Flexsteel Industries Inc

NASDAQ:FLXS

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, and welcome to the Flexsteel Industries Third Quarter Fiscal Year 2024 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Ressler, Chief Financial Officer for Flexsteel Industries. Please go ahead.

[Michael Ressler, executive]

Thank you, and welcome to today's call to discuss Flexsteel Industries' Third Quarter Fiscal Year 2024 financial results. Our earnings release, which we issued after market closed yesterday, April 29, 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 we will then 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 contain the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures. And with that, I'll turn the call over to Jerry Dittmer. Jerry?

[Jerald Dittmer, executive]

Good morning, and thank you for joining us today. I would like to start by acknowledging what was in our press release yesterday that I will be retiring from my role as CEO at the end of fiscal year 2024. I am honored to have served in this role and work alongside an incredible group of hard-working and dedicated individuals here at Flexsteel. I am proud of the foundation we have built and confident in the organization's ability to continue achieving long-term profitable growth. I would also like to congratulate Derek Schmidt, who will assume the role of Chief Executive Officer upon my retirement. Derek is a well accomplished leader, and I'm confident in his ability to continue driving results and executing on both our near-term and long-term strategies.

With that, I am very pleased to share with you our third quarter fiscal year 2024 results. While headwinds from macroeconomic challenges persist in our industry, we continue to execute our strategic initiatives and delivered sales growth of 8.2% when compared to the prior year quarter. The increased sales along with our commitment to operational efficiency and prudent cost savings drove increased operating income when compared to same quarter of the prior year, even with the addition of $2.6 million in restructuring costs related to the closure of our Dublin facility.

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 the long term. 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.

[Derek Schmidt, executive]

Thank you, Jerry, and good morning, everyone. First, I'd like to thank Jerry for his invaluable contributions to the company. Since joining Flexsteel almost 5.5 years ago as President and CEO, and His leadership has been instrumental in transforming our 130-year-old company. Under his direction, the company has crafted an exciting vision focused solely on the residential furniture market, has strengthened talent and improved culture and has accelerated investments in innovation and customer experience to drive long-term growth.

Recently, Flex deal was named by Newsweek as one of the most trustworthy companies in America, which is a true testament to Jerry's leadership. On a personal level, I'm also deeply grateful for Jerry's coaching, mentorship and support over the many years we've worked together. He has established a foundation and trajectory for the company to continue to thrive for many years to come. Thank you, Jerry.

Turning back to the business. Like Jerry, I am very pleased with our third quarter results. We are competing well, gaining share and growing the business in a challenging industry environment, where many industry participants continue to report double-digit year-over-year declines. The investments we have made in innovation, new product development, and customer experience enhancements are all paying off, and our strategies to pursue growth in new markets are working, and we see it in our results.

We grew our top line by 8.2% in the fiscal third quarter, continuing the strong momentum from the second quarter when we grew sales by 7.5%. As was noted in the earnings press release, when excluding the $1.5 million impact from the prior year's ocean freight surcharge elimination, sales growth related to unit volume and product mix was a robust 9.9% in the quarter, further reinforcing our strong sales execution.

And while we expect sluggish industry conditions to persist for the next 6 to 12 months, we remain confident in our ability to continue our growth into the fourth quarter of fiscal 2024 and into fiscal year 2025 from both continued share gains in our core business and increasing momentum in our market expansion initiatives. Part of our confidence in maintaining our growth momentum stems from our success at the recent High Point Market a few weeks ago.

While overall market attendance was solid, and up 1% versus prior year's market, the number of customer appointments in the Flexsteel showroom was impressive and increased by 29% versus prior year's market, a clear indication that our customers are leaning into Flexsteel as a preferred partner.

In addition, we showed the biggest lineup of new products in my 4 years with Flexsteel, 36 new groups and 16 line extensions. When compared with recent markets, that lineup represented almost a 40% increase in new product introductions.

Most importantly, based on positive customer feedback and commitments, we are activating almost 90% of all the new products shown at market, which is an exceptional success rate. A good portion of the new product was squarely focused on our core business, which gives us optimism that we can continue to gain share and modestly grow the core even with persistently sluggish industry conditions.

At the same time, we advanced all our market expansion initiatives at April High Point Market. First, we launched multiple new collections under our new brand, Charisma, which is intended to reach younger consumers with lower-priced on-trend products. The product was very well received, and we've added both design and engineering talent this year to quickly expand the Charisma offering over the next 18 months.

