FGI Industries Ltd.
Q1 2023 Earnings Call Transcript

Published: 14 May 2023

[Operator:]

Good morning and welcome to the FGI Industries, Inc., First Quarter 2023 Earnings Call. All participants will be in listen only-mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Paul Bartolai, Managing Director, Vallum Advisors. Please go ahead.

[Paul Bartolai:]

Thank you. Welcome to FGI Industries first quarter 2023 results conference call. Leading the call today are President and CEO, David Bruce; and Chief Financial Officer, Perry Lin. We issued a press release after the market closed yesterday detailing our recent operational and financial results. I would like to remind you that management’s commentary and responses to questions on today’s conference call may include forward-looking statements which, by their nature, are uncertain and outside of the company’s control. Although these forward-looking statements are based on management’s current expectations and beliefs, actual results may differ materially. For a discussion of some of the factors that could cause actual results to differ, please refer to the Risk Factors section of our latest filings with the SEC. Additionally, please note that you can find reconciliations of historical non-GAAP financial measures in the press release issued yesterday and in the appendix of this presentation. Today’s call will begin with a performance review and strategic update from David Bruce, followed by a financial review from Perry Lin. At the conclusion of these prepared remarks, we will open the line for questions. With that, I’ll turn the call over to Dave.

[David Bruce:]

Thanks, Paul. Good morning to everyone and thanks for joining our call today. We were very pleased with our strong operational execution and continued progress against our strategic initiatives during the first quarter, despite what remains a very challenging market environment. Even with the destocking headwinds pressuring our revenues, we were able to generate meaningful first quarter gross margin improvement, while our consistent focus on our organic growth initiatives should position the company to return to profitable growth as inventory conditions normalize. We reported a first quarter gross margin of 26.5%, which was up 925 basis points compared to the prior year period, and up 285 basis points versus the fourth quarter, despite the ongoing customer inventory correction and uneven demand trends in the repair and remodel market witnessed during the quarter. While our gross margins were helped by lower freight costs and the benefit of last year’s pricing actions, the biggest factor has been our focus on higher margin product categories and our good, better, best product strategy, which has resulted in a significantly improved product mix. While the first quarter gross margin levels are likely not sustainable for the long term, the favorable gross margin drivers remain in place and we expect strong gross margin improvements for the full year 2023 compared to last year. The inventory correction that has been a headwind to our revenue growth over the last year has persisted into 2023, with the macro uncertainty adding another layer of pressure as many large customers are taking a very cautious stance and looking to reduce inventories to levels below historical averages. This caused our first quarter revenue to decline 38% compared to last year. The more cautious inventory strategy by many of our large customers is expected to prolong the destocking headwinds, particularly in the pro channel, where the inventory correction will likely extend into the second half of the year. While the uncertain demand environment, persistent inflation and destocking headwinds are pressuring top-line results in the near-term. We are continuing to invest in our organic growth initiatives, and I’m very proud of the progress we have made on our strategic priorities during the quarter. We were awarded several new product programs with key retail partners that will be key contributors to organic growth in the coming quarters, and we continue to invest in the new kitchen cabinetry program that we discussed last quarter. We remain confident in the progress we are making on our organic growth initiatives through our brands, products and channel strategy, or BPC. Our strong performance as it relates to our BPC strategy is a testament to our commitment to innovation and customer satisfaction, and we are confident in our ability to capitalize on these successes and continue delivering value to our customers in the future. It is during challenging market environments like the one we are experiencing now, where the strengths of our business model are evident, notably our diversified product offering and longstanding customer relationships. While many industry participants are facing challenges due to consumers trading down to lower priced products, we are well positioned given our good, better, best product portfolio. We are seeing some pressure on our higher end products, particularly in Bath Furniture, but this is being partially offset by stronger growth in our good, better, private label offerings. In addition, we benefit from our deep and longstanding relationships with key customers, who look to FGI for support during difficult times. And as a result, we have not suffered any product line cancellations or customer losses. Now, looking at the broader R&R market, as I discussed earlier, we expect destocking to continue to be a headwind during 2023, and we can see this extend out further given a more conservative inventory strategy by many large customers as they reduce their base level inventory requirements. While the inventory correction has been a challenge, end market demand has held up relatively well across our key product categories. Our Bath Furniture business has seen the most pressure, but overall the repair and remodel market is performing as we would expect based on the current macroeconomic environment. The new residential construction market is not a meaningful part of our business, but there have been some signs that the market is bottoming. Commentary from the public builders has been more constructive during the first quarter, with most players noting improved order trends during the key spring selling season, as it appears buyers are starting to adjust to a new normal of higher mortgage rates. Overall, the trends in our end markets are consistent with our expectations coming into the year, and we continue to expect our end markets to decline in the mid- to high-single-digits during 2023. While the inventory pressures were more pronounced than we expected during the first quarter based on our strong margin performance progress on our organic growth drivers and stable end market trends, we remain confident in the 2023 financial targets we provided to start the year. The higher mortgage rates, persistent inflation, and macro uncertainty are clearly impacting consumer spending levels in the near-term, but we remain optimistic regarding the longer-term outlook for the kitchen and bath repair and remodel market and FGI’s position in the industry and, therefore, continue to invest in our business despite the current headwinds. As a result, we remain focused on our strategic plan and are dedicated in our efforts to drive long-term growth above the market and create value regardless of the market environment. As a reminder, our long-term strategic plan is focused on 3 key initiatives, which include

