Earnings Call Transcript - FOXF Q1 2022

Operator, Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to Fox Factory Holding Corporation's First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I'd now like to turn the conference over to your host, Vivek Bhakuni, Senior Director of Investor Relations and Business Development. Thank you, sir. You may begin.

Vivek Bhakuni, Senior Director of Investor Relations and Business Development

Thank you. Good afternoon, and welcome to Fox Factory's First Quarter 2022 earnings conference call. I'm joined today by Mike Dennison, our Chief Executive Officer; and Scott Humphrey, our Chief Financial Officer and Treasurer. First, Mike will provide business updates. Then Scott will review the quarter's financial results and then the outlook, followed by closing remarks from Mike. We will then open the call up for your questions. By now, everyone should have access to the earnings release, which went out today at approximately 4:05 Eastern Time. If you have 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 would 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 or 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, where appropriate in today's prepared remarks and within our earnings release, we will refer to non-GAAP financial measures to evaluate our business as we believe these are useful metrics that better reflect the performance of our business on an ongoing basis. Reconciliations 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.

Mike Dennison, CEO

Thank you, V, and good afternoon. We appreciate everyone taking the time to join us for today's call. I would like to start by addressing the conflict and humanitarian crisis in Ukraine. We are deeply saddened by the unprovoked invasion and recognize the significant impact these events are having on many around the world. Our thoughts are with those affected, and we hope for peace in the region soon. Although we have minimal sales in Russia, we have halted all business activities there, which we do not expect to affect our overall results materially. I am proud to announce that we began 2022 with the highest quarterly revenue in our company's history, driven by record performance in both our Specialty Sports and Powered Vehicles Product Group. We also achieved the highest earnings per share even with the ongoing global pandemic and challenging macroeconomic conditions. We encountered meaningful labor shortages in North America in early January due to the surge of the Omicron variant. Throughout the quarter, we faced significant operational disruptions within our facilities, as well as with our customers and suppliers. Despite these challenges, our strong performance in the first quarter demonstrates the resilience of our brand portfolio and our team’s dedication to delivering high-performance products to our customers. Regarding the numbers, our first quarter sales reached $378 million, a 34.4% increase compared to the same quarter last year. This exceptional growth was driven by both our SSG and PVG businesses, which grew 44% and 28% compared to the prior year period, respectively. I take particular pride in this performance because last year's first quarter was also a record for us, as the economy rebounded from the COVID lockdowns. Our quarter-over-quarter growth affirms our belief that Fox's expanded portfolio of high-performance products continues to resonate positively with our consumers. Furthermore, we reported earnings per diluted share of $1.13 compared to $0.90 in the same period last year, marking a 25.6% increase. Our non-GAAP adjusted earnings per diluted share were $1.32 compared to $1.05, which is a 25.7% increase year-over-year. Looking closer at the business, the Specialty Sports Group had an exceptional first quarter in 2022, marking our eighth consecutive record revenue quarter with nearly $170 million in sales, a 43.5% growth from the prior quarter. We continue to enhance our capacity efficiency and workforce in Taiwan while monitoring demand. We are starting to observe some inventory normalization, particularly for entry-level bikes, but high-end mountain bikes and e-bikes remain low at under two months of supply instead of the usual three to four months. Demand for mid- to high-end bikes and e-bikes continues to be robust, backed by a growing base of enthusiasts. Our order book looks strong for the remainder of 2022, aided by signs of improving supply chain capacity. However, we are concerned about the rising COVID rates in Taiwan, which have affected our production capabilities in Q2. We anticipate that bike demand will begin to moderate as we transition into the end of the year and into 2023. As we prepare for new model launches, we are investing in expanded development and testing, which has garnered positive customer feedback. Turning to the Powered Vehicles Group, Q1 2022 also set a revenue record, generating $208 million in sales, a 27.9% increase over the same period last year. This quarter is a significant milestone for PVG as it marks the first time we have crossed $200 million in revenue within a quarter, thanks to strong sales in our upfitting product lines. While we are pleased with our revenue growth, we are not entirely satisfied with the margin performance at our new Gainesville plant. The transition from Watsonville to Georgia is complete, but the shift of some production lines caused manufacturing inefficiencies, resulting in lower-than-expected throughput in the first quarter. The silver lining is that we expect to address these challenges, and corrective measures are underway to enhance margin expansion through improved productivity and vertical integration. Notably, our output has improved over the first quarter, with March witnessing the highest production levels ever for the Gainesville plant. Challenges related to labor, input costs, freight, and supply chain disruptions persist, and we believe inflationary pressures will continue for a longer period than previously anticipated. Therefore, we will keep utilizing dynamic pricing strategies to address inflation. We are confident that optimizing the operational efficiency of our Gainesville plant will lead to margin improvements as discussed in earlier quarters. We remain committed to enhancing our core competencies and differentiating ourselves in the market. While the operating environment has not changed much since Q4 of last year, our team has still delivered a 10% sequential revenue growth compared to Q4 of 2021. I want to thank every member of our FOX family for a strong start to 2022. With that, I will turn the call over to Scott.

