Flexsteel Industries, Inc. (FLXS) Q2 2020 Earnings Report, Transcript and Summary

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. [Operator Instructions] 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, Monday, January 27th 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 be, will include forward looking statements which can be identified by the use of such words as estimate, anticipate, expect and similar phrases. Forward looking statements by their nature involve estimates, projections, goals, forecast and assumptions and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed on the forward looking statements. Such risk 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, management may also refer to non gap measures which are intended to supplement but not substitute for the most directly comparable gap measures. The press release available on the website contains the financial measures. It 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'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 get the supply chain and operations working well. Additionally, we've completed a significant talent injection of leadership and subject matter experts into the organization from sales, engineering and product development to supply chain to IT. Since our first announcement last May, we've made solid progress on the restructuring plan and the six work streams we identify and we are realizing benefits of these activities in our financials and our business. Getting supply chain and operations on the right track is important, but without growth the company cannot win. We're confident our restructuring program execution is proceeding as planned. We are increasing our focus on growth. We continue to make progress redeveloping our eCommerce channel as evidenced by our strong growth here, topping 30% in the second quarter. This was the first positive year over year comparative in the eCommerce channel since I joined seeing a strong year over year comp after a couple of quarters of strong sequential growth is a nice proof point that we are getting it right and our momentum is building in this channel. We've also been busy moving our largest by an import product groups from China to other parts of Southeast Asia and it begun rolling back prices on these groups. As we transition out of the China inventory, we saw demand rebound almost instantly on these products when the pricing roll backs hit the marketplace. We will continue to work our largest volume groups into Vietnam as soon as possible and insure that sourced new product introductions are launched from this region going forward. Improving our service levels to the customers and reducing our lead times in key categories serve as another catalyst to restarting our growth engine. While our cost to serve is increased, reduced lead times remains one of our top initiatives and we are seeing results. It takes consistent delivery that reduce lead times over an extended time period for performance to be recognized and positively impact point of purchase. The stationary category, our largest domestic category still needs to prove out to customers. Right now we are still seeing a drag on demand that resulted in stationary products being down 12.5% in the first half of the year. On the other hand, our domestic recliner and motion groups where we have not had the same lead time performance challenges continue to contribute very strong results up 24% and 33% respectively in the first half of the year. Additionally, we are overhauling our new product introduction process using customer insights and building a robust product pipeline for future introductions in all our core categories to further accelerate these growth opportunities. In short, our priorities are clear, grow the top line with focus in our core categories and channels by improving our customer experience, expanding distribution, execute our six work streams and build a disciplined approach to product development and life cycle management. We expect focus and execution on these priorities that turn our sales back to a growth trajectory and improve our profitability in the coming quarters. I'm going to turn the call over to Marcus to provide a more in depth analysis of the quarter results. Marcus?

