Fox Factory Holding Corp (FOXF) 2017 Q2 法說會逐字稿

Good morning, and welcome to Fox Factory Holding Corp. Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, David Haugen, General Counsel.

Thank you. Good afternoon, and welcome to Fox Factory Second Quarter Fiscal 2017 Earnings Conference Call. On the call today are Larry Enterline, Chief Executive Officer; Mario Galasso, Executive Vice President and Chief Technology Officer; and Zvi Glasman, Chief Financial Officer and Treasurer. By now, everyone should have access to the earnings release, which went out today at approximately 4:00 or 5:00 p.m. 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 www.ridefox.com.

Please note that throughout this call, we will refer to Fox Factory as FOX for 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 risks and 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. It is important to note that these are non-GAAP financial measures. 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, Mr. Larry Enterline.

Thank you, David. Good afternoon, everyone, and thank you for joining us today. On today's call, I will discuss our second quarter 2017 business and financial highlights. Mario will then provide a more detailed update on our business, Zvi will review the second quarter financials in greater detail as well as discuss our guidance. After that, we will open the call for your questions.

Our business continued to deliver strong results for the second quarter across both our Bike and Powered Vehicle product offerings. Sales of Bike products were up 3% and Powered Vehicle products were up 43%. This growth helped us exceed our net sales and earnings expectation for the second quarter of fiscal 2017. New Bike product introductions and favorable spec positions with certain high-growth OEMs fueled our Bike growth and Powered Vehicle growth was fueled by positive demand for on-and-off road suspension products, including solid OEM sales.

As a result, we generated record sales of $120.8 million, an increase of 18% compared to Q2 last year and non-GAAP adjusted earnings per diluted share of $0.39 for Q2, above our guidance of $0.32 to $0.38. Based on our performance and our view of our business today, we are increasing our fiscal year 2017 guidance, which we will discuss in more detail.

Overall, we are pleased with our businesses' performance. In Bike, we continue to make progress with the success of our new products, and we remain comfortable with overall inventory in both the OEM and aftermarket channels. On the Powered Vehicle side, the 2017 Ford Raptor and 2017 Toyota Tacoma TRD Pro OEM programs continued to do well.

Also in the aftermarket, we believe that the current level of distributor inventory supports ongoing demand of FOX products in key categories, across certain sectors. In a competitive global industry, product innovation remains a key cornerstone of the FOX brand and our success in both Bike and Powered Vehicles. We appreciate the efforts of our team as we continue to deliver differentiated products to increase market penetration.

Looking ahead, our team remains committed to further building the FOX brand presence in our existing vehicle categories, and consistently pursuing potential new markets.

In summary, we are pleased with our operational execution and financial results for the first half of fiscal 2017. At FOX, we have a differentiated market position and continue to expand the diverse end markets we serve. We believe these aspects of our business will help us generate future growth and further enhance value for our shareholders. And with that, I'll turn the call over to Mario.

Thank you, Larry, and good afternoon, everyone. During my remarks, I'll touch on a few of our recent business highlights.

I'll begin with our Bike business. In mid-June, we launched our new FLOAT DPX2 rear shock platform for trail and all mountain bikes. Ahead of the launch, the shock had already been in the media's hands for testing, leading up to its debut. Upon product release, the favorable reviews started to roll in by such publications as MTV Neu out of Germany. They had this to say: "With the FOX DPX2, the Californians have succeeded in a big throw. Not only does it build the bridge between DPS and FLOAT X2, it will even compete with its big brother FLOAT X2 on some bikes. Its simplified settings make it easy for the rider to find a good set up. The overall support has been improved and the firm mode of the shock is generating high traction in technical climbing passages with a pleasantly smooth transition, when a hit occurs. Going downhill, there's a lot of traction and even with platform pedals, there were never any problems to keep the feet on the pedals even with violent hits."

As a result of these efforts, we believe our brand continues to resonate well and our distributor and dealer orders are strong with very positive consumer reaction.

We're now halfway through the 2017 bike race season, and FOX-supported athletes have won 17 cross country events, 4 enduro events, 5 free ride events and 30 downhill events worldwide.

