FGI Industries Ltd. (NASDAQ:FGI) Q2 2022 Earnings Conference Call August 11, 2022 8:00 AM ET
Company Participants
Paul Bartolai – Managing Director
David Bruce – President and CEO
Perry Lin – Chief Financial Officer
Conference Call Participants
Reuben Gardner – Benchmark
Greg Gibas – Northland Securities
Operator
Thank you for standing by. This is the conference operator. Welcome to the FGI Second Quarter 2022 Earnings Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there’ll be an opportunity to ask questions. [Operator Instructions]
I would now like to turn the conference over to Paul Bartolai, Managing Director. Please go ahead.
Paul Bartolai
Thank you. Welcome to FGI Industries second quarter 2022 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, including the final prospectus from our initial public offering.
Additionally, please note that you can find reconciliations of the historical non-GAAP financial measures discussed during our call in the press release we issued yesterday and in the appendix to this presentation.
Today’s call will begin with the performance review and strategic update from Dave 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, and good morning to everyone. We generated another quarter of solid operating results with second quarter revenue and adjusted operating income coming in ahead of our expectations.
As we forecasted, we have seen some moderation in the broader R&R market as a result of some of the headwinds facing the housing market. So I’m very proud of our ability to generate continued strong revenue growth and sequential margin recovery, despite the slower market growth.
We remain encouraged by the organic growth outlook for our business, as our portfolio of innovative high quality products continues to be received favorably by consumers and the solid order momentum we experienced during the first half is continuing into the third quarter. As a result, we believe we will remain on track to achieve our full year financial guidance.
Demand trends remained steady across our key product categories during the second quarter, with total revenue increasing by 13% on a year-over-year basis, driven by a strong demand for Sanitaryware and continued growth at our newer product categories.
Our Sanitaryware business grew over 50% in the second quarter, with both the wholesale and retail channels generating strong growth, while our Other product category, which is primarily our Shower Systems and Custom Kitchen Cabinetry business grew 35% in the quarter.
As I mentioned, we have seen some moderation in the broader R&R market with our Bath Furniture segments seeing the biggest impact within our product portfolio. Our Bath Furniture business was also negatively impacted by continued order delays due to supply chain issues and some pockets of elevated channel inventory. However, we remain encouraged by the broader trends in our Bath Furniture business and expect improved results in coming quarters.
Overall, a strong growth in the quarter highlights the resilience of our key product categories our ability to grow through broader market softness as a result of market share gains, growth in our new products and expansion into new product categories.
Based on our resilient end markets portfolio of innovative products and encouraging new organic growth initiatives, we expect our organic growth momentum to continue to the back half of the year.
As we have highlighted on past calls, it is important to remember that roughly 80% of our revenue was tied to the repair and remodel market, which tends to be more stable and predictable than the new construction market.
While June new home sales fell 17% year-over-year, the R&R market has remained more stable. We continue to make good progress in our efforts to offset elevated supply chain costs through pricing initiatives and other efficiency measures.
While are adjusted operating margin was down year-over-year in the quarter, we saw roughly 150 basis points of sequential adjusted operating margin improvement from the first quarter of 2022 and we expect to see continued margin improvement in the back half of the year, as a result of ongoing pricing actions, increased scale, improved mix and efficiency gains.
While we continue to monitor the macro environment, our focus is on driving above market growth and creating value regardless of the market environment. Consistent with our long-term strategic plan to compound our growth rates above industry averages, FGI intends to drive value creation through a balanced focus on product innovation, organic growth, operational improvements and efficient capital deployment.
Some of our key accomplishments against these initiatives during the second quarter are as follows. First, is our VPC strategy, which stands for brands, products and channels is the key driver of organic growth strategy. We are pursuing a number of potentially meaningful organic growth programs that can be nice contributors to organic growth over the near- and medium-term.
One area I would like to highlight is our Custom Kitchen Cabinetry business, which includes our covered bridge and craft and main cabinetry brands. As a result of rapid growth in our dealer base, as well as ongoing discussions with large customers for future growth, we have invested in manufacturing capacity to address the current and future growth needs of this business, which as we have stated before, generates higher incremental gross margins than the FGI average.
