Q3 2023 Flexsteel Industries Inc Earnings Call

Participants

Derek Paul Schmidt; COO; Flexsteel Industries, Inc.

G. Alejandro Huerta; CFO, Treasurer & Secretary; Flexsteel Industries, Inc.

Jerald K. Dittmer; President, CEO & Director; Flexsteel Industries, Inc.

Anthony Chester Lebiedzinski; Senior Equity Research Analyst; Sidoti & Company, LLC

Presentation

Operator

Good morning, and welcome to the Flexsteel Industries' Third Quarter Fiscal Year 2023 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 Alejandro Huerta, Chief Financial Officer for Flexsteel Industries.

G. Alejandro Huerta

Thank you, and welcome to today's call to discuss Flexsteel Industries' Third Quarter Fiscal Year 2023 financial results. Our earnings release, which we issued after market close yesterday, Monday, May 1st, 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 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. A 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.

Jerald K. Dittmer

I am pleased with our performance in the third quarter despite the challenging macroeconomic environment. We remained on the offense during the third quarter, delivering innovative new products and investing in our strategic initiatives. This drove sales for the quarter of $99.1 million, which was in the upper half of our guidance range.

Our growth initiatives have begun to add meaningful revenue and partially offset the challenges posed by slowing consumer demand. These initiatives, along with a continued focus on controlling operating costs enabled us to deliver operating income of $2.1 million or 2.1%, which was in the upper range of our guidance.

Along with our growth initiatives, we have committed to driving working capital efficiency and continued dedication to reducing our debt, further strengthening our balance sheet. During the third quarter, we made strides in both areas as we maintained our working capital balances, but reduced our outstanding debt by an additional $1.4 million.

We paid down debt by $20 million since the end of the fiscal 2022. We continue to see near-term challenges due to a multiple macroeconomic headwinds. However, we do not plan to detour from our commitment to deliver long-term profitable growth. With that in mind, we will continue to invest pragmatically in growth initiatives to drive sales and margin expansion.

Our organization is focused on navigating the challenges in the current environment while positioning ourselves to deliver on our long-term strategic initiatives. I'll now turn the call over to Derek to discuss our strategic initiative and operational priorities before Alejandro takes you through the further details of our financial results. I'll be back at the end of the call with some closing comments on what we see ahead.

Derek Paul Schmidt

I'm very excited about the trajectory of our business. While third quarter sales were down year-over-year from the pandemic-driven highs last year, we delivered solid sequential sales growth of 6.4% from the second quarter expect similar sequential quarter growth in the fourth quarter and anticipate building on that momentum going into fiscal year 2024 to profitably grow even with headwinds related to an expected economic slowdown.

The confidence in our growth trajectory largely stems from our early success and continued sureness in our strategic growth initiatives, which are focused on expanding our addressable market in three areas: new sales distribution, new product categories and new consumer segments.

With respect to new distribution, we are executing well and gaining momentum with Big Box customers and expect to profitably grow this channel to 5% of our total company sales this fiscal year with continued aggressive growth planned in fiscal 2024 as we already have a strong lineup of events with customer commitments over the next 12 months.

To address new consumers. Earlier this year, we launched our new Charisma brand, targeting the style and price preferences of younger consumers. The initial launch was well received. And last week, we expanded the product offering to include several new on-trend stationary groups with retail prices per sofa as targeted below $1,000.

Customer feedback on the new products was strong. The comfort and quality at this price point are exceptional compared to the competitive alternatives. We have conviction in the positioning of this new brand and our right to win with this targeted consumer and will continue investing in broadening the brand with new products.

In new product categories, we have several encouraging wins. The launch of our new Zecliner sleep solution recliner started shipping in March and has been successful. We placed the product with more than 450 retailers, the majority of which have already sold through their initial orders.

We've also recently placed Zecliner with a major regional sleep store chain, and we're pursuing other distribution relationships in this channel. We also expanded the line recently and have more innovation planned for release at October's market. Our other major new product category initiative, Flex, which is a small parcel contemporary modular furniture solution was successfully launched in the Big Box channel earlier this month and sold through much faster than we anticipated.

We have another Big Box event planned for Flex in June, and we are ramping up distribution expansion efforts across multiple e-commerce partners in the fourth quarter as well. While aggressively pursuing market expansion strategies, we are investing to renew and grow our core business, too. We are competing well and our customers validated this view during last week's April High Point market.

