Q2 2024 Flexsteel Industries Inc Earnings Call
Participants
Anthony Lebiedzinski; Analyst; Sidoti & Co. LLC
Budd Bugatch; Analyst; Water Tower Research
Presentation
Operator
Good morning, and welcome to the Flexsteel Industries second quarter fiscal year 2024 earnings conference call. (Operator Instruction) Please note this event is being recorded.
I would now like to turn the conference over to Mike Ressler, Chief Financial Officer for Flexsteel Industries. Please go ahead.
Thank you, and welcome to today's call to discuss Flexsteel Industries second quarter fiscal year 2024 financial results. Our earnings release, which we issued after market close yesterday, February 5, is available on the Investor Relations section of our website at www.flexsteelindustries.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 then we will 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, similar phrases. Forward-looking statements by their nature involve estimates, projections, goals, forecasts and assumptions and are subject to risks and uncertainties that can cause actual results or outcomes to differ material from those expressed in the forward-looking statements. Such risks and uncertainties include, but are not limited to those that are described in our most recent annual report on Form 10-K as updated by our subsequent quarterly reports on Form 10-Q and other SEC filings as applicable.
These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. And additionally, we may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. Press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of GAAP to non-GAAP measures.
And with that, I'll turn the call over to Jerry Dittmer. Jerry?
Good morning, and thank you for joining us today. I'd like to start by welcoming Mike Rassler, our new Chief Financial Officer. Mike has been with Flexsteel over 17 years in various accounting, finance and other cross functional roles. Most recently as the Vice President of Manufacturing, his appointment as CFO, reflects his leadership and contribution to the company's transformation over the past several years. And I'm excited for Mike, to further expand its positive impact on the company as CFO.
I would also like to congratulate Derek Schmidt, on his appointment to President and to the Board of Directors. Derek, promotion reflects his leadership of the company's operations and growth strategy and aligned with his expanded responsibility, since joining the company nearly four years ago.
With that, I am very pleased to share with you our second quarter fiscal year 2024 results while headwinds from macroeconomic challenges and shifts in consumer spending toward experiences and away from things persist in our industry, we continued to execute on our strategic initiatives and delivered sales growth of 7.5% when compared to the prior year quarter.
In addition, our relentless focus on operational efficiency and cost savings, Propel gross margin expansion and help fund additional investment in growth initiatives while delivering significantly improved operating income when compared to both the same quarter of the prior year and our first quarter of fiscal 2024.
While we expect the business environment in the near term to remain challenged. Our team isn't deterred and remain intensely focused on continuing to profitably grow our business throughout the remainder of fiscal year 2024, and long term. We will continue our positive momentum going into the third quarter and are confident in our ability to grow sales both compared to last year and the second quarter.
I'll now turn the call over to Derek, to discuss our results and an update on our growth initiatives. I'll be back at the end of the call with some closing comments and what we see ahead.
Thank you, Jerry, and good morning, everyone. Like Jerry, I am very pleased with our second quarter results. We are competing well in our core business and executing our market expansion initiatives resulting in both sales and profit growth even in a difficult business environment. As Jerry, noted earlier, we grew our top line by 7.5% in the fiscal second quarter. This year-over-year sales comparison continues to be adversely impacted by the elimination of ocean freight surcharges, which reduced revenue by approximately $3.5 million compared to the prior year quarter.
As discussed in our first quarter call, in the prior year, we use this surcharge mechanism to pass through a higher cost of ocean container delivery, which were significantly inflated due to supply chain issues, container delivery costs normalized throughout the last fiscal year, and we subsequently eliminated this surcharge, excluding the $3.5 million impact from this ocean freight surcharge elimination sales growth related to unit volume and product mix was a robust 11.7%, further reinforcing our strong sales execution despite challenging industry conditions.
We remain confident in our ability to continue our growth momentum into the second half of fiscal 2024 from both continued share gains in our core business and increasing momentum in our market expansion initiatives. In our core business, we expect to continue outperforming the industry by continuously improving and providing a differentiated customer experience, aligning ourselves with the strongest most capable distribution partners and driving a constant stream of relevant and compelling new product.
