Flexsteel Industries, Inc. (NASDAQ:FLXS)
Q1 2023 Earnings Conference Call
October 25, 2022 9:00 AM ET
Company Participants
Alejandro Huerta – Chief Financial Officer
Jerry Dittmer – President and Chief Executive Officer
Derek Schmidt – Chief Operating Officer
Conference Call Participants
Anthony Lebiedzinski – Sidoti & Company
JP Geygan – Global Value Investment Corporation
John Deysher – Pinnacle
Presentation
Operator
Good morning, and welcome to the Flexsteel Industries First Quarter and Fiscal Year 2023 Earning Conference Call. All participants will be in 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.
Now I’d like to turn the conference over to Mr. Alejandro Huerta, Chief Financial Officer for Flexsteel Industries. Please go ahead, sir.
Alejandro Huerta
Thank you, and welcome to today’s call to discuss Flexsteel Industries first quarter fiscal-year 2023 financial results. Our earnings release, which we issued after-market close yesterday, Monday, October 24, is available on the Investor Relations section of our website at www.flexsteel.com under News & Events.
I am here today with Jerry Dittmer, President and CEO; and Derek Schmidt, Chief Operating 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 the 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. Our performance in the first-quarter was solid given the challenging conditions we faced, including slowing consumer demand, competitive pricing pressures attempting to relieve a lot of retail inventory, as well as macroeconomic headwinds driving continuing inflationary pressures and challenges. I am encouraged by the fact that we were well-prepared for these challenges and we’re able to deliver sales for the quarter of $95.7 million, which was above the range of our guidance of $80 million to $90 million.
While we saw an expected slowdown in sales, we continue to prudently manage our spending and deliver on our cost-efficiency initiatives through delivering operating income of $0.4 million for the quarter or 0.4% of revenue, which was also above our guidance range of negative 3.5% to 0%. Near-term challenges will continue to create choppiness in our short-term results. However we remain committed to delivering long-term profitability.
During our fourth quarter call I went into details on the challenges that our industry is facing and will not reiterate those today. The organization is focused on navigating these challenges and delivering on our strategic initiatives that will deliver long-term success.
Now I’ll turn the call over to Derek to discuss our strategic initiatives and operational priorities before Alejandro takes you through further details of our financial results. I’ll be back at the end-of-the call with some closing comments and what we see ahead.
Derek Schmidt
Thank you, Jerry, and good morning, everyone. We remain on offense. As Jerry noted, business conditions are challenging and will likely remain that way for at least the next six to nine months, but we’re committed to profitably growing by gaining share from competitors in existing markets and targeting new markets of growth where we can deliver differentiated value to our customers.
As we discussed during the fourth quarter call, our growth strategy for new business has three legs: new sales distribution, new product categories and new consumer segments. We have well-defined initiatives and plans for each of these areas and we are executing to those plants. I am encouraged by our progress to start the year and excited about the long-term sales potential of these initiatives. Let me share a few highlights.
Beginning with new sales distribution, we’ve made a breakthrough with a major big-box retailer who is or will sell a meaningful number of Flexsteel branded products this year that spend all three of our major product categories, motion furniture, stationary furniture and casegoods. Our brand fits well with their consumers and given early sales success, we think they could become a top 10 customer of this fiscal year. We are investing in the relationship and new support capabilities to ensure this becomes a long-term sustainable and profitable partnership.
Next is new consumer segments. We recently launched our new brand Charisma, designed to serve customers, especially younger generation seeking good-quality stylish furniture at affordable popular prices. While these solutions are value-oriented, we’ve utilized our engineering prowess and manufacturing capabilities to reach these lower-price points without making compromises in quality and comfort that we see in so many of our competitive offerings.
Customer feedback has been great. We have a healthy backlog of orders already. The initial lineup started production last week at our Juarez facility and consists of larger-scale comfortable sofas and sectionals that are popular with younger consumers right now. We’ll continue to expand the Charisma portfolio with new product every six to 12 months, including diverse sizes and styles of furniture that are on-trend for this targeted consumer demographic.
