Latest conference call, earnings report highlights how the industry is facing the best and worst of times
DUBUQUE, Iowa — A glance at upholstery and case goods resource Flexsteel’s latest earnings report reiterates the idea that the industry indeed is experiencing the best and the worst of times.
The best of times because sales continue to rise for many resources with high backlogs. In Flexsteel’s case it had a nearly 19% increase during the second quarter, representing its sixth consecutive double-digit increase of quarterly year-over-year sales growth.
Now to the part about the worst of times. In its quarterly conference call, Flexsteel President and CEO Jerry Dittmer noted as much as 70% of the company’s sales come from globally sourced products, “which require us to import thousands of containers each quarter.”
As everyone in the industry knows, container costs are at historic highs and don’t appear to be coming down anytime soon. This and related ancillary fees related to containers being stranded for days or weeks due to port and railroad congestion have further driven up costs.
For Flexsteel this resulted in a second quarter net loss of $7.5 million, or $1.13 per diluted share, compared to net income of $8.5 million or $1.13 per diluted share in the same period last year.
The disruption in the supply chain, Dittmer noted, has caused logistics firms to increase per diem rates as high as three to four times pre-Covid levels.
As a result, he said, “ancillary charges, which used to be a negligible item on our P&L, unexpectedly 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.”
Dittmer said later in the call that with so many parties passing along various expenses, “we just had limited visibility … at the end of the last quarter in terms of what we knew and understood to be the total ramifications of the supply chain disruption on ancillary charges.”
He added that in the first quarter of fiscal year ’22, on average, the company was receiving 880 containers per month. It anticipates receiving between 250 and 300 per month during the third quarter, or “significantly lower than our peak period.” This will lower its exposure to the aforementioned ancillary costs involving freight.
Yet Dittmer noted another significant issue the company is facing is cost inflation, not just with container rates, but also materials and labor costs and domestic transportation. In Mexico alone, where it is producing upholstery, the company has seen wages increase 22%.
He noted that while the company is raising prices to pass along the higher costs, the lag in “price realization” will negatively impact gross margins near term.
For example, revised pricing is expected to take effect with new February orders, said Derek Schmidt, chief financial officer. Yet due to a lag in price realization, the company expects inflation to run higher than price by roughly $1 million to $2 million in the third quarter compared to the second quarter.
Dittmer said the price increases are not unique to Flexsteel as “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. No one in the industry likes it, but everyone understands the inflationary factors behind it.”
As Dittmer noted, the company also is taking other steps to manage its expenses.
For example, as the company already has made an investment in inventory to support higher sales and improved service levels, it anticipates reducing the number of inbound containers in the third and fourth quarters. This is expected to lower ancillary costs to less than $5 million.
“We anticipate gradually reducing inventory over the balance of fiscal 2022, while still maintaining an advantaged position with our customer service levels,” Schmidt said, noting that the company still expects to grow sales between 14% and 22% during the quarter and between 15% to 20% for the full fiscal year. “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.”
In addition, the company is “realigning with a select group of freight forwarders who can perform more effectively” and is dedicating added resources to track and minimize fees by container “on a daily basis.”
Schmidt added that the company is also “tightly managing SG&A expenses at or below $17.5 million in the third quarter” while also funding “critical long-term growth investments. If supply chain conditions worsen or inflationary pressures escalate higher, we’ll adjust our plan and take additional actions as necessary.”
The goal, Dittmer added, is to return the company to profitability for the remainder of the fiscal year.
He added that while the impact on short-term profits due to supply chain challenges is frustrating, he was encouraged by the efforts the company and his team are making to manage the cost pressures. He also said the company remains committed to its long-term growth plans, including the ramping up of production at its newest plant in Juarez, Mexico and construction of its new plant in Mexicali, Mexico, which is expected to be completed in June and begin production in August.
In addition, he said, the company’s newest distribution center in Greencastle, Pa., will begin shipping to customers next month, which is expected to improve service levels and support future growth in the region.
Flexsteel, like many others appears to be taking the right steps to address costs while planning for future growth. How that plays out will be worth watching.