Flexsteel Industries, Inc. (FLXS) Q1 2021 Earnings Report, Transcript and Summary

Good morning, and welcome to the Flexsteel Industries' First Quarter Fiscal Year 2021 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Derek Schmidt, Chief Financial Officer and Chief Operating Officer for Flexsteel Industries. Please go ahead.

Thank you, and welcome to today's call to discuss Flexsteel Industries' first quarter fiscal year 2021 financial results. Our earnings release, which we issued after market close yesterday, Monday, October 26, is available on the Investor Relations section of our website, www.flexsteel.com under News & Events. I'm here today with Jerry Dittmer, President and Chief Executive Officer. On today’s call, we’ll provide prepared remarks, and then we’ll open up 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 by the use of the 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 contains the financial and other quantitative information to be discussed today, as well as the reconciliations of GAAP to non-GAAP measures. And with that, I will turn the call over to Jerry Dittmer. Jerry?

Good morning, and thank you for joining us today. The COVID-19 pandemic continues to adversely impact the global economy in many aspects of our business operations. First, I would like to thank all our Flexsteel employees for their dedication to our company and commitment to taking care of our customers and each other during these unprecedented time. I'm proud of our team and how they have responded in this difficult and dynamic environment. In response to COVID-19, we accelerated many strategic decisions and took bold actions to transform our company over the past six months. While many of these decisions were difficult, they were necessary and it made the company much stronger and better positioned for long term profitable growth. We exited several non-core product lines to sharpen our focus on competing in markets where we feel we are advantaged. We significantly reduced operational complexity by rationalizing our product offering to what is most relevant to today's consumers and we aggressively reduced structural costs and optimize our network footprint to become nimbler, better serve our customers and expedite our return to profitability. While we are an organization dedicated to continuous improvement and there is still much work to be done, I feel we have achieved a major milestone in our transformational journey and now have a solid foundation for the future growth which is reflected in the strength of our first quarter performance, most notably double digit organic growth and return to operating margins which are near historical peak levels. While we reported net sales were up 5% in the first quarter, more importantly our organic sales growth was 18% when excluding the impact of the vehicle seating and hospitality product lines we exited last year. The sales strength was broad based, spanning both the Flexsteel and Home Styles brands, all our sales channels and geographic regions, and nearly all our product categories. From a macro viewpoint the industry has seen a surge in demand for household furniture since June as consumers spend more time at home and shift discretionary spending from travel and entertainment to home goods. No one including myself anticipated the enormity of the rebound in consumer spending on furniture when retailers began reopening their stores in late May, in early June. Our restructuring efforts have made us more agile and we've been able to capitalize on this positive shift in consumer spending for furniture sold both through retail and e-commerce channels. Our retail home furnishing sales were up 15% and e-commerce sales grew almost 40% during the quarter. Orders in retail home furnishings were even stronger than shipments with 60% year-over-year order growth in the quarter. Order demand was consistently robust throughout all three months in the period. In October orders appear to be sustaining that same strain as month to date orders are up roughly 60%. As a result our backlog ended the first quarter at a historical record high of $89 million. To support our customers and the strength of the backlog, we added several