FGI Industries Ltd.

Good morning and welcome to the FGI Industries Incorporated fourth quarter 2022 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Paul Bartoli. Please go ahead.

Thank you. Welcome to FGI Industries' fourth quarter and full year 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 factor 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 Linton. 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. Good morning to everyone, and thanks for joining our call today. 2022 was an exciting year for FGI. It was our first year as a public company, and I am extremely proud of our strong execution throughout the year, despite what turned out to be a very challenging operating environment. We made important progress against our strategic priorities and performed extremely well operationally, and as a result, we are well positioned to continue to execute on our value creation strategy in the coming years. During the year, we continued to make critical progress on our BPC initiative, which stands for Brands, Products, and Channels, and is the key driver of our organic growth strategy. I will provide more specifics later in my comments, but we further ramped key new products programs, expanded existing product categories, and launched several brand initiatives during 2022, which should enable us to gain market share, expand our market penetration, and drive strong organic growth in the coming quarters and years. In addition, we continue to make significant gains at our margin recovery initiatives with our fourth quarter gross margin up meaningfully, both versus last year and from the third quarter. Our gross margins are well above the pre-pandemic levels, and we expect continued strength in our gross margins going forward. FGI and the building products industry as a whole faced a number of challenges during 2022, including persistent inflation, ongoing supply chain disruption, global unrest, and widespread customer destocking. However, thanks to the hard work and dedication of our team members across the organization, we continue to focus on what we could control, and as a result, we believe we are in an attractive position as we enter 2023. We will likely continue to face some industry headwinds, especially in the early part of the year, but I am very encouraged by the outlook for FGI. Now turning to the quarter, our fourth quarter results were once again negatively impacted by inventory destocking at key customers, which caused our revenues to come in below our expectations and decline nearly 40% from last year. We had expected some moderation in the inventory adjustments we had been seeing, but the impact was more significant than we expected during the fourth quarter. We expect destocking to continue to be a headwind into the early part of 2023, but we have started to see customers' inventory levels begin to normalize with order cadence slowly improving during the first two months of 2023. This is more evident within the DIY channel, as we expect destocking within our pro customers to extend further into the second quarter. While it is early in the year and the market environment is very fluid, with the ongoing momentum in our internal growth initiatives, we are well positioned for a return to organic growth once channel inventory levels normalize. While our revenue performance was challenged, we made significant progress on our margin initiatives during the fourth quarter. Our fourth quarter gross margin came in at 23.7%, up from 14.5% in the same period last year, and up 280 basis points sequentially, driven by pricing benefits, more favorable mix, and lower freight costs. As a result, we were able to report gross profit that was basically flat from last year, despite the significant revenue headwinds. Our gross margins are now above the levels we enjoyed prior to the supply chain disruptions and inflationary headwinds that pressured our results and back in our targeted range. Our goal is to at least maintain the gross margin levels we achieved in the back half of the year, with a focus on further expanding our operating margin as volumes recover and we enjoy the benefits of improved scale. That said, as we continue to grow our higher margin new product categories and see a rebound in our bath furniture business, we do see additional potential positive gross margin drivers in the future. While our revenues have come under pressure in recent quarters due to customer destocking, end market demand has held up relatively well across our key product categories. We have seen some pressure in our bath furniture business as we have discussed on prior calls, But overall, the repair and remodel market is performing as we would expect during this period of market uncertainty. The new housing market is seeing considerable pressure, with new home sales down 20% plus in recent months. But the repair and remodel market has been more stable. As we look into 2023, still elevated interest rates are a headwind for new home construction and existing home sales, which does have some impact on our business. In addition, persistent inflation is a headwind for consumer spending in general, impacting our business as well. On the flip side, with new home sales under pressure, homeowners are likely to stay in their current homes longer, often leading to increased investments into updating or refreshing their existing homes, with kitchens and baths often a key priority. And it is also important to remember that nearly 40% of homes don't have a mortgage, and 85% of homes are locked into mortgage rates below today's rate, so higher mortgage rates have little impact on significant percentage of homeowners and