Equity Research - Research Analyst [2] -------------------------------------------------------------------------------- Quick -- just a question. Obviously, the pandemic has created some -- I guess some unprecedented demand for what you guys are producing. I was just wondering where you think you might be in terms of more normalized sales growth, assuming COVID didn't hit? -------------------------------------------------------------------------------- Martin Schwartz, Dorel Industries Inc. - President, CEO & Director [3] -------------------------------------------------------------------------------- Wow. I can't answer that. I mean that's -- yes. We like to think that we're building our business, and we like to think that we've made a lot of advancements independent of COVID on both the Sports and the Home front. I mean I don't think Juvenile is -- factors into what your question was. But we don't know how much of that came from COVID and how much of that came from our -- all the work we've been doing. That's a difficult one. -------------------------------------------------------------------------------- Derek J. Lessard, TD Securities Equity Research - Research Analyst [4] -------------------------------------------------------------------------------- Okay. And fair enough. I guess, maybe if you can just talk about your replenishment cycle in bikes and how much inventory you think you need to build up? And I guess I was curious to your comment as to why has model production falling now for 2021. What changed there? -------------------------------------------------------------------------------- Martin Schwartz, Dorel Industries Inc. - President, CEO & Director [5] -------------------------------------------------------------------------------- Two things. But the biggest one is we made a decision earlier in the year, and I think it's been in the press, to start our model year with the calendar year, which was not the norm for bicycles. Norm would be start shipping of bicycles in Q4 when the retail stores were sort of down and not busy, and they would have to fill up their basements with bikes. It didn't make a lot of sense, but it's what the industry did. And now we've shifted over to say, you know what, we're going to have you guys receive the bikes closer to when you actually sell them instead of sitting on them for months. And when we sit on them for months, as you know, the receivables wouldn't get paid either. So we -- it increased that, it increased cash pressures on lots of people. So we shifted a lot of the newer models towards 2021. And that was done 6, 7 months ago, the plan to do that. So when we had to bet earlier in this pandemic on what bikes would we bring in for Q4, we went, I guess, with the safest stuff, which would be the high-volume bikes. So we brought in a lot of high-volume bikes, but the high-volume bikes carry lower margins. So that's one of the reasons we're seeing an impact on our earnings in Q4. -------------------------------------------------------------------------------- Derek J. Lessard, TD Securities Equity Research - Research Analyst [6] -------------------------------------------------------------------------------- Okay. And I guess one final one for me is, maybe if you can talk about some of the cost initiatives that you did put into Juvenile? And how much of those initiatives do you think are more permanent in nature? -------------------------------------------------------------------------------- Martin Schwartz, Dorel Industries Inc. - President, CEO & Director [7] -------------------------------------------------------------------------------- Well, a lot -- I think, I mean, again, I don't have a number for you, but we did do a restructuring, and that is going towards the numbers that we said we would hit both in what we spent and what we've saved. On top of that, there are -- like you said, there are stuff at travel as an example. I mean, there's a lot of things that are temporary. But I'm going to say, there's a lot of permanent stuff there that's related to restructuring. And we're basically -- we're going to stay with the number that we gave out last year as ultimately the number that we will save over time. -------------------------------------------------------------------------------- Operator [8] -------------------------------------------------------------------------------- There are no further questions at this time. I would like to turn the call back over to the presenters for closing remarks. -------------------------------------------------------------------------------- Martin Schwartz, Dorel Industries Inc. - President, CEO & Director [9] -------------------------------------------------------------------------------- Okay. Well, that concludes today's call. I want to thank you all for being with us. I ask you to all have a pleasant weekend. And very importantly, stay safe. Thank you. -------------------------------------------------------------------------------- Operator [10] -------------------------------------------------------------------------------- Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.