Last is new product categories. We remain on-track for a third quarter launch of our new Zecliner sleep solution recliner and Flex, our small parcel contemporary modular furniture solution built to flex with people’s ever-changing lives. We recently unveiled these products to customers and received excellent feedback. In summary, we are thrilled with our progress on these growth initiatives. Market conditions and sales results might be choppy near-term, but we are making meaningful advancements in our strategic vision for the company, which will position us for long-term success.
Lastly, we continue to deliver strong results from our cost-savings initiatives. In the near-term these savings are almost entirely being used to fund price reductions to respond to the pricing pressures Jerry noted earlier, and keep us competitive in the market and retain our retail placements. These pricing pressures will eventually alleviate as inventory levels returned to normal and transportation cost stabilize. So the momentum we are building on cost-savings efforts should translate into higher gross margins.
With that, I will turn it over to Alejandro to give you additional detail on the financial performance for the first-quarter and outlook for the second-quarter of fiscal year ’23.
Alejandro Huerta
Thank you, Derek. Good morning everyone. For the first quarter, net sales were $95.7 million, down approximately $42 million or 30.5%, compared to $137.7 million in the prior year period. While down from the prior year, our sales results were better than our $80 million to $90 million guidance range provided during our fourth quarter earnings call. Compared to pre pandemic sales from the first-quarter of fiscal 2020, home furnishing product sales were up $6.5 million or 7.3%.
From a profit perspective, in the first-quarter the company delivered operating income of $0.4 million or 0.4% of sales, which was better than our guidance range of negative 3.5% to 0% for the quarter. We recorded net income of $0.3 million and earnings per diluted share of $0.05.
Adjusted net income for the quarter, which excluded onetime charges related to the unanimously rejected unsolicited bid received in August was $0.5 million and adjusted income per diluted share was $0.09. Gross margin as a percent of net sales in the first quarter was 60%. The decline from the prior year quarter was largely driven by volume decline deleveraging our fixed costs, competitive pricing pressures due to slowing demand and continued inflation in domestic transportation charges, partially offset by our cost-saving initiatives and lower ancillary charges. Operating income was supported by a $4.2 million reduction of SG&A expense, mainly through reduced compensation expense and control of other SG&A spending.
Moving to the balance sheet and statement of cash-flow. The company ended the quarter with a cash balance of $4 million and working capital of $116.1 million, which represents a reduction of $9.3 million during the quarter, primarily driven by a $19.8 million decrease in inventory. The result of the strong working capital management was solid operating cash-flow of $13.0 million during the quarter.
As previously communicated debt reduction is a key priority, and in the quarter we reduced our outstanding borrowings by approximately 20% or $7.7 million. Looking-forward, guidance for second-quarter sales is between $87 million and $97 million, while our first-quarter results were better than guidance, we feel that based on the glut of retail inventory our customers will continue to pull-back on orders or in-stock products, giving us reasons to believe the second quarter will be at a similar or declining level to that of the first-quarter.
Next on our ongoing discussions with customers and distribution partners, we remain cautiously optimistic that retail inventories should normalize in the first-half of calendar year 2023. The result of this continued demand slowdown though will be a near-term drag on our Q2 sales. However, we do expect demand to stabilize and our growth initiatives to begin to realize benefits leading to quarter-over-quarter growth in the second half of the year.
Regarding profitability, competitive pricing pressures along with continued slumping demand will adversely impact our profitability. Our near-term focus will be to continue to pragmatically adjust our costs in-line with lower sales levels. However, we continue to ensure our ability to profitably grow long-term. As such, we are projecting operating income as a percentage of sales in the range of negative 1.5% to 1.5% for the second-quarter, with the largest drivers of variability in the range being consumer demand and competitive pricing pressures.
