Flexsteel Industries Inc (FLXS) Q2 2020 Earnings Call Transcript

Good morning and welcome to the Flexsteel Industries Second Quarter of Fiscal Year 2020 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. Please note this event is being recorded. I would now like to turn the conference over to Donni Case, Investor Relations for Flexsteel Industries. Please go ahead.

Thank you and welcome to today's call to discuss Flexsteel Industries Second quarter of fiscal year 2020 financial results. Our earnings release, which we issued after market close yesterday, is available on the Investor Relations section of our website at flexsteel.com under news and events. I'm here today with Jerry Ditmer, Chief Executive Officer, and Marcus Hamilton, Chief Financial Officer. On today's call management will provide prepared remarks and then we'll 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 that can be identified by the use of 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 and 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, management may also 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 measures and other quantitative information to be discussed today as well as the reconciliation of GAAP to non-GAAP measures. And with that, I'd like to turn the call over to Jerry.

Good morning and thank you for joining us today. At the beginning of January I celebrated my one-year anniversary as Flexsteel's CEO. Within the first year of being on board, we assessed the organizational and operational effectiveness of the company and laid out a comprehensive transformational plan to optimize our supply chain and operations. Additionally, we've completed a significant talent infusion of leadership and subject matter experts into the organization, covering areas from sales and engineering to product development and IT. Since our first announcement last May, we've made solid progress on the restructuring plan across the six work streams we've identified, and we are starting to see benefits in our financials and overall business. Improving our supply chain and operations is essential; however, without growth, the company cannot succeed. We're confident our restructuring program execution is proceeding as planned. We are focusing more on growth. We continue to see progress in redeveloping our eCommerce channel, which saw growth of over 30% in the second quarter. This marked the first positive year-over-year comparison in the eCommerce channel since I joined, and it reinforces that we are on the right track with our momentum building in this area. We've also been busy relocating our largest imported product groups from China to other parts of Southeast Asia, and we have begun rolling back prices on these items. After transitioning out of the China inventory, we immediately saw a rebound in demand for these products as price rollbacks took effect in the marketplace. We will continue to shift our largest volume groups into Vietnam at the earliest opportunity and ensure that new product introductions are sourced from that region moving forward. Improving our service levels and reducing lead times for customers remain top initiatives that serve as catalysts for revitalizing our growth. While our cost to serve has increased, our dedication to reducing lead times remains a priority, and we are witnessing positive results. Consistent delivery and improved lead times over time will enhance customer performance and positively influence purchasing behaviors. The stationary category, our largest domestic product line, still needs to demonstrate value to customers. Currently, we continue to see weakened demand, with stationary products down 12.5% in the first half of the year. Conversely, our domestic recliner and motion groups have not faced the same lead time performance issues and have contributed strong results, with increases of 24% and 33% respectively in the first half of the year. Moreover, we are overhauling our new product introduction process by utilizing customer insights to build a robust product pipeline for future introductions across all our core categories. In summary, our focus is clear: grow revenues with an emphasis on our core categories and channels by enhancing the customer experience, expanding our distribution, executing our six work streams, and establishing a disciplined approach to product development and lifecycle management. We anticipate that this focus will guide us back to a growth trajectory and improve our profitability in the upcoming quarters. I'll now hand the call over to Marcus, who will provide a more detailed analysis of our quarterly results. Marcus?

