Fox Factory Holding Corp Q2 FY2020 Earnings Call

Good afternoon, everyone, and thank you for joining us. Welcome to the Fox Factory Holdings Corporation Second Quarter 2020 Earnings Release Conference Call. All participants are currently in a listen-only mode, and a question-and-answer session will follow our formal presentation. This conference is being recorded. I will now hand the call over to your host, David Haugen, General Counsel. Thank you. You may begin.

Thank you. Good afternoon, and welcome to Fox Factory's second quarter fiscal 2020 earnings conference call. On the call today are Mike Dennison, Chief Executive Officer; and Scott Humphrey, Chief Financial Officer. John Blocher, Senior Vice President of Finance, will also be available for Q&A. By now, everyone should have accessed the earnings release, which went out today at approximately 4:05 Eastern Time. If you've not had a chance to review the release, it's available on the Investor Relations portion of our website at investor.ridefox.com. Please note that throughout this call, we will refer to Fox Factory as FOX or the company. Before we begin, I'd like to remind everyone that the prepared remarks contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. Such statements involve a number of known and unknown uncertainties, many of which are outside the company's control and can cause future results, performance or achievements to differ significantly from the results, performance or achievements expressed or implied by such forward-looking statements. Important factors and risks that could cause or contribute to such differences are detailed in the company's latest Form 10-Q and in the annual report on Form 10-K filed with the Securities and Exchange Commission. Except as required by law, the company undertakes no obligation to update any forward-looking or other statements herein, whether as a result of new information, future events or otherwise. In addition, within our earnings release and in today's prepared remarks, non-GAAP gross margins, non-GAAP operating expenses, non-GAAP income tax, non-GAAP adjusted net income, non-GAAP adjusted earnings per diluted share, adjusted EBITDA and adjusted EBITDA margin are referenced. It is important to note that these are non-GAAP financial measures that we believe are useful metrics that better reflect the performance of our business on an ongoing basis. A reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures are included in today's press release, which has also been posted on our website. And with that, it is my pleasure to turn the call over to our CEO, Mike Dennison.

