Item 7. Management’s Discussion and Analysis
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10- K. In addition to historical financial information, this discussion and analysis and other parts of this Annual Report on Form 10-K contain forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K. You should carefully read the “Risk Factors” section of this Annual Report on Form 10-K to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements.
Overview
FGI is a global supplier of kitchen and bath products. Over the course of 30 years, we have built an industry-wide reputation for product innovation, quality, and excellent customer service. We are currently focused on the following product categories: sanitaryware (primarily toilets, sinks, pedestals and toilet seats), bath furniture (vanities, mirrors and cabinets), shower systems, customer kitchen cabinetry and other accessory items. These products are sold primarily for R&R activity and, to a lesser extent, new home or commercial construction. We sell our products through numerous partners, including mass retail centers, wholesale and commercial distributors, online retailers and specialty stores.
Consistent with our long-term strategic plan, we intend to drive value creation for our shareholders through a balanced focus on product innovation, organic growth, and efficient capital deployment. The following initiatives represent key strategic priorities for us, entering 2023:
● Commitment to product innovation. We have a history of being an innovator in the kitchen and bath markets and developing “on-trend” products and bringing them to market ahead of the competition. We have developed deep marketing skills, leading design capabilities, and product development expertise. A recent example of our innovative product development includes the Jetcoat Shower wall systems, which offer a stylized design option without the fuss of messy grout. We expect to continue to invest in research and development to drive product innovation in 2023.
● “BPC” (Brands, Products, Channels) strategy to drive above-market organic growth. We are focused on increasing the mix of Branded products as a percentage of sales, which is expected to result in larger available markets and gross margin expansion. Our owned brands grew to nearly 34% of sales as of year-end 2022, up from less than 1% at the end of 2010. We are focused on expanding our position in channels such as e-commerce, providing for additional growth opportunities with existing brick and mortar customers, as well as expanding with e-commerce customers. The e-commerce channel accounted for 13% of sales in 2022, up from only 2% at the end of 2010.
● Drive margin expansion. Margin expansion remains a key pillar of our value creation focus. We believe our BPC strategy will support enhanced margins through growth in branded products, new product categories, and new channels. Headwinds from supply chain disruptions and inflationary pressures impacted operating margins since 2021; however, we have adopted measures to offset these challenges, and resumed margin expansion in the back half of 2022 as these initiatives took hold.
● Efficient capital deployment. We benefit from a capital-light business model allowing us to generate strong free cash flow conversion. We expect to utilize our strong free cash flow to re-invest in the core business and drive growth through existing brand development and new product category expansion. We will also look for selective bolt-on acquisition opportunities, over time, focused within the core kitchen and bath end markets. We plan to maintain a disciplined approach to capital deployment, with most material internal investments currently subject to a company-wide 20%+ expected return on capital hurdle rate.
● Deep manufacturing partners and customer relationships. We have developed strong manufacturing and sourcing partners over the last 30+ years, which we believe will continue to give us a competitive advantage in
35
Table of Contents
the markets we serve. We also have deep relationships with an established global customer base, offering end-to-end solutions to support category growth. While recent supply chain and inflation pressures have been a headwind, our durable partnerships with manufacturing and sourcing partners have helped to mitigate these challenges.
We were incorporated in the Cayman Islands on May 26, 2021 in connection with a reorganization (the “Reorganization”) of our parent company, Foremost Groups Ltd. (“Foremost”), and its affiliates, pursuant to which, among other actions, Foremost contributed all of its equity interests in FGI Industries, Inc., FGI Europe Investment Limited, an entity formed in the British Virgin Islands (“FGI Europe”), and FGI International, Limited, an entity formed under the laws of Hong Kong (“FGI International”), each a wholly-owned subsidiary of Foremost, to the newly formed FGI Industries Ltd. Foremost was established in 1987 and has become a global leader in kitchen and bath design, indoor and outdoor furniture, food service equipment, and manufacturing. This discussion, and any financial information and results of operations discussed herein, refers to the assets, liabilities, revenue, expenses and cash flows that are directly attributable to the kitchen and bath business of Foremost Groups, Ltd. before the completion of Reorganization and are presented as if we had been in existence and the Reorganization had been in effect during the years ended December 31, 2022 and 2021.