We define our core business based upon where the majority of our current sales are derived from which is product design for primary living spaces like the living room, which are sold through independent furniture retailers and have a more traditional or transitional style that primarily appeals to Gen X and baby boomer consumers.
This core business is large and profitable, and we will continue to defend and expand our penetration in this market. At the same time, we are pursuing growth in markets outside of our core that we believe are relevant and growing and where we have a clear right to win. If you recall from prior calls, these market expansion initiatives take three forms First, consumer segments, namely Gen Z and millennials, second, product categories outside of primary living spaces, and lastly, sales distribution outside of independent furniture retailers. I'm pleased with our solid progress in all three of these areas.
First, to address younger consumers, we are repositioning our brand portfolio through a three-pronged approach. We are modernizing the Flexsteel brand and last October, we launched a strong lineup of more contemporary product at lower price points with exceptional comfort and quality. We're encouraged by initial placements and sales of these new products are ramping nicely.
We also launched the new brand charisma last year to reach younger consumers with even lower priced on-trend products. And this year, we've invested in new talent and product engineering to support charisma, and we'll be launching multiple exciting new products at April's High Point market to grow this new brand. Additionally, we continue expanding our new Flex solution with broader accessories to further improve its modularity and appeal to younger consumers.
Moving on to our second market expansion focus, which is to expand into newer product categories. We focused on health and wellness. This year with our new Z cleaner sleep chair, our recent third party sleep study validated the superior sleep results from using recliners, which we are now leveraging in our marketing and demand-generation initiatives. The product is now placed in over 960 retailers, and we are investing aggressively in additional innovation to protect our leadership position in this emerging market.
Our third market expansion focus is to broaden our sales distribution to position our brands where and how consumers want to purchase furniture, both now and into the future. For example, our flex modular solution, which I mentioned earlier. It can be purchased not only in leading retailers but also on Amazon, Wayfair, costco.com and our own online platform at flexsteelstore.com While I'm excited about our top line growth and future growth prospects, I am equally energized by our improved profitability, which has been propelled by four drivers.
First, new products with higher margin profiles. We've 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 strong cost savings within our supply chain. Third, we remained disciplined with pricing and pulled back promotions where needed to improve overall profitability. And fourth, we are achieving leverage on 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.
As I noted earlier, differentiated customer experience as an important element of share gains in our core markets. As part of our ongoing commitment to improve the customer experience, the company announced the closure of our Dublin, Georgia manufacturing plants while this decision was very difficult, it enables us to reduce customer lead times and handling damage to improve the overall customer experience while also decreasing inventory, simplifying logistics execution and improving profitability.
Currently, the Dublin facility supports less than 5% of the company's sales, and we expect to retain virtually all sales through this transition. Closure of the facility is expected to occur by the end of our fiscal fourth quarter. As part of this transition, the company expects to incur pretax restructuring and related expenses between $2.5 million and $3.2 million.
The one-time costs are associated with employee separations, inventory and equipment transfers and other expenses directly related to the closure and are expected to be incurred primarily in our third and fourth quarters of fiscal year 2024. Once the closure is fully executed and the company expects annualized savings in the range of $4 million to $4.5 million. The Dublin facility will be listed for sale upon closure, and the company anticipates a future one-time gain in excess of the carrying value of the asset.
To summarize, we are growing and gaining share under challenging industry conditions. We have robust plans to continue that growth, both through our core markets and expansion into new markets. We are rapidly improving profitability with more gains expected through fiscal 2024, and into fiscal 2025. We are generating strong free cash flow and strengthen 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. Future is bright, and I am 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 second quarter and the outlook for the third quarter of fiscal year 2024.
Thanks, Derek. For the quarter, net sales were $100.1 million, slightly above our guidance of $94 million to $100 million provided during our first quarter fiscal 2024 earnings call. As Derek noted earlier, sales growth related to unit volume and mix, which when excluding prior year quarter ocean freight surcharges was a strong 11.7% in the quarter, and we feel we have sustainable growth momentum throughout the rest of fiscal 2024, and into fiscal 2025.
