FGI Industries Ltd.

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. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Paul Bartolai, Managing Director. Please go ahead.

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 historical non-GAAP financial measures discussed during our call in the press release issued yesterday and in the appendix to 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.

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 remain 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 sanitary wear, and continued growth at our newer product categories. Our sanitary ware 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 segment 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, our strong growth in the quarter highlights the resilience of our key product categories and 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 into the back half of the year. As we have highlighted on past calls, it is important to remember that roughly 80% of our revenue is 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 our 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 BPC strategy, which stands for Brands, Products, and Channels, and is the key driver of our organic growth strategy. We are pursuing a number of potentially meaningful organic growth programs that could 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 & 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 Hajoka 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 Gojoka, 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.

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 four-year 2022 guidance. Revenue total 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, sanitary ware 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 benefit of price increase. Best 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 challenge 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 trend in the broader bath furniture market. Overall, we remain encouraged by the outlook of our best furniture business. The biggest impact in second quarter was the timing of order, which we expect to normalize in the coming quarter as this issue works through the system, resulting in improved results. Our 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 chemistry business and our JECO shower system, coupled with the pricing gains. Growth profit was $8.4 million during second quarter 2022, a decrease of 8% compared to prior period. 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 up from the first quarter as we continued to make progress offsetting the elevated 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 result 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 saw the fuel bias vanity while we increasing sales of sanitary waste. While we also had some useful comparison within our other segment. Last year, one of our customers pulled forward a large volume of shower products, which was not repeated this year. We remain confident in our margin plan and fully expect to generate continued sequential gross margin improvement in the back half of the year. GAAP operating income was $1.7 million during the second quarter of 2022, down from $3.3 million in the prior year period. Strong revenue growth was offset by growth margin pressure, investment in our organic growth initiative, and the public company cost. As a result, operating margin was 3.6% during the second quarter, which was down from 7.8% in the same period last year. but up about 200 basis points sequentially from the first quarter of 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 a 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 later 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 initiative. Our current working capital level remains elevated, but we expect this to work down over the next three 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 the industry is freighted down modestly from a volume perspective in 2022. As a result, we are reaffirming our financial guidance for 2022, which calls for revenue in the range of 182 to 189 million, operating income to be a range of 6.5 to 7.5 million, and net income to be in the range of 5 to 6 million. That completes our prepared remarks. Operator, we are now ready for the question and answer portion of our call.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star, then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then 2. Our first question comes from Ruben Garner of Benchmark. Please go ahead.

Thank you. Good morning, everybody.

Good morning, Ruben. Good morning. 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, you know, volume growth excluding that drawdown or volume decline, whatever it is, looks like excluding the inventory adjustments?

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 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. 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.

okay um yeah and for the inventory as you can see we already dropped you know from the peak time you know during year end first quarter 21 million to 18 million so far and we fully expect just like they've mentioned you know this continue will be the trend you know for the back half of 2022. okay so just to be clear um 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?

Well, again, we've been working. Sorry. Go ahead.

Go ahead.

No, no, I was going to say, you know, 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 for the second half, right? So we're starting to see a little movement now as replenishment needs are going to definitely rear their head here as we go into the second half, particularly into Q4, as everybody prepares for going into next year. So, you know, 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 category side that demand for inventory on the sanitary ware, The shower 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, you know, this is not, this inventory, back channel inventory that you're hearing about in the market now, you know, 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 Q3.

Perfect. And you mentioned in one of the slides in 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. 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 I assume that's more of a 2023 event before you start to actually recognize those cost savings?

Not necessarily. You know, we've baked in a little bit of those I'll call them freight reductions into the second half as part of our guidance. But a much larger chunk most likely would be affected in 2023. You know, as we're As we're receiving product at better freight rates into our distribution centers, obviously we're cost averaging that product, which is slowly, you know, reducing overall inventory costs. And then several customers, many customers we have, we also, you know, ship them motion containers direct where we cover freight costs. So, you know, 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 expect. 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. And to your point, most likely if things continue on the decline, there'll be a much larger impact in 2023 for sure.

