Flexsteel Industries, Inc. (NASDAQ:FLXS) Q1 2024 Earnings Call Transcript

Flexsteel Industries, Inc. (NASDAQ:FLXS) Q1 2024 Earnings Call Transcript November 4, 2023

Operator: Good morning, and welcome to the Flexsteel Industries First Quarter Fiscal Year 2024 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Derek Schmidt, Chief Operating Officer and Interim Chief Financial Officer for Flexsteel Industries. Please go ahead.

Derek Schmidt: Thank you, and welcome to today’s call to discuss Flexsteel Industries’ first quarter fiscal year 2024 financial results. Our earnings release, which we issued after market close yesterday, Tuesday, October 31, is available on the Investor Relations section of our website at www.flexsteelindustries.com, under News and Events. I am here today with Jerry Dittmer, President and Chief Executive Officer. On today’s call, we will provide prepared remarks, and then we will open the call to your questions. Before we begin, I would like to remind you that the comments on today’s call will include forward-looking statements, which can be identified using words such as estimate, anticipate, expect and similar phrases. Forward-looking statements, by their nature, involve estimates, projections, goals, forecasts and assumptions and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements.

Such risks and uncertainties include, but are not limited to, those that are described in our most recent annual report on Form 10-K as updated by our subsequent quarterly reports on Form 10-Q and other SEC filings as applicable. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. Additionally, we may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of GAAP to non-GAAP measures. And with that, I will turn the call over to Jerry Dittmer.

Jerry?

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Jerry Dittmer: Good morning, and thank you for joining us today. I am pleased to share with you our first quarter fiscal year 2024 results. While our industry faces challenging business conditions and several of our publicly traded peers have seen double-digit sales decreases in the recent quarter, we have leveraged our growth initiatives to offset these challenges and deliver sales within 1% of the prior year quarter. This year-over-year sales comparison is adversely impacted by the elimination of ocean freight surcharges, which reduced revenue by approximately $7 million, compared to the prior year quarter. In the prior year, we used this surcharge mechanism to pass through higher cost of ocean container delivery, which were significantly inflated due to supply chain issues.

Container delivery costs normalized throughout the last fiscal year and we subsequently eliminated this surcharge. Excluding the $7 million impact from this ocean freight surcharge elimination, sales growth related to unit volume and product mix was a robust 6.8%, reflecting our strong sales execution and the momentum of our growth initiatives. Our ability to drive growth in a difficult industry environment reinforces that we are competing well and gaining share. In addition, we continue our focus on operational efficiency and cost savings, which propelled a gross margin of 19.5% in the first quarter, compared to 16% in the same quarter of the prior year. This margin expansion helped fund additional investment in growth initiatives while still delivering improved operating income of $1.9 million, compared to $0.4 million in the same quarter of the prior year.

We expect the business environment in the near term to remain challenged. The industry is arguably already in a recession as consumers have shifted discretionary spending to experience-based expenditures like travel and entertainment and away from higher-priced hard goods like appliances, electronics and home furnishings. The list of headwinds working against the economy and consumer spending continues to grow. High interest rates and mortgage rates, rising fuel prices, geopolitical concerns, U.S. government uncertainty, student loan payment restart, shrinking pandemic savings, and rising credit card debt. Despite these external challenges, our team isn’t deterred and remained intensely focused on profitably growing our business in fiscal year 2024.

We enter the second quarter with positive momentum and are confident in our ability to grow sales both compared to last year and the first quarter, while also improving gross and operating margins over the first quarter. Our strategies are working. We’ll continue to innovate, drive expedient and relevant new product development and build strong brands. Regardless of demand uncertainties, we remain aggressive in identifying new growth opportunities while prudently managing costs and investing for future growth and profit enhancement. I’ll now turn the call over to Derek to discuss our strategic initiatives and financial results as well as our outlook for quarter 2 2024. I’ll be back at the end of the call with some closing comments on what we see ahead.