Scott Humphrey, CFO

Thanks, Mike. Good afternoon, everyone. I'll begin by going over our first quarter financial results and then review our guidance. Sales in the first quarter of 2022 were $378 million, an increase of 34.4% versus sales of $281.1 million in the first quarter of 2021. Our Powered Vehicles Group delivered a 27.9% increase in sales compared to the first quarter of 2021, primarily due to strong performance in our upfitting product lines. Moving to the Specialty Sports Group. SSG delivered a 43.5% increase in sales in the first quarter compared to the same quarter last year, primarily due to increased demand across all channels. Fox Factory's gross margin was 31.8% in the first quarter of 2022, a 300 basis point decrease from 34.8% in the same period in the prior year. For the first quarter of 2022, non-GAAP adjusted gross margin decreased by 270 basis points to 32.3% versus Q1 of 2021. The decrease in gross margin was primarily driven by higher inflationary pressures on all fronts including labor, material, and freight costs. In addition, the completion of the planned Watsonville California facility shutdown and the move of those production lines resulted in inefficiencies as we ramp up to full utilization of our Gainesville Georgia facility. This was marginally offset by favorable product and channel mix compared to Q1 2021, led by higher volume sales in our Specialty Sports Group and strong performance in our upfitting product lines. Total operating expenses were $66.1 million or 17.5% of sales in the first quarter of 2022 compared to $52.1 million or 18.5% of sales in the first quarter of last year. The increase in operating expenses in Q1 2022 was primarily due to higher employee-related costs, higher commission costs, as well as higher insurance and facility-related costs. Looking at non-GAAP operating expenses as a percent of sales, our non-GAAP operating expenses decreased by 30 basis points to 15.8% in the first quarter of 2022 compared to 16.1% in the same period in the prior year. Focusing on operating expenses in more detail, sales and marketing expenses increased by approximately $5.7 million in the first quarter of 2022 compared to 2021, primarily due to higher commissions and marketing-related expenses. Research and development costs increased $2.7 million in the first quarter of 2022 compared to the first quarter of 2021, primarily due to personnel investments to support future growth and product innovation. General and administrative expenses increased by approximately $5.2 million in the first quarter of 2022 compared to 2021, due to higher employee-related costs of $2.1 million, higher insurance and facility-related costs of $2.2 million from our increased revenue and expanding manufacturing footprint, as well as increases in various other costs. For the first quarter of 2022, our effective tax rate was 4.8%. This rate was lower than our estimated full-year 2022 range guidance of 11% to 15%. The lower rate in Q1 was primarily due to the impact of recently finalized tax regulations, which resulted in the release of our valuation allowance against foreign tax credit carryforwards. This impact was partially offset by decreased benefits from the effects of stock-based compensation and other discrete items. On a GAAP basis, net income in the first quarter of 2022 was $48.1 million or $1.13 per diluted share, compared to $38 million or $0.90 per diluted share in the same period in the prior year. Non-GAAP adjusted net income was $55.8 million in the first quarter of 2022, an increase of approximately $11.3 million or 25.4% compared to $44.5 million in the first quarter of last year. We delivered $1.32 of non-GAAP adjusted earnings per diluted share in the first quarter of 2022, compared to $1.05 in the first quarter of 2021. Adjusted EBITDA increased by 18.8% to $71.8 million for the first quarter of 2022, compared to $60.4 million in the same quarter last year. However, adjusted EBITDA margin decreased by 250 basis points to 