Flexsteel Industries Q2 2024 Earnings Call Transcript

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February 6, 2024

There are 6 speakers on the call.

Operator

Good morning, and welcome to the Flexsteel Industries Second Quarter Fiscal Year 20 24 Earnings Please note this event is being recorded. I would now like to turn the conference over to Mike Restler, Chief Financial Officer for Flexsteel Industries. Please go ahead.

Speaker 1

Thank you, and welcome to today's call to discuss Flexsteel Industries' 2nd Quarter Fiscal Year twenty twenty four Financial Results. Our earnings release, which we issued after market close yesterday, February 5, is available on the Investor Relations section of our website at www.flexsteelindustries.com under News and Events. I'm here today with Jerry Dittmer, Chief Executive Officer and Derek Schmidt, President. On today's call, We will provide prepared remarks and then we will open the call to your questions. Before we begin, 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.

Speaker 1

Forward looking statements, by their nature, involve estimates, projections, goals, forecasts and assumptions and are subject to risks and uncertainties that can 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 ks 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 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.

Speaker 1

And with that, I'll turn the call over to Jerry Dittmer. Carey?

Speaker 2

Good morning, and thank you for joining us today. I'd like to start by welcoming Mike Ressler, our new Chief Financial Officer. Mike has been with Flexsteel over 17 years in various accounting, Finance and other cross functional roles, most recently as the Vice President of Manufacturing. His appointment as CFO reflects his leadership and contribution to the company's transformation over the past several years, and I'm excited for Mike to further expand his positive impact on the company as CFO. I would also like to congratulate Derek Schmidt on his appointment to President and to the Board of Directors.

Speaker 2

Derek's promotion reflects his leadership of the company's operations and growth strategy and aligns with his expanded responsibility since joining the company nearly 4 years ago. With that, I am very pleased to share with you our Q2 fiscal year 2024 results. While headwinds from macroeconomic challenges and shifts in consumer spending towards experiences And away from things persist in our industry, we continue to execute on our strategic initiatives and delivered sales growth of 7.5% when compared to the prior year quarter. In addition, Our relentless focus on operational efficiency and cost savings propel gross margin expansion and help fund additional investment in growth initiatives, while delivering significantly improved operating income when compared to both the same quarter of the prior year and our Q1 of fiscal 2024. While we expect the business environment in the near term to remain challenged, our team isn't deterred and remains intensely focused on continuing to profitably grow our business throughout the remainder of fiscal year 2024 and long term.

Speaker 2

We will continue our positive momentum going into the Q3 and are confident in our ability to grow sales both compared to last year and the Q2. I'll now turn the call over to Derek to discuss our results and an update on our growth initiatives. I'll be back at the end of the call with some closing comments on what we see ahead.

Speaker 3

Thank you, Jerry, and good morning, everyone. Like Jerry, I am very pleased with our 2nd quarter results. We are competing well in our core business and executing our market expansion initiatives, resulting in both sales and profit growth, even in a difficult business environment. As Jerry noted earlier, we grew our top line by 7.5% in the fiscal 2nd quarter. This year over year sales comparison continues to be adversely impacted by the elimination of ocean freight surcharges, which reduced revenue by approximately $3,500,000 compared to the prior year quarter.

Speaker 3

As discussed in our Q1 call, in the prior year, we used this surcharge mechanism through higher cost of ocean container delivery, which were significantly inflated due to supply chain issues. Container delivery costs normalized throughout the last fiscal year and we subsequently eliminated the surcharge. Excluding the $3,500,000 impact from this ocean freight surcharge elimination, sales growth related to Unit volume and product mix was a robust 11.7%, further reinforcing our strong sales execution. Despite challenging industry conditions, we remain confident in our ability to continue our growth momentum into the second half of fiscal twenty twenty four from both continued share gains in our core business and increasing momentum in our market expansion initiatives. In our core business, we expect to continue outperforming the industry By continuously improving and providing a differentiated customer experience, aligning ourselves with the strongest, most capable distribution partners and driving a constant stream of relevant and compelling new product.

Speaker 3

We define our core business based upon where the majority of our current sales are derived from, which is product designed for primary living spaces like the living room, which are sold through independent furniture retailers and have a more traditional or transitional style that primarily appeals to Gen X and baby boomer consumers. This core business is large and profitable, and we will continue to defend and expand our penetration in this market. At the same time, we are pursuing growth in markets outside of our core that we believe are relevant and growing and where we have a clear right to win. If you recall from prior calls, these market expansion initiatives take 3 forms. 1st, consumer segments, namely Gen Z and Millennials 2nd, product categories outside of primary living spaces and lastly, sales distribution outside of independent furniture retailers.