We expect gross margins in the range of 14.5% to 16.5% in the second quarter, weighed down by fixed-cost deleverage from lower sales and pricing pressures, partially offset by our cost-savings initiatives. If sales improve as expected during the fiscal year, gross margins should improve to the mid to upper teens in the second half. We intend to prudently control SG&A costs and expect SG&A costs between $14.5 million and $15.5 million in the second quarter, which is slightly higher than the first-quarter as we begin to prudently invest in our growth initiatives discussed by Derek.
Regarding our cash-flow outlook, working capital is expected to be a source of cash-flow in the second-quarter and full-year as we plan to steadily decline inventories throughout the year. Near-term priorities for cash remain reducing debt and pragmatically funding high ROI capital expenditures. Opportunistically we may repurchase shares at a modest spending level if the stock price remains at a significant discount to our view of intrinsic value.
We continue to forecast our debt levels at the end of fiscal 2023 in the range of $0 million to $12 million. For the second-quarter, we expect capital expenditures between $0.5 million and $1.5 million. The effective tax-rate for fiscal 2023 is expected to be in the range of 27% to 28%, excluding the impact of any revaluation of deferred tax asset valuation allowances.
Now, I’ll turn the call-back over to Jerry to share his perspectives on our outlook.
Jerry Dittmer
Thanks. We believe the remainder of fiscal year 2023 will be challenging for our industry. As previously discussed, the slowdown in economy, continued inflationary pressures and lower consumer demand will continue to put pressure on our profit margins in the near-term. However, I am pleased with our well-received new products presented during the fall of 2022, a high point market and confident that our team and our long-term priorities will allow us to build upon our solid foundation and deliver long-term profitable growth.
In the near-term, we remain focused on delivering on our strategic initiatives, controlling costs, and generating cash-flow to pay-down debt and preserve liquidity, while opportunistically investing in growth opportunities.
With that, we will open the call to your questions. Operator?
Question-and-Answer Session
Operator
We’ll now begin the question-and-answer session. [Operator Instructions] First question comes from, Anthony Lebiedzinski from Sidoti and Company. Please go ahead.
Anthony Lebiedzinski
Good morning, gentlemen, and thank you for taking the questions. So first, revenue was nicely above the top-end of your guidance for the quarter. Can you talk about what led to the outperformance in the quarter?
Derek Schmidt
Yeah. So Anthony, this is Derek. So we did see exceptional sales lift during Labor Day. So I think, broadly speaking, our retailers performed really well. I think we also saw some improvement in retailer inventories during the quarter which we got a little bit of lift from. But retailer still — I mean, we’re just at a high point market here, we’ve probably seen — saw about 300 of our customers, retailer independent inventories are improving, but we probably have another three, four months to go before we get back to normal. But really strong Labor Day and I think, again, we saw some improvement later in the quarter in terms of retail inventories which helped.
Jerry Dittmer
Hi, Antony, this is Jerry. I’ll just got a little bit farther to is, as Derek said, the Labor Day was really strong. A few weeks after that, of course, we did see it kind of moderate, again slowed down a little bit. So now, we’re really looking towards what November look like was really going to — who really know what the quarter looks like then. And a lot of folks thought their retail inventories would maybe be down by this time. We think most folks still got a good two, three, four months of inventories left that they need to get through. So a lot will depend on just on the consumer out there and the buyer.
Anthony Lebiedzinski
Right. Yes, thanks guys for that. And so — I mean, do you think part of what’s going on now is just a return to sort of more normal seasonality of the business. I mean, before the pandemic typically consumer interest was heightened during holiday periods like Labor Day, like President’s Day. So do you think part of what’s just going on is just — consumers are just going back to those pre pandemic habits?
Jerry Dittmer
Yeah. Anthony, you’re absolutely correct. Where we’ve seen? We saw it at the 4th of July, we saw it at Labor Day. Our belief is, those 68 big selling times, just like we used to see back in 2019 and before, we’ve definitely gone back into that pattern.