Second, we expanded our Flex collection with new hubs and other accessories to further improve its modularity and appeal to younger consumers. And for our independent retail partners, Flex is now available in custom fabrics produced in 4 weeks or less.

Third, Zecliner, our proprietary sleep chair offering was expanded with new fabrics and a new Zofa solution, which is effectively 2 decliners connected by a center council. We continue to invest in powerful POS or point-of-sale materials to help our retailers tell the differentiated Zecliner story in store as our customers who leverage our POS materials experienced on average a sales lift 3x larger than those who don't use it. We are also embarking on national digital and print marketing campaigns to broaden consumer awareness of Zecliner and to drive increased demand for our sleep solution to our customer stores.

Fourth, we launched a broad set of compelling on-trend case good products, with superior quality under the Flexsteel brand across bedroom, dining and occasional. These are large product categories where the company is underpenetrated. We now have the design talent and advantaged supply chain to compete effectively in these categories and gain share.

Fifth and lastly, we had highly productive business development meetings that market with multiple big box retailers and e-tailers, which included both existing and new potential customers. They value the Flexsteel brand, and we'll continue to pursue opportunities to expand our sales distribution where it is profitable and sustainable long term. 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.

First, new products with higher margin profiles. We raised the threshold for new product margins and expect product life cycle management will continue to improve our gross margin over time.

Second, we're executing well operationally and delivering a strong cost savings within our supply chain. Third, we've remained disciplined with pricing and pull-back promotions where needed to improve overall profitability. And fourth, we are achieving leverage of 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.

The key takeaway is that our strategies are working and we are growing and gaining share under challenging industry conditions. We must remain aggressive with our investments in pursuit of new growth to continue our positive sales momentum and we have robust plans to continue growing through both our core markets and expansion into new markets.

We are rapidly improving profitability with more gains expected in the fourth quarter of 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.

The 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 third quarter and the outlook for the fourth quarter of fiscal year 2024.

[Michael Ressler, executive]

Thanks, Derek. For the quarter, net sales were $107.2 million, slightly above our guidance of $101 million to $106 million provided during our second quarter fiscal 2024 earnings call. We carried our positive growth momentum from Q2 into Q3 and delivered growth in both our core business as well as growth from our market expansion initiatives. Sales orders for the quarter were $111.5 million, reflecting growth of $12.2 million, or 12.3% compared to the prior year quarter. Our healthy order backlog of $61.5 million at the end of the third quarter, along with strong order trends give us confidence that we have sustainable growth momentum throughout the rest of fiscal 2024 and into fiscal 2025. From a profit perspective, the company delivered GAAP operating income of $3.0 million or 2.8% of sales in the third quarter, in line with our previously disclosed guidance of 2.5% to 3.5%.

When excluding the $2.6 million in restructuring charges related to the closure of our Dublin, Georgia facility, adjusted operating income was $5.6 million or 5.2% of net sales. The meaningful increase in our operating income was driven by higher sales and gross margin expansion. Gross margin improved to 21.7% in the quarter compared to 18.8% in the prior year quarter, a result of our team's relentless focus on cost savings, operational execution, pricing discipline and product portfolio management.

Selling, general and administrative expenses decreased to 16.5% of net sales in the quarter compared to 16.7% of sales in the prior year quarter. The decrease was due to leverage on higher sales, partially offset by investments in our strategic growth initiatives and higher incentive compensation.

Moving to the balance sheet and statement of cash flows. We continue to strengthen our balance sheet, ending the quarter with $4.6 million in cash, working capital of $96.2 million and a balance on our revolving line of credit of $14.2 million. Our inventory optimization initiatives enabled us to reduce inventory by $8.6 million in the quarter while maintaining exceptional service levels for our customers. Our increased profit, combined with improved working capital levels allowed us to pay down our debt by 21% when compared to the fiscal second quarter.

Turning to our outlook. The company reiterates its full year fiscal 2025 guidance. For the fiscal fourth quarter, we reiterate our sales guidance of $107 million to $112 million. We project GAAP operating margin in the range of 3.5% to 4.3%, which has been updated to reflect noncash charges related to the revaluation of equity awards associated with our CEO transition and retirement. We expect adjusted operating margin in the range of 5.2% to 6.0% of net sales, reflecting an increase in the low end of our previously disclosed guidance range of 5.0% to 6.0% following our strong Q3 performance.

