Flexsteel Industries, Inc. (NASDAQ:FLXS) Q4 2023 Earnings Call Transcript

Flexsteel Industries, Inc. (NASDAQ:FLXS) Q4 2023 Earnings Call Transcript August 23, 2023

Operator: Good morning, and welcome to the Flexsteel Industries Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. All participants’ will be in a listen-only mode. [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 fourth quarter and fiscal year 2023 financial results. Our earnings release, which we issued after market close yesterday, Monday, August 21, is available on the Investor Relations section of our website at www.flexsteel.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.

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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?

Jerry Dittmer: Good morning, and thank you for joining us today. I am pleased to share with you our fourth quarter and fiscal year 2023 results. We continued our strong momentum in the fourth quarter, delivering sales of $105.8 million, which was within our guidance range and represents sequential quarter-over-quarter growth of 6.8% compared to the third quarter. While we continue to face market headwinds in the form of pricing pressure and slowing consumer demand, we are executing well, and our growth initiatives are adding meaningful revenue to offset these challenges. Our growth initiatives, along with a continued focus on operational efficiency and controlling costs, enabled us to expand our gross margins and deliver operating income for the quarter of $4.2 million or 4%, which was in the upper range of our guidance.

While economic uncertainty and market headwinds will remain a challenge in fiscal year 2024, I am encouraged by the positive impact of our strategic priorities and excited to continue our momentum in fiscal year 2024. Looking back on fiscal year 2023, it was a very challenging yet exciting year. Coming off a year in 2022 of record high sales due to post-COVID demand, we were faced with slowing consumer demand, which was compounded by a glut of retail inventory that was ordered to meet expected post-COVID demand but backlogged due to supply chain disruptions. At the same time, the industry experienced pervasive price reductions as many manufacturers and retailers quickly dropped prices in response to lower ocean freight and other cost inputs, forcing others to follow suit.

The imbalance between supply and demand further intensified pressure to lower prices in order to remain competitive. And while ocean container rates began to return to normal levels, fuel prices surged. Despite the significant decline in year-over-year sales caused by these challenges, our strong team of dedicated employees identified the obstacles early and executed plans to navigate them, which resulted in higher full year operating income of $10.5 million compared to $6.6 million in the prior year. It was exciting to see the advancement of our strategic growth initiatives which included expanding our big-box distribution channel, launching our Zecliner sleep solutions recliner and our flex contemporary modular furniture solution and launching the new Charisma brand.

The impact of these growth initiatives created sequential quarter-over-quarter sales growth in the second half of the fiscal year despite the challenges already mentioned. We continue to see near-term challenges due to competitive pricing pressure and a return of demand to pre-pandemic levels amid macroeconomic uncertainty. However, we are maintaining our commitment to our strategic priorities in delivering long-term profitable growth. With that in mind, we will continue to invest pragmatically in growth initiatives to drive sales and focus on operational excellence to drive margin expansion. I’ll now turn the call over to Derek to discuss our strategic initiatives and financial results as well as our outlook for Q1 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 optimistic about the trajectory of our business and feel great about the momentum we’ve built with our growth initiatives. A few noteworthy highlights to share. With respect to new sales distribution, we continue to execute well and gain momentum with big-box customers most notably Costco. Big box represented approximately 5% of our total sales in the fourth quarter and is expected to grow faster than our other channels in fiscal year 2024 as we expand the breadth of product offerings and optimize our marketing and demand generation efforts within this channel. As important, we are building Flexsteel brand awareness with a different consumer audience through big box, which we feel will have positive, long-term growth benefits across all our channels.

In new product categories, we had good, early success with flex, which is our small parcel, contemporary, modular furniture solution. Flex was initially launched in the big-box channel last quarter, and we’ve accelerated distribution expansion to make flex available across a wide variety of selling platforms, including e-commerce partners like Amazon; Wayfair; Overstock, which recently rebranded itself as Bed Bath & Beyond; homedepot.com; and our own direct-to-consumer site, www.flexsteelstore.com. In addition, we are aggressively expanding flex into brick-and-mortar retail with our strongest, independent retail partners. New product additions will be released in October with additional plans developed to meaningfully expand the line over the next 18 months.

Zecliner, our new sleep solutions recliner, has become a home run. Over 500 retailers have placed the product with strong initial sales. We’ve also signed up multiple regional sleep store chains with more anticipated in fiscal year 2024. We expanded the line in April and have more innovation planned for release in October. This is an exciting category, and our plan is to stay ahead of any competition by constantly innovating. To expand our customer base. Last year, we launched our new Charisma brand, targeting the style and price preferences of younger consumers. With a major competitor in the sub-$1,000 sofa market recently closing their operations, we have an opportunity near term to gain additional retail penetration with Charisma. In the mid-term, we are also pursuing cost-efficient innovations to bolster Charisma’s brand position of differentiated quality and comfort at affordable prices.