Speaker 3

I'm pleased with our solid progress in all three of these areas. First, to address younger consumers, we're repositioning our brand portfolio through a 3 pronged approach. We are modernizing the Flexsteel brand and last October, we launched a strong lineup of more contemporary product at lower price points with exceptional comfort and quality. We're encouraged by initial placements and sales of these new products are ramping nicely. We also launched a new brand, Charisma, last year to reach younger consumers with even lower priced on trend product.

Speaker 3

In this year, we've invested in new talent and product engineering to support Charisma and we'll be launching multiple exciting new products at April's High Point Market to grow this new brand. Additionally, we continue expanding our new Flex solution with broader accessories to further improve its modularity and appeal to younger consumers. Moving on to our 2nd market expansion focus, which is to expand into newer product categories. We focused on health and wellness this year with our new ZCLINER sleep chair. A recent third party sleep study validated The superior sleep results from using ZCLINER, which we are now leveraging in our marketing and demand generation initiatives.

Speaker 3

The product is now placed in over 9 60 retailers, and we are investing aggressively in additional innovation to protect our leadership position in this emerging market. Our 3rd market expansion focus is to broaden our sales distribution to position our brands where and how consumers want to purchase furniture both now and into the future. For example, our Flex Modular solution, which I mentioned earlier, can be purchased not only in leading retailers, but also on Amazon, Wayfair, Costco dotcom and our own online platform at flexsteelstore.com. While I'm excited about our top line growth and future growth prospects, I'm equally energized by our improved profitability, which is being propelled by 4 drivers. 1st, New products with higher margin profiles.

Speaker 3

We've raised the threshold for new product margins and expect Product lifecycle management will continue to improve our gross margin over time. 2nd, we're executing well operationally and delivering strong cost savings within our supply chain. 3rd, we've remained disciplined with pricing and pull back promotions where needed to improve overall profitability. And 4th, we are achieving leverage on fixed costs through higher sales volume, which we believe will continue to be an important driver of operating margin improvement going forward as we grow the business. As I noted earlier, Differentiated customer experience is an important element of share gains in our core markets.

Speaker 3

As part of our ongoing commitment to improve the customer experience, The company announced the closure of our Dublin, Georgia manufacturing plant. While this decision was very difficult, It enables us to reduce customer lead times and handling damage to improve the overall customer experience, while also decreasing inventory, simplifying logistics execution and improving profitability. Currently, the Dublin facility supports less than 5% of the company's sales, and we expect to retain virtually all sales through this transition. Closure of the facility is expected to occur by the end of our fiscal Q4. As part of this transition, The company expects to incur pre tax restructuring and related expenses between $2,500,000 $3,200,000 The one time costs are associated with employee separations, inventory and equipment transfers and other expenses directly related to the closure are expected to be incurred primarily in our 3rd and 4th quarters of fiscal year 2024.

Speaker 3

Once the closure is fully executed, The company expects annualized savings in the range of $4,000,000 to $4,500,000 The Dublin facility will be listed for sale upon closure and the company anticipates a future one time gain in excess of the carrying value of the asset. To summarize, we are growing and gaining share under challenging industry conditions. We have robust plans to continue that growth, both through our core markets and expansion into new markets. We are rapidly improving profitability with more gains expected through fiscal 2024 and into fiscal 2025. We are generating strong free cash flow and strengthening our balance sheet and we are investing to continuously improve our customer experience and to drive new innovation that will differentiate us and strengthen our market leadership long term.

Speaker 3

Future is bright And I'm excited about what lies ahead for our organization. With that, I'll turn the call over to Mike, who will give you some additional details on the financial performance for the Q2 and the outlook for the Q3 of fiscal year 2024. Thanks, Derek. For the quarter, net sales were $100,100,000

Speaker 1

slightly above our guidance of $94,000,000 to $100,000,000 provided during our Q1 fiscal 2024 earnings call. As Derek noted earlier, sales growth related to unit volume and mix, which when excluding prior year quarter ocean freight surcharges was a strong 11.7% in the quarter. And we feel we have sustainable growth momentum throughout the rest of fiscal 2024 and into fiscal 2025. From a profit perspective, the company delivered operating income of $4,600,000 or 4.6 percent of sales in the 2nd quarter, which exceeded our operating guidance range of 2% to 4%. The meaningful increase in our operating income was driven by an expansion of our gross margin to 21.9% in the quarter compared to 17% in the prior year quarter.