Derek Schmidt: Thank you, Jerry, and good morning, everyone. Like Jerry, I’m confident in the outlook for our business while cognizant of the near-term headwinds we may face. At the recent October market in High Point, North Carolina, we held numerous encouraging conversations with customers, suppliers and others in the industry. I’ll share a few highlights of the quarter, what we took away from High Point market, and how they shape our view of the remainder of the fiscal year. First, we debuted our new showroom at the October Market along with 36 new product groups. Our sales team was energized and excited to take customers and suppliers through the new showroom, which provided an excellent showcase for both our current and new product lines.

The feedback from customers was extremely positive. Many noted that the traffic and energy levels were exceptionally strong in our showroom compared to others they visited, which gives us encouragement that we are competing well and differentiating through our focus on innovation and new products. Second, on past calls, I have mentioned that Zecliner, our new sleep solution recliner has been a big success. Through the first quarter, we have over 760 retailers that have placed the product on their floors with even more committing to initial placement orders at the October Market. Notably, we have seen repeat orders in excess of 60% from retailers who initially placed the product, demonstrating strong adoption by consumers. We also recently engaged an independent third party to conduct a sleep study of individuals who don’t regularly sleep in a bed.

The study compared their experience sleeping in the regular recliner chair or sofa over a 4-week period to sleeping in a Zecliner over the same time period, analyzing over 700 nights of sleep. This study found that Zecliner significantly improved perceived sleep among people who originally slept at least part of the night on a different recliner, chair or sofa. The study results also showed that 95% of individuals felt Zecliner was a better solution than other products they used in the past and 84% felt Zecliner helped improve their sleep. These results show the strength and potential of our product in this category. And we plan to expand our marketing using these study results. In addition, at the October Market, we introduced an extension to our line with [ Zofa ], a sleep solution sofa.

We plan to continue to innovate and expand offerings in the sleep solutions space. Third, we continue to expand the distribution of Flex, our modular seating line to traditional brick-and-mortar retailers where it is placing well. We also launched several differentiated functional pieces to the Flex line at October Market, including a technology hub, storage center, pet bed, and a sleep kit. We will continue innovating and expanding this platform to drive future growth as well. Finally, we continue to grow our big box distribution, notably with Costco through costco.com. Revenue generated through this customer contributed to the 10.7% growth in e-commerce sales in the quarter. In addition, we recently expanded our marketing effort through our first Costco in-store roadshow event to showcase our Flex modular furniture collection.

We have several more of these events scheduled throughout the remainder of the fiscal year and look forward to using these in-store events to further our brand awareness and customer reach. The positive energy from our interactions at Market and the success of our strategic initiatives, provides us confidence that we are well positioned to navigate the choppy near-term industry conditions and deliver sales and profit growth for the fiscal year. With that, I’ll now give you some additional details on the financial performance for the first quarter and the outlook for the second quarter of fiscal year 2024. For the quarter, net sales were $94.6 million, within our guidance of $92 million to $100 million provided during our fourth quarter fiscal 2023 earnings call.

As Jerry noted earlier, sales growth related to unit volume and mix, which excludes ocean freight surcharges, was a strong 6.8% in the quarter. And we feel we have sustainable growth momentum in both the retail and e-commerce channels. From a profit perspective, the company delivered operating income of $1.9 million or 2% of sales in the first quarter, which was within our guidance range of 1% to 3%. Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $3 million, working capital of $118.3 million, and a balance on our revolving line of credit of $33 million. Working capital and our debt balance did increase from the fourth quarter due to a reduction in payables and the normal timing of several large annual payments occurring at the beginning of our fiscal year.

Going forward, we expect inventory reduction and profit improvement to be meaningful sources of cash in fiscal year 2024 to aggressively pay down debt. Looking forward, sales guidance for the second quarter is between $94 million and $100 million, which represents sales growth of 1% to 7%. Similar to the first quarter, year-over-year net sales comparisons will be unfavorably impacted by the elimination of ocean freight surcharge revenue of approximately $4 million. Excluding the ocean freight surcharge impact, growth related to unit volume and mix has been forecasted between 5% and 12%, reflecting the strong momentum of our growth initiatives and continued share gains. Regarding profitability, we expect second quarter gross margin to improve from the first quarter with a forecasted range of 19.6% to 20.6%.

