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spk01: Good morning and welcome to the Flex Steel Industries second quarter fiscal year 2023 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press store then two. Please note this event is being recorded. I would now like to turn the conference over to Alejandro Huerta, Chief Financial Officer for Flex Steel Industries. Please go ahead.
spk02: Thank you and welcome to today's call to discuss Flex Steel Industries second quarter fiscal year 2023 financial results. Our earnings release which we issued after market closed yesterday, Monday, February 6th 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 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 10Q 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 gap 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 gap to non-gap measures. And with that, I will turn the call over to Jerry Dittmer. Jerry?
spk05: Good morning, and thank you for joining us today. In spite of challenging macroeconomic environment, I am pleased with our performance in the second quarter. I am encouraged by the progress we have made on our strategic initiatives and ability to gain share in the market, allowing us to deliver sales for the quarter of $93.1 million, which was in the range of our guidance as our growth initiatives helped to partially offset the challenges posed by high retail inventories and waning consumer demand. With these softer demand levels, we've continued to prudently manage spending, deliver on our cost-saving initiative, and offset competitive pricing pressures and inflationary costs to deliver adjusted operating income of $1.0 million. As discussed in previous quarters, we are committed to driving working capital efficiency and paying down debt. further strengthening our balance sheet. During the second quarter, we were successful in making strides in both as we improved working capital by $9 million and reduced our outstanding debt by $10.9 million. In the near term, macroeconomic headwinds pose a challenge to industry growth. However, our commitment remains on delivering long-term profitable growth and we are making pragmatic investments to support these plans. We recently announced a realignment in our organizational structure, reallocating more dedicated resources to new growth pursuits, expanding our sales force, adding sales leadership to gain market share, and investing in resources to support the expansion of product management, development, and engineering. As an organization, we are 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 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 on what we see ahead.
spk06: Thank you, Jerry, and good morning, everyone. As Jerry emphasized, we are firmly committed to our strategic growth plans. Given the current economic uncertainty, many furniture manufacturers are responding by scaling back resources and investments, but we're gearing up for growth. We are managing expenses and cash flow prudently to stay nimble, but we remain on the offense and are driving investments for future growth. I'd like to expand upon some of the recent growth investments Jerry highlighted earlier. First, we are realigning our leadership structure to accelerate new growth initiatives. Tim Newlin, who is a 25-year veteran of Flex Steel, has been named Vice President, Strategic Business Development. In his new role, Tim will leverage his experience and deep knowledge of the furniture industry to accelerate innovation, and incubate new ideas that will expand FlexDeal's business models, brands, products, and channels in profitable and fast-growing areas of the market. David Crimmins expands his responsibilities as Vice President of Sales and Product. David has leadership responsibility for driving our omni-channel strategies in our core business across retail, big box, and e-commerce. Additionally, he will strengthen the integration of our product and sales teams to improve our new product speed to market and success rate. Second, we are strengthening resources and investments dedicated to each of our three major sales channels. For example, in our retail channel, we recently created a new role of retail sales vice president who is solely focused on driving continued market share gains in that channel. We are also expanding our retail field sales team by over 10% to promote stronger customer relationships and gain share. And we've committed to implementing a new CRM solution by mid to late 2023 to improve our customer's experience. We are making similar investments to support the big box and e-commerce channels as well. Third and lastly, we are investing in our product development and engineering capacity to substantially increase both the number and speed of new product launches in the future. We're confident these collective structural changes and investments will make us more competitive and help drive profitable growth. Now, turning to our specific growth initiatives, recall that our growth strategy for new business has three legs. Number one, new sales distribution. Two, new product categories. And three, new consumer segments. We're making solid progress on all three fronts and the growth potential of these pursuits will accelerate into the second half of the year. Let me share a few highlights. Beginning