Flexsteel Industries, Inc. (FLXS) Q1 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the Flexsteel Industries First Quarter Fiscal Year 2022 Earnings Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Derek Schmidt, Chief Financial Officer and Chief Operating Officer for Flexsteel Industries. Please go ahead.

Thank you, and welcome to today's call to discuss Flexsteel Industries' first quarter fiscal year 2022 financial results. Our earnings release, which we issued after market close yesterday, Monday, October 25, is available on the Investor Relations section of our website, www.flexsteel.com, under News & 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 by the use of 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?

Good morning, and thank you for joining us today. In spite of continued global supply challenges, we executed well during the quarter and delivered strong year-over-year sales growth of 30.8% and solid profit results, which were in line with our guidance. I'm very encouraged by our sales performance. We delivered stellar growth in both shipments and orders in fiscal year 2021, and we continue that momentum into fiscal year 2022. Our near-term outlook for the market remains positive. The economy remains strong despite growing concerns about inflation and global supply chain disruptions. Consumer spending appears healthy and trends in new housing, geographical migration, and generational shifts are all positive catalysts for the long-term home furnishings growth. Both our retail and e-commerce customers remain relatively bullish on business conditions, although inflationary pressures, including higher ocean freight costs, present some risk of dampening consumer demand. While our growth outlook is promising, we are battling a multitude of significant global supply chain headwinds faced by many industries, including home furnishings. These challenges are pressuring near-term margins and creating choppiness in our profit results for the first half of fiscal 2022, which we expected. First, ocean container rates have climbed to historical highs, given large imbalances between supply and demand, and we anticipate rates will remain elevated through the first half of calendar 2022 or potentially longer. While we take appropriate actions to pass along these increased costs to the market, if we can, consumer price sensitivity and a lag in price realization are creating pressure on gross margins near term. Second, ancillary charges associated with ocean containers, such as demurrage and detention have escalated to unreasonable levels. The lack of truck drivers and warehouse workers available to pick up, unload and return containers, combined with minimal free days from shipping carriers have intensified these ancillary charges. However, our team is agile in executing multiple plans to manage these margin pressures. And as a result, we expect profit margins to improve sequentially each quarter throughout fiscal 2022. Material availability, specifically for polyfoam has been a significant constraint in ramping up North American manufacturing capacity, but conditions are improving, and we expect daily manufacturing production to gradually increase throughout the rest of the fiscal year to support both a reduction in our backlog and an increase in sales. Supplier production capacity in Asia, specifically in Vietnam, has been strained recently due to the spread of the COVID-19 delta variant. Production in parts of Southern Vietnam plummeted for the better part of August and September due to the COVID-19 shutdowns and the impact of the reduced output will likely be felt by the industry in the November to January timeframe when container receipts dropped precipitously due to the lower Vietnam production. We have been aggressively and strategically building our inventory positions over the past few quarters as a source of competitive advantage. As a result of this strategic investment, our in-stock position and service levels have improved significantly at a time when the industry will likely be stressed for inventories in the coming months, given the shutdown of furniture production in Vietnam. In summary, these supply chain challenges are frustrating, but our team views this as an opportunity to gain additional market share during a period of industry disruption. Our operations team is agile and quickly pivots as necessary to effectively maneuver through a supply chain environment that is continuously changing. Our sales and marketing teams are relentless in the pursuit of exceptional customer service and new business, and our product team is accelerating new product development and category expansion. I'm excited about our future and remain confident in our ability to deliver strong sales growth and financial results longer term. Now I'll turn the call over to Derek to discuss our financial and operational results, and I'll be back with some closing comments on what we see ahead.