Speaker 1

Moving to the balance sheet and statement of cash flows. The company ended the quarter with $3,300,000 in cash, Working capital of $100,500,000 and a balance on our revolving line of credit of $17,900,000 Our increased profit combined with improved working capital levels allowed us to pay down our debt by 46% when compared to the fiscal Q1. Looking forward, we reiterate the sales guidance release with our preliminary results announcement on January 11, 2024. And while we expect one time costs related to the closure of our Dublin facility will adversely impact GAAP operating income, we still expect to achieve our fiscal 2024 operating income guidance on an adjusted non GAAP basis. When backing out the one time costs associated with the facility closure.

Speaker 1

Specifically, for the fiscal Q3, We expect sales between $101,000,000 $106,000,000 which represents sales growth of 2% to 7%. Regarding profitability, we expect gross margin in the range of 21% to 22%. We expect gross margin to grow modestly throughout the remainder of the fiscal year and into fiscal 2025, driven by sales growth and continued realization of our cost savings initiatives. We will continue to prudently manage SG and A spending with a focus on investing in our growth initiatives and expect SG and A costs between $17,000,000 $17,500,000 for the 3rd quarter. Due to one time costs related to the closure of our Dublin facility, we expect to incur restructuring costs in the 3rd quarter between $2,000,000 $2,500,000 primarily related to employee separation costs and the transfer of equipment and materials to other facilities.

Speaker 1

We are projecting GAAP operating income as a percentage of sales in the range of 2.5 to 3.5% for the Q3. Excluding one time charges related to the closure of our Dublin facility, we expect adjusted non GAAP operating income of 4.5% to 5.5%, consistent with our previously disclosed guidance. The most significant driver of variability in our forecasted guidance ranges are consumer demand changes, increases to ocean container rates resulting from the disruption in the Red Sea and competitive pricing conditions, all of which will be largely influenced by external factors. Regarding our cash flow outlook, in the second half of fiscal twenty twenty four, we expect improved profit and further inventory reduction to be a meaningful source of cash. Near term priorities for cash remain reducing debt, resourcing new innovation and funding modest capital expenditures, mainly related to cost savings initiatives and continued modernization of our IT systems.

Speaker 1

For the 3rd quarter, we expect capital expenditures to be between $1,000,000 $1,500,000 We expect debt levels at the end of the 3rd quarter to be in the range $12,000,000 to $17,000,000 and by the end of fiscal 2024, we expect debt levels in the range of $0,000,000 to $10,000,000 The effective tax rate for fiscal 2024 is expected to be in the range of 30% to 32%. Now I'll turn the call back over to Jerry to share his perspectives on our outlook.

Speaker 2

Thanks, Mike. While we remain cognizant of macroeconomic factors, which could impact our current outlook, I am optimistic about our ability to continue to gain share and confident we can maintain our profitable growth trajectory both in the near and long term. We have great momentum and are well positioned to successfully deliver improved earnings and an even stronger balance sheet over the remainder fiscal year 2024 and into fiscal year 2025. With that, we will open the call to your questions. Operator?

Operator

The first question is from Anthony Lebiedzinski with Sidoti and Co, LLC. Please go ahead.

Speaker 4

Yes, good morning and thank you for taking the questions. So first, nice job in a tough environment for sure. So you guys talked about a lot about the market share gains in your core business. Just broadly speaking, is it are you doing more business with your existing clients or are you signing up new accounts? I mean, just wanted to get a better sense as to where those share gains are coming from.

Speaker 2

Thanks for the question. This is Jerry. Yes, a lot of our growth is in our core strategic accounts and in our core business. Obviously, we're still out up new folks at all times, but most of it has come from us going deeper and getting more placements with our core accounts.

Speaker 4

That's very helpful. So the unit volume increase certainly is even more impressive than your total sales gains. So I guess in terms of your guidance going forward, how should we think about the split between unit volumes versus pricing?