Thank you, David, and good afternoon. We appreciate everyone taking the time to join us for today's call. Before I discuss our key business highlights and recap our second quarter results, I'd like to take this opportunity to introduce Scott Humphrey as our new Chief Financial Officer. Scott has a strong record of accomplishments, and I believe will be a tremendous asset to help direct our financial discipline and operational excellence as we go forward. I'd also like to thank John Blocher, who has done a tremendous job as our interim CFO. John's tireless work during the past year, along with his long list of accomplishments during his eight years at FOX, have helped to propel our organization forward. I look forward to his future contributions, and both Scott and John will be available for any questions after our prepared remarks. Turning now to the quarter. Our committed and capable team executed incredibly well during the second quarter in an unprecedented dynamic operating environment due to the COVID-19 pandemic. The strength of our diversified business and our performance-defining product portfolio fueled our results, achieving revenue and profitability ahead of our expectations against a very difficult backdrop in the U.S. At the onset of the pandemic, we responded quickly with measures, policies, and actions to ensure the health and safety of our employees and their families and minimize any potential impacts for our business in the near term. Our teams are continuing to meet regularly to evaluate the health, financial, and social impact that the current environment is having on our employees, our communities, our valued supply chain, and our customers. During the quarter, we faced varying degrees and durations of stay-at-home orders across the U.S. that impacted our PVG manufacturing operations, OEM partners, and end-consumers. While the situation continues to remain fluid, all of our U.S. manufacturing facilities are operational. Our employees are hard at work and we remain in contact with government authorities at all levels to ensure proper safety measures and procedures at our facilities. In Taiwan, our main facility for SSG products continues to run very effectively, and the team is working tirelessly to meet the increased demand from our end markets. In terms of our results, in the second quarter, we generated sales of $183.1 million. This was better than we anticipated with Specialty Sports Group product sales up 10% compared to the second quarter of 2019. This growth also helped fuel second quarter profitability ahead of our expectations. We benefited from the increased demand for our Specialty Sports products in both the OEM and aftermarket channels, which illustrates the strength of our product lineup this year with nine new product platforms in suspension for model year 2021, as well as the general robust trend in outdoor recreational activities where social distancing is a core element of the sports we serve. We were also pleased to see a lift in aftermarket sales, and the momentum across this category has continued, if not increased, into our third quarter. Overall, our Specialty Sports Group's success and the depth of our current order book provides us with solid optimism about our SSG business heading into the second half of 2020. As expected, our Powered Vehicles Group product shipments were down in the second quarter. This reduction of shipments was directly tied to our requirements to shut our factories in the U.S. as well as requirements to do the same for our large OEM automotive and Power Sports customers. We are thankful that all of our facilities are back to production and have performed well, even while the pandemic continues to be a significant headwind throughout the U.S. In addition, our customers' factories are back to work, and shipments from those facilities have recovered. These factories are improving daily; however, not without temporary challenges associated with COVID-19 in their factories and supply chains. Our relationships with our automotive OEM customers, Ford, Toyota and FCA, are stronger than ever as we are a trusted development partner and a key manufacturer of high-performance products that drive consumer demand. We are thrilled about our spec wins, which will debut in 2021 and are eager to share these new platform wins over the coming year. Our SCA and Tuscany demand also remained strong, and I am happy to share we have recently signed a new Jeep Behlmann agreement with FCA. The first of its kind for Jeep. The deal provides us with hundreds of Jeep Rubicon Gladiators that will be upfitted and sold through our dealer relationships in North America. We believe consumer demand for the premium truck and Jeep platforms remains strong, and our upcoming introductions provide compelling and sought-after product offerings, continuing to accelerate opportunities through our SCA and Tuscany divisions. We also have some exciting launches in off-road Power Sports products. In July, Can-Am launched their 2021 two-seat Maverick X3 X rs Turbo RR and four-seat Maverick X3 MAX X rs Turbo RR with smart shocks. These two vehicles are the hero vehicles within their 2021 Maverick X3 product lineup and are performance-tuned for the desert and dunes. The smart shock system integrates our electronically controlled semi-active compression and rebound suspension that dynamically adjust based on sensor inputs, providing virtually real-time adjustments that maximize the vehicle's performance. In terms of our new manufacturing footprint in Georgia, our first phase of expansion is up and running and we remain on track for further rollout. As a reminder, our Georgia facility is a significant boost to our PVG operations. It optimizes our manufacturing supply chain footprint and further delivers on our commitment to operational excellence. I would now like to spend a few minutes providing some color on what we see for the second half of this year. We firmly believe that our growing customer base is staying closer to home and traveling less, turning to our Specialty Sports and powered vehicle products as they are inherently outdoor activities enjoyed by friends and families while keeping physically distanced. Consequently, we expect end customer demand to continue to strengthen and accelerate this quarter and into the fourth quarter. We are reasonably optimistic that factory shutdowns, either our own or our customers, are fundamentally behind us. However, keep in mind, FOX, like everyone else in the industry, will be required to adjust our operations should states and federal governments need us to take different actions. As we move forward, we believe FOX is well positioned for future growth, assuming the external environment progresses as it has for the last month or two and that there are no additional significant disruptions to the supply chain, our customers, or consumers, including any issues from adverse macroeconomic environment and increased social unrest. In summary, across our organization, we are taking necessary safety support and other measures to best manage our business in the current operating environment as we continue to deliver performance-defining products. We are working to build upon our existing accomplishments and remain confident in our long-term financial objectives as we generate sustainable growth and value for our shareholders. And with that, I'll turn the call over to Scott.