19% in the first quarter of 2022, compared to 21.5% in the first quarter of 2021. The decrease in EBITDA margin in the first quarter of 2022 is primarily due to higher inflationary cost pressures and inefficiencies at the Gainesville Georgia plant, due to the move of the last production lines after the close of the Watsonville California manufacturing facility, as discussed earlier, partially offset by the impact of higher sales. Now, focusing on our balance sheet, for the first quarter which ended on April 1st, 2022 compared to our 2021 year ended on December 31st, 2021, we ended with cash on hand of $68.8 million compared to $179.7 million. Accounts receivable was $177.9 million compared to $142 million. Inventory was $315 million compared to $279.8 million. Prepaid and other current assets was $293.9 million compared to $123.1 million. Accounts payable was $157 million compared to $100 million. And accrued expenses were $103.8 million compared to $112.4 million. The decrease in cash and cash equivalents and increase in prepaids and other assets as of April 21, 2022 were primarily due to increased chassis deposits, as we work to secure supply for the remainder of the year for our upfitting business. The increase in inventory as of April 1st, 2022 is primarily due to additional raw material purchases, to mitigate risks associated with supply chain uncertainty and higher input costs. As we see the supply chain pressures beginning to ease, we will work on reversing this trend to facilitate better free cash flow generation. The changes in accounts receivable and accounts payable reflect business growth as well as the timing of vendor payments. Change in accrued expenses is primarily due to decreases in income taxes payable and accrued bonuses which were partially offset by increases in various other expenses. Lastly, subsequent to the quarter end, we entered into a new credit facility which gives us access to a revolver of $650 million, providing us with greater balance sheet flexibility. Prior to this new agreement, we had a term-loan of $400 million and a revolver of $250 million. This change will have a potential negative impact of approximately $0.05 of EPS in the second quarter, but will provide us with a benefit of approximately $0.01 of EPS per quarter for the life of the credit facility due to reduced interest expense. Now, turning to guidance, for the second quarter of 2022, we expect sales in the range of $385 million to $405 million and non-GAAP adjusted earnings per diluted share in the range of $1.10 to $1.25 per share. For the fiscal year 2022, the company expects sales in the range of $1.5 billion to $1.53 billion and non-GAAP adjusted earnings per diluted share in the range of $5 to $5.30. For our 2022 full year tax guidance, we expect the tax rate to be in the higher end of the previously guided 11% to 15% range, as we better understand the impact of the previously mentioned changes in tax laws. In addition, we continue to expect some quarterly fluctuations in tax rates to occur during the year. I'd also like to note that we're not providing guidance on GAAP EPS as it cannot be provided without unreasonable efforts due to the difficulty of actually predicting the elements necessary to provide such guidance and reconciliations. In closing, I'm very pleased with the phenomenal results our team has produced in the first quarter, in spite of the inefficiencies in our Gainesville Georgia facility and the challenges presented by the macroeconomic environment. We surely recognize the importance of driving margin expansion in the coming months. We are focused on achieving our immediate goals, while remaining cautious in our outlook as we see lingering signs of some cost pressures and continued supply chain obstacles for the balance of the year. As our understanding of the global business environment evolves, we plan to provide incremental updates each quarter regarding our expectations for 2022. With that, I'd like to turn the call back over to Mike.