Thank you, Jerry and good morning. Net sales decreased 13% to $103 million, representing a decline of approximately $15 million during the second quarter. However, it is noteworthy that we observed an increase of 2.6% compared to the first quarter. Exiting the commercial office and custom design hospitality products accounted for a $7.3 million decline relative to the second quarter of fiscal 2019. Our largest domestic product group, stationary, yielded disappointing results in the second quarter, with sales down 15.3%. As Jerry mentioned, we believe the improvements in lead times for this category should facilitate a recovery over the next couple of quarters. On a positive note, we are very pleased with the continued strong performance in our domestic recliners and motion groups, which increased by 19.4% and 27.2% respectively during the quarter. Additionally, we were particularly pleased with our ready-to-assemble furniture sold under the Home Styles brand, which primarily through the eCommerce channel, reported growth of 30.1% in the quarter and 39.1% growth over the first quarter of fiscal 2020, making our ready-to-assemble category up 12.6% for the first half of fiscal 2020. I would like to briefly address our contract performance. We expect the wind-down of the remaining custom design hospitality orders to be completed by the end of this fiscal year, which accounts for nearly three-quarters of our overall sales contraction in the contracts through the first six months. Vehicle seating products also contributed to the sales decline, down 22% in the quarter and 14% year-to-date. For context, our vehicle seating products are sold primarily to premium Class A motor home manufacturers and are produced in our Dubuque, Iowa manufacturing plant, with a smaller portion being manufactured in our Starkville, Mississippi plant, representing approximately 6% of our year-to-date sales. It is important to note that this line is cyclical in nature and we believe it has either neared or crossed its peak demand through the cycle. As with all product lines, we continue to evaluate long-term growth and profitability potential relative to resources and other opportunities. Regarding profitability, we reported a net loss of $5.4 million, or $0.58 per share, compared to net income of $1.6 million, or $0.20 per diluted share in the second quarter last year. The reported net loss included a $5.1 million pre-tax restructuring expense, along with some other immaterial charges relating to inventory impairment and a small gain from the sale of certain assets regarding restructuring activities. Excluding these items, the company reported an adjusted net loss of $1.5 million or $0.19 per share. Please refer to the non-GAAP disclosures included in our fiscal second quarter earnings press release for the details of our adjusted net loss. Gross margin as a percentage of net sales in the second quarter fell by 250 basis points to 15.6% from 18.1% in the prior quarter. We capitalized on an anticipated strong selling season by leaning into holiday season promotions to reclaim market share, drive sales, and move inventory through both eCommerce and brick-and-mortar channels. This activity accounted for approximately 90 basis points of margin compression in the quarter. Additionally, as part of our customer and product profitability initiative, we began rationalizing products in the portfolio, which led to an inventory valuation allowance and further pressured margins in the quarter by about 150 basis points. Effectively managing the product lifecycle, rationalizing low-demand products, and simplifying our offerings are crucial to enhance product profitability for the long term. Additionally, as part of our turnaround strategy, our operations and supply chain teams are focused on enhancing the customer experience by reducing lead times, resulting in approximately 80 basis points of increased costs. We plan to address this cost increase through our network optimization work stream. Selling and general administrative expenses fell by $1.3 million to $18.1 million. As you may recall, in the second quarter of the previous year, we incurred around $700,000 in one-time expenses related to the CEO transition. I'm pleased to report we've made significant progress on realizing the restructuring savings associated with the SG&A optimization work stream. This progress was slightly offset by accelerated depreciation charges from our ERP transition and increased incentive compensation. We reported a $1.6 million income tax benefit, with an effective rate of 22.8% during the second quarter, compared to tax expenses of $0.6 million during the same period last year, which had an effective tax rate of 27.5%. Turning to the balance sheet, we had a strong quarter managing our balance sheet, generating $4.1 million in operating cash, including restructuring payments of $5.3 million during the quarter. Our advancements were driven by a deliberate plan to fully leverage the holiday season and strong consumer sentiment through smart and targeted promotions to reduce inventory and capture market share in key categories where we are confident in our execution abilities. Working capital, defined as current assets minus current liabilities at December 31st, totaled $121 million, up from $118.2 million as of June 30, 2019. The increase in working capital included a $15.1 million rise in cash and cash equivalents, mainly driven by $19.7 million in proceeds from the Riverside property sale recorded in the first quarter of fiscal 2020, and an increase in trade receivables of $3.4 million, offset by a $2 million rise in accounts payable, a $7.1 million decline in inventory, and a $6.2 million drop in other current assets, primarily due to income tax refund collections. Capital expenditures in the second quarter reached $1.3 million. We anticipate annualized CapEx in the range of $4 to $5 million. The company currently maintains $20 million on a revolver, with $18.7 million available as of December 31, 2019. This concludes our prepared remarks for the quarterly results, and I will turn the call back to Jerry, who is attending the Las Vegas furniture market for his insights from the show. Following that, we will open the line for your questions.

Thanks, Marcus. We're experiencing strong traffic and engaging discussions with our retail partners and showcasing our enhanced winning assortment. We're continuing dialogues about developing and refining our seamless retail experience between digital platforms and brick-and-mortar stores. We recognize that the success of our business is directly tied to the success of our retail partners. With that, let's open the call for some questions. Thanks.

We will now begin the question-and-answer session. Our first question comes from J.P. Geygan with Global Value Investment Corp. Please go ahead.

Good morning. Jerry, as you noted in your opening remarks, the restructuring plan is comprehensive and involves both quantitative and qualitative elements. Marcus, I believe you've touched on the cost savings element a little bit, but can you elaborate on where you stand in reducing costs for the business? Should we expect to see that in the current period or if not, when will we fully appreciate those savings?

Sure J.P. We've seen some notable savings on the SG&A side. We are further along in SG&A savings compared to operational savings. While we noted good productivity in the first quarter due to getting our plants fully staffed and operational, we did experience a minor setback in Q2 regarding overall productivity as we continue transferring processes and settling into the new facilities. However, we are certainly seeing more traction in SG&A through the first couple of quarters.

You've noted the advantages of shifting production from China to Vietnam. Can you provide more details on how that shift has progressed and the current status of your geographic exposure in each market?