Recent Trends
Due to changing market conditions, we are experiencing, and may continue to experience, lower market demand for certain of our products, particularly in our bath furniture category, as weak demand as customer destock and inventory corrections have had a negative impact on our net sales. As previously noted, we also began experiencing supply chain disruptions and inflationary pressures, which affected operating margins beginning in late 2021. However, we adopted several productivity and pricing measures to offset these headwinds and began to see resumed margin expansion in the second half of 2022. While demand for our bath furniture products remains lower than historical levels thus far in 2023, based on discussions with our existing customers and other market factors, we expect demand to pick up in the second half of 2023.
Results of Operations
For the Years Ended December 31, 2022 and 2021
The following table summarizes the results of our operations for the years ended December 31, 2022 and 2021, respectively, and provides information regarding the dollar and percentage increase (decrease) during such periods.
For the year ended
December 31,
Change
2022
2021
Amount
Percentage
USD
USD
USD
%
Revenues
$
161,718,543
$
181,943,027
$
(20,224,484)
(11.1)
Cost of revenues
130,209,538
149,740,619
(19,531,081)
(13.0)
Gross profit
31,509,005
32,202,408
(693,403)
(2.2)
Selling and distribution expenses
17,533,028
17,636,820
(103,792)
(0.6)
General and administrative expenses
7,830,023
6,194,789
1,635,234
26.4
Research and development expenses
1,053,976
646,069
407,907
63.1
Income from operations
5,091,978
7,724,730
(2,632,752)
(34.1)
Operating margins
3.1
%
4.2
%
(110)
bps
Total other (expenses) income, net
(551,428)
1,142,820
(1,694,248)
(148.3)
Provision for income taxes
860,630
961,634
(101,004)
(10.5)
Net income
$
3,679,920
$
7,905,916
$
(4,225,996)
(53.5)
Adjusted income from operations (1)
$
5,693,972
$
7,840,630
$
(2,146,658)
(27.4)
Adjusted operating margins (1)
3.5
%
4.3
%
(80)
bps
—
Adjusted net income (1)
$
4,173,555
$
6,284,572
$
(2,111,017)
(33.6)
(1) See “Non-GAAP Measures” below for more information on our use of these adjusted figures and a reconciliation of these financial measures to their closest GAAP comparators.
36
Table of Contents
Revenues
Our revenues decreased by $20.2 million, or 11.1%, to $161.7 million for the year ended December 31, 2022, from $181.9 million for the year ended December 31, 2021. The decrease in our revenues was primarily by declines in bath furniture sales partially offset by continued growth in Shower System and Other categories. Revenue categories by product are summarized as follows:
For the year ended December 31,
Change
2022
Percentage
2021
Percentage
Percentage
USD
%
USD
%
%
Sanitaryware
$
104,806,342
64.8
$
104,477,568
57.4
0.3
Bath Furniture
29,519,728
18.3
55,136,664
30.3
(46.5)
Shower System
21,586,888
13.3
19,116,188
10.5
12.9
Other
5,805,585
3.6
3,212,607
1.8
80.7
Total
$
161,718,543
100.0
$
181,943,027
100.0
(11.1)
We derive the majority of our revenues from sales of sanitaryware, which accounted for 64.8% and 57.4% of our total revenues for the years ended December 31, 2022 and 2021, respectively. Revenues generated from the sales of sanitaryware increased by 0.3% to $104.8 million for the year ended December 31, 2022, from $104.5 million for the year ended December 31, 2021, which resulted from the growth in the United States, partially offset by pricing pressure in Canada.
Our revenues from bath furniture sales decreased significantly by 46.5% to $29.5 million for the year ended December 31, 2022 from $55.1 million for the year ended December 31, 2021. Bath furniture sales accounted for 18.3% and 30.3% of our total revenue for 2022 and 2021, respectively. The revenue pressure was a result of a more significant inventory correction in the channel combined with some more pronounced end market softness.
Revenues from sales of Shower Systems increased by 12.9% to $21.6 million for the year ended December 31, 2022 from $19.1 million for the year ended December 31, 2021. Shower systems make up approximately 13.3% and 10.5% of our total revenue for 2022 and 2021, respectively. This increase was due to this increase was due to strong sales of shower walls and shower doors with certain of our large customers .
We also generate revenues from sales of Other products (custom kitchen cabinetry and others), which, in the aggregate, accounted for 3.6% and 1.8% of our total revenues for the years ended December 31 ,2022 and 2021. The increase in Other was primarily driven by strong volume growth of custom kitchen cabinetry sales to our expanding network of kitchen cabinetry dealers in the United States.
