Fox Factory Holding Corp. (FOXF) Q3 2022 Earnings Call Transcript
Fox Factory Holding Corp. (NASDAQ:FOXF) Q3 2022 Earnings Conference Call November 3, 2022 4:30 PM ET
Company Participants
Mike Dennison – Chief Executive Officer
Scott Humphrey – Chief Financial Officer and Treasurer
Conference Call Participants
Larry Solow – CJS Securities
Mike Swartz – Truist Securities
Anna Glaessgen – Jefferies
Jim Duffy – Stifel
Craig Kennison – Baird
[Abrupt Start]
….and as always, remain agile and nimble. On a long-term basis, and as these headwinds abate, we remain committed to our expectations of mid to high single-digit growth.
We will continue to strengthen our core competencies and be relentless in extending our competitive differentiation. We also believe the continued optimization of our Gainesville plant will drive margin improvement, as I discussed earlier. The dynamic operating environment has only become more complex as the year has progressed. And still, the team has delivered another record revenue quarter. This, along with raising our revenue guidance to close out the year, deserves to be celebrated and I cannot thank each and every single member of our Fox family enough for helping us challenge the impossible everyday.
And with that, I will turn the call over to Scott.
Scott Humphrey
Thanks Mike. Good afternoon, everyone. I will begin by going into our third quarter financial results and then review our guidance. Sales in the third quarter of 2022 were $409.3 million, an increase of 17.8% versus sales of $347.4 million in the third quarter of 2021. Our Powered Vehicles Group, PVG, delivered a 25.1% decrease in sales in the third quarter compared to the same quarter last year, primarily due to strong performance in our upfitting product lines and increased demand in our OEM channel.
Moving to Specialty Sports Group, SSG, delivered a 9.1% increase in sales compared to the third quarter of 2021, primarily due to increased demand in our OEM channel. On a year-to-date basis, sales were $1,193.9 million versus $956.7 million over the same period last year, an increase of 24.7%. This jump in sales is driven by increased demand, primarily in SSG OEM business and strong performance from our upfitting products.
Fox Factory’s gross margin of 33.5% in the third quarter of 2022 a 10 basis point increase from 33.4% in the same period in the prior year. For the third quarter of 2022, non-GAAP adjusted gross margin also increased by 10 basis points to 33.9% versus Q3 2021. The increase in gross margin and non-GAAP adjusted gross margin were primarily driven by favorable product mix compared to Q3 2021, led by higher volume sales in our Specialty Sports Group and strong performance in our upfitting product lines. Our results were also positively impacted by improved factory efficiencies. The increases in gross margin and non-GAAP adjusted gross margin were offset by higher inflationary pressures and we are starting to see [indiscernible] our global cost pressure.
Total operating expenses were $71.9 million or 17.6% of sales in the third quarter of 2022 compared to $50.8 million or 17.5% of sales in the third quarter of last year. The increase in operating expenses in Q3 2022 was primarily due to higher employee-related costs, higher insurance and facility-related costs, higher commission costs and higher professional fees. Moving to non-GAAP operating expenses as a percentage of sales, our non-GAAP operating expenses decreased by 30 basis points to 15.8% in the third quarter of 2022 compared to 15.5% in the same period of the prior year.
Focusing on operating expenses in more detail. Sales and marketing expenses increased approximately $6 million in the third quarter of 2022 compared to the third quarter of 2021, primarily due to higher commissions of $2.9 million. Research and development costs increased approximately $1.7 million in the third quarter of 2022 compared to the third quarter of 2021, primarily due to personnel investment for future growth and product innovation.
General and administrative expenses increased by approximately $3.4 million in the third quarter of 2022 compared to the third quarter of 2021 due to higher employee-related costs of $1.7 million as well as higher professional fees of $1 million. For the third quarter of 2022, our effective tax rate was 20.8%, as anticipated already, it’s higher than our estimated full year 2022 range guidance of 11% to 15%. The higher rate is primarily due to the impact of recently finalized U.S. tax regulation, which limits the amount of newly generated bond taxes that are credible against U.S. income taxes and resulted in an increase in foreign withholding taxes as well as increased benefits from lower stock-based compensation. These increases were partially offset by a lower tax rate on U.S. foreign derived intangible income.
On a GAAP basis, net income attributable to Fox in the third quarter of 2022 was $50.8 million or $1.20 per diluted share compared to $43.8 million or $1.03 per diluted share in the same period in the prior year. On a year-to-date basis, the net income attributable to Fox was $152.3 million or $3.59 per diluted share compared to $126.1 million or $2.98 per diluted share in the prior year period.