Looking at gross margin, we expect gross margin in the fourth quarter to land between 21.5% and 22.0% of net sales with cost savings from the Dublin plant closure of $0.4 million to $0.5 million, offset by higher ocean freight costs. We will continue to prudently manage SG&A spending with a focus on investing in our growth initiatives and expect SG&A costs between $17.5 million and $18.0 million for the fourth quarter, excluding restructuring charges and nonrecurring stock compensation expense related to the revaluation of equity awards.

Most significant drivers of variability in our forecasted guidance ranges, our consumer demand changes, supply chain disruptions due to global conflict or political instability and competitive pricing conditions, all of which will be largely influenced by external factors.

Regarding our cash flow outlook. In the fourth quarter, we expect free cash flow in the range of $5 million to $11 million. Near-term priorities for cash remain reducing debt, resourcing new innovation, and funding modest capital expenditures, mainly related to cost savings projects and business system updates. The fourth quarter, we expect capital expenditures to be between $0.2 million and $0.4 million.

We expect debt levels at the end of fiscal 2024 to be in the range of $4 million to $10 million. 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.

[Jerald Dittmer, executive]

Thanks. 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 of fiscal year 2024 and into fiscal year 2025. With that, we will open up the call to your questions. Operator?

[Operator]

[Operator Instructions] Today's first question comes from Anthony Lebiedzinski with Sidoti & Company.

[Anthony Lebiedzinski, analyst]

So first, congratulations, Derek, on your pending promotion and congratulations, Jerry, on your pending retirement. So first, I guess, a question here. So in terms of your top line, it came in above your guidance, as Mike had alluded to. So I guess, first, what drove the outperformance? And then, maybe if you could just share more details as far as growth in your core business versus sales coming from your growth initiatives like the big box expansions, Zecliner, et cetera?

[Jerald Dittmer, executive]

Yes. Thanks, Anthony. Thanks for your comments, just for Derek and I also. I'll go first, our core business is actually performing quite well. I'll let Mike comment on that, but if you take our growth initiatives, you take our -- with Derek talked about, our Charisma, our Flex initiative, our Zecliner, which is our health and wellness initiative, case goods, which isn't even hitting the top line yet per se, our big box and e-tailer initiative, all these things are clicking quite well. And you have to take the pool of all of this together and it's really encouraging where the company is going, especially when we see an almost 10% sales increase. And our belief is that we can continue this going forward, too.

[Michael Ressler, executive]

Yes, Anthony, I would just add. So, in terms of your question on how much of the growth from the core versus kind of our initiatives. So of the $8.2 million, over $7 million of that is coming from kind of our growth initiatives, which includes the Flex, Zecliner and then like the strategic account penetration, but there still was over 1% growth in our core market with retail in our existing product categories. So we are growing in the core in a challenging market, but we're also getting the benefits of those growth initiatives.

[Anthony Lebiedzinski, analyst]

Perfect. Okay. That's great to hear. And then just wondering, just sticking to the top line here. So in terms of your sales channels, you talked about the sales growing and outperforming in the brick-and-mortar versus e-commerce. How do you see that dynamic playing out near term and longer term? Just curious about that. And then whether or not as far as how to think about margin profile to those different sales channels, is there anything different or more or less kind of the same?

[Derek Schmidt, executive]

Yes, Anthony, I'll start. This is Derek. So in terms of kind of near term, I mean, we're performing exceptionally well at retail. And so even if you think about some of the items, the growth initiatives that Jerry mentioned, like Zecliner, like Charisma, again, we're having really nice success kind of within our traditional independent retailers, which as you know, are vitally important to our business. So we believe in the near term, we're going to continue to build upon that strong momentum within retail. But longer term, we've talked about we want to position our brands everywhere consumers want to buy furniture.

And so longer term, we would continue to expect that we would expand in the big box, e-tail other sales channels that we believe are relevant long term for furniture purchasing. In terms of kind of the margin impact of that, we believe, over the long term, all these channels should have a similar margin profile. Maybe in the near term, they're a bit different, but longer term, we believe, again, profitability, we should be indifferent between the channel mix.

[Anthony Lebiedzinski, analyst]

Got you. And then -- so you've done a nice job with improvement of your gross margin for sure. Can you talk about your confidence level about your ability to further improve on that in fiscal '25 and beyond?

[Michael Ressler, executive]

Anthony, I'll take that one. So yes, we feel really good about kind of where we're at right now. We've had a lot of success with our cost savings initiatives and transformed our product portfolio, which has much better profit profiles than what the legacy products are that we've retired. But we feel that we have positive processes and structure in place that we're going to be able to continue to maintain and even expand our gross margin once we start to get the benefit of some higher sales.