From a profit perspective, the company delivered operating income of $4.6 million for 4.6% of sales in the second quarter, which exceeded our operating guidance range of 2% to 4%. The meaningful increase in our operating income was driven by an expansion of our gross margin to 21.9% in the quarter compared to 17% in the prior year. Quarter.
Moving to the balance sheet and statement of cash flows. The Company ended the quarter with $3.3 million in cash working capital of $100.5 million and a balance on our revolving line of credit of $17.9 million. Our increased profit, combined with improved working capital levels allowed us to pay down our debt by 46% when compared to the fiscal first quarter.
Looking forward, we reiterate the sales guidance released with our preliminary results announcement on January 11, 2024. And while we expect one-time costs related to the closure of our Dublin facility for adversely impact GAAP operating income. We still expect to achieve our fiscal 2024 operating income guidance on an adjusted non-GAAP basis when backing out the one-time costs associated with the facility closure. Specifically for the fiscal third quarter, we expect sales between $101 million and $106 million, which represents sales growth of 2% to 7%.
Regarding profitability, we expect gross margin in the range of 21% to 22%. We expect gross margin to grow modestly throughout the remainder of the fiscal year and into fiscal 2025, driven by sales growth and continued realization of our cost savings initiatives. 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 million and $17.5 million for the third quarter.
Due to one-time costs related to the closure of our Dublin facility. We expect to incur restructuring costs in the third quarter between $2.0 million and $2.5 million, primarily related to employee separation costs and the transfer of equipment immaterial to other facilities. We are projecting GAAP operating income as a percentage of sales in the range of 2.5% to 3.5% for the third quarter, excluding one-time charges related to the closure of our Dublin facility, we expect adjusted non-GAAP operating income of 4.5% to 5.5% in system with our previously disclosed guidance.
The most significant driver of variability in our forecasted guidance ranges are consumer demand changes increases to ocean container rates resulting from the disruption in the Red Sea and competitive pricing conditions, all of which will be largely influenced by external factors.
Regarding our cash flow outlook in the second half of fiscal 2024, we expect improved profit and further inventory reduction to be a meaningful source of cash near term priorities for cash remain reducing debt, resourcing, new innovation and funding modest capital expenditures, mainly related to cost savings initiatives and continued modernization of our IT system. For the third quarter, we expect capital expenditures to be between $1.0 million and $1.5 million. We expect debt levels at the end of the third quarter to be in the range of $12 million to $17 million. And by the end of fiscal 2024, we expect debt levels in the range of $0 million 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, Mike. 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 the call to your questions.
Operator?
Question and Answer Session
Operator
(Operator Instruction) Anthony Lebiedzinski, Sidoti & Co. LLC.
Anthony Lebiedzinski
Yes, good morning and thank you for taking the questions. So first, a nice job in a tough environment for sure. So you guys talked about a lot about the market share gains in your core business just broadly speaking, is it are you doing more business with your existing clients or are you signing up new accounts? I mean, no, it just wanted to get a better sense as to where those share gains are coming from?
Anthony, thanks for the question. This is Jerry. Yes, a lot of our growth is in our core strategic accounts and in our in our core business. Obviously, we're still out signing up new folks at all times, but most of it has come from us going deeper and getting more placements with our core accounts.
Anthony Lebiedzinski
That's very helpful. So the unit the unit volume increase certainly is even more impressive than your total sales gains. So I guess in terms of your guidance going forward, how should we think about the split between unit volumes versus pricing?
Yes, I think, Anthony, it's Derek on going forward on. So in the third quarter, as we let's break pricing out between the surcharge impact and then just kind of normal pricing on the third quarter, there's about $2 million of impact of the ocean freight surcharge elimination. And then that comparison goes away in the fourth quarter from what we are assuming in terms of pricing is status quo likely for the remainder of the calendar year. And the only caveat to that is yes. As you're likely aware on, ocean freight container rates have gone up substantially.
They've actually almost doubled since the beginning of December. So if they stay at that at that rate we will have to consider on CERTAINLY turning back on some type of surcharge mechanism. But all that aside, we would expect that on the majority of the go-forward growth is related to the unit volume and mix and not a not pricing.
