Q2 2022 Flexsteel Industries Inc Earnings Call

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Good morning, and welcome to the Flex still industries second quarter fiscal year 2022 earnings conference call.

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Please note this event is being recorded.

I would now like to turn the conference over to Derek Smith, Chief Financial Officer, and Chief operating Officer for Flagstone industry. Please go ahead.

Thank you and welcome to today's call to discuss flex steel industries second quarter fiscal year 2022 financial results our earnings release, which we issued after market closed yesterday.

Today January 24th is available on the Investor Relations section of our website Www Dot flex steel dot 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 the GAAP to non-GAAP measures.

That I will turn the call over to Jerry Dittmer Jerry.

Good morning, and thank you for joining us today.

I'm encouraged by our continued strong sales performance.

We delivered growth of 18, 9% during the quarter. Despite the ongoing supply chain challenges and it was our sixth consecutive quarter of double digit sales year over year growth.

I feel we're well positioned to continue growing and gaining market share longer term.

While our top line performance has been solid we are contending with several global supply chain challenges, which are putting intense pressure on near term profits.

Most noteworthy our ancillary costs associated with ocean container logistics, such as demurrage and detention and chassis charges.

As a reminder, almost 70% of our sales are supported by globally source products, which require us to import thousands of containers each quarter.

Given our strong growth combined with concerns about ongoing global supply chain disruptions from Covid and other issues, we imported a record number of containers in the past seven months to support our growth trajectory and strategically build inventory to protect our service levels.

Unfortunately, the ramp up in imports coincide with worsening supply chain conditions as severe congestion at ports and railroads left our container stranded for days or weeks incurring ancillary fees.

At the same time the.

In the trucking industry is in crisis, given the widening gap between demand and supply of truck drivers for us the lack of truck drivers to pick up and return containers has further compounded the number of days.

Our containers are waiting and occurring ancillary fees.

All of this disruption has also embolden logistics firms to increase per diem rates in some cases by three to four times pre COVID-19 rates. While also tightening other terms the result, ancillary charges, which used to be negligible item on our P&L.

Actively ballooned to over 15 million in the recent quarter.

The magnitude of these costs is not acceptable going forward and we have deployed a variety of strategies to aggressively manage these expenses, which Derek will expound on in his comments shortly.

The other significant issue we're navigating this cost inflation as I noted global imports are a large portion of our business and we are exposed to ocean container freight rates, which continue to climb to new highs due to supply and demand imbalances were also seen inflationary cost pressures.

Other areas of our supply chain, including materials and domestic transportation.

Where we've recently experienced double digit increases in wages, notably in Mexico, which recently increased by 22%.

We are implementing price increases to pass along these higher cost to the market, where we can but the lag in price realization will negatively impact gross margins near term.

Though much uncertainty remains in our global supply chain and cost conditions could worsen we are taking actions to assertively manage costs and address margin pressures where possible to return the company to profitable levels for the remainder of fiscal 2022 .

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.

What we see ahead.

Thank you Jerry and good morning, everyone second quarter net sales.

$141 $7 million up $22 $6 million or 18, 9% compared to $119 $1 million in the prior year period.

Our sales results were at the high end of our revised $137 million to $143 million guidance range. Despite the ongoing cause supply chain issues faced in the quarter, which Gerry highlighted earlier.

Sales performance in our retail channel continues to be strong as sales increased $22 $5 million or 22, 3% versus prior year, we continue to benefit from the gains in retail product placements made over the past year as well as our healthy inventory position and <unk>.

Service levels of in stock products, as we ramp up North American manufacturing capacity, we expect our lead times on custom manufactured products to become even more competitive which should be a source of growth for the remainder of the fiscal year.

On the e-commerce side of our business sales performance was solid at $18 million, although growth was flat in comparison to a strong prior year quarter sales improved by $5 million or 38% compared to first quarter results.

We are regaining growth momentum in this channel and feel bullish on our growth outlook for the remainder of the fiscal year.

In addition to share gains with existing customers, we expect ecommerce growth to be driven by new customers, new product launches and improved content and advertising effectiveness.

From a profit perspective, we provided a business update in December that we expected an operating loss in the quarter due to significantly higher ancillary costs.

System with that guidance, we reported a fiscal second quarter net loss of $7 5 million or negative $1 13 per diluted share that compared to net income of $8 $5 million or $1 13 per diluted share in the prior year quarter.

The reported net loss included a 600000.

Dollar pre tax restructuring expense.

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 second quarter was six 7%, which was 1380 basis points lower than the prior year quarter.

A primary driver of the year over year decline in both net income and gross margin percentage is higher ancillary costs associated with ocean containers.

Which as Jerry explained exceeded $15 million in the quarter.

As outlined in the earnings press release, there are other factors influencing profit margins, but they largely offset each other as the year over year reduction in SG&A of 350 basis points more than offset the reduction in gross margin related to cost inflation and capacity growth investments.