We derive our revenues primarily from the United States, Canada and Europe. Revenue categories by geographic location are summarized as follows:
For the year ended December 31,
Change
2022
Percentage
2021
Percentage
Percentage
USD
%
USD
%
%
United States
$
103,255,662
63.9
$
112,725,240
62.0
(8.4)
Canada
41,025,288
25.4
50,391,183
27.7
(18.6)
Europe
16,844,015
10.4
18,826,604
10.3
(10.5)
Rest of World
593,578
0.3
—
—
—
Total
$
161,718,543
100.0
$
181,943,027
100.0
(11.1)
We generated the majority of our revenues in the United States market, which amounted to $103.3 million for the year ended December 31, 2022, and $112.7 million for the year ended December 31, 2021, representing an 8.4%
37
Table of Contents
decrease. These revenues accounted for 63.9% and 62.0% of our total revenues for 2022 and 2021, respectively. The decreased in the U.S. market was primarily driven by volume weakness in the bath furniture as customers' de-stocking to adjust inventory level.
Our second largest market is Canada. Our revenues generated in the Canadian market were $41.0 million and $50.4 million for the years ended December 31, 2022 and 2021, respectively, representing a 18.6% decrease. The decrease was primarily driven by volume weakness in both retail and wholesale markets.
We also derive a small portion of our revenue from Europe, which consists primarily of sales in Germany. This amounted to $16.8 million and $18.8 million for the years ended December 31, 2022 and 2021, respectively, representing a 10.5% decrease. The decrease was attributable to decreased demand that was impacted by global supply chain interruptions and inflation issues.
Gross Profit
Gross profit was $31.5 million during year 2022, a decrease of 2.2% compared to the prior-year period, as volume weakness was offset by pricing gains, a more favorable mix, and lower freight costs. Gross profit margin percentage improved to 19.5% during year 2022, up 180 basis points from 17.7% in the prior-year period, as measures put in place to mitigate the recent margin headwinds benefitted results. The improvement in the Company’s gross margin percentage is primarily attributable to solid growth in higher margin products, such as shower systems and kitchen cabinetry, continued pricing gains, and a reduction in freight costs versus the elevated levels experienced last year. The Company expects the positive factors that drove the strong margin performance to remain in place, which combined with an expected rebound in the Bath Furniture segment in the second half of 2023, should enable the Company to drive additional gross margin gains over time.
Operating Expenses
Selling and distribution expenses primarily consisted of personnel costs, marketing and promotion costs, commission, and freight and leasing charges. Our selling and distribution expenses decreased by $0.1 million, or 0.6%, to $17.5 million for the year ended December 31, 2022, from $17.6 million for the year ended December 31, 2021. The decrease was a result of the lower sales in the year 2022 compared to the prior year, which caused the decrease in sales co-op and shipping freight costs, partially offset by higher marketing and travel expenses.
General and administrative expenses primarily consisted of personnel costs, professional service fees, depreciation, travel, and office supply expenses. Our general and administrative expenses increased by $1.6 million, or 26.4%, to $7.8 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021. The increase was primarily attributable to incremental public company costs and a one-time bonus expense related to our IPO.
Research and development expenses mainly consisted of personnel costs and product development costs. Our research and development activities remained stable and are relatively immaterial to our consolidated statements of income.
Other Income (Expenses)
Other income (expenses) decreased by $1.7 million, or (148.3)%, to $(0.6) million for the year ended December 31, 2022, from $1.1 million for the year ended December 31, 2021. This decrease was the result of one-time income recognized in 2021 upon the forgiveness of the PPP loan.
Provision for Income Taxes
We recorded income tax expense of $0.9 million for the year ended December 31, 2022, and $1.0 million for the year ended December 31, 2021. The decrease resulted from the decrease in our reported income before taxes of $4.3 million, or 48.8%.
38
Table of Contents
Net Income
Our net income decreased by $4.2 million, or 53.5%, to $3.7 million for the year ended December 31, 2022, from $7.9 million for the year ended December 31, 2021. This decrease was a result of the combination of the changes discussed above.