with new sales distribution. We've made a meaningful entry into big box distribution this year with a major customer who will become a top 10 and potentially even a top five account for us. We're selling a broad set of Flex Steel products to them this year. that span all three of our major product categories, motion furniture, stationary furniture, and case goods. And we'll include launches of our major new products this year, such as Flex, the Charisma brand, and some exclusive offerings tailored to this retailer. We also have market tests scheduled in the second half with several other large big box retailers, which could evolve into meaningful revenue next fiscal year. Next is new consumer segments. Last quarter, we launched our new brand, Charisma, designed to serve customers, especially younger generations, seeking good quality, stylish furniture at affordable, popular prices. Initial retail adoption has been good, and we will extend the sales distribution of Charisma into e-commerce and big box in the second half of the year. Development is already underway to expand the product offering of Charisma and we expect to show several new smaller stationary frames at the upcoming April High Point Market. Last is new product categories. We remain on track for a third quarter launch of Flex, our small parcel contemporary modular furniture solution built to flex with people's ever-changing lives. Flex has been well received across all channels of our business and will be available for sale this quarter across four different distribution platforms, including direct-to-consumer, traditional retail, e-tailers, and big box customers. To protect our innovation, we filed both design and utility patents for this product. The other new product that we're extremely excited about is Zcliner, our sleep solutions recliner, which begins shipping to customers in March. Customer feedback has been overwhelmingly positive, and we expect strong and broad sales distribution for this product across both traditional retail and adjacent channels. Development is already in progress to offer additional product enhancements, and we are committed to driving meaningful innovation in the health and wellness category to make ZKleiner a leader in this emerging space. The organization is intensely focused near term on ramping up sales for these growth initiatives. and we're excited to see the results in the coming quarters. From an operational viewpoint, we are executing well, maintaining strong service levels, and continuing to deliver strong results from our cost savings initiatives. In the near term, these savings are being used to fund price reductions to respond to competitive pressures. While these pressures won't dissipate completely, we do expect the pricing environment to improve modestly in the second half of the fiscal year since both retailer and manufacturer's inventories have improved slightly. As a result, we expect more of our cost savings efforts to fall to the bottom line. With that, I'll turn it over to Alejandro to give you additional details on the financial performance for the second quarter, and I'll look for the third quarter of fiscal year 23.
spk02: Thank you, Derek. Good morning, everyone. For the second quarter, net sales were $93.1 million, down approximately $48.6 million, or 34.3%, compared to $141.7 million in the prior year period. While down from the prior year, our sales results were within our guidance of $87 to $97 million provided during our first quarter earnings call. From a profit perspective, In the second quarter, the company delivered operating income of $3.8 million or adjusted operating income of $1.0 million or 1.0% of sales, which was within our guidance range of negative 1.5 to positive 1.5% for the quarter. We recorded net income of $2.9 million and earnings per diluted share of 53 cents. Adjusted net income for the quarter, which excludes the one-time benefit related to the settlement of the Indiana EPA litigation, was $0.4 million, and adjusted income per diluted share was 8 cents. Gross margin as a percent of net sales in the second quarter was 17.0%. The over 1000 basis point improvement from the prior year quarter was largely driven by effectively reducing ancillary charges, prudently managing costs, and navigating competitive pricing pressures, partially offset by volume decline, deleveraging our fixed costs, and continued inflation in domestic transportation charges. Operating income was also supported by a $2.7 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 flows, the company ended the quarter with a cash balance of $1.8 million and working capital of $107.1 million. which represents a reduction of $9.0 million during the quarter, primarily driven by a $10.6 million decrease in inventory. The result of the strong working capital management was solid operating cash flow of $11.6 million during the quarter. As previously communicated, debt reduction is a key priority, and in the quarter, we reduced our outstanding borrowings by approximately 36.1% or $10.9 million. Looking forward, guidance for third quarter sales is between 93 and $103 million. While our strategic growth initiatives will begin to drive meaningful revenue in the second half of the year, the continued macroeconomic challenges will continue