their repair and remodel spending. Putting all this together, while we remain optimistic on the long-term outlook for our industry, we do see some reason to be cautious regarding the outlook for 2023. We expect the current industry headwinds, such as elevated mortgage rates, inflation pressures, and macro uncertainty, to result in our overall markets declining in the mid to high single digits during 2023. We continue to focus our energy on the things we can control in an effort to drive long-term growth above the market and create value regardless of the market environment. Consistent with our long-term strategic plan, we remain focused on our three key initiatives, which include driving organic growth using our BPC strategy, operational improvements, and efficient capital deployment. We made important progress against these strategic initiatives during 2022, positioning us to pursue profitable growth during 2023 and beyond. Some of our key accomplishments during 2022 were as follows. We made nice progress through our BPC program with continued growth on our key new product initiatives, expansion of existing brands and products, and further penetration of some of our key channels. Some key highlights include First, we meaningfully expanded our custom kitchen cabinetry business under the Covered Bridge brand, generating strong growth in our dealer network, which increased to 135 at the end of 2022, up from 71 at the start of the year. This strong momentum has continued into 2023 with 14 additional dealers added in January. As we have discussed previously, we have invested in new manufacturing capacity to support the anticipated business development opportunities for our kitchen cabinetry business both in the dealer network and with large national customers. Second, we also continue to see growing momentum in our shower systems business. In the fourth quarter, we launched our co-branded program at Lowe's, which combined our Jet Coat line with their private label brand and will be called Alana Roth Shower Wall System by Jet Coat. We believe the initial reception has been very positive and will now lead to further initiatives to enhance the program, new finishes and styles, as well as new in-store merchandising displays. Third, during 2022, we launched several new product lines and brand initiatives across the company's entire geographic footprint, including new products under FGI's flagship craft and main brand, the launch of the jet coat shower wall line to the Canadian wholesale market, and a major sanitary wear product launch in Germany that should help drive a new cycle of innovation and product development. Fourth, we expanded our geographic footprint during the year, adding locations in the United Kingdom and Australia. We are excited by the tremendous opportunities we see in these markets and will look to leverage our existing product and operational base to successfully grow into these new geographic regions. Our new sanitary wear program for Bunnings, the largest home improvement retailer in the Australian market, will feature new two-beday toilet suites that will enhance Bunnings' offering and will continue to improve our overall product mix with higher margin, higher ticket products. We are extremely excited by our continued execution against our organic growth programs under our BPC strategy, and we remain confident that these initiatives will help us drive above-market organic growth as market conditions normalize. The second focus of our value creation strategy is on operating efficiency and driving margin expansion. We clearly made significant progress on our margin recovery initiatives during 2022, as we exited the year with a gross margin of 23.7% during the fourth quarter. Our ability to quickly return to the gross margin levels witnessed prior to the supply chain disruptions in just over a year gives me confidence on our ability to continue generating profitable growth in the future. Finally is our focus on efficient capital deployment. Following the challenges caused by the supply chain disruptions and inflationary pressures, we made meaningful progress in reducing our working capital usage in recent quarters, which has resulted in improved free cash flow conversion. This further bolstered our solid liquidity position and financial flexibility. As a result, we have ample capacity to invest in our organic growth initiatives. Our strategic priorities will remain much the same during 2023. We will continue to pursue our BPC strategy to drive organic growth, including continued investments in our shower systems and covered bridge kitchen cabinetry business. Additionally, I'm excited to announce that we will be investing in a new venture targeting the kitchen market. We are very excited about this opportunity to add our rapidly growing kitchen business and look forward to providing more details as soon as we are able. We will also maintain our focus on operational execution to drive operating margin improvement and strong free cash flow generation with a goal of expanding our operating margin to the high single-digit range longer term. Finally, we will maintain our disciplined approach to capital allocation. The primary use of capital in the near term will continue to be investments in our organic growth initiatives. However, we continue to evaluate both on acquisitions and other strategic opportunities with potential partners, such as the new kitchen venture I just highlighted. Overall, 2022 was a successful and important year for FGI. While we fell short of the financial targets we set at the beginning of the year, We executed well, despite an extremely volatile and unpredictable market environment, and I am confident we are well positioned to execute on our strategy and drive strong financial results as market conditions stabilize. 