Dorel Industries Inc. Second Quarter 2016 Results ... · view and test drive the 2017 Cannondale...

Dorel Industries Inc. Second Quarter 2016 Results Conference Call

Thursday, August 4, 2016 – 1:00 PM ET

C O R P O R A T E P A R T I C I P A N T S Martin Schwartz President & Chief Executive Officer Jeffrey Schwartz Executive Vice-President, Chief Financial Officer & Secretary C O N F E R E N C E C A L L P A R T I C I P A N T S Anthony Zicha Scotiabank Nick Meyers ROTH Capital Partners Stephen MacLeod BMO Capital Markets Eric Beder Wunderlich Securities Sabahat Khan RBC Capital Markets Derek Lessard TD Securities Frederic Tremblay National Bank Financial P R E S E N T A T I O N Operator Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Dorel Industries Second Quarter 2016 Results conference call. At this time all participants are in a listen only mode. Following the presentation we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star followed by zero for operator assistance at any time. Before turning the meeting over to management, please be advised that this conference 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 on Thursday, August 4, 2016. I will now turn the conference over to Martin Schwartz, President and CEO. Please go ahead.

Martin Schwartz, President & Chief Executive Officer Good afternoon, everyone. Thank you for joining us for Dorel’s second quarter conference call. With me are Jeffrey Schwartz and Frank Rana. We will be pleased to take your questions following our initial comments and a reminder that all numbers are in US dollars. Q2 was another great quarter for Dorel Home Furnishings as it continued its consistent performance, further building shareholder value. Online growth was again the driver, easily offsetting reductions in brick-and-mortar. Online represented 43 percent of total second quarter sales compared to 34 percent a year ago. The segment’s ability to generate robust results while maintaining a competitive position is a tribute to the ongoing execution of the strategic plan developed by its management team. Dorel Juvenile posted solid margins due to strong operational performance, better than expected results in China, and overall pricing which reflects current FX realities. And we are making the required changes at Dorel’s Sports Cycling Group to improve profitability. We are encouraged as our new model bicycles are being well accepted. In addition, industry inventory levels have been declining significantly over the past couple of months. We saw abundant evidence of that last week at a very positive sales and dealer meeting, which Jeffrey, Alan Schwartz, and myself attended in Utah. 300 independent bike dealers were given the opportunity to view and test drive the 2017 Cannondale and GT models. Not only was the response to the line-up overwhelmingly positive but the three of us had an opportunity to speak personally with many of the dealers, who gave us unqualified upbeat feedback. The dealers are also enthused with the spirit and professionalism of the CSG management team, a number of whom have joined us recently. In short, it showed us that CSG is already doing many of the things needed to stay ahead of the competition and grow the business.



Jeffrey will provide all the financials, including details on some Q3 restructuring and impairment charges in sports to right-size the business in view of the current market environment. We remain quite upbeat as we have great products and the right team in place to lead us through the needed adjustments. Dorel Juvenile China again posted a profit thanks to a better domestic performance, successful cost savings, and operational improvements. We anticipate further cost savings, in part through additional opportunities and an improved production line structure. The factory continues to be reconfigured to accept Dorel’s products and an in-house quality lab is under construction at our campus in Zhongshan. As recent as last month another layer of redundant management has been eliminated. Dorel Juvenile USA’s operating profit benefitted appreciably from better margins and cost containment. In Q2 and beyond there are several stroller launches in the Quinny and Maxi-Cosi premium category, part of our strategy to upscale the US business to increase margins and diversify the customer base. As a solid contributor, the highly rated Safety 1st Grow and Go five-star car seat has seen Q2 line extensions and a June launch of the limited edition Quinny Mood Stroller and Maxi-Cosi Mico® car seat designed by Rachel Zoe was very positive. The products had an exclusive highly successful initial run at Nordstrom and are now being introduced at other retailers. Online response was also overwhelming. A progressive global rollout of the line is planned for all regions this year and next year into China. In Europe, margins have been quite good, aided by the car seat category, which continues to grow strongly, leveraging the ISI standard. In-store presence has improved in key markets with better training and improved point of sale due to enhanced in-store displays. As well, export sales have been considerably better into Russia, a market which was deeply depressed for some time. Over 30 near products are being launched in Brazil between now and the end of the year and in Chile where our retail stores are performing well. Retail distribution is being expanded with a new mid-priced chain called Baby Price. Considerable effort is being made with consumers to leverage Dorel Juvenile’s four global brands, primarily by maximizing our web presence. So far this year we’ve initiated 15 new websites in regions where we previously had little or no presence, such as North and Southeast Asia and Latin America. Another 20 new sites will go live by the end of this year. Being close to consumers and

