Q3 2024 Flexsteel Industries Inc Earnings Call

Participants

Michael Ressler; Chief Financial Officer, Treasurer, Company Secretary; Flexsteel Industries Inc

Jerald Dittmer; Chief Executive Officer, Director; Flexsteel Industries Inc

Derek Schmidt; President & CEO / International Bank of Commerce - Port Lavaca; Flexsteel Industries Inc

Anthony Lebiedzinski; Analyst; Sidoti & Company, LLC

Budd Bugatch; Analyst; Water Tower Research LLC

John Deysher; Analyst; Pinnacle Value Fund

Presentation

Operator

Good morning and welcome to the Flexsteel Industries Third Quarter Fiscal Year 2024 earnings conference call. All participants will be in a listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question. You may press star and one on your telephone keypad. Until 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 Mike Roffler, Chief Financial Officer for Flexsteel Industries. Please go ahead.

Michael Ressler

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 close yesterday, April 29th. It is available on the Investor Relations section of our website at w. w. w. dot Flexsteel Industries.com under News and Events. I'm here today with Jerry Dittmer, Chief Executive Officer, and Eric 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. And 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 the GAAP to non-GAAP measures. And with that I'll turn the call over to Jerry Dittmer.

Jerald Dittmer

Very 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 Smith, who will assume the role of Chief Executive Officer upon my retirement. Derek is a well accomplished leader and 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

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, 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, Flexsteel 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 Gary's coaching, mentorship and support. Over the many years we work together. He has established a foundation and trajectory for the company to continue to thrive for many years to come.
Thank you, Gerry. Turning back to the business like Gary, I am very pleased with our third quarter results. We are competing well gaining share in growing the business in a challenging industry environment for many industry participants continue to report double-digit year-over-year declines. The investments we've 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 four 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 product 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 advance all of 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 product. 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 and custom fabrics produced in four weeks or less.
Third decliner. Our proprietary sleep care offering was expanded with new fabrics and a new zone of a solution, which is effectively two decliners connected by us and our counsel. We continue to invest in powerful POS or point of sale materials to help our retailers tell the differentiated Z cleaner store story in store as our customers who leverage our POS materials experienced on average, a sales lift three times larger than those who don't use it. We are also embarking on national digital and print marketing campaigns to broaden consumer awareness of decliner into drive increased demand for our sleep solution to our customers 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 advantage supply chain to compete effectively in these categories and gain share.
Fifth. And lastly, we had highly productive business development meetings at market with multiple big box retailers and e-tailers, which included both existing and new potential customers. They value the Flexsteel brand and will 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 am equally energized by our improved profitability, which has been propelled by four drivers. First, new products with higher margin profiles we raised the threshold for new product margins and expect product lifecycle 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 pulled back promotions where needed to improve overall profitability. And fourth, we are achieving leverage of fixed cost 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

Thanks there. 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, 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 for 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 non-cash 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 non recurring stock compensation expense related to the revaluation of equity awards. Both significant drivers of variability in our forecasted guidance ranges for consumer demand changes, supply chain disruptions due to global conflicts 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. For 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. 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 banks.

Jerald Dittmer

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

Question and Answer Session

Operator

Thank you very much. We will now begin the question and answer session. To ask a question. You may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. We will pause momentarily to assemble our roster. Sir, Today's first question comes from Anthony Lebiedzinski with Sidoti & Company. Please go ahead.

Anthony Lebiedzinski

Good morning and thank you. So first, congratulations, Derek, on your pending promotion and congratulations, Jerry, on your pending retirement. So first, I guess 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, Spansion's decliner, et cetera?

Jerald Dittmer

Yes. Thanks, Anthony, and thanks for your comments is for Derek. And I also you know, it's I'll go first to Joe. 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 Euclid. Gary talked about our charisma. Our Flex initiative are declining, which is our health and wellness initiative case goods, which is even hitting the top line yet per se. Our big box retailer e-tailer initiative on all these things are clicking quite well. And you have to take the pool of all of this together, and it's really encouraging, you know where the companies go on, especially when we see a new and almost 10% sales increase. And our belief is that we can continue this going forward, too.

Derek Schmidt

Yes, Anthony, I would just add, so in terms of your question on how much of the growth is coming 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 decliner And then like the strategic account penetration on. But but there still was over 1% growth in our core market with retail in our in our existing product category. So we are growing in the core and in a challenging market, but we're also getting the benefits of those growth initiatives.

Anthony Lebiedzinski

Perfect. That's great to hear. And then I'm just wondering and 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 you know, how to think about margin profile to those different sales channels where it is there anything different or more or less kind of the same?

Derek Schmidt

Yes. And I'll start this is Derek on. So in terms of kind of near term, I mean, we're performing exceptionally well at retail.
And so even if you think about Avon, some of the items, the growth initiatives that Jerry mentioned like with the client 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 within retail. But one 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 on other sales channels that we believe are relevant long term for us, furniture purchasing in terms of kind of the margin impact of that, we believe over the long term, you know, all these channels should have a similar margin profile maybe in the near term that are a bit different. But longer term, we believe, again, profitability we should be indifferent between the channel mix.

Anthony Lebiedzinski

Yes.
Actually thanks, Derek, for that.
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

Anthony, I'll take that one so that 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 kind of transformed kind of our product portfolio on which has much better profit profiles than what the legacy products are that we've retired. But we feel that we have positive on processes and structure in place that we're going to be able to continue to maintain and even expand our gross margin on once we start to get the benefit of some higher sales that's cumulative for it, unless that's very important.
And already, I mean, near term, I mean, we talked about the drivers being fourfold, right on the cost savings the new product portfolio mix on pricing discipline and then the sales operating leverage. I think on a longer-term basis, we still feel confident that we can expand margins on the drivers that will narrow, though, to primarily product mix on higher margins on new product and then continued sales operating leverage, so easy structure.