Non-GAAP adjusted net income was $57.4 million in the third quarter of 2022, an increase of approximately $6.9 million or 13.6% compared to $50.5 million in the third quarter of last year. We delivered $1.35 non-GAAP adjusted earnings per diluted share in the third quarter of 2022 compared to $1.19 in the third quarter of 2021. On a year-to-date basis, non-GAAP adjusted net income was $171.8 million, an increase of approximately $25.8 million or 17.7% compared to $126 million in the prior year period. We also delivered $4.06 non-GAAP adjusted earnings per diluted share compared to $3.45 in the prior year period.
Adjusted EBITDA increased by 15.9% to $85.1 million for the third quarter of 2022 compared to $72.8 million in the same quarter last year. Adjusted EBITDA margin decreased by 20 basis points to 20.8% in the third quarter of 2022 compared to 21% in the third quarter of 2021. The decrease in adjusted EBITDA margin in the third quarter of 2022 is primarily due to change in the product mix, impact of stronger dollar and inflationary cost pressures, offset by increased efficiencies at our Gainesville site. On a year-to-date basis, adjusted EBITDA increased by 20.7% to $245 million, however, the adjusted EBITDA margin decreased by 70 basis points to 20.5% versus the prior year.
Now focusing on our balance sheet. For the third quarter, which ended on September 30, 2022, compared to our 2021 full year, which ended on December 31, 2021, we ended with cash on hand of $153.1 million compared to $179.7 million. Accounts receivable was $194.4 million compared to $142 million. Inventory was $354.2 million compared to $279.8 million. Prepaid and other current assets, was $175.4 million compared to $123.1 million, and accounts payable was $131.7 million compared to $100 million.
The increase in inventory as of September 30, 2022, is primarily due to higher input costs and the receipt of long lead time items that had been delayed. The increase in prepaid and other current assets at the end of the quarter is primarily driven by deposits for securing chassis for our upfitting business, which has been experiencing significant growth. The changes in the accounts receivable and account payable reflect business growth as well as the timing of vendor payments. Our net property plant and equipment increased to $199.6 million as of September 30, 2022, compared to $192 million at the end of fiscal year 2021, reflecting capital expenditures of $35.6 million year-to-date. Lastly, our interest and other income and expense went down by $0.3 million versus Q3 of 2021. The primary driver of the increase was a gain of $2 million from the sale of a small track of land in Georgia.
Now turning to guidance, for the fourth quarter of 2022, we expect sales in the range of $370 million to $390 million and non-GAAP adjusted earnings per diluted share in the range of $1.10 to $1.30 per share. For the fiscal year 2022, the company expects sales in the range of $1.565 billion to $1.585 billion and non-GAAP adjusted earnings per diluted share in the range of $5.15 to $5.35. For our 2022 full year tax guidance, we expect our tax rate to be closer to 15% for the year, where we had previously guided 11% to 15% range.
And also let me note that we’re not providing guidance on GAAP EPS as it cannot be provided without a reasonable effort due to the difficulty of actually computing the elements necessary to provide such guidance and reconciliations.
With that, I would like to turn the call back over to Mike.
Mike Dennison
Thank you, Scott. Once again, I am extremely pleased with the results our team has produced in the third quarter, especially given the tough economic and operational backdrop. Looking forward, we are cognizant of the rapid changes in the macro environment. Consequently, the ability to pivot and deliver on our multiple scenarios is more important than ever before. As we plan ahead for 2023, we are focused on what we can control, and we’re taking a balanced approach against an uncertain economic outlook. Our top priorities include increasing inventory trends and the generation of free cash flow driven through decision and production agility.
We are certainly pleased with our robust balance sheet, and I believe it to be one of the top defenses against any bumps in the economic environment that we may experience. We remain committed to continued improvement in our operating model for sustained and predictable performance to our long-term goals, thus, maximizing value for our employees and shareholders.
I would now like to open the call for questions. Operator?
Question-and-Answer Session
Operator
[Operator Instructions] We will take our first question from Larry Solow from CJS Securities.
Larry Solow
Thanks, guys. I guess first question, Mike, lots of moving parts. You mentioned inventory levels still remain below normal. Your backlog sounds like it’s still pretty good at least on the power vehicle side. And obviously, the economy though is continues to get a little bit worse. What kind of visibility, not giving guidance, but how is your visibility like as you look out into ‘23? And then second part of that question is, about a year ago, you gave your 2025 outlook. I think you put that together like almost 2 years ago. Do you feel as good about that outlook today as you did back then?