speaking their language is the way to go and digital marketing is the way to get there. There are a number of regional projects as well. In Brazil, the Bébé Confort collections will be transitioned to Maxi-Cosi to benefit from Maxi-Cosi’s global notoriety and reputation, and in China we are taking ownership and distribution of Maxi-Cosi in order to accelerate its retail and digital footprint throughout the country. Dorel Juvenile previewed a number of new innovative products at the Shanghai Children Products Expo last month. It was the first time all of our global brands were exhibited and the reaction was exceptional. We will also be front and centre at the Cologne, Germany and the Las Vegas shows this fall. As I mentioned at the outset, we are initiating restructuring the third quarter and have recorded an impairment charge in the second quarter at Cycling Sports Group to simplify and focus the business with a view to strengthening the bottom line. Ongoing changes are being made in the face of a continuing difficult market to ensure we grow profits even if markets remain tough. Results have been affected by sustained discounting in North America and depressed FX rates as our IBD sales outside the U.S. are significant. But the news is better as excess industry inventory levels have decreased considerably. While Dorel’s levels were well under control, those of our competition were not. Recent date from the Bicycle Product Suppliers Association indicates inventory is down by over 30 percent since January, all the more reason we remain confident and excited about our bicycle business. And some of the changes we’re making include: we’re getting out of fringe products and processes to stay focused on our core products of on and off-road bikes. Distribution for the GT brand is being moved to a third party distributor in the Chinese independent bike channel, as is currently the route to market for brands in many other countries. By the end of Q4 the majority of Pacific Cycle’s mass market and distribution operations will be relocated from Illinois to Georgia to better serve customers. And we will be exiting the three US Cannondale sports retail outlets. These actions will result in an approximately 4 percent reduction in Dorel Sport’s global workforce. A few highlights of brand, product, and marketing initiatives during the quarter. Cannondale presented its new model year 2017 product line, not only to dealers in Utah but also in Europe, Japan, and the UK. Reaction from key IBD retailers has been unanimously positive. There are ten new platforms, including the all-new



Scalpel SI cross country race bike, a new high-performance Quik, both of which are selling at traditional margins, and dealers who tried a new Moterra full suspension mountain e-bike said previously that they would never ride an e-bike, but after testing it many came back with the quote saying they were surprisingly impressed. Cannondale also hosted launches for the new lineup with journalists and consumes at events around the world and there has been significant positive media coverage. GT rolls out its new 2017 BMX Freestyle line and announced the GT Coalition, a global brand ambassador program launched to grow excitement for the GT brand around the world. Schwinn launched SmartStart™ bikes, completely redesigned children’s bikes to better fit a child’s proportions. Mass merchants have already strongly embraced the new design. I’m also pleased to say that Pacific Cycle won the Toys “R” Us vendor of the year award for strategic partnership. Finally, Eurobike is scheduled for later this month and we have a number of our bikes nominated for awards. In Home Furnishings the story is much the same and it’s all good. The segment’s strong performance was maintained with further gains in revenue and operating profit. The key driver once again was the Internet and drop ship vendor channels, building on last year’s success, easily offsetting some declines in brick-and-mortar, and all divisions contributed to profits. We are keeping a close watch on commodity prices, particularly particleboard, which has resulted in some domestic manufacturing cost increases. Our Home Furnishings is doubling its Savannah warehouse to 600,000 square feet to support its growing e-commerce business. New systems and technologies are being added to move products faster and maximize order fulfillment. I’ll now turn things over to Jeffrey for a financial perspective.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Thank you, Martin. Before I get into the numbers I want to talk a little bit about the impairment and restructuring. So, as mentioned by Martin, in light of foreign exchange rate pressures, challenging markets, and highly competitive conditions in the IBD channel, Dorel Sports recorded an impairment loss of goodwill and intangible assets of $55.3 million. On the restructuring side, we’re looking to simplify our business and focus it on stronger categories but less

categories and therefore Dorel began its restructuring activities, which will result in about a 4 percent reduction in the workforce and represents about $9.5 million. Of that, I’ve broken it down a bit, $4.2 million is the non-cash inventory markdowns to move the goods such as places like China and other areas that we’re getting out of; $1.7 million is an accelerated depreciation of fixed assets, again, non-cash; $2.3 million in severance; and $1.3 million in other associated costs. So starting in 2017 we expect to deliver annualized savings of about $5 million in relation to all of these activities. For the Juvenile segment, restructuring activities were initiated back in the third quarter of 2015 and now are expected to continue into 2017, so initially the total estimate of the cost was about $10.6 million, which has been revised for a total estimated cost now of about $24.5 million. So the difference of $13.9 million, the bulk of that is going to be $9 million, which is non-cash estimated loss on the planned disposal of some facilities in China. As I think we’ve talked in the past, we do have some excess real estate that we do not need going forward and we had a book value that we put on it back when we acquired it at the end of 2014 as the market has gone down in China. We’re just revaluing that to what we believe to be the market values for those assets that we’re looking to get rid of. In addition, another $2.7 million is related to employee severance and termination, again mostly China. We’ve had some success. We’re seeing some good numbers in China. We’re getting more efficient. We did one round last year of some layoffs that we announced and, again, we’re slimming down the amount of people that we need, so that’s really sort of a continuation of the efficiency that we’re looking to get in China. We anticipate that when we take all of the restructuring, last year and this year’s, into effect that we should have about a $9 million savings annualized from that. In addition, following a jury verdict in Marshall, Texas in regards to a car seat case which was settled for $19 million in net damages, our product likability provision and insurance coverage was covered by about $12 million so therefore the balance of the $7 million was expensed in Q2 and was put into the restructuring costs. If we look at some of the numbers now, consolidated revenue for the second quarter was $637 million, down 4.8 percent from a year ago. After removing the FX variations organic revenue declined 3.8 percent. And also excluding what we call the anticipated reduction of third-party sales in Dorel China, which is something that we’ve planned for throughout the year, this decline has dropped down to 2.1 percent.