Mike Dennison, CEO

Thanks, Scott. We are very pleased with the way we have started 2022. Our strong start to the year is the continued proof of our deep consumer connections, world-class team, and strong brand momentum. We also acknowledged our Q1 2022 margin performance, which was a point of caution. As we take note of our achievements, I assure you we are looking at the gains in efficiency very closely as gaining a competitive cost structure is critical to our success. As much as we are focused on short-term actions, our broader team continues to be laser-focused on our long-term product and operational priorities to extend our competitive positioning. Therefore, in closing, we are executing on our priorities laid out over the last couple of quarters, and I'm encouraged by the momentum in our efficiency capture as we enter the fifth month of the year. We will continue to implement our strategic priorities of market share growth, world-class operations, and cultivating an engaged workforce, all while maximizing shareholder value. I would now like to open the call for questions. Operator?

Operator, Operator

And we will take our first question today from Larry Solow with CJS Securities. Your line is open.

Lee Jagoda, Analyst

Hi, it's actually Lee Jagoda for Larry this afternoon. Thanks for taking my questions. Just to start, I think you made the comment earlier that you expect bike demand to kind of start to moderate at the end of this year and into 2023. Could you clarify whether that means slower growth or a decline year-over-year based on what you're seeing today?

Mike Dennison, CEO

Yes, this is Mike. So, what we're talking about when we talk about moderating demand in SSG is number one, return to seasonality. So, think about, usually in the winter months, you've got a slower demand cycle from a mountain bike demand perspective. It's a function of model year changes and just the weather outside. So, you'll see that start to return, which hasn't been the case in the last two years. So, that's the first comment I'd make. The second comment is I think what you'll see in 2023 from our perspective today is returning to the long-term growth rates that we've held for a number of years, which is mid- to high single-digits in bikes. So, a bigger base of business, but a more normalized growth rate on top of that.

Lee Jagoda, Analyst

Okay, that's very helpful. And obviously, investors have been generally concerned about the potential economic sensitivity around your products. And these days you're probably more exposed than you were in the last downturn to things like powered vehicles and auto. Can you just remind us how the demand for your products fared in prior economic slowdowns? And sort of what's your level of concern these days in terms of what you're seeing going forward?

Mike Dennison, CEO

So, a couple of comments. One, we haven't seen demand slack off at all in any of our product lines over the course of the end of last year as we've commented before or the beginning of this year. You have to think about this business back in 2008 and 2009 and how different it was. Again, the size of the company was the size of one of our quarters or less on an annualized basis. So, it was a pretty small company back in 2008 and 2009 compared to what it is today. And a lot of that's diversified, and I think the diversification helps us. So, yes, clearly we're an enthusiast-driven high-cost or high-priced product mix, but what we've seen in our PVD or operating business, where we're selling vehicles for dealers, hasn't slowed at all with the changes in gas prices or changes in interest rates or anything else. So, I think our consumers, our enthusiasts are pretty resilient. I don't want to go as far as saying that a recession would impact us because I'm not saying that I don't think that's true. But I do think that so far it has held to what we believe which is our enthusiasts will use our products or buy our products before they'll do something else in their family spend like a vacation. And if you're a mountain biker, you're going to be a mountain biker regardless of what the economy is doing. So, we feel pretty good about it. We think we're more resistant to recession than a lot of the categories. But again, if we have a big enough recession, it's going to impact us like it impacts everybody else.

Lee Jagoda, Analyst

That's super helpful. If I can sneak one more in here. Just in terms of the guidance that you gave for 2025 around nine months ago, is there anything in the macro or company-specific that changes that guidance one way or the other sitting here today?

Mike Dennison, CEO

No. We're still committed to that strategic direction and we feel pretty good about it.

Operator, Operator

And we will take our next question today from Mike Swartz with Truist Securities. Your line is open.

Mike Swartz, Analyst

Hey, guys. How are you?

Mike Dennison, CEO

Hey, Mike.

Scott Humphrey, CFO

Hey, Mike.