Okay, great. And then the custom cabinets addition 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, you know, potential larger opportunity, you know, in terms of new products. Is that the cabinets business or is that something else that's in the works still?

Yeah, there's a couple of 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 business this quarter by quarter since Q4. I think in the last quarter we had like a 720 basis point gain overall in our special order, our covered bridge and craft, the main kitchen business. And that's going to continue with leaps and bounds. And I think we've mentioned previously, in addition to the sales opportunities that we have, you know, these high-end kitchens, 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 continue 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.

Okay. And any way for us to quantify that? I mean, new customers are, how do these products go to market? Are the new customers, you know, is there a lot of little ones or is there a, you know, uh, one or two larger ones? How do we, how do we frame this?

Yeah. So the tradition, traditionally, um, the, the business has been, um, marketed to the dealer base, uh, throughout the country, uh, kitchen dealers, you know, whether they're a single unit or multi-unit locations, but, uh, we've been in discussions with, um, uh, a couple of larger, uh, national customers that, uh, we think that, um, you know, 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 in the dealer base.

Okay, great. I'll leave it there. Congrats on the solid results and luck going forward, guys. Great. Thank you.

Our next question comes from Greg Gibbous of Northland Securities. Please go ahead.

Hey, good morning, David and Perry. Thanks for taking the questions, and congrats on the quarter. Thank you. Thank you. You know, I just wanted to, I guess, first just see if there's maybe any different trends across your customer base categories, your segments that you're seeing, whether it's, you know, e-commerce versus large retailers or others.

Yeah, I would say as we enter the Q1, and we talked about the first quarter, the pro business and the do it for me business, particularly on the sanitary ware side, continues to be extremely strong. And we really see no end in sight, at least for the balance of this year at this point. And that's broad based across all the sanitary ware 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 back-channel 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 sanitary wear side. And 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 what builder business we do have, and we're seeing that continue. 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 see no end to that through the end of this year at this point.

Great. Very helpful. And, you know, I apologize if I missed your commentary on this, but, you know, 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 improve in the back half. I know part of it is pricing you talked about and then, you know, some of the supply chain disruption easing. Just wondering if you can kind of highlight what would maybe move margins higher there.

Yeah, so our mix, if you looked at our mix percentage in Q2 was kind of askew only because 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, you know, 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 sanitary ware, while the margin percentages are lower, the dollars are higher because the volume is very large. So, you know, 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, you know, we're taking share. We're taking small share pieces with these products. We still have, we talked about our, excuse me, our resilience through COVID and through all these supply chain issues. And we still are having customers coming to us, asking for assistance in pretty much all of our product categories as we're moving forward. They have had some struggles getting product and sourcing product. So it's a combination of pricing action and 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.

Got it. Thanks for the call there. You know, I guess if I could, lastly, or I guess two more questions. You know, wondering if you could address your comfort level with the existing liquidity balance or cash balance. And then, you know, I guess, has the M&A strategy changed at all? And are you seeing attractive targets there? And, you know, how have maybe valuations trended?

Yeah. Let me address the facility working capital first. In the first half of 2022, we used a lot of our cash for our organic business program, you know, not just on the inventory program cost that is owed. And we believe, you know, right now the working capital is very sufficient. We're going to start recovering, you know, our working capital back in the back half of this year.

Yeah, and regarding M&A, you know, 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 of some good numbers and they're maybe basing the future off of some maybe unrealistic expectations. But, you know, that's a judgment call. We have a pretty high hurdle rate, as we had mentioned, you know, back during our roadshow and I think in Q1, but, you know, we have high expectations for anything that we would, you know, approach and anybody we would 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 I'll call it gain a little experience of how we're going to focus in a little better, I think. And, you know, we're pretty confident that we'll be able to pull the lever on some of these things, you know, relatively soon, again, depending on market conditions and depending on if the deal makes sense for us.

Right. Makes sense.

Sounds good, guys.

Well, thanks again and congrats. Great. Thank you.

This concludes the question and answer session. I would like to turn the conference back over to Dave Bruce for any closing remarks.

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.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.