You know, year-to-date numbers are down 3.9 percent gross and then again after the organic and third party China sales we’re down 0.7 percent. So relatively flat with last year; however, gross profits have risen by 120 basis points in the quarter and, you know, that’s coming from Dorel Juvenile’s production efficiencies, favourable purchasing initiatives, and better pricing in areas where foreign exchange has hit us last year. Dorel Home Furnishings increased their margins through a mix of better online sales and the bike side, both Pacific and CALOI had a better product mix that also allowed us to increase our margins there. So the only area where margins were really impacted was at the Cannondale area and the IBD part of our bike business, which we’ve talked about before. So we reported an operating loss of $33.8 million for the quarter compared to a profit of $28.2 million; however, when we look at the adjusted we actually raised our earnings to $28.7 million when we exclude all of the restructuring and impairment charges. Adjusted net income for the quarter was $14.5 million or $0.45 per share compared to $16.6 million last year or $0.51 a share. Our tax rate, our effective tax rate during the quarter and the six months was 12.5 percent and 8.6 percent compared to last year’s 8.1 percent and 15.6 percent; however, when you put all the adjustments through the adjusted tax rate has risen to 23.7 percent compared to last year’s 7.9 percent for the quarter and 20 percent versus 16.2 percent last year. The variation, again, changes in jurisdiction, of which our companies generate the income, and the non-deductible impairment of goodwill affected that number. So moving over to Juvenile now, Dorel Juvenile sales declined by 9.8 percent to $239 million compared to $264 million, so when you take out, ah, that’s 9.8 percent. When you look at the organic revenue the drop was 8.2 percent and then when you remove the third-party sales that were planned the drop dropped down to 4 percent. So we still have a 4 percent real decline in income, which I’m going to address a little bit shortly. Gross profits for the second quarter rose 360 basis points to 31.2 percent from 27.6 percent in the quarter. I mean better pricing, like I mentioned, in areas that were affected by foreign exchange. Production efficiencies, primarily in China, has really helped, and although we have lower sales our pricing is a little bit better in many areas. So our mix is better. Some of the sales that we have let go were because the margins were just not

acceptable anymore. So we’re kind of exiting those areas. The operating profit decreased to $5.3 million from $9.5 million but that’s due to the $7 million car seat settlement, so adjusted profits actually increased by $1.5 million or 9.5 percent to $16.8 million in the second quarter. That is a little bit better than we expected, you know, when we spoke to the market last time at the end of the first quarter. We did get an increased earnings out of Dorel China operation as our purchasing and efficiencies have started to really kick in. And just addressing the sales issue that we’re having, again, some of the decline is related to low margin business that we’re looking to get out of. We have, in Europe, you know, we had a price increase which helped our bottom line and slowed, you know, had a small negative impact on the top line. Sales growth in other parts of the world, South America, Australia, Canada, is all positive. And looking forward to the second half of this year we believe we will start to see some revenue increases as well as profit increases. So it’s been a little bit tough as we’ve kind of restructured our sales and our customer base, particularly in the U.S., but going forward with the new product introductions that we have, we’re looking to see a revenue increase for the second half in our Juvenile business. Moving over to Sports, Sports revenue declined $14.6 million or 5.8 percent. Organically we declined by 4.8 percent, and that’s explained by lower IBD sales in North America as consumers shifted a little bit more towards opening price point bikes. Certainly a decline in CALOI sales, you know, as the continued economic challenges in Brazil have hurt us; however, we’ve also raised prices there significantly. So we’re protecting our margins and our profitability down there but it’s coming at a cost of some declining sales. This was partially offset in the bike business by increased sales in Europe to our IBD accounts as that business is picking up. Gross profit for the quarter declined by 190 basis points to 20.7 percent for the quarter. Even though we’ve actually increased our market share in North America, according to industry statistics, we’ve been affected by that industry-wide discounting due to significant inventories at the supplier level and that’s caused us to have a serious impact on our margin. As I mentioned, CALOI’s margins are doing well. They have a good improved product mix. And we are actually seeing a slightly better currency rate in Brazil than we were certainly at the end of last year. Pacific Cycle’s margins also increased slightly quarter over quarter.



