Good morning, and welcome to the FGI Industries Second Quarter 2023 Earnings Conference Call. Please note that this event is being recorded today. I will now turn the conference over to Paul Bartolai, Managing Director at Vallum Advisors. Please go ahead, sir.

Thank you. Welcome to FGI Industries Second Quarter 2023 Results Conference Call. Leading the call today are President and CEO, David Bruce; and Chief Financial Officer, Perry Lin. We issued a press release after the market closed yesterday detailing our recent operational and financial results. I would like to remind you that management's commentary and responses to questions on today's conference call may include forward-looking statements, which, by their nature, are uncertain and outside of the company's control. Although these forward-looking statements are based on management's current expectations and beliefs, actual results may differ materially. For a discussion of some of the factors that could cause actual results to differ, please refer to the Risk Factors section of our latest filings with the SEC. Additionally, please note that you can find reconciliations of historical non-GAAP financial measures in the press release issued yesterday and in the appendix of this presentation. Today's call will begin with a performance review and strategic update from David Bruce, followed by a financial review from Perry Lin. At the conclusion of these prepared remarks, we will open the line for 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. During the second quarter, we maintained focus on our long-term strategy and continued to make important progress on our growth and margin initiatives despite the sluggish demand trends and inventory headwinds, which once again pressured results. We continue to execute on our BPC growth initiatives and added several new awards and partnerships during the second quarter including a new licensing agreement that should drive incremental growth in our Sanitaryware business as well as new sales partnerships that will allow us to expand our geographic footprint into India and Eastern Europe in the coming years, all of which should put FGI in a strong position to return to organic growth as industry conditions normalize. As we have discussed on prior calls, a key focus of our BPC strategy is to increase the contribution from branded products and prioritize higher-margin markets and categories. Our success under these initiatives has been a key factor in the meaningful gross margin improvement in recent quarters. This continued into the second quarter with record second quarter gross margin of 27.4%, up nearly 1,000 basis points from last year. As a result, our second quarter gross profit declined by less than 5% despite a nearly 40% drop in revenue. While a volume rebound in the pro channel and Bath Furniture could impact the gross margin trajectory in the near term, we expect the continued benefit from our strategic focus on higher-margin categories, such as Shower Systems and Kitchen Cabinetry as well as improved operating leverage to further benefit margins over time. The industry-wide inventory correction that has been a headwind to our revenue growth has lingered into 2023 with uneven demand in the R&R channel and macro uncertainty, adding another layer of pressure. This has caused many of our large customers to take a very cautious stance on inventory levels with many industry participants attempting to reduce inventories to levels below historical averages. This has prolonged the destocking headwinds, particularly in the pro channel where the inventory correction is extending into the second half of the year. In addition, our European business centered in Germany has faced pressure due to a combination of destocking headwinds, along with significant recessionary pressures in that country. These factors are proving to be a more significant headwind than we anticipated at the start of the year. As a result, we are adjusting our full year guidance. We now expect full year 2023 revenues of $120 million to $130 million, adjusted operating income of $3.5 million to $5 million and adjusted net income of $2 million to $3 million. While we are disappointed to lower our full year outlook, we still see plenty of reasons for optimism both in the broader market and in particular, with our company-specific initiatives. Looking at the broader R&R market, demand has been uneven, but the overall market is holding up as well as we would expect. The R&R market tends to be more stable than the broader building products category, and that is what we are seeing. The Bath Furniture business continues to see the biggest impact from a demand perspective. We are taking numerous actions to drive further volume growth, including anticipated new product line rollouts and select pricing adjustments. Importantly, we are not seeing signs of broader discounting or promotional activity in the market. Looking forward, we have been encouraged by a stabilization of inventory trends as we look