Speaker 3

Yes, I think Anthony, it's Derek. Going forward, So in the Q3, as we let's break pricing out between the surcharge impact and then just kind of normal pricing. So in the Q3, there's about $2,000,000 of impact of the ocean freight surcharge elimination. And then that comparison goes away in the Q4. What we are assuming in terms of pricing is status likely for the remainder of the calendar year.

Speaker 3

The only caveat to that is, as you're likely aware, Ocean freight container rates have gone up substantially. They've actually almost doubled since the beginning of December. So if they stay at that rate, we will have to consider certainly turning back on some type of surcharge mechanism. But all that aside, we would expect that the majority of the go forward growth is related to the unit volume and mix and Not pricing.

Speaker 4

Understood. Yes. Thanks, Derek. And I was going to ask about the ocean freight costs. So those have Gone up certainly from the bottom here.

Speaker 4

Okay. But at this point, you have not passed along any higher surcharges because of the Red Sea conflict. So, okay, understood. All right. And then I guess Just wanted to dig in a little bit deeper in terms of the gross margin improvement, obviously, very strong year over year.

Speaker 4

Maybe if you could just kind of parse out, maybe go over the kind of the puts and takes as to what drove that. I know you talked about some cost savings initiatives. Obviously, you have Fixed cost leverage is there as well. So maybe if you could just go over some of the details behind the gross margin improvement and your confidence level about being able to sustain that?

Speaker 1

Anthony, this is Mike. Yes, so I think as Derek highlighted, we have kind of Four key drivers of the gross margin improvement. 1, cost savings. So we've taken some actions to reduce structural costs. In the prior year, we took a distribution center offline, which lowered our structural cost.

Speaker 1

In addition, on the cost savings side, we have Pretty strong operations team that are executing safe initiatives, both in our sourcing, manufacturing and then also in our logistics and distribution network, we feel like those processes are sustainable here going forward. The second thing Derek mentioned was introduction of new products and using product lifecycle management to improve profit kind of on a go forward basis. So we're leveraging our cost savings initiatives, as well as kind of our value engineering activities to continue to bring out new products that have a better margin profile than the legacy products we have that we're discontinuing. And then kind of the 3rd piece would be the volume leverage. As we we're real thoughtful about reinvesting back into our structural costs, so that way we get the leverage on our sales growth And then lastly, we've just been able to be more strategic around our promotional activities as it relates to moving forward moving inventory and things like that.

Speaker 3

The one thing I'll add Anthony is I think the magnitude of impact From those four levers will change over time. I think in the near term, as Mike alluded to, operationally, we're really well, lots of cost savings from that. And I think the pricing discipline has been a really big profit lever in the near term. As we look at the quarters ahead and the years ahead, what are going to be the main drivers of gross margin going forward are going to be the product lifecycle management. So as we've explained, again, We've raised the hurdle rates on new product as that becomes a larger and larger amount of our portfolio that's going to raise the overall margin profile.

Speaker 3

And then I think the operating leverage from growth. So again, I think the mix of drivers will kind of evolve here over the coming quarters and coming years. But we still feel confident in terms of our ability to continue to expand margins.

Speaker 4

Understood. Yes, thank you for that. And then, I guess, so As far as the Dublin, Georgia facility closure here, you mentioned that it's going to result in annualized cost savings The bottom end of that is $4,000,000 but noticed that you didn't change your guidance for fiscal 'twenty five. Is this just So, a function of you guys try and be conservative or just wondering if you will be reinvesting those savings elsewhere, how should we think about that?

Speaker 1

Anthony, this is Mike. So when we built our fiscal 2025 guidance ranges, we modeled out several different structural cost change scenarios and we still feel good about what we put out there for our fiscal 2025 guidance range on both top line as well as from an operating income perspective? We had several scenarios even though we had

Speaker 3

not made the decision in terms of Closing Dublin at the time we provided 'twenty five guidance, there was multiple options to drive manufacturing efficiency, which as Mike said, we built into that fiscal year 'twenty five guidance. I think we'll be in a better position here at the end of this fiscal year, early next to determine if there's potentially additional savings beyond what we've estimated that would meaningfully change our fiscal year 2025

Operator

The next question is from Budd Bugatch with Water Tower Research. Please go ahead.

Speaker 5

Good morning, Jerry. Good morning, Derek, and congratulations to you, Mike, And to you, Derek, as well. A couple of questions on the order book, if I could. Can you talk a little bit about the quality of orders in terms of the product vitality? How much of that's new business?