Anthony Lebiedzinski
Got it. Okay. Thanks for that. And then you guys talked about the competitive pricing pressures. So can you just maybe elaborate on that maybe, how much do you think that was impacted — how much that impacted the first-quarter? And just — maybe just broadly speak about the unit volume declines versus pricing for the quarter?
Jerry Dittmer
Yeah. I’ll just take a little bit and then I’ll have Darren come in a little bit. I will tell you that, we definitely saw an effect in our margins. Our margin were hit a few points because of that. I think once we get through our inventories then we will see — we’re going to see the benefits of the lower ocean freight, we’re going to see lower priced product, we’re going to be able to start shipping and taking to our consumers. So we definitely will see some margin improvement, we’ve really just got to get through these inventories which — they’ve come down greatly. I mean our inventories are down $75-plus million from their peak and we just need to bring them down here a little bit more over the next several months.
Alejandro Huerta
Hey, Antony. This is Alejandro. Good morning and thanks for the question. Just answering your unit versus sales mix decline. We actually saw pretty stable one-to-one variance between volume and mix — excuse me, units and mix because of seeing a higher manufacturing in the quarter versus other categories. So it was actually pretty stable. Derek, I don’t know if you want to answer that.
Derek Schmidt
No. I was actually going to highlight the same thing. I think what we’re most encouraged by is the strength of our manufactured business. We’ve been talking about our ability to get down to industry leading lead time for several quarters now. So we’re consistently operating at three, four week production lead times. If you look at our sales for our manufactured business, we’re actually up year-over-year by 7%. So where we’ve seen the biggest sales hit in the near-term is our imported products, which are warehoused, which have been adversely impacted, not only by higher ocean freight, but more importantly the glut of retail inventory. But I’m really encouraged, we’re really encouraged by the strength of our manufactured business.
Anthony Lebiedzinski
Okay. That’s great to hear. And then in terms of the comment about the gross margin for the back-half of the year. You guiding to kind of mid to high teens. So what are the main factors that will drive that improvement if you could just go over that that’d be great?
Jerry Dittmer
Well, Anthony, there’s a few things that are going to be driven into that. One is, the deleveraging of our fixed costs. So capacity and volume, we need to grow volume. So as that grows with our initiatives that Derek spoke about, which are manufactured products that we’re focusing on, that should help our gross margin. The other thing that’s going to impact us is getting through this ocean freight swaps and rates and having pricing stabilized. So those are going to be the two key factors we see as impacting our margin and allowing us to get to a more stable mid to high teens.
Anthony Lebiedzinski
Got it. And then lastly –
Derek Schmidt
Antony, I was just going to reiterate. I mean, as Jerry alluded to, we think retailers, it’s going to take another two, three, four months for them to work through their inventories. Once the industry is back to normalized inventory levels, we believe that’s going to take significant pricing pressure away, which will help us normalize our margin structure.
Anthony Lebiedzinski
All right. Thank you for that. And then last question here. So, certainly very nice progress with your own inventory reductions, so given kind of what you know now, will it be reasonable to assume forward inventories by the end of your fiscal year?
Alejandro Huerta
Yeah. So, again, Anthony, I don’t ever want to talk in absolute terms of dollars, because what we’re focused on is velocity in turns. So it’s really going to depend on where demand goes and what our Q1 outlook is going to look like for next fiscal year. So — but we’re targeting a reduction of over all working capital for the year of somewhere between $25 million and $35 million versus year-end fiscal year 2022.
Anthony Lebiedzinski
All right. Thank you very much and best of luck.
Jerry Dittmer
Great. Thanks, Anthony. Appreciate it.
Derek Schmidt
Thank you, Antony.
Operator
Thank you. [Operator Instructions] Next question is from JP Geygan, Global Investment Corp. Please go ahead.