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 2023 guidance. Revenue totaled $31.8 million during the first quarter of 2022, a decrease of 39% compared to prior year due primarily to ongoing inventory destocking as well as some softening in customer demand. Looking at our business lines, sanitary ware revenue was $20.2 million during the first quarter, a decrease from $34.2 million during the prior year period. The revenue decline was largely the result of channel inventory reduction by key partners, particularly in the pro channel. End customer demand has remained relatively stable, so we continue to expect volume to rebound as inventory levels are adjusted. Base furniture revenue was $6.1 million during the first quarter, down from $12.6 million last year. The best furniture business also continues to see pressure from destocking. The inventory collection in best furniture started earlier than some of our other categories. So we were expecting to see this trend begin to normalize in the back half of 2022. But we continue to see inventory reduction pressure revenue through the first quarter. Our revenue was $5.4 million during the first quarter of 2022, essentially right from the prior period. As order timing in our shell business was offset by continued momentum in our kitchen chemistry business, we expect the growth in our shell system business to resume in 2023 as we look to expand our co-branding program with Lowe's and continue our expansion into Canada. Growth profit was $7.5 million during the first quarter of 2022, basically free from last year, as the significant progress we made on our margin recovery initiatives largely offset the revenue decline. Growth margin improved to 23.7% during the first quarter, up from 14.5% last year, and 20.9% in the third quarter of 2022. The improvement in our gross margin is a result of a more favorable mixed pricing game and a reduction in freight costs versus the elevated level experience last year. We expect this positive factor to remain in place during 2023. Allow us to maintain gross margin at current levels with the opportunity for further upside driven by a potential volume recovery. GAAP operating income was $1 million during the fourth quarter, up from $0.7 million in the prior year period, excluding $0.3 million in charge during the fourth quarter of 2022. Adjusted operating income was $1.3 million, up $0.6 million, or 89% from the prior year, driven by the improved gross margin performance and lower selling and distribution expenses, partially offset by the lower revenue. As a result, adjusted operating margin was 3.2% during the fourth quarter, up from 1.4% in the same period last year. Gap net income was $0.7 million, or $0.07 per diluted share, during the fourth quarter of 2022, down from $1 million over $0.15 in the same period last year. Excluding one-time items in both periods, adjusted net income for the fourth quarter was $1 million over $0.11 per diluted share, up from $0.7 million over $0.10 last year. Now, turning into the balance sheet and our liquidity, as of December 31, 2022, the company had $10.1 million of cash and cash equivalent and total debt of $9.8 million. At the end of the quarter, we had $13.7 million of availability under our credit facilities. Net of the rate of credit combined with cash total liquidity was $23.8 million at the year end. We are pleased with the continued improvement in our working capital level. during the quarter, which had been elevated in recent quarters, owing to the supply chain challenges. The reduction in working capital drove the strong free cash flow conversion in the quarter. We expect our capital spending needs to remain around 1% of revenue. We believe we are in a solid liquidity position that is more than sufficient to fund our growth initiative. Finally, turning into guidance, Despite the challenging market environment, we were able to make significant progress in our margin recovery initiative during 2022, and we expect this positive trend to continue into 2023. However, as Dave has already highlighted, we expect the repair and remodel market to face some headwind during 2023, which we expect to result in overall R&R industry volume declining in the mid to high single-digit range during 2023. We expect inventory destocking to continue into first half of the year, which combined with the expected decline in R&R industry volumes will likely result in a challenging revenue backdrop for 2023. We remain confident in our organic growth initiative and expect to outperform the market once inventory level adjusts. In addition, our guidance reflects the investment related to our new kitchen program that Dave described, which will total roughly half a million in 2023. With this factor as a backdrop, we are providing 2023 financial guidance as follows. Revenue in the range of $145 to $163 million. adjusted operating income in the range of 6 to 6.8 million, and adjusted net income in the range of 4.2 to 4.7 million. Please note that guidance for the net income and operating income is being provided on an adjusted basis and exclude non-recurring items. 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 ask a question you may press star then one on your touchtone phone if you're using a speakerphone please pick up your handset before pressing the keys to withdraw your question please press star then two at this time we'll pause momentarily to assemble our roster our first question comes from Ruben Garner from the Benchmark Company. Please go ahead.