Thank you, Jerry, and good morning, everyone. First quarter net sales were $137.7 million, up $32.5 million or 30.8% compared to $105.2 million in the prior year period. Our sales results were at the high end of our $130 million to $140 million guidance range despite the ongoing supply chain issues based in the quarter, which Jerry highlighted earlier. First quarter sales also grew sequentially from the prior quarter, which was our highest sales quarter of fiscal 2021 and is a clear reflection of the continued strong growth momentum in our business. We saw an increase in our home furnishing products sold through retail stores of $35.7 million or 40%. We are gaining wallet share with our large strategic customers and continue to increase retail product placements, which is an important lever and leading indicator of longer-term sales growth. Feedback from customers on our performance is very positive. We are competing well with a healthy inventory position of in-stock products and competitive lead times on custom manufactured products. Products sold through e-commerce declined $3.2 million or minus 19.7%. E-commerce sales were softer in comparison to the prior year quarter when online sales increased by 40% due to COVID-19 related buying ships. Compared with the pre-pandemic fiscal 2020 first quarter, e-commerce sales for the first quarter of fiscal 2022 increased 12% for a compounded annual growth rate of 5.8%. E-commerce sales were also adversely impacted in the quarter by large price increases on our products related to rising ocean container freight rates. Competitors have recently followed suit with similar price increases and as a result, we are seeing improved sell-through of our products. We expect to regain growth momentum in our e-commerce business throughout the fiscal year, driven by new customers, new products, and improved content and advertising effectiveness. From a profit perspective, we reported a fiscal first quarter net income of $4.35 million or $0.61 per diluted share that compared to net income of $3.89 million or $0.49 per diluted share in the prior year quarter. The reported net income included a $150,000 pretax restructuring expense, primarily for facility maintenance and a pretax gain of $1.4 million due to the sale of the company's Harrison, Arkansas facility as part of the previously announced comprehensive transformation program. Excluding these items, the company reported adjusted net income of $3.4 million or $0.48 per diluted share as compared to net income of $6.3 million or $0.80 per diluted share in the first quarter of fiscal year 2021. Please see the non-GAAP disclosure included in the earnings release for a detailed reconciliation of GAAP to non-GAAP adjusted net income and adjusted earnings per share. Gross margin as a percent of net sales in the first quarter was 17%, which was 470 basis points lower than the prior year quarter. Margin improvement from higher sales volume and price realization was significantly overshadowed by increased cost related ocean container freight and ancillary charges. Ancillary charges, including detention and demurrage of containers surged in excess of $5 million in the first quarter due to the high number of incoming containers combined with external factors, namely, the shortage of labor needed to unload and return these containers to shippers in a timely manner. To address the issue, we've engaged several third-party logistics companies to help us expedite the unloading and return of containers. And as a result, expect ancillary costs to decrease materially in the second quarter. Regarding ocean container freight rates, rising costs have appeared to stabilize temporarily, but are expected to remain elevated at current levels for at least the next 6 months and potentially as long as 12 months. Assuming there are no substantial increases in ocean freight rates from current levels, pricing that is currently in place should offset these higher freight costs in future quarters. The combination of lower ancillary costs and improved price realization relative to higher ocean freight cost will result in gross margin improvement in the second quarter. Selling, general and administrative or SG&A expenses increased $4.6 million to $18.8 million compared to $14.2 million in the prior year quarter when we aggressively reduced costs in response to COVID-19 and related sales declines. In comparison to the prior quarter, which was the fourth quarter of fiscal 2021, SG&A spending was effectively flat on a dollar basis. SG&A as a percent of net sales in the quarter was 13.6% compared to 13.5% in the fourth quarter of fiscal 2021. We remain diligent in controlling expenses while still funding investments to support our long-term growth ambitions. Turning to income taxes. During the quarter, we reported a tax expense of $1.3 million or an effective rate of 23.2% compared to a tax expense of $4.1 million in the prior year quarter or an effective tax rate of 51.3%. Now moving on to the balance sheet. The company ended the quarter with a cash balance of $4 million in working capital, defined as current assets less current liabilities of $181.5 million and a $53.1 million balance on our secured line of credit. Compared to the end of fiscal 2021, working capital increased $52.7 million. The increase in working capital was primarily related to a $32.6 million increase in inventory and a $22.8 million decrease in accounts payable. As Jerry noted earlier, we made a strategic investment in inventory to support higher sales and improved service levels to customers. Given the disruption in the global supply chain, including significantly reduced production in Vietnam recently, we expect that the strength of our inventory position will be a competitive advantage and a source of additional revenue growth in the coming quarters. Capital expenditures for the 3 months ended September 30, 2021, were approximately $800,000. Now on to our restructuring update. During the quarter, the company incurred roughly $150,000 of restructuring expense, primarily due to ongoing facility and transition costs as part of our previously announced comprehensive transformation program. We expect to incur a total of approximately $500,000 to $800,000 in restructuring expenses during fiscal 2022, primarily for ongoing facility costs related to the remaining property currently held for sale and dependent upon the timing of the asset sale. Looking forward, guidance for second quarter sales is between $130 million and $140 million. For the full fiscal year 2022, we are still targeting sales growth between 15% to 20%, but achievement of that growth will be dependent on global supply chain conditions improving and stabilizing in the second half of the year. While gross margins are expected to be under pressure in the second quarter, both from ocean container freight rates and related ancillary charges, we expect these pressures to diminish compared to the first quarter, and as such, expect gross margins to improve into the high teens in the second quarter and then improve to 20% to 21% in the second half of the year, presuming supply chain conditions stabilize. In contrast to the first quarter, we expect that SG&A as a percent of sales will increase modestly to 14% to 14.5% for the remainder of the year to support strategic growth investments, but the SG&A increase will be dependent on a similar or better improvement in gross margins during the same time period. For the second quarter, adjusted operating income margins are expected in the 4.5% to 5.5% range, strained in the near-term as we work through higher ocean container, ancillary charges and freight rates. We expect adjusted operating margins to steadily improve throughout the year, with margins returning to 7% or higher by the fourth quarter of fiscal 2022. The effective tax rate for fiscal 2022 is expected to be in the range of 26% to 27%, inventory levels may increase modestly in the second quarter as we continue to invest strategically to improve in-stock service levels and provide exceptional support to our customers, but working capital is expected to be a source of cash flow in the second half of the year. As previously shared, we are also aggressively expanding our supply chain capacity to support long-term growth. During fiscal 2022, the company anticipates spending $11.5 million to $13.5 million for capital expenditures, of which the majority will be deployed to support manufacturing capacity expansion and productivity improvements. I'll turn the call back over to Jerry to share his perspective on our outlook.

