FGI Industries Ltd.

Good morning and welcome to the FGI Industries, Inc. third quarter 2023 earnings call. All participants will be in a 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. To ask a question, you may press star then one on your telephone keypad. 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.

Thank you. Welcome to FGI Industries' third 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 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 your questions. With that, I'll turn the call over to Dave.

Thanks, Paul. Good morning to everyone, and thanks for joining our call today. We are beginning to see some signs of normalization in inventory levels and order patterns in certain categories. However, inventory destocking continues to impact our results, with the recent macro headwinds prolonging the expected inventory recovery as well as impacting overall demand across our categories. While our top-line results are facing challenges, we continue to see the benefits of our margin improvement initiatives during the third quarter, with gross margin improving 530 basis points from last year. As a result, our gross profit declined only 3% during the quarter, despite the 22% profit revenues. We could see some short-term variability in our gross margins as we invest in our growth initiatives and see a rebound in our pro-channel and bath furniture business, but we believe our improved gross margin profile should be sustainable longer term, owing to our strategic focus on higher margin categories and improved operating scale. As we have discussed in recent quarters, the industry-wide inventory correction that began in the back half of 2022 has persisted into 2023, with uneven demand in the R&R channel and macro uncertainty adding another layer of pressure. This has caused many key industry players to take a very cautious stance on inventory levels, with many participants looking to reduce inventories to levels below historical averages. This has prolonged the destocking headwinds, particularly in the pro channel. In addition, our European business, centered in Germany, has faced pressure due to a combination of destocking headwinds along with macroeconomic pressures in that country. Despite these near-term headwinds, we remain bullish on the long-term outlook for our industry and FGI in particular. The median age of owner-occupied homes is roughly 40 years in the United States. Home equity levels remain high, and homeowners are staying put longer due to the high interest rates. All of this provides a favorable backdrop for long-term remodeling demand. As a result, while market demand may be uneven in the near term, we remain focused on our brands, products, and channel growth strategy, which we are confident will enable us to drive above-market growth in the coming years. and we remain steadfast in our efforts to continue our strategic investments. Our confidence in our long-term value creation formula has not changed. As a reminder, our long-term strategic plan is focused on three key initiatives, which include driving organic growth using our BPC strategy, operational improvements, and efficient capital deployment. I am very excited by the progress we made against these strategic initiatives during the third quarter, So I would like to walk through some of our key accomplishments. As it relates to our VPC program and our organic growth initiatives, we continue to execute on recently awarded new programs. We were awarded an important expansion on a recent partnership, and we continued our geographic expansion during the quarter. First, we are very excited to have extended our licensing agreement for an industry-leading overflow toilet technology into Canada. We look forward to launching new sanitary wear products utilizing this technology at the 2024 Kitchen and Bath Show. Second, we continue to expand our geographic footprint, building on the recently signed agreements providing entry into India, Eastern Europe, Australia, and the UK. During the third quarter, we initiated a partnership with our first distribution partner in India, while our products were approved for use in large commercial projects for a new national construction company partner. Third, I'm excited to announce that we are unveiling an exciting collaboration with Virtu.UK, a highly regarded bath distributor in the UK. Under this exclusive arrangement, FGI will be the sole supplier of sanitary wear, featuring a range of new toilets and sinks, including the company's innovative rimless technology toilet. Virtu.UK will showcase FGI's products on popular e-commerce platforms such as Mano Mano, Homebase, and B&Q. as well as extending this exceptional offering to their entire customer base. Fourth, we won a significant award for new business with a major US retailer that has agreed to expand their in-store bath furniture assortment with FGI. Several new collections consisting of over 20 new bath furniture items will be added, featuring brand new and exciting finishes, styles, and configurations that will roll into stores in the second quarter of 2024. Next, FGI was awarded a new toilet program at a major national U.S. wholesaler. This program will include unique product updates to current toilet offerings at this customer while also adding the recently announced new overflow toilet to the program. We expect this program will begin shipping in Q1 2024. Finally, our custom cabinetry business continues to grow rapidly with our premium Covered Bridge brand adding 93 new dealers thus far in 2023. bringing the total active dealer count to 198 at the end of the third quarter. We also continue to make progress on our new digital custom kitchen cabinetry investment, which is expected to formally launch in early 2024. We plan to have a large display at the 2024 Kitchen and Bath Show that showcases its covered bridge custom kitchen cabinetry line. We are very excited by our progress on our strategic initiatives and we remain confident that this 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 are pleased to have once again reported another quarter of strong year-over-year gross margin improvement, driven in large part by our strategic decision to focus on higher margin categories. Finally, our third focus is on efficient capital deployment. We have made meaningful progress in recent quarters in reducing our working capital usage, which has resulted in improved free cash flow conversion and lower net debt levels. This further bolstered our solid liquidity position and financial flexibility. While debt repayment and investment in organic initiatives has been our main priority, we continue to evaluate strategic bolt-on acquisition opportunities. The demand environment remains uneven, which is prolonging the destocking headwinds that have impacted our results over the last year, with several industry forecasters predicting mid-to-high single-digit declines in home improvement industry spending in 2024. While we have faced headwinds in our end markets, I am proud of the continued progress we have achieved on our strategic growth initiatives, and we have several exciting programs that should contribute to improved growth opportunities in the coming quarters. We have indicated on previous calls that we plan to continue to invest in our business despite the recent market weakness, and we have in fact increased our investments during 2023 relative to our initial expectations, which we feel demonstrates our confidence in our growth opportunities. However, The incremental growth investments, including a strategic investment we made with a major retail customer in Q3 that is expected to lay the groundwork for future growth opportunities, have impacted our outlook for 2023. Softening consumer demand coupled with continued destocking and investments for future growth have caused us to revise our full-year outlook. As a result, we now expect full-year 2023 revenues of $115 million to $120 million, adjusted operating income of $2 million to $2.8 million, and adjusted net income of $1 million to $1.5 million. While we are disappointed by our recent revenue results, we are excited about our BPC growth initiatives, and we remain committed in our efforts to continue our strategic investments in this promising direction. We believe our execution of the BPC strategy coupled with our strategic investments will allow us to outpace the negative market predictions and should enable FGI to drive organic growth in the coming year.