[Anthony Lebiedzinski, analyst]

Got you.

[Derek Schmidt, executive]

That's very important, Anthony. I mean -- near term, I mean we talked about the drivers being fourfold, right? The cost savings, the new product portfolio mix, pricing discipline and then the sales operating leverage. I think on a longer-term basis, we still feel confident that we can expand margins. The drivers will narrow though to primarily product mix, higher margins on new product and then continued sales operating leverage.

[Anthony Lebiedzinski, analyst]

Got you. Okay. And then lastly for me. So as you look to pay off your debt by next year, can you talk about like how your capital allocation priorities may change? And would that perhaps involve doing any acquisitions?

[Jerald Dittmer, executive]

Yes, Anthony. So we regularly review our capital allocation strategy with the Board. Near term, we want to continue to pay down debt and we'll continue to make a dividend a priority. But then we've talked about beginning to accumulate cash for potential value-enhancing acquisitions. But any type of acquisition, it needs to align kind of with our strategy and it needs to create shareholder value. And in the event that we're not able to identify an investment that creates value. Our Board will look at methods to return capital to shareholders.

[Operator]

The next question comes from Budd Bugatch with Water Tower Research.

[Beryl Bugatch, analyst]

Jerry, congratulations on your retirement. I can tell you it's not all it's cracked up to be. And Derek, congratulations to you on your ascension to the leadership role. And congratulations on your performance. And I do have a few questions. Last quarter, I think, Derek, you said to me that you were striving for 23% gross margin with still your aspiration in the mid- to long term over 3 to 5 years, and you made significant progress to that.

My next question goes to how about the same for SG&A. It looks at the current level at 16.5%. The leverage on the increased sales excluding the restructuring charge, was really just under 20 basis points. What -- and it looks, therefore, it looks like that most of that's variable. What are we missing here in terms of SG&A? Where are the opportunities?

[Derek Schmidt, executive]

Yes. I think in terms of SG&A, long term, we aspire to get SG&A between 15% and 16%. So again, longer-term aspiration is an 8% operating income, which in order to get there, is a 23% gross margin and an SG&A in that kind of mid 15% kind of range. In terms of current SG&A, I mean there's 2 things maybe pushing it up a little bit higher. Number one, we talked about our independent retail channel is doing exceptionally well right now. I mean we're growing the business. And that does come up with a higher variable SG&A load because of sales commissions, because of co-op to our retailers. And so again, heavier SG&A, but it's more than paid for by an attractive kind of gross margin. And then because of our performance is exceeding expectations, we are accruing a higher incentive payout for this year. Longer.

Term. We're going to continue to prudently invest in our growth initiatives, but we believe our top line will grow faster than SG&A, and we'll continue to see SG&A as a percent of sales decline as a result.

[Beryl Bugatch, analyst]

So I'm still a little bit confused as to where the opportunities are on SG&A. How do you get that to that mid-15% or low 15% range to get to your 8% op margin?

[Derek Schmidt, executive]

Yes. But we've taken actions this year that will materially reduce SG&A going into next year. And so again, that's organizational structure and talent. I won't go into the details. But again, those are already actions that have taken place and will be realized in fiscal year '25.

[Beryl Bugatch, analyst]

So just to continue to make sure I understand that's people costs or kind of structural costs like insurance and rent and stuff like that? Or how do -- what's the balance between the two?

[Derek Schmidt, executive]

Largely people costs.

[Beryl Bugatch, analyst]

Got you. Okay. And looking at the top line, can you give us, maybe a little bit more color, in terms of some numbers as to how e-com is doing? I saw the differential. I wasn't quite sure that I saw the penetration of your customers who are primarily e-comm-based versus your big-box guys, the Costcos. What do we look like in terms of that, how do we think about upholstery versus case goods? What's the penetration of the sales line?

[Derek Schmidt, executive]

I think, you're asking 2 questions. One is what does the profile look like within our product category mix. And so if you think about overall, from a company perspective, we grew this quarter at 8.2%. If you break it out into categories, now used source soft seating was up double digits. Manufacturing soft seating was up double digits. Case goods was down pretty substantially, but we're in the process of resetting that business as you saw at April High Point market. .