Mike Swartz, Analyst

I want to better understand the gross margin pressures. Can you help bridge last year to this year by highlighting the largest challenges you faced? Additionally, how should we consider the trend of gross margin for the remainder of the year and what is reflected in your guidance?

Mike Dennison, CEO

Mike, I'll start and I'll let Scott jump in and answer it as well. Our perspective on the gross margin in Q1 was majority a function of just that Gainesville consolidation. There are some inflationary pressures too, so that's the second piece of it. I'm not sure I would call it 50-50, it's probably a little bit more toward giving more consolidation or transition than it is to inflation. So, I think we have to work through that. As I mentioned in the prepared remarks, we have to get that work done. We're still committed to the 250 to 350 basis point improvement that we've talked about before occurring this year. So, it's just a lot of work to get through a lot of stuff, as you know. So, we're going to keep going after that and we feel good about it. But, I think we have to see how everything else plays out. The other thing I'd add too is we are continuing to see price increases in our business or push through price increases across our product lines, and that will help us with the inflationary challenges that might come about for the balance of the year. So, Scott?

Scott Humphrey, CFO

Yeah. No, I agree with what Mike said, Mike. I think as far as the cadence goes that you're talking about, I think we said all along we would see sort of incremental improvement each quarter once we got shut down, or once we shut down Watsonville. And so, now we need to start showing some of those efficiencies in Q2, and then I think it gets better in Q3 and then better again in Q4.

Mike Swartz, Analyst

Okay. So just build throughout the year. Okay, that makes sense.

Scott Humphrey, CFO

Yeah.

Mike Swartz, Analyst

Could you provide more insight into your pricing strategy? Specifically, is the dynamic pricing approach something new that you are implementing? Also, how much does your pricing flexibility depend on the channel or customer mix in any given quarter?

Mike Dennison, CEO

How we determine pricing is influenced by the specific product line. The pricing strategies for automotive OEM relationships, our SSG business, aftermarket, and upfitting differ in each case. We're dealing with a newly established dynamic pricing model shaped by inflationary pressures and the impacts of COVID. Previously, pricing was typically set based on the design specifications for clients like automotive manufacturers or bike OEMs. Now we are adjusting prices even during the model year or calendar year. While we used to adjust aftermarket pricing once a year, we are now making those adjustments two to three times annually. By dynamic, I mean we are responding to incoming costs impacted by inflation and making pricing changes in a relatively short timeframe.

Mike Swartz, Analyst

Okay, great. Thanks. That’s all for me.

Operator, Operator

And we will move next to Jim Duffy with Stifel. Your line is open.

Jim Duffy, Analyst

Thank you. Good afternoon.

Mike Dennison, CEO

Good afternoon, Jim.

Jim Duffy, Analyst

Guys, I want to start with a question on the upfitting business, a really nice quarter for shipments. Can you maybe give us a view of where this business stands with respect to dealer penetration and the backlog? Is the backlog you're seeing now reflective of growth from both number of dealers and vehicles per dealer?

Mike Dennison, CEO

We're seeing growth in both of those cases: numbers of dealers and in vehicles per dealer. And we're seeing the sell-through occurring faster. So inventory is not sitting in lots as long as it would have done, let's say, two years ago. So those are really positive signs for us in the business. The reality of the world right now is, before we even build the vehicle and get it sent to the dealer, it's already sold in most cases. So, that's a phenomenon that hasn't decreased; it's actually increased in kind of how we look at the business going forward. So we feel pretty good about upfitting for the foreseeable future. And we feel even better about our chassis control. As Scott mentioned, we've got a lot of chassis already in hand for the balance of this year. So last year, we had the challenge of getting enough vehicles to meet demand. This year we, at least, can have a pretty good view of plenty of chassis to fulfill the demand as we see it.

Jim Duffy, Analyst

That's great to hear. Regarding the OEM business in automotive, is the backlog still there, or is production improving? I'm trying to communicate this.