JP Geygan
Hey, good morning, gentlemen. Thank you for taking my questions. I just start with a little bit around your logistics and shipping and you mentioned that a few times. Can you give us an absolute dollar sense of where you’re seeing container rates and the impact on your other shipping cost?
Jerry Dittmer
Yeah. It’s really in two big buckets, Jeff. So we have seen what I would call port-to-port. So from Vietnam, China to LA, Houston, wherever we’re going is very close to where it was pre pandemic. So those costs have really normalized. The good and the bad of that is, we’re excited they’ve come down, they’ve come down really fast. I mean, literally just in the last several months. The costs from going from the port inbound to our distribution centers and to our customers is still really, really high, there is still obviously ancillary charges, labor is still high fuel — diesel has not come down. So those costs are very, very high. And so the two together still make our total logistics costs higher, but we’ve definitely seen a big decrease in the port-to-port charges.
JP Geygan
Great. That’s helpful. Would you speak a little bit about your labor availability and labor cost and how that’s impacting your P&L?
Jerry Dittmer
Yeah. I think it labor availability in terms of our Juarez facilities continues to be strong. So we’re confident that as we grow our manufacturing business, we can ramp-up, we will find the labor to ramp-up accordingly. So no issues whatsoever. And then our [Dublin] (ph) facility, we have a strong workforce — strong stable workforce there. So no labor concerns at this point. Labor costs, still some pressures. In Mexico we do see a statutory increase every year in the neighborhood of 20% plus, we expect that to continue. But our labor costs are still very competitive in that region of the continent.
JP Geygan
Yeah. Great. With that type of statutory acceleration in labor cost you must focus a fair amount on productivity. What can you share with us about that?
Jerry Dittmer
Yeah. Actually, despite the fact that we’ve seen some slowdown in volume, all of our plants are actually hitting really, really good productivity numbers. We measure labor hours per unit and I’m pleased to say that all of our facilities are hitting highs over the last kind of 18 months here in the most recent quarter. So as I alluded to earlier, cost-savings, we’re doing a good job across-the-board, manufacturing, logistics, sourcing in terms of delivering savings. And that’s really what’s allowing us to take some of these necessary price reductions in the market to make sure that we’re competitive and that we’re keeping the placements that we work so hard during the pandemic to gain.
JP Geygan
Yeah. Great to hear. What are you seeing in terms of raw material price increases and what type of strategies are you using to mitigate those?
Jerry Dittmer
Yeah. So we’ve seen though interesting with our raw materials. A lot of the raw materials have really started to come back-down. And they’re not back down to where they were before the pandemic, but the big spike in increases, we have not seen that recently and a lot of our suppliers, obviously, everybody is working together with us and we’ve actually seen those moderate in a good way. It’s really the labor costs that we talked about a little bit, definitely the logistics and the fuel, everything else has moderated some.
JP Geygan
Great. How should we think about your sensitivity in terms of gross margin with respect to increasing sales? In other words, at what level of sales would we expect GM to exceed 20% again?
Jerry Dittmer
Yeah. So I’ll take the first piece and then let other guys take the other one. I think the first piece is, we will see the increase. It’s really going to have more to do with what we have in inventory where we have all the — lot of the freight costs and stuff in our inventory. As we get through that [Technical Difficulty] a bump there. And then I think on the other part, as sales go up and with a lot of our new product and new customers and stuff, we should see that start to come up fairly rapidly, but I’m talking about a point or two, it’s not going to all of a sudden skyrocket. This fiscal year will we see it go above the 20%? Probably not, but I think we can definitely get up into the high-teens and for next year, obviously, the plan would be to jump over that.
JP Geygan
And was Derek going to comment on that as well.