Thanks, Mike. Good afternoon, everyone. It's great to be joining you today on my first earnings call as FOX's CFO. Since joining the company in June of this year, it's been a pleasure working with Mike, John, and the rest of the talented team here at FOX. I'm excited to be part of the FOX family and look forward to the continued success and growth of our portfolio of performance-defining products. I'll now review our second quarter fiscal 2020 financial results. Sales in the second quarter of 2020 were $183.1 million, a decrease of 4.7% versus sales of $192.1 million in the second quarter of 2019. The Specialty Sports Group experienced a 10% increase in sales compared to the same period last year, driven by high demand in both the OEM and aftermarket channels. Sales for the Powered Vehicles Group reflected a 14.5% decrease compared to the second quarter of 2019, primarily related to production shutdowns at certain of our OEM customers due to impacts from the COVID-19 pandemic. The effect of these production shutdowns was partially offset by a full quarter of sales from SCA, which we acquired in March of this year. Gross margin was 32.8% in the second quarter of 2020, a 40 basis point increase from 32.4% in the prior year period. Non-GAAP gross margin also increased by 40 basis points to 33.1%. The increase in gross margin was primarily due to our SCA acquisition, better product and channel mix and improved supply chain efficiencies, partially offset by higher factory related costs, including incremental costs related to COVID-19. Total operating expenses were $40.6 million or 22.2% of sales in the second quarter of 2020 compared to $32.7 million or 17% of sales in the second quarter of last year. The increase in operating expenses on a dollar basis was primarily due to the inclusion of SCA operating costs of $4.5 million, amortization expense of $3.7 million, and acquisition-related compensation costs of $1.2 million, partially offset by reductions in various other expenses. Non-GAAP operating expenses as a percentage of sales were 17.9% compared to 15.1% in the prior year period. For the second quarter of fiscal 2020, our effective tax rate was 19.5%. This rate is slightly higher than our previous long-range guidance of 15% to 19%, primarily due to non-deductible transaction costs related to our acquisition of SCA. Adjusted EBITDA was $33.7 million for the second quarter of 2020 compared to $38.2 million in the same quarter last year. Adjusted EBITDA margin was 18.4% compared to 19.9% in the second quarter of 2019. The lower EBITDA margin is primarily due to the impact from lower sales in some of our legacy business lines as well as incremental costs related to the COVID-19 pandemic, partially offset by the positive impact of SCA on our results. On a GAAP basis, net income attributable to FOX in the second quarter of 2020 was $12.6 million or $0.32 per diluted share compared to $22.9 million or $0.59 per diluted share in the prior year period. Non-GAAP adjusted net income was $19.7 million, a decrease of approximately $6.9 million compared to $26.6 million in the second quarter of last year. Non-GAAP adjusted earnings per diluted share for the second quarter of 2020 was $0.50 compared to $0.68 in the second quarter of 2019. Now focusing on our balance sheet. As of July 3rd, 2020, compared to January 3rd, 2020, we ended the second quarter with cash on hand of $218 million. Accounts receivable was $87.7 million compared to $91.6 million. Inventory was $148.5 million compared to $128.5 million. Prepaids and other current assets were $46.1 million compared to $17.9 million. Accounts payable was $64.9 million compared to $55.1 million. And finally, total debt outstanding was $406.4 million compared to $68 million. And our net leverage ratio on a pro forma basis was approximately 1.4 times. The changes in accounts receivable, inventory, and accounts payable reflect the addition of SCA, typical seasonality, and impacts from the COVID-19 pandemic on the company's shipment, collection, and payment cycles. The increase in prepaids and other current assets was primarily due to SCA-related items, including vehicle chassis deposits and contingent retention incentives held in escrow. Our net property, plant, and equipment increased to $147 million as of July 3rd, 2020, compared to $108.4 million at the end of 2019. The increase reflects the SCA acquisition as well as investments in our new PVG manufacturing facility in Georgia. As a measure to enhance our financial flexibility, we raised approximately $198 million in net proceeds in June from a 2.76 million share follow-on offering. Between the cash we now have on hand and the borrowing capacity under our credit facility of more than $200 million, we believe we have the liquidity and financial strength to not only support our business through this time of economic uncertainty created by the pandemic, but also to continue to proactively execute on our long-term strategic objectives. Lastly, due to rapidly evolving market conditions, domestically and internationally in response to the COVID-19 pandemic, we do not intend to provide quarterly guidance at this time. With that, I would like to now turn the call back over to Mike.

Thank you, Scott. In closing, for the second half of 2020 and heading into 2021, we believe FOX is well positioned with our diversified bike and Powered Vehicle businesses to support a growing customer base of enthusiasts that use our products to make their lives safe, enjoyable, and active. Our second quarter results demonstrate the strength of our agile operating network, the resilience of our people, the power of the FOX brand, and our performance-defining ride dynamics products. We believe these core competencies, when combined with the strength of our valued OEM partners, will continue to be competitive advantages in the market as we move forward. I would now like to open the call for questions. Operator?