new production lines in the first quarter at both of our North American manufacturing facilities and we intend to build additional capacity in calendar year 2021. As we do this, we continue to adhere to strict social distancing guidelines and sanitation best practices to protect the well-being of our valued employees. We are also working feverishly with our global supply partners to secure additional capacity and build inventory to support continued strong consumer demand. While demand trends have certainly been a pleasant tailwind to the business in the near-term there are a multitude of headwinds related to supply delays, disruptions and price increases that we are currently navigating at the same time. First global supply availability, most offshore furniture suppliers reduced capacity at the beginning of the COVID-19 pandemic as their orders declined or were cancelled. Despite these best efforts to quickly ramp up, U.S. furniture demand continues to significantly outpace global supply capacity. Closed borders due to the COVID-19 have further exaggerated the situation as many offshore suppliers do not have access to the workers outside of their home countries, which are needed to ramp up capacity faster. The downstream supply chain for materials like leather and components is also stressed, given heightened demand which has further extended lead times for some globally source items. We anticipate this supply demand imbalance to linger through mid-2021 but are working diligently with our offshore suppliers to secure required capacity. Second, ocean container availability, ocean vessel capacity was reduced early in the pandemic and has not been brought back to pre-COVID-19 levels yet. With a sharp rebound in U.S. consumer spending across multiple categories, demand for imported products has surged and spot rate for ocean containers have more than doubled with no line of sight to returning to normal levels in near-term. Third, material inflation. We are seeing significant price increases in key raw material categories. Plywood has seen massive price increases due to strong housing demand, home improvement spending and furniture demand. We are also seeing double digit increases in foam. Recent hurricanes in the Gulf region have disrupted petroleum based supply chains including the production of TDI, which is a major component of foam used in all our seating. Inflationary pressures in packaging and other materials are also starting to bubble up. Fourth, labor shortages and wage inflation. Despite relatively high unemployment the market for both skilled labor used in upholstery manufacturing and warehousing labor remains tight. As a result, we have increased hourly wage rates this quarter across multiple manufacturing and distribution facilities to improve hiring effectiveness in worker retention. Fifth and lastly, uncertainty in global trade relations. When tariffs were imposed on imported furniture items in China, the change was highly disruptive and costly to the global furniture supply chain. Flexsteel like many furniture companies pivoted quickly to reduce its exposure to China by reallocating production to other Asian countries, most notably Vietnam. The U.S. Trade Representative Office recently announced that it was investigating Vietnam for currency manipulation and exporting wood products contained illegally harvested timber into the U.S. If the investigation confirms these allegations to be true and the U.S. subsequently imposes sanctions or punitive measures on Vietnam, it will have a similar disruptive and costly impact to the U.S. furniture industry as China tariffs. Our team is responding to these challenges and is working multiple plans to mitigate and manage these headwinds wherever possible to ensure that we can continue supporting our customers and do so profitably. In summary, I'm pleased with our performance to start the fiscal year. I feel we are competing well, are managing short-term headwinds effectively, and can continue delivering strong sales growth and financial results going forward. Now, I will turn the call over to Derek to discuss our financial and operating results and I'll be back with some closing comments on what we see ahead.

