Good morning, and welcome to the Flexsteel Industries fourth quarter and fiscal year 2023 earnings conference call. All participants will be in 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 Star, then two. 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 21st, 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. With that, I will turn the call over to Jerry Dittmer. Jerry?
Good morning. 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 margin 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 and delivering long-term profitable growth. T hat 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 Q4 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, 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, w ith 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 midterm, 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 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-$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. 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. 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 margin between 18% and 19.5% in the first quarter. We expect gross margin 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 US 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-$16.5 million for the quarter. We are projecting operating income as a percent of sales in the range of 1%-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-$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%-29%. Now, I'll turn the call back over 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 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. Operator?
We will now begin the question and answer session. To ask a question, you may press Star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press Star then 2. At this time, we will pause momentarily to assemble our roster. Our first question will come from Buddd Bugatch of Water Tower Research. Please go ahead.
Thank you. Good morning, Jerry. Good morning, Derek. Thank you for taking my questions.
Yeah, good morning, Budd.
Yeah. Just can you talk a little bit about the revenue pattern and the way it materialized during the quarter? How did it look year-over-year? Maybe talk about units versus price as it came out for the fourth quarter.
Actually, if you, 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 pickup in May and June, kind of around Memorial Day holiday. Feel like we finished the quarter strong. It's interesting, you know, year-over-year, total net sales were down 15%. Unit growth was actually up 2% year-over-year. All the decline in the, in the net sales number was, was related to pricing, of which a large amount of that, pricing decline was related to ocean freight surcharges.
If you remember, if you go back 12 months ago, in Q4 of fiscal year 2022 is when we had, you know, peak ocean freight rates, probably our surcharges were at their peak, and then we virtually, I mean, we eliminated those ocean surcharges here in our most recent fourth quarter. We feel good about our, our, our momentum in the market, the fact that we had positive year-over-year unit growth. Then we're anticipating carrying that momentum into Q1, and expect to have, you know, mid-single digit unit growth in the, in the upcoming quarter as well. Budd, most of that pricing is behind us. We will see some of that as the year goes on.
There will be probably $4 million-$5 million of it we'll see here in this first quarter from the pricing actions. That's because in May is when we took the last of our ocean freight surcharges away. It'd be pretty encouraging. Probably the most encouraging thing we really saw in the fourth quarter was our unit volume being up year-over-year. That was very encouraging.
I, I agree. I'm painfully aware of what happened to ocean freight during the post-pandemic timeframe. Historically, much of your sales were retailer-based and special orders. Now with the Big Box strategy, I take it that there's a, a lot more placed on stock. How did that balance unfold during the quarter, and what do you see going forward on that?
Yeah, in terms of, again, unit volume, we feel good about, you know, really performance in both traditional retail as well as kind of our e-commerce pursuits, including big box. 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. Beyond that, we're not seeing really any material kind of changes in mix.
Are you seeing better reports from your retailers? You have a wide swath of retailers throughout the country. How is their demand looking? What, what can you see from that, from your incoming order book?
Yeah, Budd, our retailers are not panicking at all. They're actually, it, it's pretty strong, especially year-over-year. As Derek said, both the retail and the Big Box are, are both, are both up year-over-year, especially on the order side, which is very encouraging. I mean obviously, we are worried, like everybody, about what's gonna happen, if there's gonna be an economic slowdown, but right now we really haven't seen that. We're, we're pretty encouraged where we're at right now.
Yeah. Our orders for the fourth quarter, actually, total company, were up 20% year-over-year. Again, we feel like we're competing well. As Jerry alluded to, most retailers will tell us that traffic is a bit slow. The fact that we're seeing pretty, 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 and let, let some others have, have at it. Just the gross margin progress was notable. Can you give us a little bit of color on that? You called it from operational efficiencies. How does it look like with the material, labor, and overhead? Which, where were those efficiencies and, and the, and the reduced inventory drag breakdown?
Yeah.
Can you give us some color on that, and maybe a walk from quarter to quarter or year to year?
Yeah. F rom a productivity and operational efficiency standpoint, Budd, we made really good gains across all the aspects of our supply chain, s o 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 2023. Unfortunately, a lot of that got used to fund, you know, some price concessions in the market, s o good momentum on that front. And the... I'm sorry, Budd, the second part of your question?
Yeah.
The operational efficiencies.
Right. Oh, yeah. What do you see, what do you see going forward on that? How far can you take the, the gross margin level?
Yeah. I, again, we've talked about, you know, near term, midterm. Certainly, our, our goal is to get our gross margin at or above kind of 20%. Continued operational efficiency will be a, a really important part of that. The other piece that you noted, which was in the press release, is, you know, year-over-year reduction in inventory kind of write-downs. If you remember, in fiscal year 2024, Q4, you know, we had a lot of inventory. We put reserves against, you know, some of that because demand was slowing, so t hat comment as it relates to fiscal year 2023, Q4, was simply, you know, there was a, there was a negative kind of comparison in fiscal year 2022. So, overall, we feel good about our inventory levels, the, the quality of inventory, so no, no concerns on that front.