Liquidity and Capital Resources
Our principal sources of liquidity are cash generated from operating activities and cash borrowed under credit facilities, which we believe provides sufficient liquidity to support our financing needs. As of December 31, 2022 and 2021, we had cash and cash equivalents of $10.1 million and $3.9 million, respectively. We had working capital of $16.1 million as of December 31, 2022 compared to a working capital of $1.4 million as of December 31, 2021. On January 27, 2022, we closed an underwritten public offering of 2.5 million units consisting of Ordinary Shares and warrants and received net proceeds, after commissions and expenses, of approximately $12.4 million.
We believe our revenues and operations will continue to grow and the current working capital is sufficient to support our operations and debt obligations well into the foreseeable future. However, we may need additional cash resources in the future if we experience changes in business conditions or other developments, such as rising interest rates, inflation and increased costs, and may also need additional cash resources in the future if we wish to pursue opportunities for investment, acquisition, strategic cooperation or other similar actions. For example, from time to time we may provide loans or other operational support to Foremost to assist Foremost in capital expenditures or other efforts related to the manufacturing services that Foremost provides to us, which could limit the assets available for other corporate purposes or require additional resources. If it is determined that the cash requirements exceed our amount of cash on hand, we may seek to issue debt or equity securities, and there can be no assurances that additional financing will be available on acceptable term, if at all.
As of December 31, 2022, FGI’s total outstanding debt is represented by a credit facility with East West Bank.
East West Bank Credit Facility
Our wholly owned subsidiary, FGI Industries (formerly named Foremost Groups, Inc.), has a line of credit with East West Bank pursuant to a Business Loan Agreement (the “Credit Agreement”) with East West Bank, which is collateralized by all of the assets of FGI Industries and personally guaranteed by Liang Chou Chen, who holds approximately 49.75% of the voting control of Foremost. On November 25, 2022, the Credit Agreement was amended and restated with a maximum borrowing amount of $18,000,000 and a maturity date of December 21, 2024.
Pursuant to the Credit Agreement, FGI Industries is required to maintain (a) a debt coverage ratio (defined as earnings before interest, taxes, depreciation and amortization divided by current portion of long-term debt plus interest expense) of not less than 1.25 to 1, tested at the end of each fiscal quarter; (b) an effective tangible net worth (defined as total book net worth plus minority interest, less amounts due from officers, shareholders and affiliates, minus intangible assets and accumulated amortization, plus debt subordinated to East West Bank) of not less than $10,000,000 for the quarter ended March 31, 2021 and thereafter, on consolidated basis; and (c) a total debt to tangible net worth ratio (defined as total liabilities divided by tangible net worth, which is defined as total book net worth plus minority interest, less loans to officers, shareholders, and affiliates minus intangible assets and accumulated amortization) not to exceed 4.0 to 1, tested at the end of each fiscal quarter, on consolidated basis. As of December 31, 2021, FGI Industries was not in compliance with this financial covenant; however, East West Bank provided a waiver for such non-compliance. As of December 31, 2022, FGI Industries was in compliance with this financial covenant.
The loan bears interest rate equal to, at the Company ’ s option, either (i) 0.25 percentage points less than the Prime Rate quoted by the Wall Street Journal or (ii) the SOFR Rate (as administered by CME Group Benchmark Administration Limited and displayed by Bloomberg LP) plus 2.20% per annum (in either case, subject to a minimum rate of 4.500% per annum) . The interest rate as of December 31, 2022 and December 31, 2021 was 7.25% and 3.50%, respectively.
39
Table of Contents
Each sum of borrowings under the Credit Agreement is deemed due on demand and is classified as a short-term loan. The outstanding balance of such loan was $9,795,052 and $14,657,280 as of December 31, 2022 and 2021, respectively.
HSBC Canada Bank Loan
FGI Canada Ltd. has a line of credit agreement with HSBC Canada (the “Canadian Revolver”). The revolving line of credit with HSBC Canada allows for borrowing up to CAD $7,500,000 (US $5,538,734 as of the December 31, 2022 exchange rate). Pursuant to the Canadian Revolver, FGI Canada Ltd. is required to maintain (a) a debt to tangible net worth ratio of no more than 3.00 to 1.00; and (b) a ratio of current assets to current liabilities of at least 1.25 to 1.00. The loan bears interest at a rate of Prime rate plus 0.50%. As of December 31, 2022 and 2021, FGI Canada Ltd. was in compliance with this financial covenant.
Borrowings under this line of credit amounts to $0 as of December 31, 2022 and 2021. The facility matures at the discretion of HSBC Canada upon 60 days notice.