Thank you, Jerry. And good morning, everyone. First quarter net sales were $105.2 million, up $4.9 million or 5% compared to $100.3 million in the prior year period. The drivers of the increase in sales was two-fold. First, growth in home furnishings products sold through retail stores of $11.4 million or 15%, and second growth in products sold through e-commerce of $4.6 million or 40%, partially offset by a decline of $11.1 million due to the exit of our vehicle and hospitality product lines during the fourth quarter of fiscal 2020. As Jerry previously noted, excluding our exited product lines our organic net sales growth was 18% compared to the prior year quarter. From a profit perspective, we reported our fiscal first quarter net income of $3.9 million or $0.49 per diluted share that compared to a net income of $9.6 million or $1.17 per diluted share in the prior year quarter. The reported net income included a $1.4 million pre-tax restructuring expense and an approximately $700,000 gain from the sale of one of our Harrison, Arkansas facilities and an additional $2.1 million tax expense due to the remeasurement of deferred taxes and recording of a full valuation allowance on deferred tax assets. Excluding these three items, the first quarter non-GAAP adjusted net income was $6.3 million or $0.80 per diluted share as compared to a non-GAAP adjusted net income of approximately zero dollars or zero cents per diluted share in the first quarter last year. Please see the non-GAAP disclosure included in the earnings release for a detailed reconciliation of GAAP to non-GAAP adjusted net income. Gross margin as a percent of net sales in the first quarter was 21.7% versus a reported 17.2% in the prior year quarter. The 450 basis point improvement in gross margin was primarily due to structural cost reductions, operational efficiencies and fixed cost leverage on higher sales volume during the first quarter as compared to the prior year quarter. Given the strengthened demand, we had minimal price discounting and promotional activities, which further bolstered gross margins in the quarter. Selling, general and administrative or SG&A expenses declined $3.3 million to $14.2 million compared to $17.5 million in the prior year quarter. SG&A as a percent of net sales in the quarter was 13.5% compared with 17.4% in the prior year quarter. The improvements in SG&A dollar spend and as a percentage of net sales were attributable to a reduction in salaries and wages due to cost cutting measures that began last quarter due to COVID-19 coupled with decreased spending and selling and travel expenses. Turning to income taxes, during the quarter we reported a tax expense of $4.1 million or an effective rate of 51.3% compared to a tax expense of $3.2 million in the prior year quarter or an effective tax rate of 25.2%. The higher effective tax rate during the quarter was primarily due to an additional $2.1 million adjustment to revalue certain deferred tax assets resulting from improved fiscal year 2021 taxable income projections. These certain deferred tax assets are either no longer expected to be realized or will be realized at the current statutory rate of 21% versus the 35% rate in prior years. The effective tax rate for the remaining nine months of the fiscal year ending June 30, 2021 is expected to be in the range of 25% to 26%. Now moving onto the balance sheet which remains very strong. We ended the quarter with a healthy cash balance of $36.5 million and no outstanding balance on our new $25 million line of credit which was signed in August and matures on August 28, 2022. Our working capital defined as current assets minus current liabilities at September 30, 2020 was $127.8 million compared to $128.4 million at June 30, 2020. The slight decline in working capital was due to a decrease in cash of $11.7 million primarily related to share repurchases of $9 million and an increase in trade accounts payable of $1.1 million partially offset by a $5.2 million increase in inventory and a $7.6 million increase in trade receivables related to higher sales. Capital expenditures for the three months ended September 30, 2020 were approximately $400,000. During fiscal 2021 we anticipate spending $3 million to $4 million for capital expenditures and believe we have adequate working capital to meet these requirements. I would like to provide a quick update on restructuring. During the first quarter the company incurred $1.4 million of restructuring expense primarily for facility closures, professional fees and employee termination costs. We anticipated total restructuring expenses for the fiscal year 2021 of roughly $2.5 million. We also sold one of our facilities in Harrison, Arkansas for approximately $700,000 resulting in a gain of the same amount. We currently have our locations in Dubuque, Iowa, Lancaster Pennsylvania. Starkville, Mississippi and one more facility in Harrison, Arkansas listed for sale. Looking forward, we project net sales for the second quarter between $110 million and $120 million assuming no disruptions for supply chain resulting from either extended manufacturing shutdowns related to COVID-19 or shipment delays from global suppliers. Gross margins are expected in the range of 20% to 21% slightly lower than the first quarter as the positive impact of our continued margin improvement initiatives will be overshadowed by the various cost increases which Jerry noted earlier related to ocean container surcharges, material inflation notably on plywood foam in many source finished goods, domestic wage increases, and higher tariff expenses related to a temporary increase in China sourced goods. Pricing actions which the company announced to the market this week to offset part of these cost increases will be effective November 3rd on new orders for all soft seeding products. Given current order to shipment lead times we expect that orders with new pricing would likely not ship until the third quarter and as such we expect our pricing actions to have minimal financial impact in the second quarter. SG&A spending is expected to increase sequentially quarter-over-quarter due to growth related investments and higher commissions from increased sales. As a percent of net sales, SG&A is expected to range between 13.5% to 14% for the second quarter. While the deep cost reductions taken in response to COVID-19 were appropriate at the time to preserve cash and navigate the company through an extended period of economic uncertainty, we need to make strategic SG&A investments in the coming quarters to both support the current level of sales demand and pursue longer term growth opportunities. Adjusted operating income defined as operating income excluding restructuring expenses and gains losses from asset sales is expected to be between 6.5% and 7.5% as a percent of net sales for the second quarter. While the current environment is very dynamic due to ongoing uncertainty related to COVID-19, the upcoming presidential election and global trade relations, we are cautiously optimistic about the remainder of the fiscal year 2021 based on current demand trends and positive outlooks gathered for many of our retail partners. Absent of significant change in consumer demand for furniture or a major setback in the global economic recovery, we anticipate adjusted operating income for the full fiscal year in the range of 7% to 8% as a percentage of the net sales with expected gross margin expansion in the second half of the fiscal year of funding increased SG&A investments to drive long-term growth. I'll turn the call back over to Jerry to share his perspectives on our outlook.

