Flexsteel Industries, Inc.

Good morning and welcome to the Flex Steel 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, then one on your telephone keypad, And to 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 Ressler, Chief Financial Officer for Flex Steel Industries. Please go ahead.

Thank you and welcome to today's call to discuss Flex Steel Industries third quarter fiscal year 2024 financial results. Our earnings release, which we issued after market closed yesterday, April 29th, is available on the Investor Relations section of our website at www.flexfieldindustries.com under News and Events. I'm here today with Jerry Dittmer, Chief Executive Officer, and Derek Schmidt, President. On today's call, we will provide prepared remarks, and we will then open the call to your questions. Before we begin, I would like to remind you that the comments on today's call will include forward-looking statements. which can be identified using words such as estimate, anticipate, expect, and similar phrases. Forward-looking statements by their nature involve estimates, projections, goals, forecasts, and assumptions, and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. Such risks and uncertainties include but are not limited to those that are described in our most recent annual report on Form 10-K as updated by our subsequent quarterly reports on Form 10-Q and other SEC filings as applicable. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. Additionally, we may refer to non-GAAP measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures. The press release available on the website contain the financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. And with that, I'll turn the call over to Jerry Dittmer. Jerry?

Jerry Dittmer 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 hardworking and dedicated individuals here at FlexDeal. I am proud of the foundation we have built and confident in the organization's ability to continue achieving long-term profitable growth. I would also like to congratulate Derek Schmidt, who will assume the role of Chief Executive Officer upon my retirement. Derek is a well-accomplished leader and I am 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 deliver sales growth of 8.2% when compared to the prior year quarters. The increased sales along with our commitment to operational efficiency and prudent cost savings drove increased operating income when compared to the 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 properly 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 initiative. I'll be back at the end of the call with some closing comments on what we see ahead.

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 five and a half 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, Flex Steel was named by Newsweek as one of the most trustworthy companies in America, which is a true testament to Jerry's leadership. On a personal level, I'm also deeply grateful for Jerry's coaching, mentorship, and support over the many years we've worked together. He has established a foundation and trajectory for the company to continue to thrive for many years to come. Thank you, Jerry. Turning back to the business, Like Jerry, I am very pleased with our third quarter results. We are competing well, gaining share, and growing the business in a challenging industry environment where many industry participants continue to report double-digit year-over-year declines. The investments we'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 competence 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 Flex Steel showroom was impressive and increased by 29% versus prior year's market. a clear indication that our customers are leaning into FlexDeal as a preferred partner. In addition, we showed the biggest lineup of new products in my four years with FlexDeal, 36 new groups and 16 line extensions. When compared with recent markets, that lineup represented almost a 40% increase in new product introductions. Most importantly, based on positive customer feedback and commitments we are activating almost 90% of all the new products shown at market, which is an exceptional success rate. A good portion of the new product was squarely focused on our core business, which gives us optimism that we can continue to gain share and modestly grow the core, even with persistently sluggish industry conditions. At the same time, we advanced all our market expansion initiatives at April High Point Market, First, we launched multiple new collections under our new brand, Charisma, which is intended to reach younger consumers with lower-priced on-trend products. The product was very well received, and we've added both design and engineering talent this year to quickly expand the Charisma offering over the next 18 months. Second, we expanded our Flex collection with new hubs and other accessories to further improve its modularity and appeal to younger consumers. And for our independent retail partners, Flex is now available in custom fabrics produced in four weeks or less. Third, ZClyner, our proprietary sleep chair offering, was expanded with new fabrics and a new ZOFA solution, which is effectively two ZClyners connected by a center console. We continue to invest in powerful POS, or point-of-sale materials, to help our retailers tell the differentiated ZClyner story in-store, as our customers who leverage our POS materials experience, 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 ZClyner and to drive increased demand for our sleep solution to our customer stores. Fourth, we launched a broad set of compelling on-trend case good products with superior quality under the Flex Steel brand across bedroom, dining, and occasional. These are large product categories where the company is under-penetrated. 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 Flex Steel 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'm equally energized by our improved profitability. which is being 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 pull back promotions where needed to improve overall profitability. And fourth, we are achieving leverage of fixed costs through higher sales volume, which we believe will continue to be an important driver of operating margin improvement going forward as we grow the business. The key takeaway is that our strategies are working, and we are growing and gaining share under challenging industry conditions. We must remain aggressive with our investments in pursuit of new growth to continue our positive sales momentum, and we have robust plans to continue growing through both our core markets and expansion into new markets. We are rapidly improving profitability with more gains expected in the fourth quarter of fiscal 2024 and into fiscal 2025. We are generating strong free cash flow and strengthening our balance sheet. and we are investing to continuously improve our customer experience and to drive new innovation that will differentiate us and strengthen our market leadership long-term. The future is bright, and I'm excited about what lies ahead for our organization. With that, I'll turn the call over to Mike, who will give you some additional details on the financial performance for the third quarter and the outlook for the fourth quarter of fiscal year 2024. Thanks, Eric.