to put pressure on our core product offerings. However, we are optimistic that our growth initiatives will help to offset the soft consumer demand and result in quarter over quarter growth in the second half of the fiscal year. Regarding profitability, the impact of our growth initiatives will allow for profit margins to improve sequentially each quarter in the second half of the year. However, competitive pricing pressures along with continued slumping demand, will temper our profitability expansion. We will continue to focus on practical spending levels in line with lower sales levels, but invest in our growth strategies to drive long-term profitability. As such, we are projecting operating income as a percentage of sales in the range of 1.0% to 2.5% for the third quarter. with the largest drivers of variability in the range being consumer demand, competitive pricing conditions, and macroeconomic headwinds. We expect gross margins in the range of 16.5 to 18% in the third quarter, as our growth initiatives and cost savings initiatives will drive margin expansion. However, we see this being partially offset by continued pricing pressures in the market due to the compressed demand previously discussed. If sales continue to improve as expected during the remainder of the fiscal year, gross margins should sequentially improve quarter over quarter to between the mid to upper teens. We intend to prudently control SG&A costs and expect SG&A costs between $15 and $16 million in the third quarter which is higher than the second quarter as we are actively investing in our growth initiatives discussed by Derek. Regarding our cashflow outlook for the second half of the fiscal year, we expect working capital to be a source of cash, largely driven by a modest reduction in inventory, partially offset by growing account receivable balance due to the higher revenue. However, The timing of the working capital reduction will be heavily weighted in quarter four, as we expect working capital to be a modest use of cash in quarter three as accounts receivables grow in line with sales and we deepen our inventory positions of our best-selling, fast-moving SKUs. For the third quarter, we expect capital expenditures between $1 million and $1.5 million as we invest in the expansion of 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. We continue to forecast our debt levels at the end of fiscal 2023 in the range of $4 to $12 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. Thanks.
spk05: I'm optimistic about our future. Slowing economic growth and waning consumer demand are obvious challenges for the industry near term. However, we continue to make prudent investments to ensure our profitable growth and success long term. 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 sensibly investing in growth opportunities. With that, we'll open the call to your questions. Operator?
spk01: We will now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star, then two. Once again, that was star then 1 to ask a question. And at this time, we will pause momentarily to assemble our roster. And our first question will come from Anthony Lebedinsky of Sidoti & Co. Please go ahead.
spk03: Good morning, guys, and thank you for taking the questions. So you have done a very good job. Yeah, you've done a very good job of reducing your own inventories. And Derek, you mentioned, I believe, that inventories overall and the retail level have improved slightly. So what is your sense as to when inventories overall and the in the retail channel. We'll get back to so-called normal levels.
spk05: Yeah, Anthony, this is Jerry. Good question. So we just completed our West Coast market out in Vegas since we got a chance to talk to several hundred dealers and kind of see what's going on. And the answer is it's still pretty choppy. We have several people are ordering. They're seeing their inventories come down. There's still a lot of people that have inventories. You know, their foot traffic is down a little bit. And so they're inventories aren't going down quite as quick as they'd hoped. Is it three to six months? Is it the rest of the calendar year? Depending on the retailer, that's really the answer. So again, we're seeing some that have come down well and others that they said it's going to take another six to nine months to get it down.
spk03: Got it. Okay. So it sounds like a mixed bag there. Okay. But it sounds like also we are past the peak levels as well. So that's good to hear. Correct. Do you have any ballpark estimate as to how much of the various growth initiatives that you guys talked about, how much did that contribute to the quarter in terms of operating performance?
spk06: Yeah, I won't comment to the quarter, but we have provided guidance in the past, and our current forecast for all of our incremental growth initiatives is between $30 and $40 million of revenue in the full fiscal year.
spk03: Yeah, thanks, Derek, for that. And then as far as margins for those initiatives, whether the big box rollout or Charisma or Flex, are the margins for those products comparable to the company average, or how would you characterize that?
spk02: Hey, Anthony, it's Alejandro. Really good question. You know, we're driving the growth initiatives to drive accretion in our margin overall.