We are making progress with our channel expansion as well, as we recently expanded our relationship with the Hajoca Corporation, one of the largest wholesalers and building products and industrial supplies in the United States. We have significantly expanded the number of products available through Hajoca and we are excited to expand our relationship with this important partner.
Second is our focus on driving margin expansion. We continue to make progress offsetting the margin headwinds caused by supply chain disruptions and inflationary pressures. We generated strong sequential operating margin improvements during the second quarter, despite the negative impact on mix.
We continue to expect sequential margin improvement in the back half of 2022, and longer term, we believe we have an opportunity to further expand margins through a more profitable mix, efficiency gains and operating leverage.
Finally, is our dedication to efficient capital deployment, as we stated last quarter, our primary focus will continue to be on deploying capital towards organic growth strategies in the near-term. We have a number of exciting programs in development and believe this is currently the best use of capital, as highlighted by our manufacturing investment in our Custom Kitchen Cabinetry business.
Meanwhile, we continue to actively pursue bolt-on opportunities and are engaged in conversations with potential targets, although we do not have clarity on the timing of when a potential transaction could occur. We are excited by the early progress on our strategic priorities and we look forward to continuing to update the investment community on our progress against these important goals.
With that, I will turn it over to Perry for a more detailed review of our financials.
Perry Lin
Thank you, Dave, and good morning, everyone. I will provide some additional details on the quarter, give an update on our liquidity and benefit, and wrap it up with our full year 2022 guidance.
Revenue totaled $47.8 million during the second quarter 2022, an increase of 12.5% compared to the prior year, driven by strong volume growth and the continued benefit of our strategic pricing action, offset by negative mix.
Looking at our business line. Sanitaryware revenue was $32 million during the second quarter of 2022, an increase of 56% compared to the prior period, driven by strong volume growth in both our wholesale and the retail channel, as well as the benefits our price increase.
Bath Furniture revenue was $7.7 million during the second quarter, a decrease of 52% compared to the prior period. There were a couple of factors that impact the segment result in the quarter. First, we continue to experience some pushback in order from key customer during the quarter due to supply chain challenges and elevated channel inventories and we expect this issue to normalize in the back half of the year.
Second, we have seen some slight moderation in demand trends in the broader bath Furniture market. Overall, we remain encouraged by the outlook of our Bath Furniture business. So the biggest impact in second quarter was the timing of order, which we expect to normalize in the coming quarter as this issue worked through the system, resulting in improved result.
Other revenue was $7.9 million during the second quarter of 2022, an increase of 35% compared to the prior period, driven by volume growth of our Custom Kitchen Cabinetry business and our Hajoca shower system coupled with pricing gains.
Gross profit was $8.4 million during second quarter 2022, a decrease of 8% compared to prior period. A solid revenue growth was offset by supply chain disruption and elevated freight costs, as a result, gross profit margin was 17.6% during the quarter, down from 21.6% in the prior year period. While gross margin was down year-over-year, it was outperformed in the first quarter as we continue to make a progress offsetting the elevator the cost through price increase and other cost reduction efforts.
We are seeing good capture on our pricing increases and we continue to implement additional pricing action that will benefit the retail in the back half of the year. Our progress on our margin recovery initiative was somewhat masked by the effect of negative mix in the second quarter.
Negative mix was particularly impactful as we sold few bags [inaudible], while we are increasing sales of Sanitaryware. While we also had some useful comparison within Other segment, last year one of our customer pull-forward large volume of a shower product, which was not repeated this year. We remain competent in our margin trend and look forward to expect to generate continue sequential gross margin improvement in the back half of the year.
GAAP operating income was $1.7 million during the second quarter 2022, down from $3.3 million in the prior year period. Strong revenue growth was offset by gross margin pressure, investment in our organic growth initiative and the public company costs. As a result, operating margin were 3.6% during the second quarter, which was down from 7.8% in the same period last year, but up about 200-basis-point sequentially from the first quarter 2022, as our pricing action continued to take hold.
GAAP net income was $1.2 million or $0.10 per diluted share during the second quarter of 2022, down from $2.5 million or $0.36 in the same period last year. The reduction reflects the decline in operating income, as well as an increase in our diluted share count.