So our Dorel Sports segment recorded an operating loss in the quarter of about $50 million compared to $11.1 million last year due to impairment charges; however, when we look at the adjusted profit we had a decrease of $5.4 million to $5.2 million versus last year’s quarter, which was $10.5 million, I believe. Declines in the period were explained by decreases, again, in sales in North America, as I’ve talked about before, and the reduced margins from discounting. If we move over to Home Furnishings, second quarter revenue increased by 5.3 percent. For six months we’re up by 7.1 percent. For both periods the segment sales to online retailers continue to drive the revenue growth, running around 43 percent versus an average of about 33 percent last year for the six months. The growth there exceeds the reduction in sales through the brick-and-mortar channels, which is still challenging. As a result of the segment’s growth we’ve increased our footprint in Savannah, Georgia, as martin mentioned, so we’re getting ready for a busy second half, Christmas season. Gross profits increased in the quarter by 330 basis points and that came through all of our divisions within the Home Furnishings business, which is nice to see. Operating profits were $13.7 million, which represents an increase of $58.3 percent for the quarter. A lot of that is due to just increased sales volume, the improved margins, and some of the operating leverage that we have. If we move over just to our balance sheet, working capital, very happy with the progress that we’ve made when you look back to where we were last year. So our overall debt at the end of June was slightly increased compared to December 2015, the end of December, and we traditionally borrow a lot more money in the first two quarters; however, the average debt for the quarter was considerably lower than last year, so that generated lower interest on the long-term debt, which we’re happy about. But what I really want to bring to people’s attention is the focus we’ve been putting on cash flow and, as a result, the cash provided by the operating activities increased by $37 million for the quarter and $117.8 million year to date compared to last year. The main reason for that improvement is a better use of our inventory. And our inventory levels, if you look at them at the end of Q2 this year versus last year, it was almost $100 million. And we’ve been able to function very well, growing our businesses in many areas and doing it with $100 million less than inventory is something that we’re pretty proud of. So, with that, I’ll turn it back to Martin.

Martin Schwartz, President & Chief Executive Officer Okay. Thanks, Jeffrey. In terms of the balance of this year, Dorel Juvenile has done better in Q2 than our previous guidance, delivering a strong improvement in earnings. We anticipate that this trend will continue into the second half of the year. While sales growth remains challenging in certain of its markets, improved sales mix, pricing, and operational improvements are expected to generate significant earnings increases over last year. The positive performance in Home Furnishings will also continue and we’re confident that the second half will exceed last year’s performance, although the pace of earnings improvement might not be as strong as the first half. At Dorel Sports, this year’s earlier excess supplier inventory levels within the industry are decreasing; therefore, the pressure on margins experienced to date is easing. Our inventory is at much better healthier levels with less prior-year models on hand. Based on the enthusiastic initial dealer reaction I discussed, we’re anticipating strong sell-through on the model year 2017 line just introduced. This will benefit margins and we anticipate adjusted operating profit will be significantly better than last year’s second half. Overall, all three segments are poised to deliver double digit adjusted earnings growth in the second half versus last year and with the changes we have made and will continue to make we are optimistic about our results for the balance of the year. In Juvenile and Sports the majority of the improvement will come in the fourth quarter. I’ll now ask the operator to open the lines for questions but, as always, please limit your questions to two on the first round. Operator?

Q U E S T I O N A N D A N S W E R S E S S I O N Operator Thank you. Ladies and gentlemen, we will now conduct the question and answer session. If you have a question, please press the star followed by the number one on your telephone keypad. You will hear a tone acknowledging your request. Your questions will be answered in the order they are received. Please ensure you lift the



handset if you are using a speakerphone before pressing any keys. Your first question comes from the line of Anthony Zicha from Scotiabank. Please go ahead.

Anthony Zicha, Scotiabank Hi. Good afternoon, gentlemen. Martin, could you please provide us some more colour on the sport segment? Like when do you believe inventories are going to work their way out of the IBD channel and on the retail channel? I’m trying to understand like why does this occur in the first place. I know that there was a weather issue in Europe during the quarter but what’s happening to the customer base?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary I’ll take this, Tony. Yeah, I mean it is rather complicated and we have some insight but it’s not as much on our end I think as on some of our competitor’s end. So what happened last year, I know we look forward to the 2016 model year and reduced our expectations but I don’t believe our competitors did and they went and they brought in, you know, everything is made in China so you’ve got to pre-order all that, and I think they brought in a lot of product. I don’t know why, but they did. And according to the industry statistics that we have, in January supplier inventory was, again, not retailer inventory but supplier inventory, was 40 percent higher than the previous year, so some of our optimism is that the same report in June has stated that now in June supplier inventory is 8.8 percent higher than last year. So we’ve moved that number down significantly, which is good. I can tell you at Dorel we have, like as we’re moving now into the 2017 year, so we do have 2016 model year bikes still that we have in stock that we will sell, but our number is 50 percent less than last year. So we have significantly less bikes that we have to worry about clearing as we get into the second half of the year, which means we get to start to sell our new 2017 bikes earlier and more, you know, get a better penetration and better mix of the higher-margin 2017 bikes than we did last year.