We expect gross margins to grow throughout the fiscal year with expected sales growth and continued realization of our cost savings and operational efficiency initiatives. We continue to prudently manage SG&A spending while investing in our growth initiatives, and expect SG&A costs between $16 million and $17 million for the quarter, similar to the first quarter. We are projecting operating income as a percent of sales in the range of 2% to 4% for the second quarter and expect operating income margins to improve throughout the year in parallel with forecasted gross margin improvement. The most significant drivers of variability in the second quarter guidance range continue to be consumer demand and competitive pricing conditions, both of which will be shaped by macroeconomic factors.

Regarding our cash flow outlook, working capital is expected to be a major source of cash flow in the second quarter and full year as we anticipate inventories to steadily decline throughout the year. Near-term priorities for cash remain reducing debt, resourcing new innovations, and funding modest capital expenditures mainly related to cost savings projects and continued modernization of IT systems. We expect debt levels at the end of fiscal 2024 in the range of $0 million to $15 million. For the second quarter, we expect capital expenditures between $1.5 million and $2 million. The effective tax rate for fiscal 2024 is expected to be in the range of 29% to 32%. Now I’ll turn the call back over to Jerry to share his perspectives on our outlook.

Jerry Dittmer: Thanks. While we expect business conditions to be choppy in the near term, I am confident that we are taking the right steps to secure profitable growth and our long-term growth outlook remains promising. We are well positioned to successfully deliver improved earnings and an even stronger balance sheet over the remainder of fiscal year 2024. With that, we will open the call to your questions. Operator?

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question is from Anthony Lebiedzinski of Sidoti. Please go ahead.

Anthony Lebiedzinski: Good morning and thank you taking the questions. So I guess, first, just a quick comment. I thought it was helpful that you guys provided the impact of freight surcharges for first quarter of last year and you gave an indication about the second quarter. So as we look beyond the second quarter as far as the second-half of last year, was there anything meaningful to call out as far as rate surcharges? Or was it less of an issue? If you could just remind us about that.

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Q&A Session

Derek Schmidt: Yes, Anthony, it’s Derek. So it dissipates throughout the year. So for the third quarter, the impact of the surcharges would be a little less than $3 million. And in the fourth quarter, it’s a little less than $1 million. So we unwound those ocean freight surcharges gradually throughout the year, hence why you see a decrease in the year-over-year impact to revenue.

Anthony Lebiedzinski: Got it. Yes, thanks, Derek. And then in terms of the growth initiatives, can you perhaps maybe quantify how much that impacted your first quarter sales results, and as far as your outlook for the balance of the year? Just looking to get more clarity about how much is Flex, Zecliner and big-box expansion helping you guys?

Derek Schmidt: Yes. No, the color I can provide, Anthony, is I prefer not to give you exact numbers, but the growth initiatives were a substantial factor in terms of our growth. If you were to take those out, I mean, our business would probably be down not as large as certainly our external kind of peers, but it would be down probably in the high single-digit, low double-digit range. So really, the growth initiative — the good thing is the growth initiatives are working, we’re building momentum, and we believe, again, there’s room for the revenue from those growth initiatives to continue to expand, which we believe at this time will allow us to grow every single quarter here year-over-year for the remainder of the year.

Jerry Dittmer: The other piece of that too, Anthony, is we continue to come out with more line extensions and more of these growth initiatives that are going to also help us in the future. You might remember at Market, both Flex and Zecliner, there are additional SKUs and products that we brought out to enhance those even more.

Anthony Lebiedzinski: Got it. Yes, yes. And certainly, the new showroom looked pretty good as well. So as far as the gross margin improvement, certainly nice job there as well. And it sounds like you expect continued improvement there. So I mean, given the overall improvements to the business, I mean, as we look out beyond fiscal ’24, I mean can we get to — I mean, what’s your sense as to like where gross margins could go to, assuming, of course, a normalized demand environment?

Derek Schmidt: Yes. I think, certainly, our target to end the year would be closer to 21%. So exit this year closer to a 21% gross margin. And then continue to kind of grow the top line and leverage fixed cost to expand that into fiscal year ’25.