We've come up with a very fresh, compelling line of new case goods. And so we believe, longer term, that's going to be a growth lever. But in the near term, it is weighing on the overall portfolio growth. And then e-commerce in our homestyles brand has been down double digits. And that largely mirrors what we're seeing in the external environment. So we've heard from our large customers, Amazon, Wayfair that we're competing consistently or better than the categories that we participate in. So the overall message is the really the core of our business, which is sourced and manufacturing soft seating is doing exceptionally well. And we're going to continue to invest in that, and that largely will manifest itself in terms of kind of new product introductions as well as new forms of innovation.

On the case goods side, like I said, you saw a really compelling lineup of new product here at April point or April High Point market. And then in terms of the channel mix, Costco continues to grow at a modest pace and is profitable. And then independent retail was doing exceptionally well right now. So that's kind of the dynamics of what's going on within the business. Is that helpful?

[Beryl Bugatch, analyst]

It is very helpful. And the independent retail, is that primarily same location, same store, same client based? Or is there a growth in new clients, new retailers, new dealers that is accounting for a substantial portion of the growth?

[Derek Schmidt, executive]

The largest portion of the growth is we're gaining additional placements within existing retailers, especially at what we consider our largest, most critical strategic accounts. So we believe that, from a distribution standpoint, we're fairly well aligned with who's who across the industry. Now, it's just a matter of continuing to gain share and we're realizing that in terms of additional [ core ] placements within their stores.

[Beryl Bugatch, analyst]

And are you seeing those [ core ] placements to and you talked about the case goods and that's really critical for case goods is to get it placed on a floor. How do those placements look year-over-year or to your goals?

[Derek Schmidt, executive]

Yes. So again, we just came up with a fresh lineup of really good-looking product. We have activated virtually all of that product shown at market, which, again, we make the decision of what to activate and what not to activate based upon retailer feedback and commitments. And so most of that product here has already been -- they'll go through their first cuttings, product will arrive this fall.

So I mean that's when we'll start to realize some of the sales there. But feedback was very strong. I mean, basically, we had multiple customers indicate clearly Flexsteel's back in the case goods business. So we're strategically committed to that category. We're putting talent and resources behind it, and we'll continue to bring forth like, I think, aggressive and compelling new product introduction.

[Beryl Bugatch, analyst]

Okay. I remember when Flexsteel got into the case goods business. So you're correct, though, we'll write this typically, we don't see new case goods introductions, particularly with the sourcing situation in the industry the way it is now with relying so heavily on overseas sourcing that gets into the product results until really just about the end of the time we go to market in October. We'll start that stuff hit the floors in -- at that time. Is that the right way to think about it? So we're really looking at a next year kind of impact.

[Derek Schmidt, executive]

Exactly. Yes.

[Beryl Bugatch, analyst]

Okay. Well, congratulations to you, Derek. I look forward to our continued conversations and best wishes to you, Jerry, on your retirement. I suspect you'll find a lot to do.

[Derek Schmidt, executive]

Thanks, Budd.

[Jerald Dittmer, executive]

Thanks, Budd.

[Operator]

The next question is from John Deysher with Pinnacle.

[John Deysher, analyst]

Thanks for taking my questions, most of which have been answered. Just a couple of minor ones. What was the backlog at the end of the quarter, please?

[Michael Ressler, executive]

The backlog into that $61.5 million, which was growth over -- which was about $6.5 million growth over where it ended at the end of Q2.

[John Deysher, analyst]

Yes. Solid improvement. And what were e-commerce sales this quarter versus a year ago, please?

[Derek Schmidt, executive]

Yes, we don't share absolute numbers. But that, as I indicated in the last in Budd's question, I mean they were down double digits. So again, that's reflective of, I think, what we're seeing externally in that channel.

[John Deysher, analyst]

Down double digits from a year ago or from the prior quarter?

[Derek Schmidt, executive]

No, from year-over-year.

[John Deysher, analyst]

Year-over-year, down double digits. Is that correct?

[Derek Schmidt, executive]

Correct.

[Operator]

This concludes today's question-and-answer session. I would now like to hand the call back to Jerry Dittmer for any closing remarks.

[Jerald Dittmer, executive]

Thank you. In closing, I want to express my gratitude for the privilege to serve the Flexsteel family. I am proud of our collective successes. I believe the best is yet to come. And with Derek's leadership, he will propel the organization to new heights. I have no doubt that Flexsteel will continue to flourish, thanks to the passion and commitment of all our employees and partners. Everyone, have a great day. Thanks.

[Operator]

The conference has now concluded. Thank you for your participation. You may now disconnect your lines.