Anthony Lebiedzinski
Understood. Yes. And Thanks, Derica. And I was going to ask about the ocean freight costs. So those have gone up certainly for from the bottom here on. Okay. But at this point, you have not passed along any higher surcharges because of the Red Sea conflict, so on. Okay, understood. All right.
And then I guess just an yes, just wanted to dig in a little bit deeper in terms of the gross margin improvement. Obviously very strong year over year. Maybe if you could just kind of parse out maybe go over the kind of the puts and takes as to what drove that. And I know you talked about some cost savings initiatives obviously you have a fixed cost leverage. Is there as well. So maybe if you could just go over some of the details behind the gross margin improvement and your confidence level about being able to sustain that?
Anthony, this is Mike. Yes, I think as Derek, highlighted on that, we have kind of four key drivers of the gross margin improvement on one cost savings. So we've taken some actions to reduce structural costs in the prior year. We did we took a distribution center offline, which lowered our structural cost to in addition on the cost savings side, we have some pretty strong operations team that are executing sales initiatives on both in our sourcing manufacturing and then also in our logistics and distribution network. We feel like those processes are sustainable here going forward.
The second thing Derek mentioned was the introduction of new products and using product lifecycle management to improve profit kind of on a go forward basis. So we're leveraging our cost savings initiatives as well as kind of our value engineering activities to continue to bring out new products. You know that have a better margin profile than the legacy products we have that are we are discontinuing and then kind of the third piece would be the volume leverage as we were real thoughtful about reinvesting back into our structural costs. So that way, we get the leverage on our sales growth initiatives.
And then lastly, we've just been able to be more on strategic around our promotional activities on as it relates to moving forward moving inventory and things like that.
The one thing I'll add, Anthony, is I think we know the magnitude of impact from those four levers will change over time. And I think in the near term, as Mike alluded to, you know, operationally, we're executing really well on lots of cost savings from that. And I think the pricing discipline has been a bit of really big profit level in the near term.
As we look at on the quarters ahead and the years ahead, what are going to be the main drivers of gross margin improvement going forward are going to be the product lifecycle management on. So as we've explained again, we've raised the hurdle rates on new product as that becomes a larger and larger amount of our portfolio that's going to raise the overall margin profile. And then I think the of the operating leverage from growth, so so again, I think the mix of drivers will kind of evolve here over the coming quarters and coming years. But we still feel feel confident in terms of our ability to continue to expand margins.
Anthony Lebiedzinski
Understand. and thanks for that. Thank you for that. And then I guess year or so, as far as the the Dublin, Georgia facility closure here on you mentioned that it's going to result in annualized cost savings of the bottom end of that is $4 million. But I noticed that you didn't change your guidance for fiscal '25. Is this just a function of you guys trying to be conservative? Or I'm just wondering if you're going to be reinvesting those savings elsewhere? Or how should we think about that?
Anthony, this is Mike. So when we built our fiscal 2025 on guidance ranges, we modeled out several different structural cost change scenarios, and we still feel good about what we've put out there for fiscal 2025, guidance range on both top line as well as from an operating income perspective.
We had we had we had several scenarios, even though yet we had not made a decision in terms of closing Dublin, at the time we provided 25 guidance, there was multiple options to drive manufacturing efficiency which, as Mike said, we built into that fiscal year 25 guidance.
I think we'll be in a better position here at the end of this fiscal year. Early next to determine if there's potentially additional savings beyond on what we've estimated that would meaningfully change our fiscal year 25 guidance.
Anthony Lebiedzinski
Understood. Well, thank you very much and best of luck and I'll pass it onto others.
Thanks, Anthony.
Thanks, Anthony.
Operator
Budd Bugatch, Water Tower Research.
Budd Bugatch
Good morning, Jerry. Good morning, Derek, and congratulations to you, Mike. On and to you, Derek as well. A couple of questions on the order book, if I could. Can you talk a little bit about that? The quality of orders in terms of the product vitality, how much of that new business? I know you said most of it's coming from the existing strategic accounts, but kind of curious as to what you're seeing in terms of new placements and increased penetration in those accounts and with the new product versus old product.
And so at the highest level of bug, a lot of them are getting new placements on the floor. We do have obviously, our Flex and Zig finer products are doing very well. And those obviously are also driving a big piece of that.