PPP Loan
On April 9, 2020, FGI USA entered into a loan agreement in connection with the Paycheck Protection Program (“PPP”) and received proceeds of approximately $1.68 million (the “PPP loan”) under the CARES Act. Interest on the loan accrued at a fixed interest rate of 1.0%. Under Section 1106 of the CARES Act, borrowers are eligible for forgiveness of principal and accrued interest on the loans to the extent that the proceeds are used to cover eligible payroll costs, mortgage interest costs, rent and utility costs, otherwise described as qualified expenses. During the year ended December 31, 2020 FGI USA used all of the PPP loan proceeds to pay for qualified expenses. 100% of the PPP loan proceeds were used for payroll related expenses. Under the current provisions of the CARES Act, any recipient of a PPP loan may be subject to an audit by the SBA to confirm it qualifies for the loan and that the proceeds were used for qualified expenses as prescribed by the PPP rules. FGI USA submitted its application and supporting documentation for forgiveness on December 22, 2020. As of December 31, 2020, the balance of the PPP loan was included in the short-term loan on the consolidated balance sheet. On February 8, 2021, FGI USA received approval of forgiveness of the PPP loan from the SBA. Upon such approval, the entire balance including principal and interest was forgiven and recorded as other income on our consolidated statements of income and comprehensive income.
Cash Flows
The following table summarizes the key components of our cash flows for the years ended December 31, 2022, and 2021.
For the Year Ended December 31,
2022
2021
USD
USD
Net cash provided by (used in) operating activities
$
980,265
$
(3,217,321)
Net cash used in investing activities
(1,063,823)
(51,890)
Net cash provided by financing activities
7,010,568
3,316,826
Effect of exchange rate fluctuation on cash
(743,478)
(182,277)
Net changes in cash
6,183,532
(134,662)
Cash, beginning of period
3,883,896
4,018,558
Cash, end of period
$
10,067,428
$
3,883,896
Operating Activities
Net cash provided by operating activities was approximately $1.0 million for the year ended December 31, 2022 compared to cash used in operating activities of $3.2 million for the year ended December 31, 2021. The increase was primarily attributable to a decrease in accounts receivable of approximately $13.5 million, a decrease in inventories of approximately $8.0 million, and net income for the year of approximately $3.7 million, , a decrease in other noncurrent
40
Table of Contents
assets of approximately $0.9 million, a decrease in right-of-used assets of approximately $0.9 million, an increase in accounts payable-related parties of approximately $0.1 million. These drivers were partially offset by a decrease in accounts payable of approximately $17.3 million, plus an increase in prepayments and other receivables - related parties of approximately $2.5 million, a decrease in accrued expenses and other current liabilities of approximately $1.9 million, a decrease in operating lease liabilities of approximately $1.4 million, a decrease in income taxes payable of approximately $1.2 million and an increase in prepayments and other current assets of approximately $1.0 million, non-cash items of approximately $0.6 million,.
Net cash used in operating activities was approximately $3.2 million for the year ended December 31, 2021 and was primarily attributable to an increase in accounts receivable of approximately $11.1 million, an increase in inventories of approximately $13.0 million, an increase in other noncurrent assets of approximately $2.8 million, which were partially offset by net income for the year of approximately $7.9 million, plus various non-cash items of approximately $0.7 million, an increase in accounts payable of approximately $12.5 million, and an increase in accrued expenses and other current liabilities of approximately $2.5 million.
Investing Activities
Net cash used in investing activities was approximately $1.1 million and $0.1 million for the years ended December 31, 2022 and 2021, respectively. The increase in cash used was primarily attributable to increases in the purchase of property and equipment.
Financing Activities
Net cash provided financing activities was approximately $7.0 million for the year ended December 31, 2022, which primarily represents the net proceeds from issuance of units in the IPO of $12.4 million and partially offset by repayment of bank loans of $4.9 million and a decrease of $0.5 million excess payment over carrying value resulted from long-lived assets acquisition from affiliate.
Net cash provided financing activities was approximately $3.3 million for the year ended December 31, 2021, which represents the net proceeds from bank loans of $5.3 million and net decrease in parent company investment of $1.9 million.
Commitments and Contingencies
Capital Expenditures
Our capital expenditures were incurred primarily in connection with the acquisition of property and equipment. Our capital expenditures amounted to approximately $1.1 million and $0.1 million for the years ended December 31, 2022, and 2021, respectively. We do not expect to incur significant capital expenditures in the immediate future.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements including arrangements that would affect our liquidity, capital resources, market risk support and credit risk support or other benefits.