Thank you. Good morning, everybody. Hey, good morning, Ruben.

Good morning, Ruben.

I'm wondering just if we could square up the outlook a little bit on the top line. So you mentioned R&R down, I think, mid to high single digits as a market. Would the destocking impact be incremental to that mid to high single digits? And if so, is there any way you could kind of quantify what kind of hit you're anticipating that to have on the first half of 23?

Yeah, thanks, Ruben. I'll bring that back to, let's go back to Q3 just to give the whole picture here. So Q3 of last year, you know, is when we started to see a very abrupt impact from the destocking in the middle of Q3, into late Q3. And it was initially with retail. We saw on the retail side first, and then it followed up on the pro side of our business. So that we fully expect. And that was obviously the largest impact that we saw in Q4. And we continue to see that, as we had mentioned, going into the first half of this year. So in relation to the market decline, you know, the market decline without destocking isn't as impactful because we are still taking share. We haven't lost any market share. We haven't lost any programs in the market. And we're continuing to add new incremental business. We have several opportunities on the table that we expect to execute in the second half. So in the end, destocking is the major impact. And we're seeing a bit of a relief in order cadence that I think I mentioned as we've entered Q1 as it relates to destocking on the retail side. The pro side, again, we expect to continue a little bit more towards the middle of the year, but the second half is when we anticipate that we should see more of a normalization as far as the impact of destocking and As far as the R&R market, we sort of baked in what we expected, but at the same time, we've also baked in some opportunities that we know are going to be executed, and we have others that we have not baked in that we feel very, very confident about in the second half.

Okay, so just to be clear, the mid- to high-single-digit market decline would not include the impacts of destocking. That would be incremental to...

Yeah, that's correct. That's obviously assuming all things were equal going into Q1, for example, if there was no destocking, we would definitely anticipate a softening in the market, but our expectation would be that we'd be able to outpace that with market gains that we're seeing with new business opportunities.

Perfect. And then on the kitchen investment, I recognize you don't have a ton of detail right now, but one question about it, is there any revenue benefit in the guidance for this year baked in from that, or is 2023 for the most part an investment year and so the cost is going to have an outsized impact?

Yeah, you're exactly correct. So we anticipate that there'll be no revenue. We did not make any revenue into the guide. for that new investment, but we did build in the anticipated and expected investment for 2023, and we would see the benefits of that next year.

Okay, and how about pricing, just given the destocking environment and the consumer and what happened over the last couple of years? Can you just walk us through any pushback you've been getting what kind of maybe tied into the cost that you're seeing or have you started to see deflation in a bigger way and therefore you're able to give some of the price back?

Yeah, I think we've actually seen a little positive effect in some sense. So I'll just give a little broader picture. We'll go back again to last year where obviously there were enormous inflationary pressures as we entered for the entire year, and I think I had mentioned on previous calls that we were adjusting price to our customers throughout the year, and the majority of those price actions were executed by the end of Q4, and so some obviously wouldn't have full impact until this year. We don't really anticipate any additional inflationary pressures at this point, and what we have seen in the market, you know, As you know, even though we have grown sales of our brands, our proprietary private label brand business is still a larger portion of our business. And we are seeing more what I would call trade down activity in the market from maybe more premium priced brand names to the private label brands, particularly in the retail environment. And as you know, we also sell within, I'll say, a good, better, best strategy within the private label space. So we're seeing a little advantage there, a little tailwind for us, because we anticipate that that's going to continue to be strong. And customer sentiment on private label brands right now is quite positive. So we look at that as a tailwind as we enter the first half and continue into the second half of the year as well.

Great. Thanks for the detail, guys. I'm going to pass it on. Good luck this year.

Thank you. Thank you. The next question comes from Greg Kibos from Northland Securities. Please go ahead.

Hey, good morning, Dave and Perry. Thanks for taking the questions.

Hey, Greg.