Thank you. At this time, we will be conducting a question-and-answer session. Our first question is from Larry Solow with CJS Securities.

Good afternoon and congratulations on a good quarter, and welcome, Scott, to Fox Factory.

Thanks.

I have a couple of quick questions regarding the Specialty Sports segment, which has shown a very strong performance. It's clear that you are well positioned coming into COVID with nine new platforms. John or Mike, could you discuss the increased demand for bikes? Has your core customer changed, or is it more about a resurgence in the category? I'm looking to understand how you perceive this and the sustainability of the growth.

Thank you, Larry. It's good to hear from you. In the bike business, we're certainly seeing a rise in demand across all product categories and throughout the industry. I've referred to it as a bike renaissance before, and that accurately reflects what we are experiencing. The demographics are shifting, with new participants entering the sport. Additionally, there is significant demand for available bikes, which is leading consumers to opt for higher-end bikes that they might not have considered before. We are attracting new customers partly due to this trend and also because more people are eager to spend time outdoors. Many are redirecting funds that would typically go to vacations to purchasing bikes and enjoying local dirt roads and nature. The crucial question is whether this trend will last long-term. I believe we will see some continuation of this growing demographic in the future. However, we will need to assess how this evolves over the next year or two. Regardless, we are pleased to witness increased demand across a wider variety of customers.

Absolutely. Switching to the Powered Vehicle segment, total sales were down 15%. Do you have an organic figure or an estimate? The decline seems primarily related to the difficulty in accessing vehicles, as OEMs and dealers were closed, rather than a lack of demand. With most places now reopening, should we expect a significant rebound in Q3?

We have a strong order book in Q3, which indicates that the issue wasn't related to customer demand. It was primarily due to factory and customer shutdowns that limited consumers' ability to purchase vehicles in Q2. As mentioned in our prepared remarks, we attribute this situation to the shutdowns and not to a decline in customer demand; in fact, customer demand has increased. Regarding your question about organic versus inorganic growth, SCA in the quarter was approximately $20 million, which gives you a reference point.

Yes…

Yes. So we are good.

Okay. And for my last question regarding the gross margin, it was surprisingly up a little bit. I know the overall EBITDA margin was down. Is the increase in gross margin mainly due to the mix at SCA, or are capacity constraints and operating efficiencies still affecting you? Could you discuss that a bit? Thanks.

Yes. The simple answer is it's really mix and channel and the benefit of SCA. So that's the simple answer. The more complex answer is, of course, we had costs attributed to shutdown factories and to running less efficiently in our factories in the quarter that were negative to that benefit. However, we are starting to see some improvements in the California operations and of course, Georgia is coming up. So it's a little bit of a mix of issues in terms of efficiencies on the downside, of course, caused by factories who are not running or running less at capacity, and then the offset benefit of just getting healthier in California and Georgia.

But going forward, would you expect now that Georgia is up and running, and that's been sort of a headwind, can actually become a tailwind over time?

Over time, for sure. And as we've talked before, Larry, we think that's probably a function of kind of 2021 as we complete that transition into Georgia. But we absolutely expect that headwind to convert to a tailwind.

Great. Excellent. Thanks for the color. Thanks a lot.

Our next question is from Mike Swartz with Truist Securities.

Good evening. I’d like to discuss the strength in the end markets, especially in bicycles and Power Sports. There have been positive reports from several public companies related to demand. Can you provide insights on the backlogs you're observing, both from a retail standpoint and from your own backlog? Does this seem likely to continue into 2021?

Yes. Mike, we need to examine the demand closely and discuss it by sport. Specifically in bikes, we're seeing consistent and significant demand from our distributors, dealers, and OEM partners. As I mentioned earlier, this trend continues into Q3, and our main challenge is meeting the increased demand in this quarter. This positive trend is expected to carry into Q4, although it's too early to predict what the sales will look like after the holiday season. We're all keeping a close eye on it, and I believe it bodes well for the end markets, continuing into 2021, but we'll have to wait to see how much. Regarding Power Sports, we are collaborating with the same customers mentioned in recent reports, and we notice strong demand in Q3 and Q4 as well. We are also focused on fulfilling that demand. Both businesses, Power Sports and bikes, are benefiting from a shift in customer behavior, encouraging people to use our products outdoors and spend their money differently than before. However, it's premature to discuss the implications for 2021 without understanding the economic landscape and the ongoing pandemic. We need to see how these factors play out concerning their impact on the end of 2020 and into 2021.