Now I'll move on to our Powered Vehicle business. On July 25, Polaris launched their 2018 RZR XP Turbo Dynamix Edition, featuring our Live Valve active suspension. Live Valve is part of an electronic suspension system, developed in conjunction with Polaris that processes data from multiple vehicle sensors to adjust the suspension virtually instantaneously to meet the demands of the terrain.

Initial reactions from the launch were positive, and we're very excited to have brought this technology to market. UTVUnderground had this to say about how Live Valve performs: "After testing the new 2018 Polaris RZR XP Turbo Dynamix Edition with FOX Live Valve technology, I am sold. With Comfort, Sport and Firm settings at your fingertips, you have a setting for whatever type of terrain you're in and you can really feel the difference between modes. Hill climbing and rocks, I went Comfort mode and it smoothed it out. Got into the big stuff and went into a full boogie Firm mode and sent it right on top of the bumps. I'm pretty impressed, so check it out for yourself. If there's a demo ride in your area, take advantage and go out and feel this new Live Valve technology from FOX."

I'll conclude with a few of our recent race results in Powered Vehicle segments. At the San Felipe 250, Rob MacCachren won the overall with our Off-Road Race Manager, Wayne Israelsen, co-driving, making it Rob's third consecutive win in Baja. At the NORRA Mexican 1000, Cameron Steele took the overall win in the multi-day Baja race. Shannon Rentsch won his fifth outright title at the Tatts Finke Desert Race in Australia. And we continue to rack up the circle track wins with over 300 year-to-date.

I would now like to turn the call over to our CFO, Zvi Glasman, to review our financial results. Zvi?

Thank you, Mario. Good afternoon, everyone. I'll focus on our second quarter results, then review our guidance. As Larry stated earlier, sales in the second quarter of 2017 were a record $120.8 million, representing an increase of 18.1% versus sales of $102.3 million in the second quarter of 2016.

Gross margin was 32.3% for the second quarter of 2017, a 70-basis-point increase from 31.6% in the prior year period. The improvement in gross margin was primarily due to favorable product and customer mix and improved manufacturing efficiencies. Excluding acquisition-related costs, non-GAAP gross margin for the second quarter of 2017 expanded 60 basis points as compared to the second quarter of last year.

Total operating expenses were $20.9 million or 17.2% of sales in the second quarter of 2017 compared to $21.1 million or 20.6% of sales in the second quarter of last year. The slight decrease in operating expenses is primarily a result of the conclusion of our acquisition-related compensation arrangements, partially offset by strategic investments to support future business growth and increased incentive and stock-based compensation expense.

Non-GAAP operating expenses stated as a percentage of sales were 15.7% versus 16.3% in Q2 of last year. Focusing on expenses in more detail, our sales and marketing expenses increased approximately $0.6 million, primarily related to investments to support our brand, including higher employee-related costs.

Research and development expenses increased approximately $0.4 million due to investments in our product lines and technologies. As we've previously stated, the timing of R&D and promotional expenses often changes between quarters and years depending on a number of factors, including product launch cycles.

Our general and administrative expenses in the second quarter of 2017 were $8.1 million compared to $7.1 million in the prior year period. The change was primarily due to increased stock and incentive-based compensation costs.

In the second quarter of 2017, our tax rate was approximately 22.7% compared to 16.9% in the same period last year. The increase in the effective tax rate was primarily due to the impact of the increase in pretax income and resulting increase in tax expense with no corresponding increase in tax credit and deductions.

Adjusted EBITDA was a record $24 million for the second quarter 2017 compared to $18.6 million in the same quarter last quarter. Adjusted EBITDA margin was 19.9% compared to 18.2% in the prior year quarter.

On a GAAP basis, our net income in the second quarter of 2017 was $13.7 million compared to $8.9 million in the prior year period. Earnings per diluted share in the second quarter of 2017 were $0.35 compared to $0.24 in Q2 of 2016. Non-GAAP adjusted net income was $15 million, an increase of $3.2 million as compared to $11.8 million in the second quarter of the prior year period.