Mike Dennison
Yes, Larry. I’ll start your second question first. We still are confident in 2025 vision. We didn’t expect to see the growth we have seen in the last 2 years in SSG when we laid out that vision. So we got a bit ahead of ourselves probably getting to that 2025 number with a great success in the last few years. But even with a flattened or diminished SSG business on a short-term basis, we still feel comfortable with the long-term plan. Partially because in this kind of the first question, our spec share on our OEM bike has remained strong and gotten stronger throughout the 2 years. So we’re gaining market share. That’s the positive. The negative is, to your question, about kind of next year is you’ve just got so many moving pieces from foreign currency and inflation around the world in foreign currency in Europe specifically, where there is still a really clunky supply chain by meaning we might be to deliver shocks and forks, but somebody else can’t deliver a drivetrain or something else.
So you’ve got lots of parts and pieces of bikes sitting out somewhere in the supply chain that needs to be configured. And that’s causing a lot of clunkiness and a very opaque view of what ‘23 would look like relative to actual net demand. So we’re being pretty conservative about it. Obviously, as you mentioned, I’m not going to guide ‘23 just yet. And also, we’re not going to guide it just because there is stuff is changing daily. By the time we get to that ‘23 guide, we will have a pretty clear view, but a lot’s changed even in Q4 and over the last 2 weeks. So we’ve contemplated that in the guide that Scott gave you his comments. I think you need to give us a couple of months to really get our hands around ‘23. But I would expect that even with the upside [indiscernible] and the downside of market volatility in just the overall economy is going to cause us to be pretty conservative in what we estimate ‘23 to look like.
Larry Solow
Right. So it sounds like at least on the SSG side below sort of that normal targeted growth.
Mike Dennison
On the SSG side, but on the PVG side, which we didn’t talk about, Larry, we’re seeing significant volume coming through in the auto OEM side, and powersports is still really strong. So the benefit of our business model is the diversification, right? So even if I see a little bit of weakness in the bike side, we’re seeing some strength in other parts of the business, PBD is still doing really well, and we will continue to do really well. So that’s what I love about the business. I think the diversification is there really help carry us through.
Larry Solow
Right. Okay. Great. And you mentioned, obviously, Georgia, efficiencies continue to improve there. I guess the question I have is that you kind of reaffirmed your sort of 250 to 300 bps basis point improvement. It won’t be a linear improvement, right? But you expect sort of are we kind of in a accretive mode now where we should kind of be adding at least additional incremental benefits per quarter as they move out?
Mike Dennison
Yes. I think you’ll start to see that. We didn’t really see it as incremental benefit in Q3, but I think we start to see that now. And I think as you see it continue throughout ‘23.
Larry Solow
Right. And this quarter was also impacted, I guess, by mix too, the OEM, the auto OEM piece…
Mike Dennison
You know us well. Yes. As there is – you move to more of that auto OEM mix, you get the benefit of high volume, low mix that you don’t get the benefit of some of the gross margins that you would see in other parts of the business.
Larry Solow
Okay. Great. And then just last question on the balance sheet, obviously, it’s improved the last couple of years. Would you entertain the idea of an acquisition in this environment? Or might you be a little more cautious and keep some powder dry?
Mike Dennison
A little bit of both, actually. We are looking at some potential opportunities in the space, and we’ve always got good opportunities. So we have not stepped away from that notion of an acquisition. And we’ve talked [indiscernible] today as a management team as we go into pretty uncertain economic times next year, we’re going to be pretty conservative on how much leverage we want in the business. So what that might mean is we do less significant acquisitions, but really well targeted acquisitions. And the good news is, if there is good news in a bad recession or a bad economy, things get cheaper. And that’s a good [indiscernible] using our dry powder to pick up things that we think are long-term valuable to the company.
Larry Solow
Got it. Great, okay. Excellent. I appreciate all the color. Thanks.
Mike Dennison
You bet.
Operator
Our next question comes from Mike Swartz from Truist Securities.
Mike Swartz
Hey, guys. Good afternoon. Maybe just a couple of questions here on guidance, you beat the midpoint of your third quarter EPS guide by about $0.10. you’re raising the full year by about $0.07. Maybe give us some context to some of the puts and takes. I know currency I know interest rates are probably headwinds to that. But just how should we think about that guidance increase?