The energy in our showroom was outstanding. We continue to modernize the Flexsteel brand with the introduction of new on-trend product designs and covers at more competitive price points while maintaining the differentiated comfort and quality that defines the brand.

As for future growth at Flexsteel is exciting. We're investing in the right initiatives, strengthening our market leadership through innovation and building a strong culture focused on delivering an exceptional customer experience and strong financial performance.

With that, I'll turn it over to Alejandro to give you additional details on the financial performance for the third quarter and the outlook for the fourth quarter of fiscal year 2023.

G. Alejandro Huerta

For the third quarter, net sales were $99.1 million, down approximately $41.4 million or 29.5% compared to $140.4 million in the prior year period. While down from the prior year, our sales results were within our guidance of $93 million to $103 million provided during our second quarter earnings call.

From a profit perspective, the company delivered operating income of $2.1 million or 2.1% of sales in the third quarter, which was also within our guidance range of 1% to 2.5%. In addition, we recorded net income of $1.5 million and earnings per diluted share of $0.28.

Gross margin as a percentage of net sales in the third quarter was 18.8%. As compared to the prior year quarter, we saw a 310 basis point improvement, primarily driven by a continued focus on managing expenses and the realization of cost savings initiatives, partially offset by volume decline, deleveraging our fixed costs and discrete pricing actions taken as competitors have become aggressive with price reductions to reduce inventory.

SG&A expenses were modestly higher than in the prior year quarter by $0.2 million, mainly due to investment spending to drive our growth initiatives. Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $2.4 million and working capital of $106.6 million, which is a slight reduction of $0.5 million during the quarter. A controlled working capital management resulted in a solid operating cash flow of $5.8 million during the quarter.

As previously communicated, debt reduction is a key priority. In the quarter, we reduced our outstanding borrowings by an additional $1.4 million, bringing our debt balance down to $17.7 million as of the end of the quarter. Looking forward, the sales guidance for the fourth quarter is between $100 million and $110 million, which represents a 1% to 11% sequential quarter-over-quarter improvement.

We are forecasting that the challenging macroeconomic environment will continue to temper the demand for our core product offerings. However, our growth initiatives, which have begun to drive meaningful revenue will help offset this and result in subsequent quarter-over-quarter sales growth.

Regarding profitability, our growth initiatives impact and continued focus on managing costs will allow profit margins to improve sequentially in the fourth quarter. However, the challenges previously mentioned and continued pricing pressures will temper our profitability expansion.

As such, we are projecting operating income as a percentage of sales in the range of 2% to 4% for the fourth quarter. The most significant drivers of variability in the guidance range will be consumer demand and competitive pricing conditions, both of which will be shaped near term by macroeconomic headwinds. We expect gross margins between 17% and 19% in the fourth quarter as our growth and cost savings initiatives will drive margin expansion.

However, we see this partially offset by continued pricing pressures in the market due to the compressed demand previously discussed. If sales continue to improve as expected in the quarter, gross margins should stabilize in the upper teens. In addition, we intend to prudently control SG&A costs and expect SG&A cost to be between $16 million and $17 million in the fourth quarter, which is higher than the third quarter as we are actively investing in our growth initiatives discussed.

Regarding our cash flow outlook, we expect working capital to be a use of cash for the quarter, driven mainly by an increase in receivables and a modest increase in inventory, partially offset by an increase in accounts payable. For the fourth quarter, we expect capital expenditures to be between $1 million and $1.5 million as we continue to invest in expanding our ERP capabilities.

We also may continue to opportunistically repurchase shares at a modest spending level if the stock price remains at a significant discount to our view of the intrinsic value. Based on our inventory needs to support our sales growth, we expect debt levels to be higher than previously communicated with the range of $10 million to $18 million by the end of fiscal 2023.

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.

Jerald K. Dittmer

The positive momentum we've gained in the first nine months of fiscal 2023 has me optimistic regarding our long-term profitable growth potential. Slowing economic growth and waning consumer demand are obvious challenge for the industry near term. However, we remain focused on delivering on our strategic initiatives by investing in our talent, systems and operational capabilities.

These will allow us to achieve our long-term sales and profitability goals. With that, we'll open the call to your questions.

Question and Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) Our first question will come from Anthony Lebiedzinski with Sidoti & Co.