Non-GAAP adjusted earnings per diluted share for the second quarter of 2017 were $0.39 compared to $0.32 in the second quarter of 2016.

We believe non-GAAP adjusted net income and adjusted EBITDA are useful metrics that better reflect the performance of our business on an ongoing basis. You'll find a reconciliation of all GAAP to non-GAAP financial measures in our earnings press release issued today.

Now focusing on our balance sheet. As of June 30, 2017, we have cash on hand of $43.3 million. Total debt outstanding was $64.9 million compared to $66.7 million of debt outstanding as of December 31, 2016. Inventory was $89.4 million as of June 30, 2017, compared to $71.2 million as of December 31, 2016. Accounts receivable was $63 million as of June 30, 2017, as compared to $61.6 million as of December 31, 2016. Accounts payable was $51.1 million as of June 30, 2017, as compared to $36.2 million as of December 31, 2016.

The changes in accounts receivable, inventory and accounts payable are primarily attributable to business growth and our normal business seasonality.

Accrued expenses decreased to $29.9 million as of June 30, 2017, from $34.4 million as of December 30, 2016, primarily due to the final scheduled earn-out payment related to one of our 2014 acquisitions, partially offset by our normal business seasonality.

Turning now to our outlook. For the third quarter of 2017, we expect sales in the range of $119 million to $125 million and non-GAAP adjusted earnings per diluted share in the range of $0.40 to $0.44. For fiscal year 2017, we are raising our previous guidance and now expect sales in the range of $458 million to $470 million and non-GAAP adjusted earnings per diluted share in the range of $1.43 to $1.51.

For 2017, we now expect non-GAAP operating expenses to be lower than our expected long-term target of just below 17%. For 2018, we expect to return to our longer-term target OpEx as we support strategic initiatives such as ERP, support continued business growth and higher compliance costs, resulting from the process of exiting our emerging growth status.

We believe that the 2017 annual tax rate will be in line with our previously provided guidance of 18% to 20%. However, our tax rate is trending toward the upper end of the range on our increased profitability expectations. We expect the Q3 tax rate to be in the mid to upper teens, while Q4 will likely be in the mid to upper 20s.

We're pleased with our business performance and year-to-date growth. As we mentioned to you on our earnings call earlier this year, we anticipated a more front-loaded year as a result of the timing of new product introductions. Consistent with our previously communicated expectations and implicit within our Q3 guidance, we continue to expect a lower growth rate in Q4.

However, we would point out that our expected growth for the entire year exceeds our original expectations and exceeds our long-term targeted growth rates. As we have previously stated, the quarterly growth often varies between years based on timing of vehicle introductions and other factors.

Looking at the second half of this year, we will be lapping some very successful Powered Vehicle introduction. Based on our visibility into future new Powered Vehicle product introductions, our growth rate in 2018 will be lower than our 2017 and more consistent with our annual long-term target ranges in 2018. We remain confident in our ability to achieve our growth targets of mid-to-high single digits in Bike and low double digits in Powered Vehicle over the long term. Additionally, as we've mentioned previously, Powered Vehicle growth is subject to new vehicle introduction timing and will not necessarily be linear between quarters or years.

I'd also like to note that we are not providing guidance on a GAAP -- on GAAP EPS as it cannot be provided without unreasonable efforts due to the difficulty of accurately predicting the elements necessary to provide such guidance and reconciliation.

Finally, as a reminder, non-GAAP adjusted earnings per diluted share, exclude the following items net of applicable tax: Amortization of purchased intangibles, contingent consideration valuation adjustment, acquisition-related compensation expense, including related foreign currency transaction gains or losses, certain acquisition-related adjustments and expenses, litigation-related expenses and offering expenses. These adjustments are more fully described in the tables included in our press release, which has been posted on our website. I'd now like to turn the call back over to Larry.

Thank you, Zvi. With that, we'd like to open the call for questions. Operator?

Operator, are you there?

(Operator Instructions) Our first question comes from Andrew Burns with D.A. Davidson & Co.

I have a sort of a longer-term big picture question. There was discussion about the Live Valve technology and you also have this intelligent ride dynamics and you're increasingly [have seen] electronic component tree embedded in your suspension products. If you could just maybe talk about how that will change the business going forward? What types of investments are required? What is the margin potential and price points if this product only gets further and further advanced.