[Perry Lin:]

Thank you, Dave, and good morning, everyone. I will provide some additional details on the quarter given an update on our liquidity and balance sheet and wrap it up with our full year 2023 guidance. Revenue totaled $27.2 million during the first quarter of 2023, a decrease of 38% compared to prior year, primarily due to continued inventory destocking as well as some softening in customer demand. Currency was headwind during the quarter and negatively impact revenue by 1.1%. Looking at our business line, sanitaryware of revenue was $15.4 million during the first quarter, down from $26.8 million during the prior year period. The revenue decline was driven by channel inventory reduction at key partners, particularly in the pro channel, as customers are becoming increasingly cautious regarding inventory levels, with some large customers reducing their inventory level to below normal historical levels. There have been some pocket of softness, but overall end customer demand has remained relatively steady. Bath Furniture revenue was $5 million during the first quarter, down from $10.1 million last year. The Bath Furniture business also continued to be negatively impacted by elevated channel inventory levels, which has been prolonged by some modest weakening of demand. Shower System revenue was $5 million during first quarter 2023, down from $6 million last year. The decline in Shower System revenue is expected to be temporary as momentum in the business remains strong, highlighted by several awards with national retail partners that will begin rollout in second half of 2023. Other revenue was $1.8 million during the first quarter of 2023, up from $700,000 last year, driven by growth in our custom kitchen cabinetry business. Gross profit was $7.2 million during the first quarter, down only 4.3% from last year, as the revenue decline experienced during the quarter was offset by more favorable mix and lower freight cost. As a result, gross margin improved to 26.5% during the first quarter, up from 17.3% last year and 23.7% in the first quarter of 2022. While we expect this positive factor to remain in place in during 2023, we don’t expect to be able to sustain the first quarter gross margin levels. However, we continue to expect 2023 gross margin to improve meaningfully from 2022 levels. Our operating expense increased to $7.2 million during the first quarter, up from $6.8 million last year, as we continue to invest our growth initiative despite the near-term revenue headwinds. The higher operating expenses reflect marketing spending for new product initiative, expenses for Kitchen & Bath trade show, costs to support the Australia and UK expansion, and expenses tied to our new kitchen business development opportunity. GAAP operating income was nearly breakeven during the first quarter with operating loss was $3,000, down from $0.7 million in the prior year period. Excluding $100,000 in onetime business expansion expenses, and IPO related legal expenses during the first quarter of 2023. Adjusted operating income was $0.1 million, down from adjusted operating income of $0.9 million during the prior year period, driven by the decline in gross profit combined with the incremental growth investment. GAAP net loss was $0.3 million or $0.03 per diluted share during the first quarter of 2023, down from GAAP net income of $0.5 million or $0.05 in the same period last year. Excluding one-time item in both periods, adjusted net loss for the first quarter of 2023 was $0.2 million, over $0.02 per diluted share, down from adjusted net income of $0.7 million over $0.07 last year. Now, turning to the balance sheet and our liquidity, as of March 31, 2023, the company had $7.4 million of cash and cash equivalent, and total debt of $8.4 million. At the end of the quarter, we had $15.1 million of availability under our credit facilities. Net of a letter of credit combined with cash, total liquidity was $22.5 million at quarter end. We continue to be pleased with the improvement in our working capital levels, which has been elevated during 2022 owing to the supply chain challenge. The reduction in working capital has driven strong free cash flow conversion over the last 2 quarters, and we currently are in the net debt position of $1 million, an improvement of $10.5 million compared to our pickup [ph] net debt of $11.5 million at second quarter 2022. We believe we are in a solid liquidity position that is more than sufficient to fund our growth initiative. Finally, turning into the guidance. While inventory destocking had bigger-than-expected impact during the first quarter, end customer demand has remained largely in line with our expectations and we continue benefit from our margin improvement initiatives. We continue to be encouraged by our organic initiative with several new programs set to launch in the second half of the year. As a reminder, our guidance reflect the investment related to our new kitchen program that’s total roughly $0.5 million in 2023 as well as additional investment in growth initiative. With this factor as a backdrop, we are maintaining our 2023 financial guidance, the total revenue in the range of $145 million to $163 million, adjusted operating income in the range of $6 million to $6.8 million, and adjusted net income in the range of $4.2 million to $4.7 million. Please note that guidance for net income and operating income is being provided on an adjusted basis and excludes non-recurring items. That completes our prepared remarks. Operator, we are now ready for the question-and-answer portion of our call.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Greg Gibas with Northland Securities. Please go ahead.

[Greg Gibas:]

Hey, good morning, David and Perry. Thanks for taking the questions. Congrats on the nice execution in the challenging environment. I wanted to ask, I guess, given the revenue performance in Q1 seemed a little bit below your expectations and perhaps the ongoing destocking was maybe worse than you anticipated too. What kind of gives you confidence that you can maintain that full year revenue outlook?