Now turning to balance sheet and our liquidity. As of June 30, 2022, the company had $3.1 million of cash and cash equivalent and the total debt of $14.7 million. At the end of the quarter the company had $3.3 million of availability under our credit facility, net of letters of credit. Combined with cash, total liquidity was $6.4 million at June 30th.
We are in a solid liquidity position that is more than sufficient to fund our growth initiated. Our current working capital level remained elevated, but we expect this to work down over the next three months to six months. We expect our capital spending need to remain around 1% of revenue.
As we look into remainder of 2022, we remain confident in our growth trajectory and execution on our margin recovery initiatives. We have started to see some slowing in demand in the broader industry, which has been relatively in line with our expectation at the start of the year and we continue to believe it is prudent to assume that industry is operated down modestly from the volume perspective in 2022.
As a result, we are reaffirming our financial guidance for 2022, which call for revenue in the range of $182 million to $189 million, operating income to be a range of $6.5 million to $7.5 million and net income to be in the range of $5 million to $6 million.
That completes our prepared remarks. Operator, we are now ready for the question-and-answer portion of our call.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Reuben Gardner of Benchmark. Please go ahead.
Reuben Gardner
Thank you. Good morning, everybody.
David Bruce
Good morning, Reuben.
Perry Lin
Good morning.
Reuben Gardner
So inventory drawdown in the broader building product space has been a big topic of late, and I think, Perry mentioned, that there is too much inventory in the channel and I think your own inventory is a little bit elevated. Can you talk about what your assumptions are for the second half in terms of how much inventory drawdown is baked into your guide and what the underlying volume growth excluding that drawdown or volume decline, whatever it is, looks like excluding the inventory adjustment?
David Bruce
Yeah. I can talk a little bit about that first. This is Dave. So, yeah, we, obviously, knew this going into the beginning of the year, because we had the higher inventory levels entering Q1 and we’ve been drawing down that inventory slowly.
A good majority of our inventory spikes were based on a couple of things, the slower Bath Furniture sales, but also a new bath shower wall program and shower base program with one of our larger retail customers. But that’s slowly drawing down and the sales of that product at the POS level have been quite strong.
So we fully expect to continue to draw that inventory down as the year goes on and as we continue to penetrate new customers and take smaller market share with that product as well. So we’re not as concerned about that continuing as we enter the second half. Reuben?
Reuben Gardner
Okay.
David Bruce
Okay.
Perry Lin
Yeah. And for the inventory, as you can see, we already dropped from the pick time during year-end first quarter $21 million to $18 million so far and we fully expect just like, Dave mentioned, this — the continue will be the trend for the back half of 2022.
Reuben Gardner
Okay. So, just to be clear, at the customer level, how much do you think — how much excess product do you think they have today versus where they’ll want to be at the end of the year?
Perry Lin
Well, again…
David Bruce
We’ve been working. Yeah.
Perry Lin
Sorry. Go ahead, Reuben.
Reuben Gardner
Go ahead.
David Bruce
No. No. I was going to say, we — we’ve seen this already from the beginning of the year. So we’ve been working very closely with our customers on their inventory levels and what we have. So we — Bath Furniture, as an example, which has been our biggest challenge in the first half of the year, we’re already starting to see some of that open up in the second half, right? So we’re starting to see a little movement now, as replenishment needs are going, definitely they had here as we go into the second half, particularly into Q4, as everybody prepares for going into next year.
So despite even the market demand, there’s just going to be a need to replenish the product as we go into the second half from the Bath Furniture side. And from our Other product categories side, the demand for inventory on the Sanitaryware, the shower, are — could just continue to be strong anyway. So we didn’t run into as much of an issue there.
So, as we, like I said, this is not — this inventory, backed out inventory that you’re hearing about in the market now. We’ve seen this from the beginning of the year. So we were already ahead of this and knew that going into the first half of the year, we would have a challenge. But like I said, we’re already starting to see momentum and movement, particularly on the Furniture side going into the — into Q3.