Anthony Zicha, Scotiabank And that’s why—

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary That’s part of the reason we’re more optimistic. We don’t have that sort of anchor behind us. We also believe, I mean if you look at Shimano’s latest press release, you know, and they supply the entire industry, I believe their sales in the first half were down high teens, something like that, which means that people, ah, the industry is ordering less bikes right now than they did the previous year, which leads us to believe that our competitors are also being smarter in how many bikes they bring in, which hopefully will therefore not lead to the same amount of excess inventory that occurred the year before. So that’s a big part of our optimism. The fact that we’re going to get back, you know, to a profitably level and have a better profitability level is really related to those two things. We have great bikes, there’s no question about that, and we just think that... We have less bikes to clear, which means we’re going to have to sell our new ones, and the industry itself hopefully will have less clearance bikes.

Anthony Zicha, Scotiabank Okay. My second question is with reference to juvenile. Jeffrey, you had mentioned that you exited more of the low margin business. You also gave us an indication that your business in Canada was positive, Australia was positive, but you didn’t mention anything about the US, so could we presume that the US, your biggest market, has been negative? And what’s happening there? Are you losing market share? What about the competitive landscape?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary It’s actually interesting. We are definitely losing market share in some accounts. I won’t talk accounts, specific accounts on a conference call, so please don’t ask, but there are certain accounts that we have dropped our market share and there’s other ones that we have gained market share and with the new listings that we’re going to be shipping in the second half of the year we’ll definitely pick up some market share. And we’re pleased with that. It’s a good mix. We’re gaining with people we want to gain from and we’re losing with people that if I had to lose it’s not so bad.



Anthony Zicha, Scotiabank And are you selling more on the Internet as well in the United States?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Yes. It’s still not up anywhere near the home furnishing level at all but it’s, yeah, every year we’re gaining more through the Internet channel, it just doesn’t represent as much as it does in home furnishings.

Anthony Zicha, Scotiabank How do clients feel about that? That’s my last question.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Well, I mean let’s take a customer like a Wal-Mart. We sell walmart.com, so to us that counts as the Internet. So, you know, obviously... The Internet is what it is now and I think every retailer accepts it and is trying to figure out the best solution to it. So we’re doing... We will be, you know, look, we forecasted a strong second half. We’re already up in the first half. I believe, you know, according to what we see our second half sales will start to beat last year, we’re going to start to see some improvements there.

Anthony Zicha, Scotiabank Okay. Thank you very much.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary We’ve been focusing for a couple of years on margin and that’s working. So, yeah, I know we’ve got to draw, we eventually have to get the top line moving again, and we will, but we’re not displeased with the fact that our margins are going up even if our sales are dropping a bit.

Anthony Zicha, Scotiabank Okay. Thank you, Jeffrey. Thank you, Martin.

Operator Your next question comes from the line of Dave King from ROTH Capital Partners. Please go ahead.

Nick Meyers, ROTH Capital Partners Hello, guys. This is Nick Meyers on for Dave King. How are you doing? First, can you talk about some of the pricing actions you’re taking in juvenile and is that a function of responding to currency moves or are you guys also feeling more pricing power on your new products?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary I think that’s related to markets that were affected by currency. For instance, Brazil. There was a bit move last year in the real and, you know, we then increased our prices and now that’s kicked in in the margin. We’re not really talking about markets like the US in which, you know, there hasn’t been obviously any currency movement. So it’s just in respect to foreign currencies.

Nick Meyers, ROTH Capital Partners Okay. And then in home furnishings, it seems like the growth has slowed a little bit but it seems like mainly because of difficult comparisons, but comparisons are getting a bit easier in the back half. Can you talk about how we should be thinking about the magnitude of growth there in the back half?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary It’s tough for us to forecast. This is kind of all, a bit all new for us as well. The momentum is there. We’re continuing to do more and more it’s just a little bit difficult, and I think I said it last quarter, you know, we weren’t expecting as explosive a growth as we’ve seen. So nothing’s changed. There’s no major headwind. I mean we do see some costs coming up a bit, to be honest. I mean (inaudible), and there are some costs that could impact us, I don’t know that they will yet, but we do expect a lot of strength but I just don’t, I don’t have the magnitude, certainly not ready to discuss the magnitude of it now.



Nick Meyers, ROTH Capital Partners Okay. And I think you mentioned last quarter, can you update us on how much you had in e-com in the home furnishings this quarter and how much was e-com up in this quarter, sorry, and where does it stand as a percentage of sales?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Well, it’s about 43 percent.