Derek Schmidt
Yeah. Maybe your question regarding kind of sales volume. I think Jerry answered it well. We’ll see a nice margin improvement here as the pricing pressure starts to alleviate. We’re feeling really good about our growth initiatives. So we’ve been at high point market here in North Carolina last seven days. We’ve gotten extraordinary feedback on our new products, which I which I mentioned earlier in the call. That is really going to be our lever to continue to grow our sales sequentially quarter-over-quarter. So my belief, as we head into the second-half and absent of significant economic slowdowns, we’re really well-positioned I think to continue to kind of grow the business into fiscal year ’24. And if we do that, I think we’ll get the sales leverage in — be able to deliver that 20% kind of plus gross margin that you inquired about.
JP Geygan
Great. Appreciate it. Congrats in what has arguably a very, very challenging time. It sounds like you took that as an opportunity to really grab market share, introduce new products, new channels, et cetera. So, from our perspective it seems like you’re doing all the right things. Good luck.
Jerry Dittmer
Great. Thank you.
Operator
Thank you. Next question will be from John Deysher of Pinnacle. Please go ahead.
John Deysher
Good morning. Thanks for taking my question. I was just curious about the new Mexicali plan. I think that was set to open in this quarter, and I was just wondering how that’s going? And where there any learning curve type costs that were embedded in the third quarter results — in the first quarter results?
Jerry Dittmer
Yeah. John, we’ve actually delayed the opening of the Mexicali facility given the slowdown in demand. We still view that facility as a long-term strategic asset. As we’ve talked about, we have ambitious long-term growth goals, we believe we have the initiative and the plans in place to deliver on those. And having the capacity in Mexicali long-term is going to be instrumental in terms of achieving that growth. However, given the recent slowdown in demand, we have ample capacity in our Juarez facility and Dublin facility to adequately support growth. So it’s really the timing of when we start up Mexicali is going be dependent on just the acceleration of our growth initiatives and when we get closer to meeting that capacity.
John Deysher
Okay. Thanks. Do you own the land there or someone else –
Jerry Dittmer
That is leased.
John Deysher
And has any construction even started on that plant.
Jerry Dittmer
It is a leased facility, the building is completely done and ready for occupation once we feel that we need to ramp-up the capacity.
John Deysher
Okay. So you’re not depreciating it since it’s not operating, correct?
Jerry Dittmer
We are recognizing lease costs on a monthly basis.
John Deysher
Lease costs. Okay. But not depreciation on the building itself.
Jerry Dittmer
No, we have not installed any equipment.
John Deysher
No equipment. Good. And the other question is, what is the backlog at the end of the third quarter — first quarter, please?
Jerry Dittmer
Yeah. We’ve seen backlog go back to historic norms and we’re sitting at $56 million of backlog at the end of the quarter. And our expectation would be that by the end of the year we’d be sitting somewhere in the mid-50s to low 60s, which again, is back to pre-pandemic norms.
Derek Schmidt
I mean the good thing about our backlog was that — is that, we are consistently delivering on three to four week production lead times for our manufactured business, which we still feel as probably the most competitive in the industry. It’s the key catalyst for why we continue to grow our — the manufacturing portion of our business.
John Deysher
Okay. Sounds good. Best of luck going forward.
Jerry Dittmer
Thank you, John.
End of Q&A
Operator
Thank you. This concludes our question-and-answer session. I’d like to turn the call back over to Mr. Jerry Dittmer for closing remarks. Please go ahead.
Jerry Dittmer
Great. Thanks, Nick. In closing, I would again like to thank all our Flexsteel employees for their outstanding performance and service during the first quarter. We’re just wrapping up here. As Derek mentioned, we are still in high point, had a really, really good high point market here this fall. Our showroom look spectacular, it was really set-up great for selling. Our new Charisma, flex recliners sleep solutions, our Latitude Southaven products all just looks fantastic and we’re, really excited about getting back-out into the market with all these new things. We’ve made a lot of good investments in these and are pretty excited about where we think it can take the company.
I also would like to thank you all for participating in today’s calls. If you have more questions, obviously, feel free to reach out and we look-forward to updating you all on our next call. Thanks. Everybody have a great day.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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