The success of these new growth outlets coupled with our continued investments in our core business give us confidence to profitably grow the company in fiscal year 2024 and beyond. We are also proud to have published our first annual ESG report, which can be found on our website at www.flexsteelindustries.com. This report lays out the foundation of our approach to environmental, social and governance matters and formalizes our ongoing commitment to sustainable and responsible business practices. We are dedicated to making a positive difference wherever we can guided by the belief that not only is it the right thing to do, but it’s also the right thing for our business long-term. We are already combining sustainable business practices with product innovation to bring differentiated value solutions to the market as exemplified by our new Sky seating line, which utilizes CloudLux, a cushion fill made from recycled plastic bottles.

Not only does CloudLux provide exceptional comfort, but every three-piece Sky sofa helps prevent 730 plastic water bottles from entering waterways and landfills. We’re excited about our ESG journey and convinced that we can positively impact people, communities and our planet while also supporting and accelerating our growth strategies through these efforts. With that, I’ll now give you some additional details on the financial performance for the fourth quarter and the outlook for the first quarter of fiscal year 2024. For the fourth quarter, net sales were $105.8 million, within our guidance of $100 million to $110 million, provided during our third quarter earnings call. More importantly, our sales results represent a sequential increase of 6.8% from the third quarter, which is our second consecutive quarter of sequential sales growth and reflects the strong sales momentum driven by our growth initiatives.

From a profit perspective, the company delivered operating income of $4.2 million or 4% of sales in the fourth quarter, which was at the high-end of our guidance range and represents a continuation of sequential quarter-over-quarter operating margin improvement throughout fiscal year 2023, even with increased strategic investments to support long-term growth. Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $3.4 million, working capital of $115.5 million and a balance on our revolving line of credit of $28.3 million, a 25% decrease from the prior year. Working capital and our debt balance did increase from the third quarter, due to the timing of inventory receipts, which were heavier in the fourth quarter as we bring in new products and additional inventory to support our growth initiatives.

However, compared to prior year, we have executed our plan to reduce inventory levels and pay down debt and our balance sheet remains strong. We continue to prioritize debt reduction and expect inventory to be a meaningful source of cash in fiscal year 2024 to further pay down debt. Looking forward, sales guidance for the first quarter is between $92 million and $100 million. The first quarter is historically our slowest quarter of the year as furniture purchases are often deferred by consumers in favor of travel and entertainment during the summer months. That said, we are anticipating year-over-year unit volume growth in the low to mid-single digits as a result of our growth initiatives. But the elimination of ocean freight surcharges which occurred in the most recent quarter, will reduce revenue by approximately $5 million, compared to the prior year first quarter and ultimately keep year-over-year total sales dollars relatively flat.

This revenue drag from the prior year ocean freight surcharges will lessen throughout the year, and we expect our growth initiatives, which have begun to drive meaningful revenue to more than offset this and result in subsequent quarter-over-quarter and year-over-year sales growth. Regarding profitability, we expect gross margins between 18% and 19.5% in the first quarter. We expect gross margins to grow modestly throughout the fiscal year with expected sales growth and continued operational productivity. Near-term, the recent strength of the Mexican peso versus the U.S. dollar is having an adverse impact on our margins given our large manufacturing presence in Mexico and is masking the favorable benefits of our operational efficiency gains.

We will continue to prudently manage SG&A spend, while investing in our growth initiatives, and expect SG&A costs between $15.5 million and $16.5 million for the quarter. We are projecting operating income as a percent of sales in the range of 1% to 3% in the first 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 first 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 source of cash flow in the first quarter and full-year as we anticipate inventories to steadily decline throughout the year.

Near-term priorities for cash remain reducing debt, resourcing new innovation and funding capital expenditures. We may continue to be opportunistic with share repurchases at modest spending levels if the stock price remains at a significant discount to our view of intrinsic value. We expect debt levels at the end of fiscal 2024 in the range of $0 million to $15 million. And for the first quarter, we expect capital expenditures between $1.5 million and $2.5 million. The effective tax rate for fiscal 2024 is expected to be in the range of 27% to 29%. Now I’ll turn the call back over to Jerry to share his perspectives on our outlook.

Jerry Dittmer: Thanks. While economic uncertainty remains, I am confident that our long-term growth outlook remains promising. Our team’s commitment to profitable growth and the foundations we have put in place have positioned us to successfully deliver improved earnings and an even stronger balance sheet in fiscal year 2024. We are focused on our strategic growth initiatives, investing in future innovation and delivering sustainable profit through operational efficiencies while continuing to reduce inventory levels and pay down debt. In summary, we’re enthusiastic about fiscal year 2024 and the long-term growth opportunities for the company while being mindful that we still face near-term economic uncertainty. With that, we will open up the call to your questions. Operator?

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Budd Bugatch of Water Tower Research. Please go ahead.

Budd Bugatch: Thank you. Good morning, Jerry. Good morning, Derek. Thank you for taking my questions.