Absolutely, I appreciate the question. The actual percentages for our production in China have continued to decrease. Initially, we had about 50% of our total production in China. I don't have an exact number for where we will land upon completion, but it will likely be closer to around 25% of our volume. For the most part, the transition is progressing well. We've successfully relocated many of our products, and we have been able to implement the new pricing without the tariffs, resulting in a strong influx of orders. However, we recognize there are some suppliers who are experiencing challenges due to reliance on China. Overall, we've been pleased with how our suppliers and partners in the region are performing.

Great. Lastly, Marcus, you've previously suggested that the company might be exploring alternative sources of funding, but based on your operating cash flow this quarter, it seems that might not be an immediate necessity anymore. Can you provide an update on any potential additional capital for the business?

As you mentioned, we've had a strong quarter from a cash flow standpoint, and we expect that trend to continue. Thus, we've reduced our search for alternative financing methods. As noted in the release and what you'll see in the upcoming quarterly report, we've renewed our line of credit that expired at the end of December and extended it through June. Overall, the situation remains stable, and we haven't drawn on any lines outside of the letters of credit associated with the line.

Thank you for your time.

Our next question comes from Mike Hughes with SGF Capital. Please go ahead.

Good morning. I have a couple of questions regarding the stationary business. What percentage of the mix does that represent?

I do not have the exact percentage offhand, but for our domestic business, it comprises around 20-25%. Overall, it would be less than 10% of our total business, but it remains an important segment for us.

Can you remind us what led to the decline there and why the lead times are expected to improve over the next few quarters?

Certainly. Reflecting on our transformation over the last six to eight months, we have made many product transitions in our facilities. With the shutdowns of certain plants, we have managed to absorb production into our Dublin, Starkville, and Lorez plants. While we had previously experienced delays, we are currently back to normal lead times and believe we can demonstrate that improvement to our partners going forward. Overall, we feel positive about the situation moving ahead.

Regarding the vehicle seating business, did you indicate that it represented around 6% of overall revenue in the first half of the year?

That is correct.

So that makes up roughly two-thirds of contract revenue at this point. The math would suggest it would reflect about 6% of roughly $100 million in quarterly revenue, which would amount to $6 million, while the contract revenue stands at about $9 million. Is that accurate?

Ballpark, that's correct.

How are the margins for that business segment performing?

The vehicle seating margins have been somewhat challenging due to the relocation to the new facility in Dubuque, which has incurred considerable depreciation expenses. The volume has also declined primarily due to the cyclical nature of that market. The overall industry has been down for the last year and is projected to fall again in 2020, leading us to find this segment challenging from a margin standpoint.

I understand the RV business has undergone significant wholesale destocking this past year. Retail sales reportedly performed 5-7 points better than wholesale figures. Now that wholesale is improving, are you seeing any positive impact on that segment?

Actually, we are not observing that shift. Our vehicle seating business continues to decline. As mentioned, we have witnessed a sales decline in 2019 and are projecting a further decline in 2020 due to the cyclical nature of this business.

Are we to expect the aggressive pricing strategies you implemented during the December quarter to carry over into the second half of the year in March and June?

Marcus, would you like to address that?

We were indeed quite aggressive during the holiday season by promoting several products, especially in eCommerce and a bit on our China imports. We needed to clear out overstock in some areas and create room for the transition to our Vietnam-sourced products. We've effectively reset our inventory in both those categories. However, I do not anticipate that the heavy promotional efforts will extend into the third quarter. We will certainly look for opportunities to run targeted promotions, but we won't be driving them as heavily as we did during the holiday season.

You previously indicated a slight step back in operational productivity, particularly in the December quarter. In the earlier September quarter, you reported around $2 million in cost savings. Were any cost savings achieved on a net basis within the December quarter, either in G&A or operationally?

In the December quarter from a gross margin perspective, we did not realize significant productivity compared to the same quarter last year. However, on the SG&A side, we saw just over $1 million in restructuring savings during the quarter.

So the $18 million quarterly SG&A figure seems reasonable for us to expect moving forward?

Yes, that's likely accurate at this stage.

I noticed a VAT tax reversal on the cash flow statement. Was that total $943,000 reflected entirely in the December quarter, and did it enhance your margin?

Yes, that benefited our gross margin, and it was indeed realized entirely in the December quarter.

At this time, there are no further questions. I would now turn the conference back over to Mr. Jerry Ditmer for any closing remarks.

Thank you, Sarah. You may have noticed today’s call had some challenges as I am participating while at the furniture show in Vegas while Marcus is in Dubuque. I want to emphasize that we are actively working to transform our company and unlock its full potential. I believe in our team's ability to execute despite facing significant headwinds. We appreciate the continued support from all our partners. I look forward to updating you on our progress in the next quarter. Have a great day, everyone.

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