spk03: Okay, that's great to hear. And then... In terms of the operating margins overall, certainly nice to see pretty good improvement from last year. Back in fiscal 21, you were at roughly 6.5% operating margin. Certainly realize that it's a much different operating environment now, but it looks like ocean freight costs have come down, labor rates have stabilized. I obviously gave guidance for Q3, but then As we look beyond the Q4, going out to fiscal 24, I know you haven't given guidance yet, but just overall, broadly speaking, how should we think about the progression of the operating margin going forward?
spk06: Anthony, it's Derek. As we look out for the balance of the second half, we are starting to work through some of our higher cost inventories And so we'll see margins stabilize and sequentially improve throughout the quarter. We expect, you know, similar trend in fiscal year 24, so sequential improvement kind of year over year. We do plan on investing more behind our growth initiatives. So I stated, you know, earlier in the call, we're adding roles dedicated to our strategic growth initiatives. We're expanding capacity. around new product development. So some of the incremental margin improvement year over year will be tempered by higher investments, which we believe will have a phenomenal ROI and will drive long-term profitable growth.
spk03: Got it. Yeah, thanks for that, Derek. And then any update on the Mexicali facility? Where are you guys with that?
spk06: Yeah, so certainly in the near term, we do not – foresee a need to utilize that, and we're still evaluating and pursuing opportunities to potentially sublease that in the near term, but still keep it as a long-term option to support our growth.
spk03: Got it. Okay. All right. Well, thank you, and best of luck going forward.
spk05: Thanks, Anthony.
spk01: Once again, if you would like to ask a question, please press star, then one. And our next question will come from JP Geegan of Global Value Investment Corporation. Please go ahead.
spk04: Thank you. Good morning. It sounds like you have some very interesting developments to put, particularly Zclinder beginning to ship in March and the imminent launch of Flex. You addressed the impact on margins with Anthony, but can you discuss both of those initiatives and then the expected impact of um your your strategic growth plans on the overall business be it revenue or margins or product penetration but really more broadly i think as we look at all of our growth initiatives um recall that we've kind of split them out in these three legs you know new consumer segments new sales distribution new product categories
spk06: I think the impact of these growth initiatives on the company longer term will position Flex Steel where the market is going to grow. We're still certainly dedicated to our traditional retail channel, as obvious by the investments that we mentioned earlier. But in two to three years, a much larger proportion of our sales will come from big box channel and e-commerce a larger proportion of our sales will come from more modern stylish Furniture that is geared towards younger generations And and and and I think what you'll find is that we're pivoting towards differentiated innovation as a competitive advantage of the company and I think I Flex and ZCline are good examples of that in the near term, and we're going to continue to challenge ourselves on how we bring meaningful innovation that's different than the competitive set because there's a lot of furniture out there. So I think everything that we've got going on near term is really an example of how we're trying to transform the company for the long term.
spk04: Can you discuss your entry into the big box segment, particularly the impact on margins, both short-term and longer-term, and then other nuances, perhaps like inventory or storage requirements or fulfillment requirements, and any challenges you've faced thus far?
spk06: Yeah, I think in terms of big box, the margin profile is better than the current portfolio average. So as Alejandro alluded to, we expect this We expect all of our growth initiatives to drive margin expansion, kind of long-term, big box included. The vast majority of what we're selling through that channel right now is online. And we are not building inventory necessarily in line in retail stores. I think that will evolve in the future, but it is predominantly an online business. I think I think there's – I'll phrase it differently, JP. There's been some really good learnings around the expectations that that channel has that I think long-term will actually make us a stronger company. We're thinking differently around, you know, our factory audits, quality programs, fulfillment service. again, that I think it's going to force us to build capabilities that will serve us well in other areas of the business, which will only lend itself to accelerated growth.
spk05: Yeah, JP, this is Jerry. So we have, obviously, we're used to sending product to a lot of different dealers, a lot of different places all over the country because we have broad distribution. This distribution is the same, and the big box players, there's three to four of them that we are in deep trials with right now, and they're working quite well. Derek's point of the learnings, there are a lot of learnings there because a lot of this product does not go through our normal distribution networks, things like that. Most of this product is online. Some of it, we do have trials that are going to be in some big chain stores here coming up. The exciting part here is that the learnings we're having are going to really help us in our core business also because it's really helped us balance it. A lot of this is product that we have. We are also in the process of developing new products for these channels also.