That's great color. Thank you, Mike. And maybe similar lines. Just can you talk about the supply chain a little bit? Obviously, you have a supply chain that spans the globe and with all kind of the various impacts of COVID, shipping constraints, this, that and the other. Maybe talk about any near-term constraints that you could have in either your bike or your Powered Vehicle businesses?

Thank you, Mike. Regarding the bike sector, we are actively working to make our supply chain adaptable to the rise in demand. This is a broader challenge beyond just the biking industry. While we have solid controls in place and are managing our supply chain effectively, there are components of bikes that need to be built and shipped. This situation is reflected across the bike industry, where many are struggling to restock inventory in dealerships. Although we are not significantly affected compared to others, disruptions in the industry can indirectly impact us. Fortunately, the situation is improving day by day as companies adapt and respond. For our larger customers and partners, this is likely less of a concern. For smaller, boutique suppliers of components or bikes, it's more challenging due to their lack of purchasing power compared to larger companies like ours. We are aware of this and monitoring it closely, but it won’t dramatically impact our outlook for the third quarter. In terms of Powered Vehicles, which relies primarily on a US-based supply chain, things are quite stable. Our factories are responding well to supply chain demands and increased orders. We're addressing the higher order volume and ensuring we have the necessary supply chains in place. So far, there haven’t been any major issues for us as we look to Q3, assuming there isn't a further worsening of the pandemic in the regions where we operate.

Thanks a lot.

Our next question is from Scott Stember with CL King.

Good evening and thanks for taking my questions.

Hi, Scott.

Within Powered Vehicles, we are aware of the different end markets and their performance. Some markets are recovering more quickly than others, particularly among the big three, especially for Ford with the Raptor and other products. Can you discuss how their production might affect you in the next few quarters in terms of getting operations back on track? Additionally, are there any expected chassis availability issues for SCA?

I will address the second question first, Scott. It's important to include Tuscany in this discussion because both entities within FOX rely on the big three and others to secure chassis to meet demand. We are pushing hard. When those factories shut down, they don't resume producing those trucks, and we need to ensure we obtain the necessary units to support our needs. One advantage we have, which I noted earlier, is that with the new Jeep brand, we have access to a fresh supply of hundreds of vehicles that will help us in Q3 and Q4 to fill any gaps left by Ford and other chassis models we support. We feel fairly confident about this, but we remain focused on securing all the chassis we need. Regarding production, as I mentioned earlier, it tends to be inconsistent due to COVID cases affecting their factory operations, which forces them to shut down or reduce capacity. This situation complicates manufacturing. They are navigating these challenges, and we are adjusting our plans accordingly. Unless there are significant changes in their operations, I believe we will be fine, but we need to keep a close watch on this daily and collaborate with them. Additionally, the major automotive manufacturers depend on supply chains from Mexico, some of which have had trouble returning to similar efficiency levels post-pandemic.

Got it. And maybe talk about the Gladiator model that will be through SCA and Tuscany, maybe talk about that a little bit, just the product and when that will start generating revenues for you guys.

Yes, we will start generating revenues in the third quarter. This is quite immediate as we are currently working on those vehicles. It represents a significant achievement that we've been pursuing for some time. Historically, our Jeep upfits were done on a case-by-case basis whenever a dealer sent us a vehicle. We would customize it and return it to the dealer. Now that we are receiving vehicles directly from Jeep, we can handle much greater volumes and create various models. You can already view these models on our website, allowing us to target a new customer base effectively. We are enthusiastic about this development, as we believe Jeep upfits are highly effective for our purposes. Overall, we see this as a favorable long-term opportunity for us.

Got it. That's all I have. Thanks, again.

Thanks, Scott.

Our next question comes from Rafe Jadrosich with Bank of America Merrill Lynch.