Scott Humphrey
Yes. No, absolutely, Mike. I think we’re trying to, as always, be somewhat conservative in our outlook, but we are fighting against a little bit of currency headwind. We started a hedging program in Q3, which was very successful in helping us mitigate some of that impact that we would have seen otherwise. And we’ve already had a fairly robust interest rate swap program in place to help combat interest rates, but we certainly have not swapped all to fixed. And so we are impacted by higher rates a little bit. Taxes, we’ve also raised our guidance for the year because we had some return to provision adjustments that will come through in Q4, so we have some headwinds, not to mention mix continuing to materialize as we expected, but a little bit even more on the automotive OE side, which, as Mike just said makes it tougher for us to overcome with improvements in efficiencies in Gainesville. So I think just kind of taking a very balanced approach to our outlook for Q4 given some of the sort of non-business things that we’re faced with. I think we’re still happy with what we see in Q4 from a business perspective. We’re just fighting against a whole bunch of other things.
Mike Swartz
Okay. That’s helpful. And I noticed on the balance sheet, the prepaids came down sequentially pretty nicely. I guess, how should we read that in terms of either demand or chassis supply in the upfitting business?
Mike Dennison
Yes. Demand is still very strong and chassis supply, actually, you should read it as a good thing for chassis supply because we felt comfortable enough in our relationships and in our sort of our feedback that we’re getting from the OEs. Specifically, we’ve talked about how when it hits our balance sheet in prepaids that that’s primarily like an FCA relationship with Ram and Jeep, that we felt pretty comfortable that we were going to be able to get access to chassis and so were during pandemic, we had gone out and bought everything that we could get our hands on. We have curtailed that in order to better manage our working capital. As I mentioned last quarter, that was going to be a big focus for us was getting working capital under control. And all credit is due to the team in our PVD group and especially over in Birmingham at SCA for working to get that inventory level down so that we’re living more on like 6 months of chassis versus 12 to 15 months.
Mike Swartz
Okay, great. Appreciate that.
Operator
Our next question comes from Anna Glaessgen from Jefferies.
Anna Glaessgen
Hi. Thanks for taking my question. First, I wanted to touch on the upfitting business. Great to see the demand strength there. Previously, we have talked about how you could start to see some macro sensitivity towards the entry-level side of that business. Could you talk about how that business is performing by pricing tier?
Mike Dennison
Yes. Anna, this is Mike. It’s still performing strongly across the entire platform. So, we haven’t seen anything kind of fall off. I would say, in September, we saw length of time on a dealer’s lot increase a little bit, but still on the historical average, pretty good. So, as we think about kind of Q4 and into next year, we are pretty bullish on that PVD business because it does seem that it’s weathering some of these inflationary pressures better than other parts of the business and other consumer products. So, so far, we are feeling pretty good about it.
Anna Glaessgen
Great. Thanks. And then turning back to SSG, could you maybe comment on where we stand in terms of channel inventories, or is POS matching self in a little bit better? Is there still a little bit more to build and how that should shape the expectation into 2023?
Mike Dennison
Yes. I think it’s getting close to equilibrium. The challenge is, and I mentioned this in Larry’s question is that you have got a lot of clunkiness still in the unfinished bike side of the supply chain because you have got parts and pieces of bikes but not full bikes. So, we got to see that really flow through hopefully in Q4 and early Q1 to get a really good sense of kind of where the volumes are in the channels for the high-end premium bikes. But I would say that we are still a little bit under equilibrium now, we will work our way in that direction. So, we will see that seasonality in Q4. We will see it in Q1. Those are things that, as I have said to you before and drivers, I think that gives us some confidence that we can have a reasonably soft landing in bike because without seasonality, you kind of feel like you are going to fall off the cliff. And so I feel pretty good that we are going to start to see that come through in the next couple of quarters.
Anna Glaessgen
Great. Thanks.
Operator
[Operator Instructions] We will take our next question from Jim Duffy from Stifel.
Jim Duffy
Thank you. Michael, I want to start with a question on the upfitting business. Can you speak about the opportunity for additional penetration on dealer lots, where you stand right now relative to the opportunity and appetite from incremental dealers to engage with you in that business?
Mike Dennison
That’s a big lever for us, if we see sales start to slow in the current dealer range. It’s still been a challenge in the first three quarters of this year to get enough trucks back stuff out to the lots to support new dealer engagements, but we certainly get better. And I think that’s really our opportunity going through the end of Q4 into next year is to expand from 2,200 dealers to 2,500 dealers and beyond. You have heard me talk about it in the past. I think that getting to the consumers across the country in a more efficient way across a broader dealer network is really our upside opportunity. We are close to capacity in our PVD business, so we are going to be expanding a little bit of space and capability to get some more throughput going into next year. But the dealer growth is obviously kind of top in the line [ph] for us.