into the back half of 2023 and into 2024. We have also been encouraged by the recent housing data, which is showing signs of stabilization and improvement as buyers get accustomed to the new level of mortgage rates. Commentary from the public builders continues to be more constructive with most players noting improved order trends and increasing buyer confidence. Overall, the trends in our end markets are largely consistent with our expectations coming into the year, and we continue to expect our end markets to decline in the mid-to-high single digits during 2023. While the trends in 2023 have been more challenging than originally expected, our longer-term optimism for the Kitchen & Bath repair and remodel market and FGI's position in the industry remain unchanged. As a result, we continue to invest through this cycle and remain focused on our strategic plan, which ultimately is to drive long-term growth above the market and create value regardless of the market environment. As a reminder, our long-term strategic plan is focused on 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 second quarter. So I would like to walk through some of our key accomplishments. As it relates to our BPC program and our organic growth initiatives, we were awarded several important new programs and entered into a couple of exciting partnerships during the quarter. First, we entered into a 5-year licensing agreement that will provide FGI access to an industry-leading overflow toilet technology, which will provide a key differentiator in the market. We expect to launch new sanitaryware products utilizing this technology at the 2024 Kitchen & Bath show. Second, we entered into two exciting new partnerships that will enable us to expand our geographic footprint into the high-growth Indian and Eastern European markets. We engaged MurA India, a sales organization based in Mumbai, India, to serve as a catalyst for our geographic expansion and heightened market presence in India. MurA India will focus exclusively on marketing and selling FGI's Sanitaryware line of products to both wholesale and hospitality trade channels across the country. In addition, we also recently formed a strategic partnership with MIA Partner to extend our presence into Eastern Europe. Leveraging their expert resources located in the target customer countries, MIA Partner working with our international sales team is now actively identifying potential customer targets in the region, prioritizing cultural relevance and understanding throughout the process. This collaboration aims to significantly enhance FGI's market penetration and growth prospects in the Eastern Europe region to further support our BPC strategy. Third, we continue to execute on recently announced awards, including our online shower door program for an existing large Canadian retail partner, which commenced in June 2023 and the rollout of FGIs industry-leading Shower Wall program into as many as 300 locations of a large U.S. retailer. Both programs are on track and should contribute to improved Shower Systems orders in the second half of 2023 and into 2024. Our custom cabinetry business continues to grow rapidly with significantly higher incremental gross margins than the company average. Our premium Covered Bridge brand added 57 new dealers thus far in 2023, bringing the total dealer count to 180 at the end of the second quarter. As we mentioned last quarter, we continued to develop a new business venture that we feel has tremendous potential in the online custom kitchen cabinetry space. We look forward to updating the market on our progress in the coming quarters. 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 once again made excellent progress on our margin improvement initiatives as we reported another quarter of strong year-over-year gross margin improvement. While lower freight costs and pricing have been a contributor to the improved margin performance, we think it is important to understand that our strategic decision to focus on higher-margin categories has been the main driver of the improved performance. And we view this as a structural shift that will continue to benefit margins over the long term. Finally, it's 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. At the same time, we continue to actively pursue bolt-on opportunities, although as we have stressed on previous calls, we remain disciplined and rigorous in our approach to our acquisition strategy. Overall, while macro conditions have been a challenge and we are disappointed to fall short of our original financial targets, I am very proud of our execution. We continue to generate strong margin improvements. We were awarded several new business programs, including important partnerships to further expand our geographic footprint into new high-growth markets, and we made important progress on our strategic goals. We think this all serves to position the company very well for the future. 