Thank you, Jerry and good morning. Net sales decreased 13% to a 103 million or a decline of approximately 15 million during the second quarter. However, it's noteworthy that we saw an increase of 2.6% from the first quarter. Exiting the commercial office in custom design hospitality products accounted for 7.3 million of decline from the second quarter of fiscal 2019. Our largest domestic product group stationary delivered disappointing second quarter results with sales off 15.3%. As Jerry discussed, we believe with our improved lead times in this category, we should begin to see a recovery over the next couple of quarters. On a positive note, we were very pleased with our continued strong performance in our domestic recliners and motion groups which were up 19.4 in 27.2% respectively in the quarter. We were also very pleased with our ready to assemble furniture sold under the home styles brand and distributed primarily through the eCommerce channel reported up 30.1% in the quarter and delivered 39.1% growth over the first quarter of fiscal 2020 this puts our ready to assemble category up 12.6% through the first half of fiscal 2020. I'd like to turn briefly to contract performance. We expect the wind down of the remaining custom design hospitality orders to be completed by the end of this fiscal year. The wind down accounts for nearly three quarters of our overall sales contraction and contract in the quarter and 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 almost exclusively to premium Class A motor home manufacturers. These products are manufactured in our Dubuque Iowa manufacturing plant with a smaller portion manufacturing our Starkville Mississippi plan, representing approximately 6% of our year to date sales. It's important to note the line is cyclical in nature and in our opinion has neared or perhaps crossed the peak demand through the cycle. Also, this product line carries a fair bit of product complexity, strict regulatory compliance requirements and specialized engineering support to be successful in the automotive space. As with all product categories, we continue to evaluate the long term growth and profitability potential of each product line within our portfolio relative to resource requirements and other opportunities. Turning to profitability we reported a net loss of $5.4 million or $0.58 per share compared to net income of $1.6 million or $.20 per diluted share in the second quarter last year. The reported net loss included a $5.1 million pretax restructuring expense from some and some other immaterial charges related to inventory impairment and a small gain on sale of some assets related to restructuring. Excluding these items, the company reported an adjusted net loss of 1.5 million or $0.19 per share. Please refer to the non-gap disclosure included in our fiscal second quarter earnings press release for more information on the calculation of our adjusted net loss. Gross margin as a percent of net sales in the second quarter declined 250 basis points to 15.6% versus 18.1% in the prior quarter. We took advantage of an expected strong selling season to lean in on holiday season promotions to take back share, gross sales, and move inventory across both e-commerce and brick and mortar channels. This activity accounted for approximately 90 basis points of margin compression in the quarter. As part of our customer and product profitability initiative, we started rationalizing products in the portfolio which resulted in an inventory valuation allowance, further pressuring margins in the quarter by approximately 150 basis points. Effectively managing the product life cycle, rationalizing the products, cutting off the tail, and simplifying our product offering is key to improving product profitability for the long term. Additionally, as part of our turnaround strategy, the operations supply chain teams have been committed to improving the customer experience through reduced lead times resulting in approximately 80 basis points of increased costs. We will work to mitigate this cost increase with our network optimization work stream. Selling & general administrative expenses decreased 1.3 million to 18.1 million. As you will recall, on the second quarter of the prior year, we had approximately 700,000 of onetime expenses related to the CEO transition. I'm pleased to report we've made tremendous progress on delivering the restructuring savings associated with the SG&A to optimization work stream. This progress was partially offset with accelerated depreciation charges associated with our ERP transition to the new scope and higher incentive compensation. We reported a $1.6 million income tax benefit or an effective rate of 22.8% during the second quarter compared to tax expenses of 0.6 million in the comparable period or an effective tax rate of 27.5%. Turning to the balance sheet, we had a very good quarter managing the balance sheet and generated 4.1 million in operating cash including restructuring payments of 5.3 million within the quarter. Our progress was driven by an on purpose plan to take full advantage of the holiday season and strong consumer sentiment to lean deeper into our channels with smart and targeted promotions to reduce inventory and take market share in key categories where we are confident in our ability to execute. Working capital, current assets minus current liabilities at December 31st was 121 million compared to 118.2 million as of June 30, 2019. The increase in working capital included a $15.1 million increase in cash and cash equivalents primarily due to the $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 an increase in accounts payable of 2 million, a decline in inventory of 7.1 million and a decline in other current assets of 6.2 million, primarily due to the collection of income tax refund. Capital expenditures in the second quarter were 1.3 million. We expect annualized CapEx to be in the range of four to five million. The company currently maintains 20 million on a revolver of which 18.7 million remained available at December 31st, 2019. This concludes our prepared remarks on the quarter results and now I'll turn the call back to Jerry who is at the Las Vegas furniture market for his observations from the show. Following that we will open the call for your questions.

Thanks Marcus. We're having a robust traffic and great discussions in placements with our retail partners and showing them our enhanced winning assortment. We are continuing to discuss with them our development and refinement of our seamless retail experience between digital platforms and brick and mortar stores. We recognize that the success of our business is directly related to the success of our retail partners and with that, let's open up the call for some questions. Thanks.

We will now begin the question and answer session. [Operator Instructions] 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, 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 taking some cost out of the business? If we see that in the current period or if not, when we'll fully appreciate those savings?

Sure J.P. So we've, we've seen, some pretty good, we've seen quite a bit of savings on the SG&A. We're, we're further ahead on SG&A than we are in, in the operation side. Just with getting the plants fully staffed and up to speed, we saw some pretty good, productivity in the first quarter out of the plants. We had a little bit of a setback in Q2, in terms of our overall productivity there. As we, as we get stuff transferred and settled into the new facilities. But, on the SG&A side, we're certainly seeing much more traction, through the, through the first couple of quarters.

Okay. You've noted the advantages to shifting production from China to Vietnam. Can you add some more color about how that shift has proceeded and how complete the processes and possibly your geographic exposure to each market?

Yeah, I can do that. So appreciate the question. So the actual percentages continued to come down and you know, we were probably 50% of our total was in China. I don't have the exact number of, where we'll land when we're done, but it'll probably be closer to maybe a quarter of our volume is when we're all complete. For the most part it's going well. We've transitioned a lot of our products, in fact, and we've been able to transition over and take the new pricing without the tariffs. We've seen really good orders when that happens and we see a good pickup. But we continue to do that. We probably are in the middle innings of doing that. We've got several of our suppliers that were already there and a few that are moving there. We have a couple that are obviously struggling because a lot of their stuff's coming from China. But overall we've been real pleased with our, uh, with our suppliers and partners over there and how they're performing.

Great. Finally, Marcus, you've suggested in the past that the company might be searching for alternate sources of funding and you recently renewed your line of credit and based on your operating cash flow this quarter, it seems like that might not be an imperative anymore. Can you provide an update on potential additional capital for the business?