For the quarter, net sales were $107.2 million, slightly above our guidance of $101 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 percent of sales in the third quarter, in line with our previously disclosed guidance of 2.5 to 3.5 percent. 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 percent of net sales. The meaningful increase in our operating income was driven by higher sales and gross margin expansion. Gross margin improved to 21.7% in the quarter compared to 18.8% in the prior year quarter, a result of our team's relentless focus on cost savings, operational execution, pricing discipline, and product portfolio management. Selling general and administrative expenses decreased to 16.5% of net sales in the quarter compared to 16.7% of sales in the prior year quarter. The decrease was due to leverage on higher sales, partially offset by investments in our strategic growth initiatives and higher incentive compensation. Moving to the balance sheet and statement of cash flows. We continue to strengthen our balance sheet, ending the quarter with $4.6 million in cash, working capital of $96.2 million, and a balance on our revolving line of credit of $14.2 million. Our inventory optimization initiatives enabled us to reduce inventory by $8.6 million in the quarter while maintaining exceptional service levels for our customers. Our increased profit combined with improved working capital levels allowed us to pay down our debt by 21% when compared to the fiscal second quarter. Turning to our outlook, the company reiterates its full-year fiscal 2025 guidance. For the fiscal fourth quarter, we reiterate our sales guidance of $107 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 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 and $18.0 million for the fourth quarter, excluding restructuring charges and non-recurring stock compensation expense related to the revaluation of equity awards. Most significant drivers of variability in our forecasted guidance ranges are consumer demand changes, supply chain disruptions due to global conflict or political instability, and competitive pricing conditions, all of which will be largely influenced by external factors. Regarding our cash flow outlook, in the fourth quarter, we expect free cash flow in the range of $5 to $11 million. Near-term priorities for cash remain reducing debt, resourcing new innovation, and funding modest capital expenditures. mainly related to cost savings projects and business system updates. The fourth quarter, we expect capital expenditures to be between $0.2 and $0.4 million. We expect debt levels at the end of fiscal 2024 to be in the range of $4 to $10 million. The effective tax rate for fiscal 2024 is expected to be in the range of 30 to 32%. Now, I'll turn the call back over to Jerry to share his perspectives on our outlook.

Thanks. While we remain cognizant of macroeconomic factors which could impact our current outlook, I am optimistic about our ability to continue to gain share and confident we can maintain our profitable growth trajectory both in the near and long term. We have great momentum and are well positioned to successfully deliver improved earnings and an even stronger balance sheet over the remainder of fiscal year 2024 and into fiscal year 2025. With that, we will open up the call to your questions. Operator?

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. Today's first question comes from Anthony Lebedzinski with Sidodian Company. Please go ahead.

Good morning, and thank you. So first, congratulations, Derek, on your pending promotion, and congratulations, Jerry, on your pending retirement. So first, I guess the 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 expansion, ZCliner, et cetera.

Yeah, thanks, Anthony. Thanks for your comments just for Derek and I also. You know, I'll go first. Our core business is actually performing quite well, and I'll let Mike comment on that. But if you take our growth initiatives, you take our, you know, what Derek talked about, our charisma initiatives, our Flex initiative, our ZCliner, which is our health and wellness initiative, Case Goods, which isn't even hitting the top line yet per se, our Big Box and eTailer initiative. All these things are clicking quite well. And you have to take the pool of all of this together. And it's really encouraging, you know, where the company is going, especially when we see, you know, an almost 10% sales increase. And our belief is that we can continue this, you know, going forward too.

Yeah, Anthony, I would just add, so in terms of your question on, you know, 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, ZCliner, and then like the strategic account penetration. But there still was over 1% growth in our core market with retail and our existing product categories. So You know, we are growing in the core, you know, in a challenging market, but we're also getting the benefits of, you know, those growth initiatives.

Perfect. Okay, that's great to hear. And then just wondering, you know, just sticking to the top line here, so in terms of your sales channels, you talked about the sales growing and outperforming and brick and mortar, right? 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, is there anything different or more or less kind of the same?

Yeah, I'll start. This is Derek. So in terms of kind of near term, I mean, we're performing exceptionally well at retail. And so even if you think about, you know, Some of the items, the growth initiatives that Jerry mentioned, you know, like ZCliner, like Charisma, again, we're having really nice success kind of within, you know, our traditional independent retailers, which, you know, as you know, are vitally important to our business. So we believe in the near term we're going to continue to build upon that strong momentum within retail. But longer term, we've talked about, you know, 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 into big box, e-tail, other sales channels that we believe are relevant long term for furniture purchasing. In terms of kind of the margin impact of that, we believe over the long term, you know, all these channels should have a similar margin profile. Maybe in the near term, they're a bit different, but longer term, we believe, again, profitability, we should be indifferent between the channel mix.