Critical Accounting Policies
The consolidated financial statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements and accompanying notes requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We have identified certain accounting policies that are significant to the preparation of the consolidated financial statements. These accounting
41
Table of Contents
policies are important for an understanding of our financial condition and results of operations. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management’s difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to consolidated financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included elsewhere in this registration statement, we believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our consolidated financial statements.
Use of estimates and assumptions
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Significant accounting estimates reflected in our consolidated financial statements include the useful lives of property and equipment, allowance for doubtful accounts, inventory reserve, accrued defective return, provision for contingent liabilities, revenue recognition, deferred taxes and uncertain tax position. Actual results could differ from these estimates.
Foreign currency translation and transaction
The functional currencies of our company and our subsidiaries are the local currency of the country in which the subsidiaries operate, except for FGI International which is incorporated in Hong Kong while adopting the United States Dollar (“U.S. Dollar” or “USD”) as its functional currency. The reporting currency of our company is the U.S. Dollar. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. The equity denominated in the functional currencies is translated at the historical rates of exchange at the time of capital contributions. The results of operations and the cash flows denominated in foreign currencies are translated at the average rates of exchange during the reporting period. Because cash flows are translated based on the average translation rates, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Translation adjustments arising from the use of different exchange rates from period to period are included as a separate component of accumulated other comprehensive income included in the consolidated statements of changes in parent’s net investment. Transaction gains and losses arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency in the consolidated statements of income and comprehensive income.
For the purpose of presenting the financial statements of subsidiaries using the Renminbi (“RMB”) as functional currency, our assets and liabilities are expressed in U.S. Dollars at the exchange rate on the balance sheet date, which was 6.9653 and 6.3762 as of December 31, 2022 and 2021, respectively; parent’s net investment accounts are translated at historical rates, and income and expense items are translated at the average exchange rate during the period, which was 6.7164 and 6.4543 the years ended December 31, 2022 and 2021, respectively.
For the purpose of presenting the financial statements of the subsidiary using the Canadian Dollar (“CAD”) as functional currency, our assets and liabilities are expressed in U.S. Dollars at the exchange rate on the balance sheet date, which was 1.3541 and 1.2697 as of December 31, 2022 and 2021, respectively; parent’s net investment accounts are translated at historical rates, and income and expense items are translated at the average exchange rate during the period, which was 1.2945 and 1.2549 for the years ended December 31, 2022 and 2021, respectively.
For the purpose of presenting the financial statements of the subsidiary using the Euro (“EUR”) as functional currency, our assets and liabilities are expressed in U.S. Dollars at the exchange rate on the balance sheet date, which was 0.9338 and 0.8815 as of December 31, 2022 and 2021, respectively; parent’s net investment accounts are translated at historical rates, and income and expense items are translated at the average exchange rate during the period, which was 0.9474 and 0.8406 for the years ended December 31, 2022 and 2021, respectively.
42
Table of Contents
Accounts receivable
Bills and trade receivables include trade accounts due from customers. In establishing the required allowance for doubtful accounts, management considers historical collection experience, aging of the receivables, the economic environment, industry trend analysis, and the credit history and financial conditions of the customers. Management reviews its receivables on a regular basis to determine if the bad debt allowance is adequate and adjusts the allowance when necessary. Delinquent account balances are written off against allowance for doubtful accounts after management has determined that the likelihood of collection is not probable.
Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average cost method, based on individual products. The methods of determining inventory costs are used consistently from year to year. A provision for slow-moving items is calculated based on historical experience. Management reviews the provision annually to assess whether, based on economic conditions, it is adequate.
Property and equipment
Property and equipment are stated at cost, net of accumulated depreciation and impairment. Depreciation is provided over the estimated useful lives of the assets using the straight-line method from the time the assets are placed in service. Estimated useful lives are as follows:
Useful Life
Building
20 years
Leasehold Improvements
Lesser of lease term or expected useful life
Machinery and equipment
3 – 5 years
Furniture and fixtures.