Sure. Andrew, this is Mario. So Larry and Zvi can probably speak to maybe price points and different things, but from a technology standpoint, it is a focus of ours. You'll remember that we've been speaking about Live Valve in various forms for many of these calls. We -- you referenced the iRD system, which we did in collaboration with Shimano. That's been on the market, already for several years within the Bike product line. And it is an interesting time for us. These things are packaged in mechanical sliding sort of legacy structures, which we know very well. But now we're into things like controllers and wiring harnesses and connectors and fast-acting valves and it's a big area of focus for us here at FOX.

Yes, and I think we're believers that with electronics and systems on these vehicles, you're going to see the suspension talking to other elements of the vehicle and it makes for a pretty exciting future. And I think what -- both in the performance and safety of a lot of the vehicles we're involved in.

In terms of the margin and the price points, we would tell you that we obviously only sell premium-priced products and when we sell things at the very top of our product line with the most technology, those tend to have better margins than other products we sell. But on a blended basis, this is not inconsistent with the margin profile of the higher-end products that we introduced and sold.

Thanks. And just to put it another way as we think about new product introductions over the next 5 years, is it fair to think that a greater percentage of those new introductions will include some sort of electronic componentry?

Well, I think it's fair to say that you're going to see more products of this type introduced. It's a transition. Again, these things are typically going to be initially at the higher end. I think over time, you'll see that pick up as a percentage of the things that we bring out. I think you'll see it on more vehicle classes in the future. Keeping in mind, when we say electronic suspension, that still spans a large application range from mobile control, which we've had out on other vehicle classes, to things that get more and more fully active.

Our next question comes from Mike Swartz with SunTrust.

This is Anna on for Mike. First question, I just want to ask how you -- we should be thinking about eMountain bike opportunity and how it's evolving over time?

Similar -- for the bike industry, Anna, let's say, it's a big area of focus. So we believe that our Live Valve technology has a real nice application. In E-BIKE, there aren't typically a lot of batteries and extra power sources on bicycles. So while we do have a pedal only application for Live Valve with its own battery, the E-BIKEs have a larger battery capacity so that allows us to do some different things with it. But E-BIKE is a big focus in the industry. We're playing well with some E-BIKE-specific products for Mountain Bike. And over time, we'll also participate in the more urban, commuter-oriented versions of those.

Got it. That's helpful. And then, could you remind us how you're thinking about using your growing free cash flow?

Yes, look, I think in terms of priorities, first and foremost to support the growth of the business, whether that means investing in production facilities like our -- like in El Cajon or in Taiwan or whether that entails investing in ERP systems. That would be priority #1. I think priority #2 would be strategic acquisitions that meet our financial and strategic criteria. I think we've done share buybacks before and we would look at share buybacks, and we'd look at paying down debt more aggressively as well.

Got it. And then last quarter, you called out you were seeing strength in oil regions. Has that continued?

Can you repeat that again?

Sorry, last quarter, you called out that you were seeing relative stronger oil region performance. Has that continued into the second quarter?

Yes. I think we were -- we continued to be pleased with the recoveries we saw in some of the parts of the world that are more dependent, particularly on Western Canada. Also a little bit in the Southwest in the U.S. So again, I think we're happy that they are continuing to recover. I don't think we would say that they're fully back.

Right. Yes, that makes sense. And then just last one for me. There's been a lot of commentary that bike OEM exports from Taiwan have been declining. Any color you can provide on what's going on there?

Well, I think, are you hearing the overall bike industry? Again, I think it's pretty well documented that, that's been challenged. But within that, I think we continue to see that Mountain Bike is doing better than overall Bike. And high-end Mountain Bike is doing better than overall Mountain Bike. So I think clearly, the overall bike industry, road, mountain, hybrid, comfort, cruising is having some challenges. E-BIKE continues to be probably the bright spot in all of that. But I think maybe that's what you're hearing.

Our next question comes from Craig Kennison with Baird.