Gotcha. Yeah. Thanks, Derek, for that. And then, so, yeah, 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?

Anthony, I'll take that one. So 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, which has much better profit profiles than what the legacy products are that we've retired. But we feel that we have positive processes and structure in place that we're going to be able to continue to maintain and even expand our gross margin. once we start to get the benefit of some higher sales.

Gotcha.

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

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

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

Got it. Well, thank you very much and best of luck. Thanks, Kathy.

Thank you. The next question comes from Bud Bugach with Water Tower Research. Please go ahead.

Good morning. Jerry, congratulations on your retirement. I can tell you it's not all that it's cracked up to be. And Derek, congratulations to you on your ascension to the leadership role. And congratulations on your performance. I do have a few questions. Last quarter, I think, Derek, you said to me that you were striving for success 23% gross margin was still your aspiration in the mid to long term over three to five years, and you've made significant progress to that. My next question goes to, how about the same for SG&A? It looks, you know, at the current level at 16.5%. The leverage on the increased sales excluding the restructuring charge, was really just under 20 basis points. And it looks, therefore, it looks like most of that's variable. What are we missing here in terms of SG&A? Where are the opportunities?

Yeah, I think in terms of SG&A, long-term, we aspire to get SG&A between 15 and 16 percent. So, again, longer-term aspiration is an 8 percent operating income. which in order to get there is a 23% gross margin and, you know, an SG&A in that kind of mid 15% kind of range. In terms of current SG&A, I mean, there's two things maybe pushing it up a little bit higher. 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. And 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 incentive payout for this year. Longer term? We're going to continue to prudently invest in our growth initiatives, but we believe our top line will grow faster than SG&A, and we'll continue to see SG&A as a percent of sales decline as a result.

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

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

So just to continue to make sure I understand, that's people costs or kind of structural costs like insurance and rent and stuff like that? What's the balance between the two? Largely people costs. Gotcha. Okay. And looking at the top line, can you give us maybe a little bit more color in terms of some numbers as to how e-comm is doing. I saw the differential. I wasn't quite sure that I saw the penetration of your customers who are primarily e-comm based versus your big box guys, the Costco's. What do we look like in terms of that? How do we think about upholstery versus case goods? What's the penetration of the sales line?

But I think you're asking two questions. One is, what does the profile look like within a product category mix? And so if you think about, you know, overall from a company perspective, we grew this quarter at 8.2%. If you break it out into categories, now you source soft seating was up double digits. Manufacturing soft seating was up double digits. 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 e-commerce and our Homestyles brand has been down double digits. And that largely mirrors what we're seeing in the external environment. So we've heard from our large customers, Amazon, Wayfair, that we're competing consistently or better than the categories that we participate in. So the overall message is, you know, really the core core of our business, which is sourced and manufacturing soft seating, is doing exceptionally well. And we're going to continue to invest in that. And that largely will manifest itself in terms of kind of new product introductions as well as new forms of innovation. On the case good side, like I said, you saw a really compelling lineup of new product here at April point or April high point market. And then in terms of the channel mix, you know, you know, Costco continues to grow at a modest pace and is profitable. And then independent retail is doing exceptionally well right now. So that's kind of the dynamics of what's going on within the business. Is that helpful?

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

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

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

Yeah, so again, we just came up with a fresh lineup of really good-looking product. We have activated virtually all of that product shown at market, which again, we make the decision of what to activate and what not to activate based upon retailer feedback and commitments. And so most of that product here has already been, they'll go through their first cuttings. Product will arrive, you know, this fall. So, I mean, that's when we'll start to realize some of the sales there. But feedback was very strong. I mean, basically we had multiple customers indicate, you know, clearly FlexDeal is back in the case goods business. So we're strategically committed to that category. We're putting talent and resources behind it, and we'll continue to bring forth, I think, aggressive and compelling new product introductions.

Okay. I remember when Flexio got into the case goods business. So you're correct, though. Typically, we don't see new case goods introductions, particularly with the sourcing situation in the industry the way it is now with relying so heavily on overseas sourcing that gets into the product market. results until really just about the end of the time we go to market in October. Um, we'll start to see that stuff hit the floors in, uh, at that time. Is that the right way to think about it? So we're really looking at, uh, a next year kind of, uh, impact. Exactly. Yep. Gotcha. Okay. Well, congratulations to you, Derek. I look forward to our continued conversations and, uh, Best wishes to you, Jerry, on your retirement. I suspect you'll find a lot to do.

Thanks, Bud. Thanks, Bud.

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

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

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

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

Yeah, we don't share absolute numbers, but as I indicated in Bud's presentation, I mean, they were down double digits. So, again, that's reflective of, I think, what we're seeing externally in that channel.

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

No, from year over year.

Year over year, down double digits. Is that correct? Correct. Thank you.

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.

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

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