Anthony Lebiedzinski

Okay.
And then lastly for me, I so 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?
Yes.

Michael Ressler

Anthony on. So we regularly review our capital allocation strategy with the Board on near term. We want to continue to pay down debt, Tom, 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, you know about, but any type of acquisition it needs to align kind of with our strategy and it needs to create shareholder value in the event that we're not able to identify an investment that creates value. Our Board will look at on methods to return capital to shareholders.

Anthony Lebiedzinski

Got it. Well, thank you very much and best of luck, but I think that the.
Thank you.

Operator

The next question comes from Budd Bugatch with Water Tower Research.
Please go ahead, Kevin.

Budd Bugatch

Good morning, Jerry. Congratulations on your retirement. I can tell you it's not all it's cracked up to date. And Derek, congratulations to you on your ascension to the U.S. to the leadership role and congratulations on your performance. And if I do have a few questions on last quarter, I think Diederik, you said to me that you're striving for from 23% gross margin was still your aspiration in the mid to long term over three to five years, and you made significant progress to that. And I'm my next question goes to about the same for SG&A. It's some it looks. So you know, at the at the current level at 16.5% on the deleverage on the increased sales, excluding the restructuring charge was really just under 20 basis points. What it looks. Therefore, it looks like the most of that variable. What do we what are we missing here? In terms of SG&A where the opportunities?

Derek Schmidt

Yes, I think in terms of SG&A on long term on, we aspire to get SG&A between 15% and 16%. So again, long longer-term aspiration is an 8% operating income on which in order to get there is a 23% gross margin and SG&A in that kind of mid mid 15% kind of range on in terms of current SG&A. And I mean, there's two things maybe pushing it up a little bit higher on number one, you know, 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 on. And so so again, heavier SG&A. But you know, 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 higher and incentive payout for this year. From longer term, we're going to continue to prudently invest in our growth initiatives, but we believe our 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.
So I'm still a little bit confused as to where the opportunities are here and how do you get that to that mid 15 or low 15% range to get to your 8% op margin?
Yes, but we've taken actions this year on that will materially reduce SG&A going into next year. And so again, that sets organizational structure and talent on I won't go into the details. But again, those are already actions that have taken place and flow will be realized in fiscal year 25.

Budd Bugatch

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

Derek Schmidt

Honestly people costs .

Budd Bugatch

Okay. On April is looking at the top line. Can you give us maybe a little bit more color in terms of some numbers as to how e-comm is doing? I saw the differential. I wasn't quite sure that I saw penetration of your your customers who are primarily you come based on versus your big box guys and the Costcos. What do we look like in terms of that, how do we how do we think about a poultry versus case goods, which so what's the penetration of the? And today I'll cover the sales line by.

Derek Schmidt

I think if you're asking two questions, one is what does the profile look like within our prior 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 you saw soft seating was up double digits. Manufacturing soft seating was up double digits on case goods was 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 and then e-commerce arm in our Home Styles brand has been down double digits. And that's largely mirrors on 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 on that we participate in. So the overall message is seasonal. The really the core core of our business, which is sourced and manufactured soft seating is doing exceptionally well and we're going to continue to invest in that. And that's largely will manifest itself in terms of kind of new product introductions as well as new forms of innovation.
On case goods side that like I said, you saw a really compelling lineup of new products here at April point for April, High Point Market.
And then in terms of the channel mix, you know, Costco continues to grow at a at a modest pace arm and is profitable on and then independent retail is doing exceptionally well right now. So on, that's kind of the dynamics of what's going on within the business.

Budd Bugatch

That's helpful.
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 new clients, new of new retailers, new dealers that is accounting for a substantial portion of the growth.

Derek Schmidt

The largest portion of the growth growth is we're gaining additional placements within on existing retailers, especially at what we consider our largest most critical strategic accounts so on. We believe that from a distribution standpoint, we're fairly well aligned with who's who on 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.

Budd Bugatch

And are you seeing this where placements to and you talked about the the case goods and that's really critical for case goods is to get it placed on a floor on how does that how do those placements look come year over year or into your to your goals?

Derek Schmidt

So so again, we just came up with a fresh lineup of really good looking product. We have activated virtually all of that product shown on ad market, which again, we make we make the decision of what to activate and whatnot at tax rate based on retailer feedback and commitments. And so most of that product here has already been third, they'll go through their their first cuttings product will arrive, you know, this fall on. So I mean that's when we'll start to realize some some of the sales there. But feedback was very strong. I mean, basically, we had multiple customers indicate clearly flex deals back in the case goods business. And so we're strategically committed to that category. We're putting talent and resources behind it. And we'll continue to bring forth like aggressive and compelling new product introductions from I remember when wind were inflexible got interpreted switch business.

Budd Bugatch

And so you're correct, though, we'll ride goods 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 on overseas sourcing that gets into the the product tone results until really just about the end of the time we go to market in October, we'll start Triade 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

Exactly.

Budd Bugatch

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

Operator

Thank you. The next question is from John Deysher with Pinnacle. Please go ahead.

John Deysher

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

Michael Ressler

The backlog ended at $61.5 million, which was growth over all, which was about $6.5 million growth over where it ended at the end of Q2, solid improvement.

John Deysher

And what are e-commerce sales this quarter versus a year ago, please?

Derek Schmidt

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

John Deysher

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

Derek Schmidt

From year over year.

John Deysher

Year over year down double digits. Is that correct?

Derek Schmidt

Correct.

John Deysher

Thank you.

Operator

Thank you. 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

Thank you. And in closing, I would like 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 in with Gary's leadership to 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.

Operator

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