spk04: Understood. That's helpful. Thank you. How should we expect? your capital allocation priorities to change, if at all, as you focus on strategic growth? And in particular, how much debt are you comfortable carrying in your capital structure, and how do you intend to modulate dividends and share repurchases?
spk02: Hey, this is Alejandro, JP. Good question. You know, we've talked about this. First and foremost, we're focused on paying down our debt. And with the outlook of somewhere between $4 and $12 million by the end of fiscal year 2023, That doesn't mean we're not opportunistically looking for growth opportunities to invest in, but we're measuring those against an ROI profile. So first and foremost, pay down debt, and then look for strategic opportunities to invest, whether that be equipment, machinery capabilities, or even expansion from a production perspective. And then at this time, we're not thinking about changing our dividend outlook for our investors, but obviously that's something we discuss with our board on a very regular basis and we'll continue to have those discussions. But we want to add the best value possible back to our shareholders.
spk06: JP, just to add to Alejandro's comments, you know, as we think longer term, again, our intent is to start to build up both cash as well as debt capacity to pursue, you know, strategic acquisitions. Long term or... I guess midterm, we'd be comfortable going up to three, three and a half times EBIT in terms of debt levels to pursue the right acquisition. But we do want to continue to strengthen the balance sheet so that we can pursue those opportunities if the right one comes along.
spk05: The other question you had, JP, was in regards to our share repurchase. We will continue to look at that and be opportunistic. If our stock stays, you know, at a level that we feel it's a very good investment for our shareholders, we will continue to do that.
spk04: Okay. And then one final point of clarification. Derek, you alluded to an ROI expectation on your strategic growth initiatives before. Can you put any sort of color around that?
spk06: Yeah. I mean, the only color I'll give JP is, you know, we – We look at all of our investments relative to our cost of capital, and we have confidence that how we're deploying capital is going to generate shareholder value creation. So, again, I won't give you specific ROI numbers, but rest assured that we've got confidence that these things are value-added.
spk04: Okay. Appreciate your time and taking my questions, and congratulations on that nice quarter. Thanks, JP.
spk01: The next question comes from John Beshear of Tentacle. Please go ahead.
spk07: Good morning. Thanks for taking our questions. Just to confirm, the product that's going into the big box retailers, that's your brand, correct? You're not doing any type of private labeling?
spk05: We're actually doing some of both. So we do have actually they are sometimes using their own uh, you know, brands, uh, they are sometimes using our brands and sometimes we are also just, uh, coming out with, with some new labels that we may also use going forward.
spk06: Currently though, John, the vast majority of what is flowing through big box today is flex steel branded. Um, but we are exploring, you know, some other white label options for what I'll call lower cost product.
spk07: Okay. White label is private label.
spk06: Correct.
spk07: Okay. All right. So you'll be able to discuss that more as you get through the process of testing and all of that, correct?
spk04: Yes, correct.
spk07: Okay. Fair enough. The other question is, what was the backlog at the end of the quarter?
spk06: Roughly 60 million. It's been, I think, since the beginning of the year, kind of floating between 55 and 60 million. So it's stabilized and back to normal levels.
spk07: Okay. Very good. Thanks and good luck.
spk06: Thank you. Thank you.
spk01: This concludes our question and answer session. I would like to turn the conference back over to Jerry Dittmer for any closing remarks.
spk05: Thank you. In closing, I would again like to thank all our Flex Seal employees for their outstanding performance and service during the second quarter. We are really excited about our future and what everyone is bringing with us. I would also like to thank you for participating in today's call. Thank you for those that asked questions. And please reach out if you have any additional ones. We look forward to updating you on our next call. Thanks, everybody. Have a great day.
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