Flexsteel Industries Inc (FLXS) Q4 2023 Earnings Call Transcript

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. 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.

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. 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?

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.

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 to Jerry to share his perspectives on our outlook.

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.

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

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

Yes, good morning, Budd.

Can you discuss the revenue pattern during the quarter? How did it compare year-over-year? Additionally, can you speak about the relationship between units and price in the fourth quarter?

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 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.

So Budd, most of that pricing is behind us. We will see some of it as the year progresses. We expect to see around $4 million to $5 million from the pricing actions in this first quarter, which is due to our elimination of the last of our ocean freight charges in May. The most encouraging aspect we observed in the fourth quarter was our year-over-year unit volume increase, which was very promising.

I agree. I'm very aware of what happened to ocean freight during the post-pandemic period. Historically, a lot of your sales were through retailers and special orders. With the big-box strategy now in place, it seems there is much more focus on inventory. How did that balance play out during the quarter? What do you anticipate for the future in that regard?

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.

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?

Yes, Budd, our retailers are not panicking at all. They're actually performing quite strongly, especially compared to last year. As Derek mentioned, both retail and big box sales are up year-over-year, particularly on the order side, which is very encouraging. While we share concerns about a potential economic slowdown, we haven't observed any negative impacts so far. Therefore, we remain optimistic about our current situation.

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.

I'll ask just a couple more questions but let others go first. The progress in gross margin was impressive. Can you provide more details on that? You attributed it to operational efficiencies. How do those efficiencies relate to labor and overhead costs? Specifically, where were those efficiencies, and how did the reduced inventory write-downs contribute? Can you give us an overview from quarter to quarter or year to year?

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?

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

Yes. We've discussed our near-term and mid-term goals, aiming to achieve gross margins of at least 20%. Maintaining operational efficiency will be crucial for this objective. Additionally, as mentioned in the press release, there has been a year-over-year decrease in inventory write-downs. In the fourth quarter of fiscal year '24, we had significant inventory levels, and we set aside reserves due to slowing demand. The mention regarding the fourth quarter of fiscal year '23 was relative to a negative comparison from fiscal year '22. Overall, we are optimistic about our inventory levels and their quality, so we have no concerns in that regard. Looking ahead, we are confident in our capacity to expand overall margins throughout fiscal year '24, driven primarily by two factors: ongoing operational efficiencies and volume leverage.

The other thing, too, Budd and there are two things is the inventory will continue to come down. We don't feel that there'll be growth during this fiscal year in inventory even as our revenue goes up. And probably the only thing we really, that's kind of an uncontrolled one right now, is obviously the peso versus the dollar is having a negative effect on us here in the short term and maybe even longer term. We saw about $1 million last year, and we'll see probably a good $400,000 this year in this first quarter as the peso and the dollar aren't really moving in the best direction for us.

I see. You mentioned inventory as a source of cash and that it's at $122 million at the end of the year. What is the goal for the end of fiscal ‘24? Is it $100 million, back to the level it was before the pandemic?

Yes, I think in that range. Our goal would even be a little bit better than that but that would definitely our goal.

And so that would get your funded debt down to just about zero, if not at zero?

Correct. I mean we stated it's $0 million to $15 million, but our ultimate goal, obviously, is to get that down to zero.

Got it. Thank you very much. I'll let others ask questions and come back in the queue, if possible.

Thanks, Budd.

The next question comes from Anthony Lebiedzinski of Sidoti & Co. Please go ahead.

Good morning and thank you for taking the questions.

Good morning, Anthony.

Yes, good morning. I am curious about the revenue impact from the growth initiatives. Derek, you mentioned the big-box impact for the quarter. Overall, how much do you think the collective efforts of big-box expansion, Zecliner, flex, and others contributed to the fourth quarter sales? Also, how should we view this in terms of the outlook for fiscal '24?

Yes. In the fourth quarter, we generated a little less than $10 million from growth initiatives. As we head into fiscal year '24, we are optimistic about the momentum. For fiscal year '24, we estimate that our growth initiatives could contribute an additional $30 million to $40 million annually, on top of what we achieved in fiscal year '23.

We're hoping, Anthony, that the plan is for that to be maybe the rise of somewhere in that 15% range going forward on an annual basis.

Got it. Yes, thanks for that. And then certainly, a terrific job with gross margin expansion. I know for the upcoming quarter here, it looks like there will be a little bit of a sequential decrease because of, I guess, lower revenue. But overall, do you think you can get above 20% at some point later this fiscal year? Or is that not doable just yet?

If we do it sequentially, I think the answer would be yes. I mean, obviously, our revenue will be down in that $10 million type range, so that does have an effect here in the first quarter. But historically, our second, third, fourth quarters are stronger quarters, and so the plan will be to continue to take that upward. And maybe for the year, it'll average close to that 20%. But hopefully, by the end of the fiscal year, we will be above that 20%.

Okay. Very good. And then as far as inventories at retail, I would like to hear your perspective. I know you talked about last year having a glut of inventory at the retail level. What's your sense now as far as inventory levels to your customers?

Yes, that’s a great question. Overall, our strong retailers are doing well. However, there is some caution as they are uncertain about the economic outlook. Most of our retailers are managing fairly well, but the decline in store traffic is notable. Sales remain stable, and customers who do visit tend to make purchases. However, the reduced foot traffic is leading to some concerns regarding inventory levels. On the whole, retailers are in a solid position, and we are noticing positive trends with sell-through rates and order returns.

Okay, that's good to hear. By the end of fiscal '24, you could potentially be debt free. As you look beyond that, what would you say your cash flow priorities will be as you aim to be debt free by the end of '24?

Yes. The main one, of course, will be to continue with our growth initiatives because we plan on taking a lot of our growth initiatives and doing more with each one of them, coming out with new products, enhancements, things like that. Obviously, we'll continue to look at acquisitions if there's things that are favorable there but those are really the main two.

Got it. Well, thank you very much and best of luck.

Thanks, Anthony.

This concludes our question-and-answer session. I would like to turn the conference back over to Jerry Dittmer for any closing remarks.

Great. Thanks. In closing, I want to thank all of our Flexsteel employees for their dedication and outstanding performance during the fiscal year. I'm also thankful to all of you, Budd and Anthony, for participating in today's call. We really appreciate that. Obviously, you can please contact us if you have any additional questions, and we look forward to updating you on our next call. Thanks, everyone, for listening and participating today.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.