Nick Meyers, ROTH Capital Partners 43 percent of sales? Okay. Okay, perfect. And then just one last thing, on the 2017 (inaudible), I know you touched on it a little bit but can you talk a little bit more about what’s driving the positive outlook for a potential sell through and then when did those ship or when do those begin to ship?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Some of them that Martin mentioned already are in stores and they’re doing well, so that gives us some confidence there, and the rest of them I think are shipping throughout the second half. I know that that e-bike, mountain e-bike, which is big in Europe, I mean we’re not expecting too many units in North America, people aren’t ready for it. It’s an amazing product. I rode it. It’s fun going uphill on a mountain bike effortlessly, which allows—I mean it’s a strange concept, an e-mountain bike. You’d figure mountain bikers are so authentic they would never want to kind of cheat on having an assist motor on it, but for older people that want to get up the mountain so that they can come down it’s amazing and even for a younger person who can now go up and down and do so many more runs because it’s so much fun to go up the mountain. It’s a great product. So for Europe that’s being introduced and shipping in Q4, so we’re expecting to see those results. I think we really, really hit a sweet spot now with the product. In fact, I can tell you that for the first time our team feels like we have a full product range now of bikes. We’ve been doing a little catch-up. I mean I know we introduced a ton of bikes last year and a lot of bikes again this year but... We’re not 100 percent full but we’ve got all the categories that we, almost all the categories that we need. We’ve got a really good offering now. So we’re pretty excited about the product line.

Nick Meyers, ROTH Capital Partners Okay, perfect. Thank you for the colour and good luck in the second half.

Operator Your next question comes from the line of Stephen MacLeod from BMO Capital Markets. Please go ahead.

Stephen MacLeod, BMO Capital Markets Thank you. Good afternoon. I just wanted to ask a little bit about the goodwill impairment in the sports business. Is that more weighted to either Cannondale or Schwinn or either or is it pretty broad across the two brands specifically?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Well, we didn’t actually write-down the brand, right, so the brands are still good, it’s more the, it’s the business of the IBD channel business is really what, the goodwill in that business. I mean it’s done, you know, it’s an accounting exercise in which we take the operating unit—is that what we call it? The operating unit?—and we forecast out the present value of the cash flows plus all sorts of other stuff and it has to cover a certain number and with the FX change, and, again, we can’t anticipate a better FX in the future, we just didn’t, you know, didn’t cover the number we needed to cover, so we elected to take this non-cash charge.

Stephen MacLeod, BMO Capital Markets Okay. So is it mostly related to FX then as opposed to deterioration in the market?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary No, I mean it’s the slow industry, the fact that we’re struggling now. We expect improvements over the next few years for sure but, again, the number wasn’t there. You know, the competitive environment right now, it’s just, you know, you can’t put together a future plan without assuming that there’s too many changes from



today, and when we did it the numbers just didn’t cover what we needed to cover. So we just took an opportunity now to just write-down those tangible assets and goodwill. We didn’t touch the brand asset. Like the brand is still where it was when we bought the company.

Stephen MacLeod, BMO Capital Markets Okay. Okay, thank you. And then when you talk about the double digit EBIT growth in the back half of the year, is it safe to assume that that’s generally weighted to Q4, similar to the expected cadence for juvenile and sports?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Yeah. I mean those two, we’re not expecting decreases from last year in either of those areas, so we’re seeing certainly an improvement even in Q3 for the bike business, because they’ve been way behind, but, you know, it’s really clear in Q4 that that’s where those two areas are going to have the bulk of their growth. And home furnishings looks like, at this point, a fairly, I don’t know, equal quarter.

Stephen MacLeod, BMO Capital Markets Okay. And so the juvenile business, you know, would you expect it to be sort of flat or even potentially down in Q3?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary It’s tough to say at this point. It’s in that range. I mean it’s a little early but we won’t see a lot of growth in Q3 in the juvenile, but certainly with the new introductions that are coming through that we’re pretty excited about. There are some big—they’re not necessarily new products but they’re new products in accounts that don’t carry it now. That should give us a good volume boost. And a lot of that is going to hit by Q4, so expecting more in Q4. As well in juvenile, for instance, we have retail stores down in South America and Q4 is both summer and Christmas time down there, so that’s really when we make a lot of the earnings down there, so we’re expecting that to be strong as well.

Stephen MacLeod, BMO Capital Markets Okay. And then just finally on the top-line outlook, so you talked a little bit about, on the juvenile side, you know, improvement in earnings, and then on the sport side similarly around the inventory, but would you also expect the top line for juvenile and sports to be strong in the second half of the year?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary On the juvenile side, yes. Sports, let’s see... Yeah, we’re seeing an increase in sports. It’s not a big increase. The increase is going to be on the gross margin line. So, yeah, we do see both—on the top line we see an increase in both sports and juvenile.

Stephen MacLeod, BMO Capital Markets Okay. Okay, that’s great. Thank you.

Operator Your next question comes from the line of Eric Beder from Wunderlich Securities. Please go ahead.

Eric Beder, Wunderlich Securities Good afternoon. Could you talk a little bit on the juvenile side what do you see as your biggest kind of opportunity to grow that business, either in category or country? Where do you look upon the juvenile as the biggest top line opportunity?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary It’s certainly product. At this point it’s definitely product. We’ve had some really nice successes in the last year on car seats, whether that be in Europe or in North America. And other places too. I mean Australia has had a great run as well. So definitely we’ve done some really good things and now we’re working on getting some more strollers. Strollers is a big opportunity for us. We’re working on some really interesting stuff over the next year. So a continued growth of better new product. We have the distribution around the world, we have our



sourcing for it, so it’s just a matter of getting good product. In addition, from a, I guess, earnings side too, is really getting China working even better. We also have Chinese retail or China is, you know, no retail stores, we don’t have retail stores, but selling our product in China is improving, but we are getting to the point where as we can fill up the factory with a little bit more volume we’re expecting to have some nice returns in China. So I’d say China and better product are the two avenues.