Jerry Dittmer: Yes, good morning, Budd.

Budd Bugatch: Just can you talk a little bit about the revenue pattern and the way it materialized during the quarter? How did it look year-over-year? And maybe talk about units versus price as it came out for the first — for the fourth quarter?

Derek Schmidt: Actually, if you were to look at the quarter, Budd, we started probably the quarter a little bit slow in April and then saw a really nice pick up in May and June kind of around Memorial Day Holiday. So I feel like we finished the quarter strong. It’s interesting. Year-over-year, total net sales were down 15%. Unit growth was actually up 2% year-over-year. So all the decline in the net sales number was related to pricing, of which a large amount of that pricing decline was related to ocean freight surcharges. So if you remember, if you go back 12 months ago in Q4 of fiscal year ‘22 is when we had peak ocean freight rates, probably our surcharges were at their peak. And then we virtually — I mean we eliminated those ocean surcharges here in our most recent fourth quarter.

So there was a big revenue decline related to that. But we feel good about our momentum in the market, the fact that we had positive year-over-year unit growth and then we’re anticipating carrying that momentum into Q1 and expect to have mid-single-digit unit growth in the upcoming quarter as well.

Jerald Dittmer: So Budd, most of that pricing is behind us. We will see some of that as the year goes on. There will be probably $4 million, $5 million of it we’ll see here in this first quarter from the pricing actions, and that’s because we — in May when we took the last of our ocean freight charges away. So it would be pretty encouraging, probably the most encouraging thing we really saw in the fourth quarter was our unit volume being up year-over-year. That was very encouraging.

Budd Bugatch: I agree. I’m painfully aware of what happened to ocean freight during the post-pandemic time frame. And historically, much of your sales were retailer-based and special orders. Now with the big-box strategy, I take it that there’s a lot more placed on stock. How is — how did that balance unfold during the quarter? And what do you see going forward on that?

Derek Schmidt: Yes. In terms of, again, unit volume, we feel good about really performance in both traditional retail, as well as kind of our e-commerce pursuits, including big box. So I think we’re competing well in kind of both channels. Obviously as we alluded to in our opening remarks, we expect that big box will grow faster than the other channels given the fact that, again, this is a relatively kind of new probe for us. But beyond that, we’re not seeing really any material kind of changes in mix.

Budd Bugatch: And are you seeing better reports from your retailers? You have a wide swath of retailers throughout the country? How is their demand looking? What can you see from that from your incoming order book?

Jerald Dittmer: Yes, Budd, so our retailers are not panicking at all. They’re actually — it’s pretty strong, especially year-over-year. And as Derek said, both the retail and the big box are both up year-over-year, especially on the order side, which is very encouraging. Obviously, we are worried like everybody about what’s going to happen if there’s going to be an economic slowdown. But right now, we really haven’t seen that. So we’re pretty encouraged where we’re at right now.

Derek Schmidt: Yes. Orders for the fourth quarter, actually, total company were up 20% year-over-year. So again, we feel like we’re competing well. As Jerry alluded to, most retailers will tell us that traffic is a bit slow. So the fact that we’re seeing pretty robust year-over-year order growth would suggest certainly that we’re gaining some share and we have good momentum.

Budd Bugatch: I’ll ask just a couple of more, but let some others have at it. Just the gross margin progress was notable. Can you give us a little bit of color on that? You called it from operational efficiencies. How does it look like with the material labor and overhead? What’s — where were those efficiencies and the reduced inventory write-downs, give us some color on that and maybe a walk from quarter-to-quarter or year-to-year?

Derek Schmidt: Yes. So from a productivity and operational efficiency standpoint, Budd, we made really good gains across all the aspects of our supply chain. So that’s manufacturing, that’s global sourcing, that’s logistics. So we have three strong leaders in each of those areas, and they’re doing a great job executing from my viewpoint in terms of just constantly driving cost savings. They’ve been doing that all fiscal year ‘23. Unfortunately, a lot of that got used to fund some price concessions in the market. So good momentum on that front. And I’m sorry, Budd, the second part of your question? Operational efficiencies?

Budd Bugatch: Right. Yes, what do you see going forward on that? How far can you take the gross margin level?

Derek Schmidt: Yes. Again, we’ve talked about near-term, mid-term, certainly, our goal is to get our gross margins at or above kind of 20%. Continued operational efficiency will be a really important part of that. The other piece that you noted, which was in the press release is year-over-year reduction in inventory kind of write-downs. If you remember in fiscal year ’24, Q4, we had a lot of inventory. We put reserves against some of that because demand was slowing. So that comment as it relates to fiscal year ’23, Q4 was simply — there was a negative kind of comparison in fiscal year ’22. So overall, we feel good about our inventory levels, the quality of inventory. So no concerns on that front. So I think as we go forward, we feel pretty confident around our ability to continue to expand overall margins throughout fiscal year ’24, and the big levers there are two-fold. It’s continued operational efficiencies and then second, volume leverage.