Thanks. As Derek outlined, we delivered solid financial performance in the quarter and have gotten back to near peak operating margins much sooner than anticipated. The transformation plan is working with profitability restored and plans in place to sustain that profitability, we are now pivoting to the next stage in our transformation to aggressively pursue new sources of profitable growth. We are building out comprehensive plans to achieve our growth potential and we'll be in a better position to share these growth plans with you in the coming quarters. Delivering growth above market will undoubtedly require new investment, which we currently intend to fund with margin expansion initiatives if possible. As a reminder, there are several strategies which are core to our future success and will guide our future growth plans. First, we are committed to being an omni-channel company. We intend to be wherever our customers and consumers want to buy furniture and to provide them a path to purchase consistent with how they want to buy. E-commerce will be a critical growth area including direct-to-consumer capabilities. We have recently launched a new website for our home sales brand www.homestylefurniture.com and began selling a limited assortment of homestyle branded furniture online. Second, we will expand our product portfolio across large relevant categories in varied price points and will effectively market these products through powerful brands tailored to targeted consumer segments. Third, we'll deliver a differentiated and valued customer experience. And fourth, we will expand our agile, lean and resilient global supply chain as a competitive advantage. With that, we'll open up the call to your questions. Operator?

[Operator Instructions] First question comes from Milan Mehta of Evaluate Research. Please go ahead.

First off I would just like to congratulate you on your excellent results. My question is what is your segmentation for your international sourcing? What percentage of your raw material furniture shape from Asia such as China, Vietnam and Thailand and even your Mexico regions?

Yes. Today, if you look at the mix of sourced products versus manufactured products in North America, roughly 60% is sourced and the other 40% is manufactured in North America.

The next question comes from Mike Hughes of SGF Capital. Please go ahead.

Can you just elaborate a little bit on the plywood and foam price inflation, to buy that all on a spot basis or is it under contract, and did any of that inflation impact the quarter you just reported?

Yes. In terms of a very slight impact in the current quarter, the larger impact is going to be felt here in the second quarter and going forward. So, most of our plywood buy is not under contract. So we are a bit vulnerable to what's happening in real time in those markets. What I can tell you is I mean we were buying board pre-COVID probably in the $20, low $20 range and it has spiked well over $30. We have you know our sourcing group is doing a good job of finding alternative sources for lower cost plywood. So, we're doing our best to mute that as best as possible. Similarly foam is the other big inflationary pressure that we're feeling and we're seeing roughly about 16% increase on our foam supplies, and again we’re vulnerable to the spot market on that input as well.

So, the price of lumber spiked in a big way right through the end of August and then it's kind of rolled over. I know that's plywood was different than lumber, but have plywood prices start to sort of a pullback as far as what you're seeing out there?

No.

Okay.

No - I think you know the surge in demand around home improvement, housing has kind of constrained overall capacity combined with you know the big surge in kind of furniture - and so right now there is still a supply demand imbalance.

So all your competitors are faced with the same issues. So just any initial commentary or feedback from your customers on the price increases - I assume it's going to stick given the demand environment?