Thanks. If I could follow up just on maybe the cadence this year, with the expectations for inventory destocking to normalize in the second half, Can you be maybe more specific on what you, whether quarterly or between the two halves, are kind of expecting within your guidance?

Yeah, so we anticipated originally we were thinking that destocking, and when I say originally, this is prior to the guide, we thought destocking would end a bit quicker. But here's what we think, you know, and it's a bit different geographically. We started to see in our Canadian market the wholesale, or I'll call the pro market, rebound a bit quicker. We started to see some recovery earlier in the first quarter where here in the US we anticipate the pro market at this point to become more normalized, maybe more in the middle of the year into the late part of the second quarter. Retail, we've already started to see some breakthrough as far as order cadence. I wouldn't call it cadence at this point. I would just call it the beginnings of the inventory levels dropping. On our customer side, so to give you an example, many of our customers experienced anywhere between 40 to 70% higher than normal inventory levels as they went into the fourth quarter last year. So those levels are, as you can imagine, it takes time to normalize that. So I think what we're going to see on the retail side is more of a normalization by the middle part of the year. And I think second half would be, my anticipation would be, we'd see cadence that would be more normal. In that part, and on the pro side, again, I think same, but a little bumpier because of the housing market and understanding where new construction is going to go, because some of our pro business, obviously, is not just for smaller contractors, but our products do end up in new construction as well. So even though that's a small part of our overall business, we'll have to watch the pro side a little closer.

Got it. Very helpful, Dave. Makes a lot of sense. And if I could follow up, I know you spoke to kind of what you're seeing destocking relative to each channel, and I think it was kind of DIY and then pro channels hit the most as of late. I'm wondering if you could just kind of cover the other channels in terms of maybe relatively speaking how they're being impacted from destocking.

Yeah, well, it's very similar. A lot of our e-com channels are linked or related to brick and mortar, right? They're brick and mortar customers that sell online, and it's the same effect as far as the destocking goes. We're seeing the same on our hospitality distributors that we deal with as well, although that's actually picked up a bit. We are seeing, since our kitchen and bath show that we were at in January, we've seen a little bit more activity on the hospitality side than we have on our typical pro business. So, yeah, I mean, I think it's an industry-wide sort of overall average. I don't think one channel has particularly outperformed another. I would just say in general that retail seems to have broken first in a sense than more of the pro or commercial side of our business.

Got it. And, you know, wanted to ask you on gross margins. You know, nice to see the strong performance there despite the lower revenue. And I think in your prepared remarks, you mentioned some other drivers of gross margin expansion going forward. Doesn't sound maybe near term, but could you maybe elaborate on what those factors could be?

Sure. So, you know, we've mentioned and when we've posted some of our results by category, you know, we've really experienced exponential growth in our shower systems business and in our kitchen business. And that's where I think when we originally, you know, going back to the beginning of 2022, when we first went IPO, we talked about our BPC strategy. We really anticipated a large growth area there in those higher margin categories. And we continue to do that and we're continuing to see that. So, And not only that, you know, I think I've talked about not getting into the weeds of all of our product categories, but we've talked about how we're reengineering the mix of all of our programs, including our cabinetry and the sanitary wear business. So we're really reengineering the mix in every one of our product categories to continue to grow not only the brands and the image, but the quality of the product, the ticket, the margin. But what we're seeing first, we're seeing the impact of the shower systems business and the kitchen growth. That's part of the margin driver. That's part of the reason you saw margin improve. But that's also the drivers that you're going to see, as we expect, going into the balance of this year as well.

Okay. Understood. I guess the last one for me, I just wanted to – You know, see if you could speak to the impact that you're still seeing from the supply chain disruptions. You know, trying to get a sense of whether they're changing at all or if they're kind of, you know, the same over the last several quarters.

Yeah, I would say now that things have pretty much moderated. You know, there's always blips on the screen, so to speak, as it comes to supply chain. But as of right now, I would say that we're almost back to a pre-pandemic level. as far as disruptions. So we're getting, we have a lot more cadence now in our ordering and our delivery. So yeah, that's no longer on the radar right now as a threat for the year.

Okay, great.

Thanks, guys.

Yep.

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

Well, 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.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.