[David Bruce:]

Thanks, Greg. It’s Dave. Yeah, there’s a couple of things. So as definitely we have seen the destocking extend, part of that is also due to the softening of the R&R like we mentioned, which is extending that destocking period. And, I think, I also mentioned some of our larger customers are also looking at reduced inventory levels as a base, as they move forward, as a cautionary move, right, because they want to make sure that inventory levels are more in line with where the market and demand is. With that said, though, we fully expect that in the second half, you’re going to see what I used to call a bullwhip effect, which is going to be now customers are going to have a need for inventory and need to replenish. I think I mentioned on our last call that we’ve seen that trickling in from the retail side. We’ve seen more of the destocking pressure on the pro business. But as you heard, we’ve seen and heard some more positive comments from the builder side of the business, and we would expect the second half for that to ease. Secondly, as I mentioned on today’s call, we have a lot of new programs more than what you just heard, but the three that I mentioned today, or four [ph] the additional growth in our shower business as well as our kitchen business, we fully expect to execute those and execute more new incremental business, despite where the market is for the second half. So when you take the lighter Q1, a lot of that business, those initiatives, many of them were not baked into our guidance. So we actually have a good expectation that we would be able to continue to meet our revenue guidance for the year. For sure, we would expect that we’d probably be getting closer to the low end of that guidance depending on how far that destocking goes out. But that bullwhip effect of destocking ending and reordering coupled with new incremental sales gives us that confidence.

[Greg Gibas:]

Great. That’s extremely helpful, Dave. I wanted to follow-up, I guess, on that gross margin improvement. How much was maybe a result of the price increases versus the mix shift and maybe versus the result of lower freight costs year-over-year? And I also wanted to…

[David Bruce:]

Yeah, that’s a good question. Go ahead.

[Greg Gibas:]

I guess, I think your comment was also around – it’ll be difficult to maintain these levels of gross margins going forward. I just wanted to get a sense of why you’re thinking about that?

[David Bruce:]

Yeah, I want to clarify that. So we’ve been seeing a rapid improvement in our margins for various, first, I’ll tell you why. We have had impact, obviously, from freight reductions. A large part of our change, though, has to do with the pricing actions we took and also with mix shift. You can see where our shower business has grown to a sizable portion of our business now, kitchens continues to grow, and those were all higher margin businesses for us. And we fully expect, like Perry had mentioned, we’re going to improve our margin meaningfully as we move along compared to prior years. And we fully expect to get we’re not deviating from our guidance of saying longer term – mid-term, really, mid- to high-single-digit EBIT margins as we move forward with our BPC strategy. So that’s still in place. And I think when I mentioned can’t maintain these longer-term, we still expect to see further margin improvement as we go through these quarters. And then what most likely will happen is as we expect to get more demand and order activity from the pro side, especially when we talk about some of the more lower margin product categories on some of the promotional product in sanitaryware. The margin percentages will come down some, but the dollars will increase, and that’ll add obviously to our overall gross margin dollar accretion. So we fully expect that our margins longer term will continue. I think when I mentioned it today, we were really referencing more the fact that the speed that our margins are growing now, as the revenues are lower, our margins will improve. Part of that is mix, right, because we’re not going to see some of the more lower margin product categories, which create a lot of the volume. But overall, as a business, as we grow out and execute that BPC strategy, like I mentioned today, with shower and kitchen growth, those margins will continue to grow.

[Greg Gibas:]

Okay, great. That’s helpful. I guess, last one for me. We did want to follow-up on your commentary on those several new product programs with your retail partners, great to hear that those are coming in. And, I guess, first question around those would be the timing, I think, you said the back half of this year was maybe when those would start to see effect. Just trying to think of maybe how much Q3 versus Q4 four? And, I guess along those lines, I think, you talked about maybe three of the key ones there, you said there’s more. Just trying to get a sense of the magnitude or how much of a needle mover there’ll be on organic growth in the back half or into next year?

[David Bruce:]

Yeah, I mean, they’ll be meaningful. The timing in our business is – anybody’s business, but timing with us, with shipping from Asia and understanding when things are arrived, some of that is up to us that’s completely finalized things with our retail partners as far as store sets and operational issues that go on domestically here. So if we do it, that’s why I mentioned the second half, Q3, Q4, sometime we would expect some bit could trickle over into Q1 of 2024 and, of course, next year we would have more of a straight-line knowledge of that business month-by-month. But I would just say to you that these are meaningful opportunities. Other ones in the hopper, too, as I would say, they’re all meaningful and material to the business in a meaningful way. And again, the ones I mentioned to you today, I brought up because they will start to impact our top-line in our margins in the second half for sure.

[Greg Gibas:]

Okay, great. I appreciate the color.

[Operator:]

Thank you. As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to David Bruce for any closing remarks.

[David Bruce:]

Thank you for your time and interest today. We appreciate your continued support of FGI. Stay well, and we look forward to connecting with you on our next quarterly call.

[Operator:]

Thank you. The conference of FGI Industries has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.