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 full year 2023 guidance. Revenue totaled $29.2 million during the second quarter of 2023, a decrease of 39% compared to the prior year due to continued inventory destocking as well as some modest softening in our customer demand. Currency was a headwind during the quarter and negatively impacted revenue by 1.2%. Looking at our business line, Sanitaryware revenue was $18.8 million during the second quarter, down from $32.3 million during the prior year period due to continued inventory headwind, particularly in the pro channel. We continue to see large customers take a cautious stance regarding inventory levels, given sluggish demand trends, which is pruning the inventory correction. However, our sanitary revenue did increase 23% sequentially from the first quarter of 2023 as we are seeing some customers beginning to return to more normal order patterns, and we are hopeful for a continued rebound in order trend in the back half of the year as inventory levels normalize and demand rebounds driven by recent improvement in the housing industry fundamentals. Bath Furniture revenue was $4.8 million during the second quarter, a decline from revenue of $7.7 million in the prior year period. The broader Bath Furniture market, in particular Bath Cabinetry, has continued to experience sluggish demand trends, causing inventory levels to remain elevated. In response to the ongoing demand headwinds, as Dave mentioned, we have made some modest pricing adjustments on certain Bath Furniture products, which is expected to drive improved demand. Shower Systems revenue was $4.3 million during the second quarter, down from $6.5 million last year due to some modest inventory destocking and order timing. While revenue declined from last year, the overall momentum in the business remains strong, with the recently awarded new program expected to drive improved trends in the second half of 2023. Other revenue, which consists primarily of the custom Kitchen Cabinetry business, was $1.3 million during the second quarter, essentially flat from the prior year. While there was a modest low in order following the strong path of the new business coming out of the Kitchen & Bath show at the start of the year, the trend in the business remains strong, and we expect strong momentum in the back half of the year. Gross profit was $8 million during the second quarter, a decrease of only 4.9% compared to last year, as the recent revenue headwind continued to be offset by improved margin performance. Gross profit margin improved to 27.4% during the second quarter of 2023, up 980 basis points from last year. While mainly driven by more favorable product mix, gross margin also benefited from lower freight costs and the full benefit of the price increase implemented during 2022. Our operating expense increased to $7.4 million during the second quarter, up from $6.7 million last year as we continue to invest in our growth initiatives. The higher operating expenses reflect marketing spending for new product initiatives caused to support our geographic expansion program and the expenses tied to our new kitchen business opportunity. GAAP operating income was $580,000 during the second quarter of 2023, down from income of $1.7 million in the prior year period. Excluding one-time expenses, adjusted operating income was $642,000 during the second quarter. The decline in operating income was a result of the revenue decline and the continued investment in operating expenses tied to the group's initiatives, partially offset by improved gross margin. As a result, operating margin was 2% during the second quarter, down from 3.6% in the same period last year, but an improvement from the breakeven possibility during the first quarter of 2023. GAAP net income was $0.1 million or $0.01 per diluted share during the second quarter of 2023 versus net income of $1.2 million or $0.10 per diluted share in the same period last year. Excluding one-time items, adjusted net income for the second quarter of 2023 was $0.2 million or $0.02 per diluted share. Now turning to the balance sheet and our liquidity. As of June 30, 2023, the company had $6.9 million of cash and cash equivalents and total debt of $7.9 million. At the end of the quarter, we had $15.7 million of availability under our credit facility, net of debt credit. Combined with cash, total liquidity was $22.6 million at quarter-end. We believe we are in a solid liquidity position that is more than sufficient to fund our growth initiatives. Finally, turning to guidance, as Dave discussed, inventory destocking has proven to be a bigger headwind than expected. As a result, we are lowering our full year 2023 guidance. Please note that guidance that Dave outlined for net income and operating income is being provided on an adjusted basis and excluded nonrecurring items. In addition, our guidance includes approximately $0.5 million in expenses for our new Kitchen Cabinetry initiative. That completes our prepared remarks. Operator, we are now ready for a question-and-answer portion of our call.