Reuben Gardner
Perfect. And you mentioned in the — one of the slides and the press release talks about ocean rates coming down but expected to remain above pre-COVID levels kind of through the end of the year and into next year. What…
David Bruce
Yeah.
Reuben Gardner
Can you remind us how that flows through to your P&L as those costs come down? I know it’s only a portion of the business, what kind of benefit could you see and is that more of a — to that, I assume that’s more of a 2023 events before you start to actually recognize those cost savings?
David Bruce
Not necessarily. We’ve baked it a little bit of those. I’ll call them freight reductions into the second half and as part of our guidance. But a much larger chunk most likely would be affected in 2023.
As we’re receiving product at better freight rates into our distribution centers, obviously, we’re cost averaging that product, which is slowly reducing overall inventory costs. And then several customers, many customers we have, we also shipped our ocean containers direct where we cover freight costs. So those costs are coming down immediately, too.
So as it moves, it will affect us this year in the second half. Some of that may be more than we even expected. And I think we had mentioned that last time that that’s a potential upside for us that was not forecasted into our second half guidance. So — and to enter your point, most likely, if things continue on the decline, there’ll be a much larger impact in 2023, for sure.
Reuben Gardner
Okay. Great. And then the Custom Cabinets edition that you talked about, can you give us a sense for what kind of impact that can have on your business as we move into next year? And then, is that — last quarter I think you were alluding to potential larger opportunity, in terms of new products, is that the Cabinets business or is that something else that’s in the works, though?
David Bruce
Yeah. There’s a couple things in the works outside of Cabinets. But Cabinets in particular are really, really growing fast and we do have large opportunity next year for Cabinets. Specifically, we’ve had just a tremendous increase in the Cabinet businesses quarter-by-quarter since Q4.
I think in the last quarter, we had like a 720-basis-point gain overall in our — especially our Covered Bridge cab the main Kitchen business and that’s going to continue but leaves some bounds.
And I think we’ve mentioned previously, in addition to the sales opportunities that we have, this high end Kitchen business comes with higher incremental gross margins as well. So we’re going to see, not only are we going to see that growth continued in the second half of this year, but we’re going to see material growth sizably next year as we enter into some newer programs with some new customers with that business.
Reuben Gardner
Okay. And any way for us to quantify that, I mean, new customers or, well, how did these products go-to-market or the new customers, is there a lot of little ones or is there a one or two larger ones? How do we frame this?
David Bruce
Yeah. So the traditionally the business has been marketed to the dealer base throughout the country, Kitchen dealers, whether they’re single unit or multi unit locations. But we’ve been in discussions with a couple of larger national customers that we think that — we’re having great discussions with and that we might be able to execute some programs, which would be multiples of what we do now on the dealer base.
Reuben Gardner
Okay. Great. I’ll leave it there. Congrats on…
David Bruce
Yeah.
Reuben Gardner
… the solid results and look going forward guys.
David Bruce
Great. Thank you.
Operator
Our next question comes from Greg Gibas of Northland Securities. Please go ahead.
Greg Gibas
Hey. Good morning, Dave and Perry. Thanks for taking the questions and congrats on the quarter.
David Bruce
Thank you.
Perry Lin
Thank you.
Greg Gibas
I just wanted to, I guess, first to, see if there’s maybe any different trends across your customer base categories or segments that you’re seeing, whether it’s e-commerce versus large retailers or others?
David Bruce
Yeah. I would say, as we entered Q1 and we talked about the first quarter the Pro business and the Do It For Me business, particularly on the Sanitaryware side has continues to be extremely strong and we really see no ending sight at least for the balance of this year at this point. And that’s broad based across all the Sanitaryware categories, sinks, toilets, from a range of price points, all the way through the whole program in North America and in Europe.
The Shower side has done the same thing. We’ve seen not only growth with current customers, but we continue to expand and add customers on the Shower Systems business. And the same has happened I just mentioned with Kitchens, how that’s grown too.
So I would say, the only real softening and we mentioned this last time, the softening that we have seen has been on the Bath Furniture, but that was really more of an effect of backchannel inventories that piled up at the end of 2021 and into the beginning of 2022 and we’re starting to see that eventually flush out.