The other color that I'll add, but is that on we actually measure internally what our sales, the percentage of our overall sales from new products and we measure new products over the last kind of three years and it that's close to 25%. So we feel good that we are driving relevant new product that's resonating with the market, and we would expect going forward, that new product would make up at least 25% of our overall sales, if not more going forward.
Budd Bugatch
And that's pretty much a classic definition of product vitality there, um, so when you look at that on a wired or core continuing moving average, how has that changed over the last 12 to 18 months?
It's definitely increased we've been we've been more aggressive around launching new products in on that trajectory will continue.
And okay. So so if you looked at it basically on just auto one instead of a one year basis instead of a three would be higher than 25% would be the that's that weighted moving average that would have the way to read that answer well, it's difficult to compare one, I mean, one year versus three year because you've got a lot more product in the three-year ARM.
But if you look at that three year percentage what it is today.
If you were to rewind and go back 12 months ago, it was lower than the 25%. So again, and we do expect going forward that number to increase throughout throughout time.
Budd Bugatch
That help us, I think show obviously always hard to put numbers to things. I know you the color is qualitative and the numbers are quantitative, and that's a definitely a weakness of the analytical community wanting to be more quantitative and wanting numbers.
Um, I'm also curious as to the change in the composition of costs and how to look at maybe something on contribution margin going forward with taking Dublin out and go the facilities left, what's the variable cost structure look like the MLO. and D. and T. kind of compact components of cost on a normalized basis. And what is the fixed cost component look like?
It doesn't change, meaning that mean that meaningfully from what we what we've shared previously with you. But if you look at the composition of the $4 million to $4.5 million savings on from day one on a little less than $2 million of that is from structural cost reduction on the rest of it is, you know, efficiencies around variable costs.
Budd Bugatch
So looking at the you had, I think and correct me if I'm wrong, my memory is I'm old and my memory is faulty, but I do believe you told us a couple of years ago that I think that the target gross margin was in the low 20s. We seem to be there. What's that? What's that that looked like going forward?
Yes, from a gross margin perspective on, certainly we're striving or aspiring to 23% or more kind of in the mid long term on. And then we rank the order income.
Budd Bugatch
Does mid-long term have a have a ratified two years three to five --
three to five years.
Budd Bugatch
And you have to get I and if I and I do I read the guidance right that for 25 years, you're saying that you're going to have? No, no debt. Is that the way to read that? I'm trying to make sure I understood the table.
Yes, that is correct.
Budd Bugatch
If you do want that down to zero and one step zero, what's the what's the use of cash look like? What is your what's your thought process?
Yes, in terms of capital allocation, but on also I laid out earlier in the call, you know these these pursuits to expand our penetration in new markets, and we would look for value-enhancing acquisitions that would accelerate our penetration into one of the one of those three areas either help us address the needs of younger consumers, expand our product category penetration beyond the living room or expand our sales distribution beyond the independent retailer.
So the areas that we've kind of talked about in terms of acquisition priorities with the potential of outdoor company on a direct to consumer company or a company with a modern, mid-priced lifestyle kind of brand. So we would expect to start to potentially accumulate some cash on the balance sheet on and more proactively look for value-enhancing acquisitions
Budd Bugatch
And that takes you out of manufacturing or into retail or into or out of furniture.
No. That we're squarely focused on residential furniture on certainly in the midterm we do not desire to on to be in retail ourselves on. So this is again, it's this is leveraging our core competence and bringing in new capabilities on with them, furniture wholesaling for lack of a better term.
Budd Bugatch
Okay. All right. Thank. Thank you very much for. Congratulations on the quarter and best of luck for the balance of the fiscal year and beyond then.
Thanks.
Operator
(Operator Instruction) This concludes our question and answer session. I would like to turn the conference back over to Jerry Dittmer for any closing remarks for you.
In closing, I'd like to thank all our Flexsteel employees for their dedication and outstanding performance during the quarter. And thanks to all of you for participating in today's call. Please contact us with any additional questions, and we look forward to updating you on our next call. Everybody. Have a great day. Thanks.
Operator
The conference has now concluded, and thank you for attending today's presentation. You may now disconnect.