Speaker 5

I know you said Most of it's coming from existing strategic accounts, but I was curious as to what you're seeing in terms of new placements, increased penetration in those accounts and with new product versus old product?

Speaker 2

Yes. So at the highest level, But a lot of them are getting new placements on the floor. We do have obviously our Flex and Zipline products are doing very well. And those obviously are also driving a big piece of that.

Speaker 3

Yes. The other color that I'll add, Budd, is that We actually measure internally what our sales the percent of our overall sales from new products. And we measure new products over the last kind of 3 years and That's close to 25%. So we feel good that we are driving relevant new product that's resonating with the market. And we would expect going forward that new product would make up at least 25% of our overall sales, if not more, going forward.

Speaker 5

And Derek, that's pretty much a classic definition of product vitality there. So when you look at that on a weighted Or a continuing moving average, how has that changed over the last 12 to 18 months?

Speaker 3

It's definitely increased. We've been more aggressive around launching new products and that trajectory will continue.

Speaker 5

Okay. So if you looked at it basically on just on a one instead of a 1 year basis, instead of a 3, it would be higher than 25% would be That's weighted that moving average, is that the way to read that answer?

Speaker 3

Well, it's difficult to compare 1 year versus 3 year because you've got a lot more product in the 3 year. But if you look at that 3 year percentage, what it is today and if you were to Rewind and go back 12 months ago, it was lower than the 25%. So again, and we do expect going forward that number to increase throughout time. Does that help?

Speaker 5

I think so. I always try to put numbers to things. I know The color is qualitative and the numbers are quantitative and that's definitely a weakness of the analytical community Wanting to be more quantitative and wanting numbers. I'm also curious as to the change in the composition of costs And how to look at maybe something like a contribution margin going forward with taking Dublin out and The facilities left, what's the variable cost structure look like, the MLO and D and T kind of components Of cost on a normalized basis and what does the fixed cost component look like?

Speaker 3

Yes, it doesn't change meaning I mean that meaningfully From what we've shared previously with you, Budd, if you look at the composition of the $4,000,000 to 4.5 $1,000,000 savings from Dublin, a little less than $2,000,000 of that is from structural cost reduction. The rest of it is efficiencies around variable costs.

Speaker 5

So looking at the you had I think and correct me if I'm wrong, my memory is I'm old and my memory is faulty. But I do believe you told us a couple of years ago that I think that the target gross margin was in the low 20s. We seem to be there. What's that look like going forward?

Speaker 3

Yes, from a gross margin perspective, certainly we're striving we're aspiring to 23% or more kind of in the mid long term. And we've raised the

Speaker 5

model. Does mid long term have a 3 to

Speaker 2

5 years. 3 to 5 years.

Speaker 5

3 to 5 years.

Speaker 3

3 to 5 years, you had to get.

Speaker 5

All right. And if I and do I read the guidance right that for 'twenty five, you're saying that you're have no debt. Is that the way to read that? I'm I was trying to make sure I understood the table.

Speaker 1

Yes, that's correct.

Speaker 5

So you do want that down to 0? And once that's to 0, what's the use of cash look like? What is your thought process?

Speaker 3

Yes. In terms of capital allocation, Budd, so I laid out earlier in the call, These pursuits to expand our penetration in new markets, we would look for value enhancing acquisitions That would accelerate our penetration into one of those three areas, either help us address the needs of younger consumers, expand our product category penetration beyond the living room or expand our sales distribution beyond the independent retailer. So the areas that we've kind of talked about in terms of acquisition priorities would be potential outdoor company, A direct to consumer company or a company with a modern mid priced lifestyle kind of brand. So we would expect to start to potentially accumulate some cash on the balance sheet and more proactively look for value enhancing acquisitions.

Speaker 5

And does that take you out of manufacturing or into retail or We're out of furniture or out

Speaker 3

of No, no. We're squarely focused on residential furniture. Certainly, in the midterm, we do not desire to be in retail ourselves. So this is again, this is leveraging our core competence and bringing in new capabilities within furniture wholesaling, for lack of a better term.

Speaker 5

Okay. All right. Thank you very much. Congratulations on the quarter and best of luck for the balance of the fiscal year

Operator

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

Speaker 2

Great. Thank you. In closing, I'd like to thank all our Flexsteel employees for their dedication and outstanding performance during the quarter. Call. Everybody have a great day.

Speaker 2

Thanks.

Operator

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

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