Eric Beder, Wunderlich Securities Great. And you guys have done a great job of paying down debt over the last year plus. Do you have a goal or a range where you want to get the debt down to? How do you look upon the debt?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Yeah, our goal is to get the debt to EBITDA level under 2.5. We actually got under, our adjusted, I’m using adjusted earnings, we got our debt down below 3, which we’re really happy with, and we’d like to get it below 2.5, and then I think we’d be in a good space.

Eric Beder, Wunderlich Securities Great, thank you. Good luck in the rest of the year.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Thank you.

Operator Your next question comes from the line of Sabahat Khan from RBC Capital Markets. Please go ahead.

Sabahat Khan, RBC Capital Markets Thanks. Can you maybe talk about the progress of where about the factories are and kind of the, I guess, refurbishment or renovation phase and where the mix stands right now in terms of your own products versus

third party? And kind of when do you expect those factors to be in a position where you kind of no longer need to make any more (inaudible)?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary You know what? I’m not sure I heard you correctly. Your voice came out a little bit low. Maybe you can—

Sabahat Khan, RBC Capital Markets Sorry, I’ll try again. Just trying to get an update on where the Dorel China facility stands at, where you are in the process of refurbishing those and where the product mix stands right now.

Martin Schwartz, President & Chief Executive Officer As we said, we’ve been making a lot of improvements in the factory. Our efficiencies are getting up. That’s why we’re reducing the headcount. There’s still a lot more to go but we’re much farther ahead than we thought we would be at this point in time. The products are coming out of there on time. And we have two factory facilities. The smaller factory facility we’re almost running 100 percent on-time delivery. The quality levels have gone up from the point where we bought it where the quality levels, let’s say, at the end of the production line running 60 percent, 65 percent are running now in the roughly mid-90 percent range. So we’ve made a lot of changes there. Also, as the third parties move away, and this is totally expected, we’re bringing in more and more of Dorel products into the factory and we’re setting up lines specializing in being able to produce certain products that we had been buying from other suppliers. So basically it’s in constant transformation but it’s all good.

Sabahat Khan, RBC Capital Markets Thanks. And just one question on Brazil. I guess there’s obviously the economic issues but what do you expect is going to be the impact potentially of the Olympics that are going on? Is it a distraction for consumers or would that maybe lead to more retail traffic?



Martin Schwartz, President & Chief Executive Officer Well, you know what, in talking to our people yesterday at CALOI, they say if you go out on the street there doesn’t seem to be much going on. It just seems to be very neutral among the local people. And they’re not anticipating much changes. It’s not like two years ago with the World Cup where everybody was focused on soccer/football and not on bikes. So we don’t see any negative impact.

Sabahat Khan, RBC Capital Markets Thank you.

Operator If there are any additional questions at this time please press star followed by the number one on your telephone keypad. Your next question comes from the line of Derek Lessard from TD Securities. Please go ahead.

Derek Lessard, TD Securities Thanks. Good afternoon, everybody. Maybe just taking a step back and getting your 30,000-foot view on your longer-term strategy and, you know, maybe just looking at your overall business mix, do all of them still remain core to your longer-term strategy?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Yeah. I mean it’s funny, because if you start looking at earnings you start to see all three of them are getting closer together with the growth of the home furnishing business. So at this point, yeah, they are all core. We’re spending a little bit more time looking at the growth opportunities in home furnishings given the distribution channel that we have, so I would say that’s become more prominent at our level as we see continued upside. I mean it’s, you know, we figure that we’re a very good supplier to a very fast growing channel and I believe we can continue to supply that channel a lot of other products, and that’s where we expect a lot of growth to come from as well. All three. I mean the juvenile business has been fairly chaotic for the last three or four years, certainly internally as we’ve added businesses and we bought stuff and we now have our own supply channel,

and all of that, you know, it’s been chaotic getting everything going but we see, we sort of have a vision now. Like everything is in place and now we’ve got to execute and we’re seeing that this year. We’re seeing a nice, steady year. It’s not explosive but it’s nice and it’s growing and the earnings are going to grow through the year. And, like I said, second half we’re going to start to see the sales picking up. So we’re pretty optimistic about that business.

Derek Lessard, TD Securities And I guess maybe what about Cannondale? I guess if you sort of look at it, you know, you’re number four in terms of market share whereas in juvenile you’re a strong number one or two. Does that concern you in any way?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Well actually, I mean the way that the internal group looks at that is we have a lot more market share we can get at then in juvenile per se, if you know what I mean. It’s harder—

Martin Schwartz, President & Chief Executive Officer More room to grow.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Yeah, there’s more room to grow. We did grow. The statistics for the first half of this year shows our market share up. Having said that, some of that is on lower priced bikes. And what we might start to see going forward is our average retail, of which we’re the highest, might start coming down now as we become a much better, stronger player at lower price points as well as at some of the higher price points. We were never really that good and that competitive at the more volume-oriented lower price points and I think the product mix we have today is changing that. So we’re pretty optimistic about that, despite all the, and you know them well, the issues in the industry, you know, we do see a bit of a light at the end of the tunnel and I think we’ve got a great product line that will be able to take advantage of that time when there isn’t such an excess inventory overhang in this industry.