Hi, good afternoon. Guys, it's Rafe. Thanks for taking my questions. Can you speak a little bit more about the kind of the rationale and the strategy behind the equity raise and the timing? And maybe remind us of the priorities for cash going forward. And is M&A still your top priority, I mean kind of what you're looking for going forward?

Yes, Rafe, I'll speak to this and such, and John can jump in too. When we did the equity raise, it was a function of the markets becoming available for us to take that kind of action and really put us back on to an offensive position. So really, when we think about equity, we think about having the ability to turn from defense and kind of in the middle pandemic challenge to offense as we come out of it to look at companies that are a good fit for us from an acquisition perspective and fit the criteria of the business we run. So first and foremost, having a strong balance sheet gives us that ability for offense, but it does allow us to have a strong liquidity position should this pandemic continue on into 2021 and beyond. So it's a little bit of offense and a little bit of defense. But fundamentally, our use of cash is organic growth, inorganic growth and then managing our balance sheet. And Scott, any other thoughts?

Yes, I was just going to say, I think the equity raise in conjunction with the amendment on our credit agreement also just adds to that kind of strong liquidity position for either of what Mike is talking about, either to go out on offense or to play defense if this pandemic extends longer than we hope.

Thank you. You've mentioned the bike momentum in Power Sports. Can you share what you're observing regarding end market demand for off-road vehicles and whether you're experiencing a similar increase in demand on the auto OEM side as you have in other segments?

Yes, absolutely. We're seeing significant demand in the premium sector of the automotive business, meaning more expensive trucks, and we're seeing that both from an OEM perspective and our OEM relationships as well as in our upfitting business. So it kind of crosses over both of those categories. And we haven't seen any slowdown in that demand or that desire for those types of products. So we think that continues to be strong into Q3. I think we'll have to look at what happens kind of into the late Q4 in 2021. But right now, that demand remains very strong. Again, I think the bigger issue in that part of the business is getting enough supply to support the demand versus demand.

Great. And then just the final question from me. Obviously, gross margin was better than expected in the second quarter even though you had some incremental expenses. Like, how do we think about that going forward? Was that a one-time mix benefit or should we expect kind of better efficiency going forward to continue to drive gains despite the higher cost?

Yes. Rafe, this is Scott. I think Mike mentioned earlier, we will look at that. We've got some benefit in the quarter from mix and channel. And so yes, it's more of a one-time because the OEMs had their production facility shut down for roughly half the quarter and so we ended up with, let's say, more aftermarket business on a percentage basis than we normally would.

Okay. Got it. Thank you.

Our next question comes from Jim Duffy with Stifel.

Thank you. Good afternoon guys.

Hi, Jim.

You expect end market demand continues to accelerate in the back half of the year. I want to talk about that as it relates to Powered Vehicles in the context of channel inventories. How would you characterize the current inventory deficiency in the channel right now relative to the rate of demand as it stands relative to OEM production rates? Do you have an estimate for when you might expect channel inventories to actually catch-up with the rate of demand?

Yes, Jim, it depends on the original equipment manufacturer and their model year changes. As we've discussed before, it hinges on two factors. One is the pandemic-related shutdown that occurred right when they were supposed to transition to a new model year. This led to complex considerations for them regarding vehicle distribution to dealers and whether to continue with the current model year or switch to the new one. This created a challenging situation for both them and us. Currently, they have moved past that initial problem, established their plans, and provided us with their forecasts. We are producing based on those forecasts and doing our best to keep up. At this moment, supply is trailing behind demand in the premium category. They have to work very hard to meet the demand in the North American market now, and we are doing everything possible to support that effort. I expect this scenario to persist, as our forecast order books are strong due to this demand. However, I anticipate that supply will continue to lag behind demand for the next several months.

Is there any sort of technical difficulty happening?

Yes. Jim, sorry about that. You seemed to have a connection issue. I'm not sure if the operator understood you better than we did, but I couldn't catch that.

It sounds like we've lost him again, gentlemen.

Yes.

We have reached the end of the question-and-answer session. I would like to turn the call back to Mike Dennison for closing remarks.

Thanks, everyone. We appreciate your participation and questions on today's call. And thank you for your interest in FOX. With that, stay safe and healthy, and have a nice evening.

Thank you. This concludes today's conference. You may disconnect your lines at this time.