Wanted to jump into the Mountain Bike category first. Revenue was up 3%, but it's my impression you're gaining share, and you're also growing your content per Bike and you're entering new price points. So what could you tell us about the broader marketplace, assuming you're significantly outperforming it?

Again, I think when you look at the markets we principally serve, I think from a broader standpoint, we think inventory's in pretty good shape now. Broadly, again, there's -- you could still point to a bike model that might have an issue. But we think broadly, we feel pretty good about that. We still think overall, the category has not resumed the kind of growth it was seeing several years ago. We again look to continue to perform and hit our targets with as you noted things like new products, getting into the lower price point, continuing to expand our effort in wheels. And so again, I would say that we believe we are outperforming the market that we find ourselves in. And we're doing it with -- through those mechanisms.

Craig, I would like to point out that this year, in the remaining year we called out that there would be different seasonality. And on a year-to-date [basis], Bike is actually up 8%, which is more in line with our long-term targets. So for the full year, we continue to expect Bike to be in line with our mid to high single digits' target growth rate, which as you say, is likely outperforming the industry.

And, Craig, you look at a lot of the stuff that comes out about the industry and announcements by some of the other public players in it. And I don't think there's any -- our sort of view now is it's gotten better than it was a few quarters ago. But still, I think it's challenging for a lot of the people that are operating in it.

Yes. That's really helpful. I'm trying to get a feel for how much of your growth, call it year-to-date, that 8% metric, is a function of industry volume growth versus your ability to take share with more content per bike or your ability to get on some smaller bikes where you didn't have product before with maybe some of the...

Yes, Craig, the answer to that question would be yes.

Got it. And then second question on Live Valve. Really impressive technology we saw on the Polaris unit. We know you've partnered with them, so there's got to be some joint intellectual property there. What's the exclusivity you have with Polaris? And at what point might that product be released more broadly to the power sports market?

Well, Craig, I would first say, we don't comment on it, our relationships with any specific customer. But clearly, we have put a lot into the Live Valve technology, both in the Bike area as well as the Powered Vehicle area. I think you will see that in the future. Again, Polaris, I think, was an early adopter here of the technology, and there are certain elements in their system and, again, if you look at it, it's broken down. We did certain parts of it, dealing with the Live Valve and the shock. Lake clearly did a lot of work in the control parts of the technology. So I think going forward, clearly, they've got things that are proprietary to them that we wouldn't necessarily have the freedom to offer. But we believe that in the future, that we will be able to offer our technology to a wide variety of applications.

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

I was wondering if you could -- can you walk us through just the SG&A dynamic that you talked about for 2017 [where you said] it's going to be a little bit lower than 17% this year and then percent of sales a little bit higher. It'll kind of go back up next year. Can you just like walk us through what's driving that dynamic?

Yes, a couple drivers. Yes, we have been saying consistently that our long-term SG&A target is kind of like high 16s, maybe as high as 17%. This year is a little lower. As we've been saying, it's not an area we're looking to get operating leverage because we believe that continuing to reinvest in the business, whether it be with sales and marketing R&D or on the platform, we think it's going to enable us to continue to grow. So with that caveat, next year there's a couple things that are different than this year. Firstly, as of June 30, 2017, our market cap is such that we anticipate exiting emerging growth status. We won't be an EGC. And without -- with along -- what comes along with that is having SOX 404 requirements, higher audit fees, higher internal costs in order to be SOX 404 compliant. That's thing number one. Some other factors, we are getting ready to really launch into the next phase of our ERP. We do think our ERP spending is going to tick up. And then, lastly, we're hiring aggressively in -- largely in R&D in order to support the revenue growth. So we think it'll tick up next year closer to the long-term target.

And then, in terms of just the gross margin mix benefit that you're seeing. Can you give a little bit more color on what's driving that? Is that having the large auto OEMs, is that a higher gross margin business? And then when you said mix -- sorry.