Yes. With - so we just got done with our market event in high point and there are numerous competitors in the industry that are taking pricing largely due to the same factors that Jerry mentioned in his opening comments. So the retailers certainly don't like it, but they're seeing pricing that's broad based because everybody in the industry is feeling the impact of the same drivers.

Okay. And then the ocean container surcharges - weren't they in place for the full quarter - will you able to - were you able to recapture those higher costs?

Yes. So we implemented a container surcharge or a pass-through to our retail customers at the beginning quarter. At that point in time, - I mean we were starting to see container rates go up about $1,200 today and the spot rate kind of market - I mean we're seeing some containers that are almost $3500 more or 2x what they were kind of pre-COVID. So given the sensitivity around the price increase that we just kind of took, we have made a strategic decision that we're going to absorb the additional kind of container surcharge that we're feeling in the short-term rather than try to pass that off to retailers. And we're hopeful that once we get through the holiday season, we will start to see more capacity, container capacity come online and those rates should come down.

Okay. And in your guidance of course peaks in the absorption of the higher container costs?

Yes. We does.

Okay. And then last - go ahead I'm sorry.

Which is one of the reasons that we expect our gross margins to be slightly lower in the second quarter relative to the first quarter.

And then last two questions just on the balance sheet, the assets held for sale are about $13 million. I saw that you listed the Dubuque facility for $16.5 million. I assume that's the biggest of the assets that are for sale. I'm not sure when you put it on the market, but any initial interest in that facility?

Yes. We've had a multiple offers several of which we felt were too low and we rejected. We did have actually assigned LOI that unfortunately fell through here this past week. As I've stated before, we're going to be - we're in a good cash position. I mean we're going be patience with that sale to make sure that we get fair market value.

Okay. And then last one the tax receivable, what's the status and amount of that?

Yes. We actually received roughly $8.5 million the first week in October, so immediately after quarter end.

[Operator Instructions] The next question comes from David Rold of Portolan. Please go ahead.

Just wondering how much of the earnings requirement this quarter was driven in part by salary cuts that despite [indiscernible] sustainable, any clarity you can give there?

Yes, this is way I frame it up, I wouldn't necessarily call it - when you talk about salary cuts, are you talking about the temporary reduction in executive salaries or are you talking about? Less than a $0.5 million.

And how quickly do you think you can start working through your backlog when do we start to see that come down?

Well.

Go ahead.

Yes, so this - at this point the backlog is very high, but we're able to work it down a few different ways. Of course in our e-commerce business is really we don't have much of a backlog that goes out a day or two. Most of our sourced goods we're able to ship most of those in two to three weeks. And so that, it's a big part of it of our backlog, but the good news is we're able to ship that and turn it fairly quickly. It's our two North American plants that really have this nine to 11-week lead time that where we think we can continue to bring it down and that's our plan. Even though again as we said in our commentary a little bit ago that orders were up by 60% so far this month. We're still seeing very robust order growth. If we can continue to get raw materials we can continue to bring it down, but we will not really see it have a huge change probably somewhere into our third quarter.

The next question comes from Jeff Geygan of Global Value Investment Corporation. Please go ahead.

Jerry in your opening comments you mentioned the addition of capacity in the near future. Judging from your CapEx guidance I can't imagine that you're building new facilities. But can you elaborate on what that looks like?

Yes, for the most part what we're doing right now - it is not new facilities that, we're building. We are looking at expanding some of our facilities really slightly more from a lease standpoint or something as we go forward. We also right now most of our expansion has been just putting additional lines into both of our plants.

And is there additional capacity in your existing port - how much additional capacity can your existing plants accommodate?

So, we can take a probably a 20%, 25% more. Most of that though is related to manpower. So, right now - as we hire more people we're able to - obviously to expand and open up new lines. It's really not capital - that’s the constraint right now. And again, we don't run full second shifts in any of our facilities. We do run second shifts in both of them and that's another option we have, but again it's really more manpower constrained at this point.

Okay.