At this time, we will take our first question from Reuben Garner with Benchmark. Please go ahead.

Thank you, good morning guys.

Good morning, Reuben.

Good morning Reuben.

So just trying to clarify the comments on the destocking. You mentioned some customers were showing signs of returning to normal order patterns sequentially. Is all the destocking that you're seeing at this point at the pro level? And can you remind us how much of your business goes through that channel? And then, I guess, maybe just for clarification purposes, what you're seeing specifically at retail?

Yes. Thanks for the question. Yes. We're seeing it in both the pro and retail side, it is moderating. So that is why we mentioned that they continue to come down, but there's more of a lag. And as you know, we have a relatively high concentration of some larger customers in both the pro and the retail side. And as their inventory has been funneling down and moving out through the channel, their baseline inventory levels are also being adjusted to be a bit lower than they were prior to all of these inventory issues. And at the same time, in both the pro channel and the retail channel, we're seeing a softening. We've said that the R&R market is projected to be down in the high single digits this year. So when you combine the softening of the demand side with the extended lower inventory levels, it is dragging out a little bit more of what we expected on the destocking side. Now again, because of the larger customer size that impacted us and extend it a bit, it's very hard for us to recover that as quickly as we would have wanted to. We didn't completely anticipate. We were cautious to think that may extend further into the year. And I think we had mentioned that. But by doing so, it obviously is a challenge to overcome as quickly.

So we have limited financial history with you guys. Is there normally like a destocking quarter for your industry? And if so, is that something that is just being pushed out, like we're seeing in other categories where the retailers or the dealers' channels just saying, hey, look, we normally stock up in the fourth quarter. We're going to push pause and wait just given all the uncertainty, we're going to wait until early part of next year to make sure the consumer is okay, have things okay before we go ahead and kind of return to normal buying? Is there something like that a dynamic like that in your space potentially?

For the most part, no. There's not much seasonality to our business. There is a bit of seasonality on the retail side related to the spring season since more people get out and promote their spring businesses, leading to a slight increase in activity. The only seasonality we noticed last year was towards the end of the season due to our manufacturing being primarily in Asia. People tend to get ahead of the holiday season, such as Chinese New Year, and usually place more orders towards the end of the year in anticipation of those holidays. However, last year we were in the midst of inventory destocking, so we did not experience that. This year, we expect to see a return to that trend because it has historically been a normal pattern for us through various cycles. We hope to see this again as we enter the second half of the year.

Okay. Great. And then last one for me. Your margin performance has been encouraging in the last couple of quarters. It looks like you're creeping back into that kind of mid-single-digit operating margin range that you were a few years ago, but you're getting there a very different way. How do we think about that, that kind of makeup between gross margin and what your operating expense line looks like? Longer term is something in the mid to upper 20s from a gross margin standpoint, sustainable? And will you have to continue to spend on the OpEx line to get there? Or is there leverage to come when volume rebounds?

That's a great question, and I'm glad you raised it. We believe there is significant leverage available. I've mentioned before that while we're not a startup, we're operating with a startup mentality. Even though we face some downturns in business, we are committed to reinvesting for growth. Our focus on concentration risk with a few larger customers has limited options, which is why we are investing in multiple avenues, including the digital kitchen venture, entering the Indian market, breaking into the U.K. market, and expanding in Eastern Europe. All of these initiatives aim to create a more level playing field for us with our BPC strategy. Currently, we are subscale, which means larger customers can either positively or negatively influence our results. Our goal is to grow and scale the business, broaden our market reach, enhance our channels, and diversify our product offerings for our customers. To address your question directly, we anticipate just over $1 million in operating expenses this year that won't generate revenue until next year. While we could have avoided this spending to improve our operating income or net income figures according to our guidance, that wouldn't benefit us in the long run. Our focus is on the long-term outlook, and we are being prudent with our expenditures. We believe these investments will yield significant returns as we progress.

Great. And I'm going to sneak one more follow-up. And so Perry mentioned, I think it was Bath Furniture adjusting some prices to try to drive demand, just kind of tying into that sustainability question on the gross margin side. Is that kind of indicative of where we can stay going into next year? Or you're going to have to give some back with inflation kind of coming in?