Moving to the balance sheet. The company ended the quarter with a cash balance of $4 million and working capital of $171 $1 million and a $60 million balance on our secured line of credit.

Compared to the end of fiscal 2021.

Working capital increased by $42 4 million the increase in working capital is primarily related to a $17 $9 million increase in inventory.

A $29 $7 million decrease in accounts payable, which largely related to payments for inventory purchased at the end of fiscal 2021.

As Jerry noted earlier, we made a strategic investment in inventory to support higher sales and improved service levels to customers.

We anticipate gradually reducing inventory over the balance of fiscal 2022, while still maintaining an advantage position with our customer service levels.

Looking forward guidance for the third quarter sales is between 135 and $145 million, which translates to sales growth between 14 and 22% year over year.

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 and the impact of rising cost inflation in the second half of the fiscal year.

Given uncertainty on cost inflation and supply chain conditions, we are not providing detailed profit guidance for the third quarter at this time, but as Jerry alluded to earlier, we are taking aggressive actions to increase the likelihood of returning the company to profitable levels in the third and fourth quarters.

Three key initiatives include first lowering ancillary charges to less than $5 million in the third quarter by reducing inbound containers.

Given our strong inventory position, we intend on gradually reducing inventories without compromising service levels.

Next we are realigning with a select group of freight forwarders, who can perform more effectively and managing the physical flow of our containers and reducing ancillary fees and finally, we are dedicating additional internal and external resources to track and minimize fees by container on the daily basis.

For our second profit improvement initiative, we are implementing pricing increases across most of our products to offset cost inflation from ocean freight materials wages and domestic transportation costs.

Revised pricing will be effective with new February orders.

Due to the lag in price realization, we expect caution cost inflation to run higher than price by roughly $1 million to $2 million in the third quarter compared to the second quarter.

Lastly, we will tightly manage SG&A expenses at or below $17 $5 million in the third quarter, while still funding critical long term growth investments.

If supply chain conditions, worsen or inflationary pressures escalate higher we will adjust our plan and take additional actions as necessary.

Regarding our cash flow outlook working capital is expected to be a source of cash flow in the second half of the year as we reduce inventory levels.

Near term priorities for cash include funding capital expenditures and reducing debt.

For fiscal 2022, the company anticipates spending 10, five to $12 $5 million for capital expenditures of which a large portion will be spent in the fourth quarter related to equipment for our new production facility in Mexicali, Mexico.

The effective tax rate for fiscal 2022 is still expected to be in the range of 26% to 27% and restructuring expenses are estimated at $1 million for the full year.

I'll turn the call back over to Gerry to share his perspectives on our outlook.

Thanks Derek.

While the short term profit impact of continued supply chain difficulties is frustrating.

Encouraged by our growth momentum and confident that our team is adjusting to manage external cost pressures, while remaining steadfast in executing our long term growth strategies.

Our recent investments to expand capacity.

We will both support future growth and build supply chain resiliency.

Duction at our third and newest manufacturing plant in Juarez, Mexico is ramping up as expected and construction of our new facility in Mexicali, Mexico is still on target to be completed by June and will start production in August .

Our new distribution center in Greencastle, Pennsylvania will begin shipping to east coast customers next month, and we will improve service levels and support future growth in that region.

In addition, we continue to strategically invest in our talent.

Brand product innovation and digital capabilities to advance our growth ambitions in summary, I remain enthusiastic about our prospects for long term profitable growth.

With that we will open up the call to your questions operator.

We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad.

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Once again Star then one to ask a question at this time, we will pause momentarily to assemble the roster.

And our first question comes from Anthony Perella of Punch <unk> Associates. Please go ahead.

Hi, guys. Good morning, Thanks for taking my question.

Good morning.

If you could it would be helpful on the topline sales growth.

How much of that 18.9% is from what's the breakdown between volume and pricing there and then.

Most recent quarter.

Yes, the price component is in the low teens and the remainder is unit volume growth.

Okay.

That's great and then going forward could you give some more color on how those price increase conversations are going with customers as we head into <unk>.

Fiscal Q3 and into February orders.

Yes.

And industry perspective were everybody who competes in the industry has broadly impacted by by inflation. So we are seeing competitors at this time take similar pricing actions.

So we feel that the pricing that we're pushing forward. That's effective February 1st is in line with the competitive set known in the industry likes it but everyone understands the inflationary factors behind it so.

So we don't believe that we are going to be disadvantaged or adversely impacted by our pricing actions.

Compared to our competitors.

And then just one last one.

With the business update in December I think you quoted ancillary charges at around 10 million and I think in the release it is around $15 million is there any.

Anything that Pops up in the last couple of months that led to that change or is that just a realization of the higher ancillary costs that you had mentioned.

Yeah. Unfortunately Anthony.