I think, you know, as we go forward, we feel pretty confident around our ability to continue to expand overall margins throughout fiscal year 24. The big levers there are, are twofold: It's continued operational efficiencies, and then second, volume, volume leverage.
The other thing, too, Buddd, in there, the two things is the inventory will continue to come down. We don't see that there'll be growth during this fiscal year in inventories, even as our revenue goes up. Probably the only thing we really that's kind of an uncontrolled one there right now is obviously the Mexican peso versus the US 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 Mexican peso and the US dollar aren't really moving in the best direction for us.
I, I see. You did talk about inventory as a source of cash, and it's at what? $122 million at the end of the year. Do you think, is it... What's the goal for the end of fiscal 2024? Is it $100 million back to where it was maybe in before pandemic timeframe?
Yeah, I think in that range. Our goal would even be a little bit better than that, but that would definitely be, definitely our goal.
That would get your, your, your, your funded debt down to just about zero, if not, if not at zero.
Correct. I mean, we've stated it's 0 to, to 15, but our, our, our ultimate goal, obviously, is to get that down to 0.
Got you. Thank you very much. I'll let others ask questions and come back in the queue if, if, if possible.
Thanks, Buddd.
Once again, if you would like to ask a question, please press Star, then one. The next question comes from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.
Good morning, and thank you for taking the questions.
Good morning, Anthony.
Yeah, good morning. Just curious, as far as the revenue impact from the growth initiatives, I know Derek, you talked about the, the Big Box impact for the quarter. Just overall, when we look at collectively, Big Box expansion as well as Zecliner and Flex and others, how much of that do you think contributed to the fourth quarter sales? Then kind of, how should we think about that as far as outlook for fiscal 24?
Yeah, in terms of the fourth quarter, you know, a little less than $10 million was derived from kind of growth initiatives. Going into certainly fiscal year 2024, we feel good about the momentum there. As it relates to fiscal year 2024, we would estimate that our growth initiatives would contribute probably another, on an annual basis, another, at least $30 million-$40 million over and above what we delivered here in fiscal year 2023.
We're hoping, Anthony, that the plan is for that to be maybe to rise up somewhere in that 15% range going forward for the-- on an annual basis.
Got it. Yeah, thanks for that. You know, certainly, you know, terrific job with the gross margin expansion. I know for, for the upcoming quarter here, looks like there will be a little bit of a, you know, sequential decrease because of, I guess, you know, lower revenue. The, you know, overall, do you think you can get above 20% at some point later this fiscal year, or is that probably not, not doable just yet?
If we do it sequentially, I think the answer would be yes. I mean, obviously, our revenue will be down, you know, in that $10 million type range, so that does have an effect here in the first quarter. Historically, our second, third, fourth quarters are stronger quarters, and so the plan will be to continue to take that upward. Maybe for the year, it'll average close to that 20%, but hopefully by the end of, end of the, of the fiscal year, we will be above that 20%.
Okay. Very good. Then, you know, as far as, you know, inventories at retail, we would like to hear your perspective. I know you, you talked about last year having a glut of inventory at the retail level. What, what's your sense now as far as, inventory levels, to your customers?
From where we're at or from where our retailers are at?
Yeah.
As far as where the retailers are at, I mean, yeah. Last year, obviously, there was this big glut of inventory just as demand started to slow down.
... You know, fast forward, you know, a year later, I mean, do, do you feel like, you know, your retail customers have a, in general, you know, appropriate inventory levels or still maybe too much? You know, just wanted to get a, you know, better perspective from you.
Yeah, it's a good question. Our retailers, for the most part, especially our strong retailers, are in a good place. Of course, they're, everyone's a little bit cautious, not sure what's gonna happen from an economic standpoint, but most of our retailers are in a decent place. A lot of their caution comes from store traffic is what's really down. Sales are, are hanging in there pretty well, and, and most of the folks coming in are coming in to buy, but, but true retail traffic is down. And as that correlates into inventories, people are a little bit cautious. For the most part, most of our retailers are in good place, and we're seeing a lot of good, they sell through, their orders come back our way, which is good.
Okay, that, that's good to hear. Then, By the end of fiscal 2024, you could potentially be debt-free. As you move beyond that, you know, what would you say would be your cash flow priorities as you look to be, you know, looks like, you know, debt free, but, you know, by the end of 2024?
The, the main one, of course, would be to continue with our, 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, with new products and enhancements, things like that. Obviously, we'll continue to, 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 is now concluded. Thank you for attending today's presentation, and you may now disconnect.