Anthony Chester Lebiedzinski

Good to see you guys certainly revitalizing the core and certainly looking to certainly expand on your growth initiatives. I guess, first, how much of the revenue in Q3 came from your growth initiatives? If you could guys give us a ballpark estimate, that would be great.

Derek Paul Schmidt

Overall, what we've talked about for the year is roughly $30 million incremental revenue from our growth initiatives. I think in the third quarter, rough estimate is probably between $12 million and $13 million.

Anthony Chester Lebiedzinski

And then just looking at the breakdown of the sales for the quarter, you guys talked about e-commerce versus retail. Just wondering or just curious to get your thoughts in this post-COVID environment. How do you guys think this will play out as far as sales to traditional retailers versus e-commerce? How do you see that evolving?

Jerald K. Dittmer

The e-commerce part of our business obviously is challenged. Our four largest customers have all have or will release their numbers, and they're pretty depressed. And we, of course, see the same thing and the same trend.

That's one that we'll keep watching. I think in time, we still think the e-commerce part is a strong part of the future for furniture and for sales. But right now, it's at depressed levels even further down than we would have seen in a pre-pandemic at this point.

For the other part of our business, it's really, we're at the point now where it's kind of what's going on in the economy? Which is one of the reasons you see the guidance, the range we gave going forward. It's really orders in orders out at this point in time.

Luckily, in our belief is a lot of our new initiatives, as Derek just gave you some numbers are going to continue to kick in and will help us in the future. It's really going to come down, like I said, to what we're seeing from an economic standpoint with the consumer.

And right now, as you can see, a lot of our, you just came out to market, a lot of our customers were down quite a bit. We've seen some of that effect. But again, we're being offset by our new initiatives.

Anthony Chester Lebiedzinski

And then as far as inventory levels at retail, how would you describe that as far as what are you guys seeing now versus maybe a few months ago? I'm curious to get your thoughts on that.

Jerald K. Dittmer

We just came out of market. And overall, most of our retailers, especially our stronger retailers are all feeling pretty good. Do they still have inventory? Sure, but they're at a place where they're feeling comfortable with them. We've started to see, like I said, reorders, we're starting to see some reorders for a lot of the new things that we came out with because they've got room in their DCs, and that could handle a lot of those things.

Going forward, there's still some. I'd still tell you probably 1/3 of our retailers still have too much inventory. And the biggest thing is it's just it's going out slower than they thought because the demand is a little bit slower.

Anthony Chester Lebiedzinski

And then certainly, as far as gross margin, it was up sequentially and year-over-year. Maybe if you could just go over like the puts and takes of that. I know, maybe if you could just extend on that. And then while on the subject of gross margins, is it reasonable to assume that over time, you could get back to over 20% gross margins? How should we think about that?

G. Alejandro Huerta

As we think about the sequential growth expansion quarter-over-quarter, as Derek mentioned, we're seeing meaningful revenue from our growth initiatives, which are all accretive to our margin profile. That, combined with cost savings initiatives that we're driving very hard and focused on within the group.

What is hurting us a bit is the deleveraging of our fixed assets. As you know, we have Mexicali on our books that we have a plan for in the future. But that is fixed cost we're absorbing. And in an overall capacity has been a little bit below where we call it optimal. We're seeing that as an offset.

Long term, as we shared at your conference about two months ago now, we do see a path long term to getting above 20% again, but it is a slow growth that we see getting back to that level.

Anthony Chester Lebiedzinski

How should we think about SG&A expenses in terms of core spending versus spending on the growth initiatives?

G. Alejandro Huerta

Any SG&A expansion that we will have is going to come from our growth initiatives, Anthony. That is where we're focused. That is what we're driving. Our core will be maintained to ensure that it doesn't fall off and that we can continue to support it.

But growth initiatives is where we will see incremental investment throughout the next few quarters as we grow those opportunities.

Jerald K. Dittmer

Sounds good. Well, thank you, and the best of luck.

Operator

(Operator Instructions)

It appears there are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Jerry Dittmer for any closing remarks.

Jerald K. Dittmer

In closing, I'm grateful to all our Flexsteel employees for their outstanding performance in service during the quarter. I also want to thank Anthony for participating in the call and having questions for us today.

If any of the other folks have any additional ones, please let us know. We look forward to updating you on our full year performance in our next call. Everybody, have a great rest of the day. Thanks.

Operator

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