Yeah, so we've, as you said, we had a really good quarter from a cashflow perspective and we expect that to continue. So we've backed off in terms of our looking for those alternative financing methods. What I, you know, as you, as you'll see in the, in the release and you've seen the queue coming up here in a couple of days, you'll see that we've renewed our one credit line that expired at the end of December. We extended that through June. So nothing, nothing really changed there. And of course, we haven't drawn on any of the lines outside of the lines of letters of credit that are on the one, the one line. So that's where we're at from a liquidity standpoint on, on loans.

Great. Thank you for your time.

[Operator Instructions] Our next question comes from Mike Hughes with SGF Capital. Please go ahead.

Good morning. A couple of questions for you just on the stationary business. What percentage of the mix does that represent?

I don't know. I don't know that I'd have that off the top of my head. I mean, it's a, from our domestic business, it's probably, you know, 20-25% of our domestic business. Overall it would be something less than 10% of our total business, but it's an important part of our business.

Okay. And can you remind us what happened there and why the lead times will actually improve over the next few quarters?

Yeah, we've actually, if you go back into our transformation over the last six, eight months, we've made a lot of product moves in some of the facilities we shut down and manufacture that product as we've got our Dublin Starkville and Lorez plants are absorbing that and that's just one area that we are just going a little bit slower. But, we're actually back to normal lead times right now. We've just got to prove that to our partners going forward. For the most part, we think it's behind us and we're feeling pretty good about it.

Okay. And then, just a question on the vehicle seating business, did you say that was 6% of the overall revenue in the first half of the year? Is that correct?

Correct.

Okay. So it represents roughly two thirds of the contract revenue at this point. Right? Because it would be 6% of roughly a hundred million dollars in quarterly revenue, which is 6 million and the contract revenue is 9 million. So it's about two thirds, right?

Ballpark. That's correct.

Okay. And how are the margins on that business? The vehicle seating.

So the margins on that are, are, um, are uh, you know, have been, have been, I'll just call it challenged because of the relocation in the new facility in Dubuque, has put quite a bit of, you know, depreciation, expense, etc on that business and as well as the volume in that business has declined, mainly because of the cyclical nature of it. We've reached a peak, the overall industry has been down for the last year and, and projected to be down again in 2020. So we find that business to be challenged from a margin perspective.

So you, my understanding the RV businesses, there was a lot of wholesale destocking last year in retail performed by, I don't know, five, six, seven points better than the wholesale numbers. So it looks like wholesale is now improving, which should help that business for you or are you seeing that that at all?

No, we're, we're not actually, we're seeing, we're seeing that business decline. We saw, as I said, we saw a decline in 2019 we'll see a further decline in 2020, is what we're, we're projecting through that cyclical nature of that business.

Okay. Just a few more. If I can sneak some in there. The aggressive pricing that you saw in the December quarter, should we expect that to carry over to the back half of the year, the March and June quarter?

Go ahead Marcus.

So I think that we we're pretty aggressive in, during the holiday season of promoting some product specifically in eCommerce and a little bit on our, on our China business. That was coming in from overseas, trying to get out of that inventory where we were, overstocked in some areas and making room for the switch over to the Vietnam product. So we, we've done I think a really good job there and overall resetting the, resetting the, the inventory in both those areas. So I don't, I don't see that continuing through the third quarter as heavy. Of course we'll look for opportunities to do spot promotions, et cetera, but it's not something that we're going to continue to drive, like we did in the, in the Q4 holiday season.

Okay. And you already touched on this with the prior caller, but I'm a little more specific on the cost saves. You said it was a little bit of a step back on, on the operational front, just from a productivity standpoint. In the December quarter, I think the September quarter you had about $2 million in, in cost saves. Were there actually any on a net basis between the G&A operationally, any saves in the December quarter?

Yeah. In the December quarter from a, from a gross margin perspective, we didn't, we didn't feel, much productivity, versus the prior year quarter. But in the SG&A side, we saw just in the quarter about a million dollars of, of a little over a million dollars of restructuring savings.

So is the $18 million a quarter in SG&A, a good number at this point on a go forward basis?

I think we can, you know, that's probably about, that's probably about right I think at this stage.

Okay. And one last one for you. I saw on the cashflow statement there was something related to a VAT tax and it looked like a reversal to me. So was that $943,000 all in the December quarter? That would've benefited margins.

Yeah. So that did benefit gross margin

And that was all in the December quarter?

That was all in the December quarter.

Okay. Thank you very much.

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

Hey, thanks Sarah. So you'd saw us be a little clunky today is because I am actually at the furniture show in Vegas and Marcus is in Dubuque. So that's why you have heard a little bit on our handoff where we do want to let you know that we're working hard to transform our company and achieve its full potential. I am confident that our teams and associates ability to execute even the face of strong headwinds. We're grateful for all our partners continued support. I look forward to updating you on our progress next quarter. Everybody have a great day. Thanks.

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