Thanks. Given my confidence in our team and our strong growth momentum, we are aggressively working plans and investments to expand capacity to both fulfill the current backlog and support future growth. Our third and newest manufacturing plant in Juarez, Mexico, started operations in July and is ramping up production with improved polyfoam availability. Construction started on our new facility located in Mexicali and will be completed by June 2022. This month, we opened a new distribution center in Greencastle, Pennsylvania to better service our customers in that region and to handle increased inventory levels to support growth. We will be building inventory in the new DC over the coming months and expect to service customers by February 2022. In addition to these supply chain investments, we will continue to invest strategically in our business to improve our customers' experience, expand our digital and e-commerce capabilities, build our brands, and drive product innovation relevant to the market. We have recently showcased our new brand refresh with visual and experiential alignment across our showroom, website, product displays, and marketing assets. This was well received by consumers, customers, suppliers, and Flexsteel associates earning excitement about our strong path forward. In summary, we're excited about the long-term growth opportunities for the company, and we are making strategic moves to support our valued customers, realize our growth potential, and create shareholder value. With that, we will open up the call to your questions. Operator?

Great. Thanks. Well, in closing, I'd like to thank all our Flexsteel employees for their outstanding performance and service during the quarter. I'd also like to thank you who did call in to our call today. I realize our story is a lot like what you're hearing out in the news these days. But we do have really, really exciting growth plans in front of us as you can see in our release and you heard in our prepared comments. So we're very, very excited about the future and appreciate everyone, like I said, coming on, and we look forward to updating you on our next call. Thank you very much today.