So I would say that our strongest channel consistency has come from that Pro Do It For Me business, particularly in the Sanitaryware side. Right now we see that continuing easily through the balance of the year. We know that a lot of these customers are going into multifamily.
We do a lot of multifamily business, relatively speaking, when it comes to our builder business, we do have and we’re seeing that continue as, even though the housing market is softening, there’s still a lot of housing shortage and there’s a lot of projects that have been out there that still have to be completed. So we just really started to see no end to that through the end of this year at this point.
Greg Gibas
Great. Very helpful. And I apologize if I miss your commentary on this, but I think, you were saying, you don’t expect similar trends with the mix in the back half and just wondering if you could maybe go over your assumptions on why we would see gross margin improved in the back half, I know part of it is pricing you talked about and then some…
David Bruce
Yeah.
Greg Gibas
… of the supply chain disruption easing. Just wondering if you can kind of highlight that the — what would maybe move margins higher there?
David Bruce
Yeah. So our mix — if you looked at our next percentage in Q2 was kind of a skew only because of, we were comping a large buy-in for a large national retailer on our Shower business. So the numbers were kind of distorted because of that.
But getting back to your margin growth, we have — the programs that are growing, like, we mentioned, Kitchens and Shower come with higher incremental gross margins for us to begin with. And the Sanitaryware, while the — why the up — the margin percentages are lower, the dollars are higher, because the volume is very large. So, ultimately, we’re trying to capture those gross margin dollars by the end of the year.
We still have — we’ve implemented pricing actions in the first half. And I think on our last call, we mentioned we will be implementing additional pricing actions that would be taking place and take effect in the second half, which is happening right now. So we’re confident of that.
But maybe more importantly, on organic demand, we’re taking share. We’re taking small share pieces with these products. We still have — we talked about, excuse me, our resilience through COVID and through all the supply chain issues and we are — we still are having customers coming to us, asking for assistance and pretty much all of our product categories as we’re moving forward as they have had some struggles getting product and sourcing products.
So it’s a combination of pricing action, new introductions, taking market share, and then of course, resilience and having inventory. We are in a great inventory position here and we’ve continued to supply relatively consistently from our factory partners, that’s allowing us to take additional share and also take on additional customers.
Greg Gibas
Got it. Thanks for the caller there.
David Bruce
Yeah.
Greg Gibas
I guess, if I could lastly, or I guess, two more…
David Bruce
Yeah.
Greg Gibas
I am wondering if you could address your comfort level with the existing liquidity balance or cash balance. And then, I guess, has the M&A strategy changed at all, and are you seeing attractive targets there and how have maybe valuations sort of trended?
David Bruce
Okay. Yeah.
Perry Lin
Yeah. Let me address the facility of working capital first. First half of 2022, we use a lot of cash for our organic business program, not just on the inventory program costs that is our end. We believe right now the working capital is very sufficient. We kind of start recovering our working capital back in the back half of these a year.
David Bruce
Yeah. And regarding M&A, we’ve been active, like, we mentioned in the release, there seems to be relatively robust activity out there for people that are looking to make some changes. I would say that maybe some of the ask has been, in our opinion, maybe a bit high. They’re coming off with some good numbers and they’re maybe basing the future off of some maybe unrealistic expectations.
But that’s a judgment call. We have a pretty high hurdle rate, as we had mentioned, back — during our roadshow and I think in Q1, but that we’re — we have high expectations for anything that we would approach and anybody, we will approach any company, we would look at for M&A and a lot of things have to work.
But I think the good news is, we’ve had some good experience so far, looking at some of these possible acquisitions and we’re starting to gain, I’ll call it, gain a little experience of how we’re going to focus in a little better I think and we’re pretty confident that we’ll be able to pull the lever on some of these things relatively soon again, depending on market conditions and depending on if the deal makes sense for us.
Greg Gibas
Right. Makes sense. Sounds good guys.
David Bruce
Yeah.
Greg Gibas
Well, thanks again and congrats.
David Bruce
Great. Thank you.
Operator
This concludes the question-and-answer session. I would like to turn the conference back over to Dave Bruce for any closing remarks.
David Bruce
Thank you for the 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
This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.
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