And as we bring on new people there's roughly a three - kind of four month kind of ramp up because a lot of labor in our - manufacturing facilities - it is skilled labor. So it does take time to develop a skill set to manufacture furniture.

Okay. As you think about wage and material costs rising - is there any mechanism or strategy that you are currently employing or will employ to hedge against those costs?

So, our - single largest way that we're going to mitigate some of those inflationary increases is through the price increase that we're passing through to retailers that we announced yesterday which will be effective November 1. And in terms of other means of offsetting that you know as Jerry noted we increased labor rates across many of our facilities. We believe in the long-term that we will improve not only our recruiting efforts. But workforce retention, which should have an intangible benefit around improved quality customer service and productivity. So, we believe that - part of that investment we will get a return from. In terms of the inflationary items - of the material inflationary items there - is really no mechanism or derivatives out there in the market to protect against those specific items. So, our only really controllable way of offsetting those is to find alternative sources or to do kind of value engineering and reduce our content where permissible.

Finally, given your desire to expand or take the company to the next phase of growth are you considering acquisitions and if so. Do you have a pipeline built and what criteria might you be using to identify potential targets?

So, acquisitions are absolutely on the table. What I will tell you and I think I've mentioned this before. We're going to be very disciplined in terms of what we go after. Our criteria are twofold. One is a strategic fit. In other words does it align and accelerate our long-term strategic plan. And then the second determinant is does it create value for our shareholders. So in terms of strategic fit for an acquisition to be attractive to us it would need to give us exposure into new products, new markets, new business models that we currently don't have confidence. What we will not do is go out and do acquisitions just to put higher sales numbers on the board. So again, if it has strategic fit, if it brings us new capabilities or access to new products and new markets that's what we would consider.

The next question comes from John Deysher of Pinnacle. Please go ahead.

Thanks for taking my question. I was just curious on the 40% increase in e-commerce, what was that exactly? Was that buy online pickup in store or was it buy online ship to home or what was that and how do you see that unfolding going forward?

Yes a majority of that is online orders that we get that are shipped out of our distribution centers directly to the business or to the folks home.

Okay. So when either to the home or to the store or when you say business you mean customer business?

Yes, really it’s threefold. It's to - a customer workplace to their home. And we also do have what's called a brick-and-click where we actually have sent product to our retailers and they in turn deliver it out to the end user.

Okay. And…

And maybe.

Go ahead?

Maybe I'll give you just a little bit more color and context. So as we define our e-commerce business there are three sub-channels that we want to go to market in. One is through, large e-tailers Amazon, The Wayfair’s which is a good part of our business today. The second kind of sub which is brick-and-click so our brick-and-mortar retailers who have an e-commerce capability are selling through their platforms. And then the fourth sub-channel is direct-to-consumer. So selling our own product online and shipping it direct-to-consumer. And as I think Jerry mentioned in his statements, we recently launched a new site for our home - homestylesfurniture.com and we are starting to sell direct-to-consumer today.

Yes, I've looked at that, that's a good site. The other question is in terms of the new products or products you're considering?

We’re also going to be expanding out more into areas like you know outdoor patio furniture. We have a very large market obviously in our e-commerce business, and kitchen carts. We'll continue to do our pulsar products both our seating products, bedrooms et cetera. For the most part we will stay in that furniture strain and just expand it out more to different - probably lifestyles different price points things like that.

What about accessories. Is that out of interest to you?

We look at accessories - I think we have to stay where we're advantaged and where we have core competencies and that's something we could look at. But that would be something that's further out right now - it really doesn't hit into our core competency right now.

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

Great, thank you very much. I appreciate everyone participating in today’s call and for your questions. Our restructuring is complete. We are close to our historical peaks in sales and profits. The transformation of our core processes will continue as we also pivot to our growth initiatives going forward. We will continue to be transparent going forward and give you our best view at that time. We look forward to updating you all on our next call. Stay healthy, safe and sane. And thanks again for participating today.

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