3 – 5 years
Vehicles
5 years
Molds
3 – 5 years
Leases
We determine if an arrangement is a lease at inception. Operating leases are included in right-of-use assets (“ROU assets”), accrued expenses and operating lease liabilities — noncurrent on the consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the duration of the lease term while lease liabilities represent our obligation to make lease payments in exchange for the right to use an underlying asset. ROU assets and lease liabilities are measured based on the present value of fixed lease payments over the lease term at the commencement date. The ROU asset also includes any lease payments made prior to the commencement date and initial direct costs incurred and is reduced by any lease incentives received. We review our ROU assets as events occur or circumstances change that would indicate the carrying amount of the ROU assets are not recoverable and exceed their fair values. If the carrying amount of the ROU asset is not recoverable from its undiscounted cash flows, then we would recognize an impairment loss for the difference between the carrying amount and the current fair value.
As most of our leases do not provide an implicit rate, we generally uses our incremental borrowing rate on the commencement date of the lease as the discount rate in determining the present value of future lease payments. We determine the incremental borrowing rate for each lease by using the incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. Our lease terms may include options to extend or terminate the lease when there are relevant economic incentives present that make it reasonably certain that we will exercise that option. We account for any non- lease components separately from lease components.
Lease expense for lease payments is recognized on a straight-line basis over the lease term.
43
Table of Contents
Fair Value Measurement
The accounting standard regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires disclosure of the fair value of financial instruments held by us.
The accounting standards define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement and enhance disclosure requirements for fair value measures. The three levels of the fair value hierarchy are as follows:
● Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
● Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
● Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.
Financial instruments included in current assets and current liabilities are reported in the consolidated balance sheets at face value or cost, which approximate fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest.
Revenue recognition
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.
We generate revenues from sales of kitchen and bath products and recognizes revenue as control of its products is transferred to its customers, which is generally at the time of shipment or upon delivery based on the contractual terms with our customers. Our customers’ payment terms generally range from 15 to 60 days of fulfilling its performance obligations and recognizing revenue.
We provide customer programs and incentive offerings, including co-operative marketing arrangements and volume-based incentives. These customer programs and incentives are considered variable considerations. We include in revenue variable considerations only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the variable consideration is resolved. This determination is made based upon known customer program and incentive offerings at the time of sale and expected sales volume forecasts as it relates to our volume- based incentives. This determination is updated on a monthly basis.
Certain product sales include a right of return. We estimate future product returns at the time of sale based on historical experience and record a corresponding reduction in accounts receivable.
We record receivables related to revenue when it has an unconditional right to invoice and receive payment.
Share-based compensation
We account for share-based compensation in accordance with ASC 718, Compensation — Stock Compensation (“ASC 718”). In accordance with ASC 718, we determine whether an award should be classified and accounted for as a liability award or an equity award. All of our share-based awards were classified as equity awards and are recognized in the consolidated financial statements based on their grant date fair values.
We have elected to recognize share-based compensation using the straight-line method for all share- based awards granted over the requisite service period, which is the vesting period. We account for forfeitures as they occur in
44
Table of Contents
accordance with ASU No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. Our company, with the assistance of an independent third-party valuation firm, determines the fair value of the stock options granted to employees. The Black Scholes Model is applied in determining the estimated fair value of the options granted to employees and non-employees. The Company recognized share-based compensation $383,572 and $0 in 2022 and 2021, respectively.
Income Taxes
Deferred taxes are recognized based on the future tax consequences of differences between the carrying value of assets and liabilities and their respective tax basis. The future realization of deferred tax assets depends on the existence of sufficient taxable income in future periods. Possible sources of taxable income include taxable income in carryback periods, the future reversal of existing taxable temporary differences recorded as a deferred tax liability, tax-planning strategies that generate future income or gains in excess of anticipated losses in the carryforward period and projected future taxable income.
If, based upon all available evidence, both positive and negative, it is more likely than not (more than 50 percent likely) such deferred tax assets will not be realized, a valuation allowance is recorded. Significant weight is given to positive and negative evidence that is objectively verifiable. A company’s three-year cumulative loss position is significant negative evidence in considering whether deferred tax assets are realizable, and the accounting guidance restricts the amount of reliance we can place on projected taxable income to support the recovery of the deferred tax assets.
The current accounting guidance allows the recognition of only those income tax positions that have a greater than 50 percent likelihood of being sustained upon examination by the taxing authorities. The Company believes that there is an increased potential for volatility in its effective tax rate because this threshold allows for changes in the income tax environment and, to a greater extent, the inherent complexities of income tax law in a substantial number of jurisdictions, which may affect the computation of its liability for uncertain tax positions.