Jim Duffy
Great. Then Scott, a couple of questions coming your way, there was some encouraging commentary about opportunities to realize margin benefit from Gainesville in 2023. I realize there is some uncertainty on the top line. But I am curious then to call out from a gross margin mix standpoint into 2023, just with respect to the mix towards powered vehicles and away from SSG?
Scott Humphrey
Yes. Sure, Jim. I think and certainly, I want to go back to when you are talking about uncertainty, as Mike mentioned, I think on the PVG side, we are not seeing any weakness. And in fact, are expecting to see growth continue, and so not a big concern there. But I think you are right in thinking about from a mix perspective, I mean that’s something that we have talked about many times over the last couple of years, as we see that mix change, we are going to be impacted by that margin mix and then the improvements or the efficiencies in Gainesville will hopefully help to offset that. And so they may not be showing up as clearly in the posted results, but the improvements are going to be there in sort of how it’s mitigating any of that mix.
Jim Duffy
Okay. And then, Scott, can you talk more about just opportunities to improve our working capital efficiency. It seems like inventory is certainly an opportunity. Would you expect to see progress with that in 2023 to help cash flows? And then how should we think about the prepaid accounts balance from here?
Scott Humphrey
Yes. We are still working to optimize our inventory levels in upfitting. And so that’s the prepaid piece. I think we can get a little bit more benefit out of that here in the short-term. But like I have said before, the team has done a phenomenal job in, I would say, kind of readjusting their sort of mindset from COVID. We need to take everything we can get our hands on to moving to more of a what do we need to actually meet demand and moving into that kind of head space. I think your debt on inventory is a focus for us right now and we will continue to be next year. We have got to get our turns improved. Mike mentioned that in his prepared remarks. It is a huge focus for us next year and even in Q4, how we are managing inventory and improving our turns and our cash flow related to that.
Jim Duffy
Thank you.
Operator
And our last question comes from Craig Kennison from Baird.
Craig Kennison
Hey. Thanks for taking my question as well. I am curious what you are seeing on the power sports side with your customers that make side-by-side ATVs, snowmobiles and other products. We know those channels have had very little inventory through the pandemic period, but maybe that’s improving. I am curious what you are seeing. And I am curious if your OEM customers have begun to taper orders at all as they get through this period of severe shortage.
Mike Dennison
Yes. Craig, this is Mike. In terms of the back half of that question, we haven’t seen any tapering yet. Our customers are pushing us to produce more. We are getting better quarter-on-quarter. The first part of this quarter already, we are doing a lot better to get that product out the door. We are still a pretty significant backlog situation with those customers. So, we will work really hard to meet their expectations and deliver products in. I think ultimately, Powersports will start to trend like bike, but I don’t know that we will see that even in the next year. I don’t know yet, it is probably too early to call the ball for the back half of next year, but the first half is going to look like this year, just more of it. So, my expectation is eventually we will see some of that kind of equilibrium coming back into Powersports, but we are not here in that yet.
Craig Kennison
Thanks. And then just as a follow-up. If you look at your white space opportunity within Powersports specifically, what does it look like to you? Do you have opportunities to win spec share, get on new models or with any new brands? Where do you see the biggest opportunity to grow beyond what the industry can provide you?
Mike Dennison
We have some stuff in process right now, Craig. I think it’s really interesting, and I don’t want to call it out on the call as we are still working through the details of it. But there is parts of that business that I think creates significant white space for us, not just in new technologies or new vehicles, but in new ways of approaching the market. Aftermarket in that space has been a very small business for a long time. We bought a shock therapy to help us understand it better. We have learned a lot in that acquisition, even though it was a small acquisition. And so we are getting ready for some significant changes in ‘23 that we are pretty excited about that I think we can start talking about in the next couple of earnings calls that will show us some good growth even as that market starts to kind of balance itself out.
Craig Kennison
Great. Okay. Thank you.
Scott Humphrey
Thanks Craig.
Operator
It appears we have no more questions at this time. I will now turn the program back over to Mike Dennison for any concluding remarks.
Mike Dennison
Thanks. We appreciate everyone taking the time to join us on today’s call. And we hope to talk to you soon, and have a good evening. Thank you.
Operator
This does conclude the Fox Factory Holding Corporation third quarter 2022 earnings call. You may now disconnect your line and have a great day.