Anthony Lebiedzinski: All right, that’s very helpful. And then in terms of SG&A dollars, so those were up around 13% looks like for this quarter here. And I know you gave guidance for Q2 as well. But then kind of looking beyond that, I mean, I know you guys are investing in your growth initiatives. But I guess longer term, I mean, how fast will those expenses grow? I mean what is your outlook for that?

Derek Schmidt: Yes. I would expect, Anthony, for the remainder of the year for SG&A — quarterly SG&A to kind of be within that $16 million to $17 million range per quarter. I think as we think about fiscal year ’25, I would expect SG&A to grow at a lower rate than the overall top line. So we would expect to leverage fixed costs, including SG&A investments kind of going forward. So there is more investment there to be had to continue to propel the top line, but it would grow at a rate lower than our overall top line, in future years.

Anthony Lebiedzinski: All right. Well, sounds good. That’s all I have. I’ll pass it on to others. Well, thank you very much, and best of luck.

Derek Schmidt: Thanks, Anthony.

Operator: The next question is from Bud Bugatch of Water Tower Research. Please go ahead.

Bud Bugatch: Good morning. Jerry and Derek, congratulations on a good quarter. I had a couple of questions. I know that the sales growth in dollars were 6.8% excluding the freight surcharge on an apples-to-apples basis. But on a units basis, you talked about units and mix, can you give us an idea on units how that growth was like, for example, upholster receipts, how did that grow year-over-year?

Derek Schmidt: Yes. The way we think about the product categories, Bud, manufactured kind of stationary and sourced soft seating are probably our largest categories. They encompass almost about 90% of our sales. So to give you some perspective on units, our sourced soft seating business on units was up 13.7% year-over-year and manufactured stationery was up 3.7%. So we feel good about both of those numbers, and I think they’re reflective of the fact that we’re competing well in the market and gaining share.

Bud Bugatch: And the manufactured growth is where you would get leverage on cost of goods sold, is that the way to think about that? The sourced product is primarily variable cost?

Derek Schmidt: Primarily — I mean there’s two ways to think about it. Manufactured, certainly, we’d be leveraging our fixed cost structure related to our plants. But we also have three distribution centers. And so the way I think about growing our sourced business, that does leverage the fixed cost of our distribution network as well.

Bud Bugatch: Okay, thank you. That gets me into the cost of goods sold and the composition of it. But I think, if I remember right, and correct me if I’m wrong, because my memory is old like I am, and failing. You had talked about a couple of years ago maybe getting gross margins into that 20% range, and that kind of was the target. And if I look back historically, I think the largest — the highest gross margin percentage that I see going back five or six years ago, particularly for that second quarter was like about 22.6% for the end of the year, maybe close to 23%. Is that the high watermark? Where are you looking to — and how do you get there?

Derek Schmidt: So first of all, when you look back four or five years ago, you have to remember that the composition of our business was much different than it is today. Recall that we exited hospitality, health care, commercial office, RV seating. Those businesses — many of those businesses had a higher gross margin, but they also had a significant SG&A load. And so the split between gross margin and SG&A as a percent of sales has changed because of that mix. So one, the historical comparisons aren’t the best benchmark. That said, going forward, we’ve talked about our aspiration is to get gross margins up in that 22% to 23% range. And I think with continued top line growth, with prudent management of our fixed cost structure, and continued cost savings, we have a path to get there over the next several years.

Bud Bugatch: Okay. And MLO or the components of cost of goods sold, how should we think about that? Materials, particularly in the manufactured, somewhere around 50%, Labor 10% and the balance between Overhead and distribution and transportation. How do you get there?

Derek Schmidt: Yes. You’re not probably too far off, Bud. Materials — it’s a little bit difficult because on the sourced side, we’re buying finished goods. So I don’t have visibility in terms of the breakout between materials, labor overhead for our sourced business. But in general, materials, 50% to 60%, you’re right, labor and overhead kind of in that 20% to 25% range, and then logistics about 15%.

Bud Bugatch: And the logistics would impact primarily the — I mean, not primarily, but the sourced goods would be primarily a logistics hit to cost of goods sold. You bring the inventory in and you add logistics cost to the inventory and it works its way through as it’s sold, is that the way to think about that? And that’s where you get the…