Derek Lessard, TD Securities Okay. Thanks for that colour, Jeff. Maybe if you can add, ah, there’s been some management, I’ve read that there’s been some management changes at CSG, maybe if you can just touch on that.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Management team... Additions or...? I’m not sure what you’re getting at. I’m not—

Derek Lessard, TD Securities Well I guess Nick Hage was promoted and—

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Oh, right. Okay. Sure, sure. Yeah. One of the areas that we didn’t have properly done before, we never really had an American business unit. We had a European business unit, a Canadian business unit, a UK business unit, and then a global American business unit, and I think that was a mistake for a number of years because nobody was really focused just on the US. Nick Hage now is the general manager of the United States and his team under him, which I think I’ve met now, I think all of them, is a very impressive group of girls and guys that are all fairly new. So I would say the people running our American business today are new and they are a significant step forward in what we used to have there. So we are expecting our American business to be much more focused. You know, we’ve exited retail, we’ve exited a few other areas that were distractions and, frankly, we want to say, hey, we’re a bike company first and let’s be really, really good at being that before we start getting into other areas like retail and a few other things. And we’re really just focusing. So I think we’ve got the right team there now and we’re pretty happy and that’s, you know, again, we’re optimistic. I’ve seen the plans. I know we don’t understand everything that’s going to happen in the industry, because there’s some weird stuff that some of our competitors have done, and that’s okay, we can just worry about ourselves, and I think we’ve got a good team and we’ve got a good product line and we have a good strategy now going forward that’s much more focused.

Derek Lessard, TD Securities Okay. And just maybe one final follow up before I re-queue. When do you think the restructuring or cost savings will start to hit the bottom line?

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Which ones are we talking about?

Derek Lessard, TD Securities Sports.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Sports? Next year. So we have a number of about $5 million that should be impacted positively in 2017.

Derek Lessard, TD Securities All right, okay. Actually one final question, and it’s just switching gears to juvenile. Any potential impact from Brexit? I know you mentioned some lower sales volumes in Europe, just wondering if you guys have thought about what Brexit means for the business.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary Well, in the short term there was a negative impact. I believe it was about $1 million. Yeah, I think at least $1 million, just because of the currency hit that we took in Q2. So yeah, the UK, which is a nice business for us, it’s not a material business, it’s not going to change anything, but it’s a solid business and, yeah, I think we’re going to have, both on the juvenile side and the bike side, a slower year next year in the UK just because of the turmoil. Longer term, I’m not qualified, I don’t think, to answer what’s going to happen, but I’ll tell you we’re predicting for the next 12 months for business just to be slower.

Derek Lessard, TD Securities Okay. Thank you.



Operator Your next question comes from the line of Frederic Tremblay from National Bank Financial. Please go ahead.

Frederic Tremblay, National Bank Financial Thank you. You’ve commented on the inventory levels in the US IBD channel, I was wondering if you can comment on inventory levels at the retail level for the mass channel please.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary The retail level of the mass channel, I think it’s okay. I don’t think there’s any changes. The POS was a bit slow in April and May. I mean I think it would, similar to Canadian weather, the Midwest was not great. It did pick up at the end. June was good. I believe July was a good month as well. So I think inventories are sitting in normal positions.

Frederic Tremblay, National Bank Financial Okay. And you spoke about an expansion of your Savannah facility in home furnishings, I just want to clarify if that’s been done or if it’s an upcoming project and I guess the impact on your CapEx guidance from that.

Jeffrey Schwartz, Executive Vice-President, Chief Financial Officer & Secretary It’s a project that’s going to be ongoing through the second half. You know, we mentioned that we’re moving some bike distribution from Illinois to George. What we’re doing is the bike business is taking over the existing home furnishing facility and the home furnishing is moving into a much bigger facility, and all that will be done and should be completed by the end of the year. No material CapEx on that.

Frederic Tremblay, National Bank Financial Thank you.

Operator There are no further questions at this time. I turn the call back over to the presenters.

Martin Schwartz, President & Chief Executive Officer I want to thank everybody for joining us today. It’s been an encouraging first half for Dorel. Home furnishings and juvenile are nicely on track and we’re confident that changes being made in sports will bring the desired results. My sincere thanks to all our employees worldwide for their efforts during the quarter. Much has been accomplished and our shareholders are and will be rewarded for their patience. We are very optimistic about the balance of the year. Thank you all again and have a good afternoon.

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

Dorel Industries Inc. Second Quarter 2016 Results ... · view and test drive the 2017 Cannondale...

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Transcript of Dorel Industries Inc. Second Quarter 2016 Results ... · view and test drive the 2017 Cannondale...