Mike Dennison, CEO

The OEMs haven't gotten much better. So we're still seeing some lagging ramps to some of the product lines that we would have expected to have seen improve. So we haven't seen that yet in the numbers. We do expect to see that at some point in the year. But in Q1, we didn't see much improvement in the automotive OEM side of the business. And on advancing, that's a supply chain issue for them clearly. These are the vehicles they'd like to be selling right now that they just can't build.

Jim Duffy, Analyst

Understood. The last one for me, just shifting to the bicycle business for a moment. You had been sharing with us a convention of number of months to meet customer demand and additional months to replenish channel inventory. Is that tracking as you expected? Is it fair to assume that that's simply reduced by three months since you last communicated it?

Mike Dennison, CEO

That's the way I see it, Jim. I mean, we kind of went off of that kind of definition of terminology just because we can start to see the seasonality return in Q4. So there's going to be a much easier methodology to communicate kind of where we think we are in the cycle. Again, I think Q4 starts to look more like a normal seasonal quarter. And I think 2023 kind of gets us back to those numbers that you have expected in two or three years ago when you were talking to us then. Thank you.

Scott Humphrey, CFO

Thank you.

Operator, Operator

We'll go next to Craig Kennison with Baird. Your line is open.

Craig Kennison, Analyst

Hey, good afternoon. Thanks for taking my question. It's been a very helpful call. I guess I wanted to ask about Live Valve. Just wondered if you could give us an update on that technology and maybe just frame how far that market has been penetrated and what opportunities still exist? And then maybe, if you could add on to it like what kind of runway is there to that from an innovation standpoint? I feel like that's a core technology?

Mike Dennison, CEO

Live Valve is absolutely a core technology. As I've said in the past, Craig, I think everything becomes smart and connected. And as we start thinking about new vehicle platforms, Live Valve is a key component of that. So, it's grown significantly in both our bike business and in the Powered Vehicle business, as you probably heard me comment in most of our power sports customer lines, as well as our automotive lines, have converted to a version of Live Valve in their high-end product category. So I think that's going to continue to expand and grow. We actually announced today, it's a little bit of a segue, but we announced today our partnership with Extreme E, which is electric vehicle off-road racing. It's a global off-road racing category, and we are the supplier and the developer of product for that Extreme E race series going forward. We think that's fantastic. It's going to let us bring things like Live Valve technology ultimately to the e-vehicle platform and in this case e-vehicle racing, just as we've done in Baja 1000 and the race platforms. So we're going to continue to push that, and we think that's a fundamental platform for long-term business growth.

Craig Kennison, Analyst

Thank you. And then I wanted to ask about Outside Van, which was a nice acquisition you did last year. I know you had huge demand for that product and people were paying you upfront to build those vans. And I think you had plans to increase capacity significantly. It is going to be sensitive to maybe RV trends, which we know kept low at least from a production standpoint. Are you seeing any slowdown in that business?

Mike Dennison, CEO

We're not. Again, we have the fortunate or unfortunate problem of just not having enough capacity to meet the demand. So, if you saw a slowdown in that side of the business, it's we probably still wouldn't feel it, based on the next year's work and the ability to produce. We are trying to add capacity so we can get at that market because we think it's an important market. But I think it's also a unique part of the RV market overall, where you've got a much younger participation in the demographic. And people who are really just making lifestyle changes versus just having a fifth wheel or a motor home in a driveway. People that are buying outside vans are kind of a different breed than maybe what you're seeing in the overall RV market. So, I think we're going to fare better than the broader category. And again, a pretty small part of our business, but we really won't be out of backlog for another year.

Craig Kennison, Analyst

Perfect. Thank you.

Mike Dennison, CEO

Thanks, Craig.

Scott Humphrey, CFO

Thanks, Craig.

Operator, Operator

This concludes the Q&A portion of today's call. I would now like to turn the call back over to Mike Dennison for any additional or closing remarks.

Mike Dennison, CEO

Thank you. I'd like to thank everyone for joining today's call, and have a good afternoon and evening. Thank you.

Operator, Operator

This does conclude today's program. Thank you for your participation and you may disconnect at any time.