Yes. I believe we are taking several steps. We made some pricing adjustments and, more importantly, we are changing the product mix across our assortments, particularly in cabinetry. The majority of our Bath Furniture portfolio has traditionally focused on the high end. However, as the market has evolved, we've seen a shift towards what I would describe as the middle range. We are actively adjusting our assortments to align with this new customer demand, and these changes will be implemented as we enter the second half of the year. We will showcase these adjustments prominently at our major trade show in the spring, but by then, they will already be in effect. Additionally, we have made some pricing adjustments, and as we noted in previous quarters, even though freight costs have decreased, we still made changes to our pricing. Along with adjusting our product mixes and enhancing them, we are confident that we will continue to see sequential margin growth as we progress.

Great. Thanks and good luck going to the rest of the year.

No problem. Thank you.

And our next question will come from Greg Gibas with Northland Securities. Please go ahead.

Great, good morning Dave and Perry, thanks for taking the question.

Hey Greg, how are you?

Thanks. If you could break down the factors behind the change in guidance, how much of it is due to ongoing destocking trends compared to other shifting dynamics you are observing?

Yes, it's a good question. They are closely related because destocking alone has a historical context. Right up until 2022, the industry went through the longest stretch of active stocking in the past 20 years, which lasted 26 weeks. When we reached the point of destocking last year, it occurred before we anticipated any decline in R&R demand. Consequently, destocking has prolonged, user market demand has decreased, and customers have re-evaluated their baseline inventory levels, leading them to lower those as well. Thus, all these factors combined have softened the demand side. However, based on our conversations with customers, industry research, and market sentiment, we observe that inventory levels are stabilizing, although there is a delay in the process. Customers aim to sell off existing inventory, which is still being impacted by softening demand. Once those inventory levels drop, we expect to see an improvement in order cadence. We have noticed some orders returning to an extent, such as in Bath Cabinetry, yet it hasn't been consistent. We are not back to what we consider a normal order rhythm, and that situation has persisted longer than we expected. This situation played a significant role in our decision to adjust the guidance, as our major customers on both the professional and retail fronts have faced notable impacts that are challenging to overcome at this time.

Great. That's very helpful, Dave. And I think it makes sense regarding what you're seeing. But I guess the follow-up there, is the order cadence improving? Or is it kind of just leveled out at where we saw it in Q2? Just wondering, maybe the dynamics you're seeing in Q3 like are they improving? Or is it kind of consistent? And along with that question, maybe what is the cadence that's implied within your guidance for Q3 versus Q4 for the remainder of the year?

Yes. If you look at our overall guidance, the second half forecast is slightly lower, but it's closer to our original guidance compared to the first half. The majority of our revenue impact is expected in the first half. We anticipate returning to a more typical situation in the last two quarters. For instance, in August, we are starting to see some improvement and more consistency. Although it's too early to draw firm conclusions since it's only been a month and a half, the overall mood is leaning towards positivity, and there's increased activity. All the programs discussed last quarter are on track for rollout, which should lead to additional gains from the new initiatives. We considered this information while forecasting and believe that the trend will stabilize, helping us meet the targets we set.

Great. Appreciate the color there. Because I know it's still early in the quarter relatively, but it's kind of good to hear that it's not trending worse than it was. So that's helpful. And I think you already touched on this. And sorry, I got on the call a little bit later, but could you just break out what channels maybe saw the worst of the destocking trends and which held up relatively better?

I would say for us, and we look at a lot of market data and this was sort of supportive with the data, but really on the pro side on our Sanitaryware because the Sanitaryware, as you know, is the largest product category for the company globally and in all the divisions, obviously. So that's where we experienced the most hit as far as destocking was on the Pro Sanitaryware side; and secondly, would have been on our Bathroom Furniture on the retail side. So those are the two major impacts that were tough to recover from this first half.

Great, appreciate it. Thanks.

And this concludes our question-and-answer session. I'd like to turn the conference back over to David Bruce for any closing remarks.

Thank you for your time and interest today. We really appreciate your continued support of FGI. Also please note that we will be attending the Northland Capital Markets Conference on September 19th. Stay well. And if we don't connect during the quarter, we look forward to speaking with you on our next quarterly call.

Thank you.

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