Well, we don't comment specifically on customers and there's -- as you know, there's not too many of those. So I'd be reluctant to speak about them specifically. But if you look at our gross margin over the last several years, we've been consistently driving it up. And customer and products and channel mix has, in some cases, been a drag and in other cases, it's been a benefit. It is a bit of a benefit this year. But along with that comes our various and efficiency initiatives and supply chain initiatives and along with designing for manufacturability and move to Taiwan. And so we have a whole host of factors that are helping to drive the margin up and we hope to continue that margin improvement over the next several years.

In the past, you've given some long-term gross margin targets or at least in terms of expansion or where you could be -- or I think you've spoken about a 20% plus EBITDA margin? Are you -- do you feel, based on kind of what's happened over the last 6 months and you sort of exceeding expectations, are you more confident that you'll be able to, I guess, meet or exceed that? Or is this sort of in line with what your expectations have been?

Look, I think the lower operating expenses this year is going to be a transitory thing at least as it continues into next year. So I mean, I wouldn't say we feel more or less confident. We continue to be confident. We've got a long-term program in place with a lot of different folks in the organization focused on delivering their particular aspect of improving margins and continue to march to that beat.

And then the last one for me. Just in terms of the -- has there been any changes to your input cost outlook?

No. I would say it's more or less in line.

Our next question comes from Jim Duffy with Stifel.

A few questions from me. Within Powered Vehicles, I'm interested in the evolving mix of OEM to aftermarket. Clearly you have some great OEM programs contributing to growth. Is the aftermarket business seeing a halo effect?

I think that the aftermarket business -- as you say, we feel like the Powered Vehicle business is performing well, along the diversity of our entire product portfolio. Clearly, the reintroduction of the Ford program and the launch of the Toyota have had a good impact on us this year. But we would tell you that across the entirety of our portfolio, we feel pretty pleased with the performance.

Yes, I think clearly, Jim, we've always believed that there is a great virtuous circle connection between OEM and aftermarket. And I believe it's fair to say that getting our product out there on OEM vehicle clearly does help our aftermarket on-road Replacement shock business.

Have you guys ever seen correlation in the aftermarket business to SAAR or new vehicle sales?

No. I think if you try to use the figures coming out of Detroit and worldwide automotive figures, probably not a great correlation there. What you'll find, people when they buy, for instance, a new truck, they're going to take it out and get it lifted and put the suspension on it. That's a category. I think when things soften up a little bit and they can't go out and buy that new truck, they may go upgrade the one and keep it another couple years. So I don't think there's a great correlation there. Hey, we look at the general -- the health of the general consumer market a lot. And again, we are believers in, the better the economy, the better our business will do. I do think there'll be a correlation there. But in terms of trying to tie it broadly to new vehicle sales, probably not a great correlation.

Okay. And this next question, I'll preface it by saying, it may not be an easy one to handle. But the question on everyone's mind in the investment community is, does this phenomenal 2017 growth create impossible compares as you look out to '18? To the best of your ability, can you guys share some thoughts on that, please?

Well, sure. Firstly, it's premature for us to provide 2018 guidance, but we would...

Fair enough, yes.

We would tell you that clearly 2017 growth was above our long-term target growth. And so we would not expect a similar growth profile next year. While we're not prepared to give you our long-term -- or 2018 guidance, we continue to feel confident about our long-term growth targets.

Okay. Great.

Yes, Jim, I think -- and Zvi's talked about this before. In Powered Vehicle particularly, you've got -- your business is definitely tied to some of these new vehicle launches, right? And that's -- they're all over -- we don't necessarily know now exactly when everything is going to happen on OEMs that we may have. So there's some variability there. And I think what we've tried to tell people, hey, from quarter-to-quarter or even year-to-year, these things are going to vary, right. This year, we had a great year. We're having a great year based on some of the introductions. Next year, as Zvi said, while it's way too early for us to put out a forecast, because we don't know where everything is. It might be a bit lower depending on that, or could be the same or could be a little higher. That's what we don't know.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Larry Enterline for closing remarks.

Thank you. Thank you for your questions and your interest in FOX. We look forward to continuing to execute our plans and updating you on our progress as we go forward with these quarterly earnings calls. I'm also thankful for the support of our customers and suppliers, and the hard work of our great group of enthusiastic employees, all keys to our continued success. Thank you and have a good day.

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