We record interest and penalties on our uncertain tax positions in income tax expense.
We record the tax effects of Foreign Derived Intangible Income (FDII) and Global Intangible Low- Taxed Income (GILTI) related to our foreign operations as a component of income tax expense in the period the tax arises.
Recently issued accounting pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016- 13, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” amending the accounting for the impairment of financial instruments, including trade receivables. Under previous guidance, credit losses were recognized when the applicable losses had a probable likelihood of occurring and this assessment was based on past events and current conditions. The amended current guidance eliminates the “probable” threshold and requires an entity to use a broader range of information, including forecast information when estimating expected credit losses. Generally, this should result in a more timely recognition of credit losses. This guidance became effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted for interim and annual periods beginning after December 15, 2018. The requirements of the amended guidance should be applied using a modified retrospective approach except for debt securities, which require a prospective transition approach. In November 2019, the FASB issued ASU 2019-10 which finalized the delay of such effective date to fiscal years beginning after December 15, 2022 for private and all other companies including emerging growth companies. As an emerging growth company, the Company adopted this guidance from January 1, 2023, and the adoption of the standard will not have an impact on our financial position or results of operation.
Non-GAAP Measures
In addition to the measures presented in our consolidated financial statements, we use the following non-GAAP measures to evaluate our business, measure our performance, identify trends affecting our business and assist us in
45
Table of Contents
making strategic decisions. Our non-GAAP measures are: Adjusted Income from Operations, Adjusted Operating Margins and Adjusted Net Income. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles in the United States (“US GAAP”). They are supplemental financial measures of our performance only, and should not be considered substitutes for net income, income from operations or any other measure derived in accordance with GAAP and may not be comparable to similarly titled measures reported by other entities.
We define Adjusted Income from Operations as GAAP income from operations excluding the impact of certain non-recurring expenses, including expenses related to COVID-19 protocols. We define Adjusted Net Income as GAAP net income excluding the tax-effected impact of certain non-recurring expenses and income such as expenses related to COVID-19 protocols, unusual litigation fees and non-recurring compensation expenses related to our IPO. We define Adjusted Operating Margins as adjusted income from operations divided by revenue.
We use these non-GAAP measures, along with U.S. GAAP measures, to evaluate our business, measure our financial performance and profitability and our ability to manage expenses, after adjusting for certain one-time expenses, identify trends affecting our business and assist us in making strategic decisions. We believe these non-GAAP measures, when reviewed in conjunction with U.S. GAAP financial measures, and not in isolation or as substitutes for analysis of our results of operations under U.S. GAAP, are useful to investors as they are widely used measures of performance and the adjustments we make to these non-GAAP measures provide investors further insight into our profitability and additional perspectives in comparing our performance over time on a consistent basis.
The following table reconciles Income from Operations to Adjusted Income from Operations and Adjusted Operating Margins, as well as Net income to Adjusted Net Income for the periods presented.
For the year ended
December 31,
2022
2021
Income from operations
$
5,091,978
$
7,724,730
Adjustments:
Non-recurring IPO-related compensation
255,871
—
Arbitration legal fee
221,258
—
Anti-dumping penalty (1)
124,865
—
COVID one-time expenses
—
115,900
Adjusted income from operations
5,693,972
7,840,630
Revenue
$
161,718,543
$
181,943,027
Adjusted operating margins
3.5
%
4.3
%
(1) Represents an additional charge related to one-time anti-dumping/countervailing duty legal fee, as shown in prior periods.
For the year ended
December 31,
2022
2021
Net Income
$
3,679,920
$
7,905,916
Adjustments:
Non-recurring IPO-related compensation
255,871
—
Arbitration legal fee
221,258
—
Anti-dumping penalty (1)
124,865
—
COVID one-time expenses
—
115,900
Other income (PPP Loan)
—
(1,680,900)
Total
4,281,914
6,340,916
Tax impact of adjustment at 18% effective rate
(108,359)
281,700
GILTI high tax re-selection
(338,044)
Adjusted net income
$
4,173,555
$
6,284,572
(1) Represents an additional charge related to one-time anti-dumping/countervailing duty legal fee, as shown in prior periods.
46
Table of Contents
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
We are a smaller reporting company as defined in Regulation S-K and are not required to provide the information under this item.
47
Table of Contents