I mean really the over at least the last six months there has been so much disruption in the global supply chain specifically logistics.

And there are so many different parties involved in movie container, that's the freight forwarder or the shipping line towards the railroads domestic trucking companies.

And all of them to varying extents.

I'll say, probably taken advantage of the current environment.

And started implementing either new charges or raising prices on an existing charges.

And so when you have that many parties.

Passing along ancillary charges, we just had limited visibility.

I think you know.

At the end of last quarter in terms of what we what we knew and understood to be the total total ramifications of the supply chain disruption on ancillary charges.

As I noted in my comments I mean, what we are doing specifically to get control over these charges in the near term as we are slowing inbound containers I'll give you a perspective that.

In the in the first quarter of fiscal year 'twenty two.

On average we received 880 containers per month.

We anticipate for the third quarter.

Of the year in receiving somewhere between 250 and 300 containers per month, so significantly lower.

Then our peak period.

We are also aligning ourselves like I said with what we believe are the strongest most capable freight forwarders, who can effectively manage this and we're putting internal resources. Those are the things those are the steps that give us confidence that we can substantially reduce these ancillary charges.

In the coming quarter.

That's great.

So for me that's fine.

Keep up the good work guys.

Okay. Thanks Anthony.

Our next question comes from Josh <unk>.

<unk> of global value investment Corp. Please go ahead.

Yes. Thank you good morning, guys I appreciate you taking my questions here.

Good morning, Jeff.

With respect to your logistics costs of $15 million during the quarter, maybe more broadly discussing ancillary did you suggest.

Suggests that that number was going to $5 million in Q3, So I understand that there may have been a 10 million dollar increase that you think.

Can be mitigated.

Well part of that as you just heard Gary's comments Jeff.

We're bringing close to 900 containers and now we're going to.

Bringing that down closer to $2 50 to 300, our inventories are in a good place right now.

And even though we're continuing to see escalation that we have not seen these charges minimize at all in fact, we're still seeing ocean container rates rise, we're hoping with the Chinese new year is coming that we would see.

A little bit of a decrease we have not so overall areas are still where they are better or higher but the big decrease there is until that starts to stabilize we will be bringing in a lot less containers plus where it is.

Derek often mentioned, we've gone down to just six to eight main folks who are using and hopefully we'll be able to get some better terms and conditions going forward using less folks that can help us estimate these costs better because these costs as we've said our.

Costs that used to be negligible and now they've become a big part of our business. So we're going to just continue to monitor them and have put a lot of resources in place to monitor this.

Yes sure I appreciate the color just to be certain on this so is the roughly 900 versus $2 50, a normal seasonal event or is this truly.

And inventory replenishment.

One time event.

Yeah, it's lower than what our normal run rate would be because we have such a strong inventory position, we feel that we can slow things up and still.

Still maintain really really good service levels.

Great appreciate it.

Next question your SG&A improved by 350 basis point.

To 12, 4% of sales is this a good percent run rate on a forward basis.

No, Jeff I would say.

It's a appropriate I think percentage for the near term given the gross margin pressures and the uncertainty that we're facing and we're going to control cost.

You know in a very disciplined fashion.

As we think you know prospectively about a multi year period.

I'm still of the mindset that we are going to target gross margins longer term above 22% and then SGA SG&A in the 14% to 15%.

Got it alright, well good job on your cost management I know, it's been a tricky time for everybody last question with respect to capital allocation, our board approved a $30 million buyback.

You have given that youre paying on a current basis, you've talked about capex net $10 million to $12 million, how should we think or how are you thinking in the board potentially about capital allocation, particularly in light of you draw on your revolving credit facility and this recently announced share potential share buyback.

Yes, I think Jeff the I'll reiterate the cash priorities that I mentioned earlier I'm really for the remainder of calendar 2022 are going to be funding, our capex, which is primarily related.

Related to.

The build out of our new Mexicali facility, and then and then debt reduction.

What I am Directionally targeting for calendar 2022 is a reduction in inventory of at least $30 million and a corresponding decrease in debt.

The additional.

Share repurchase authorization.

Is is.

It was due to two factors one as of today, we have only about $1 million left on our existing authorization.

And then we still want the flexibility and the Optionality to free.

Repurchase shares when our cash priorities change and one we believe the stock is trading at a at a price below our view of intrinsic value.

So what I wouldn't do Jeff is interpret that the $30 million additional authorization constitutes a near term priority of cash to do more share repurchases.

But it is an option that we have.

In the future to continue share repurchases, where we believe it's appropriate.

Thank you for the clarification in your time again good luck.

Thanks, Jeff Thanks, Jeff.

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

Thank you in closing I'd like to thank all our <unk> employees for their outstanding performance in service during the second quarter.

I would also like to thank you for participating in today's call. Thank you for your questions today and please reach out if you have any additional ones and we look forward to updating you on our next call everyone have a great day. Thanks.

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

Okay.

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