Good morning and welcome to the Flexsteel Industries Fourth Quarter and Fiscal Year 2019 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. 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. 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 Donni Case, Investor Relations for Flexsteel Industries. Ms. Case, please go ahead. .
Thank you Anita, and welcome to today’s call to discuss Flexsteel Industries fourth quarter and fiscal 2019 financial results. Our earnings release, which we issued after market close yesterday, Monday, August 26, is available on our Investor Relations section of our website, www.flexsteel.com under News and Events.
On the call today is Jerry Ditmer, Chief Executive Officer, who is at an offsite location today, and Marcus Hamilton, Chief Financial Officer, who is here in Dubuque. Following management’s prepared remarks, we will 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 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 prediction of future events. Additionally, management 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 reconciliation of the GAAP to non-GAAP measures. With that, I’d like to turn the call over to Jerry Ditmer.
Jerry?.
best in class products, the talent and dedication of our people, and the financial flexibility to execute our strategy. I will start today with a progress update on our restructuring plan. In a few minutes, Marcus will unpack the financial results for us.
Our approach has been to look at Flexsteel with an open mind and with a viewpoint of future growth opportunities. We analyzed the business and opportunities top to bottom, created a robust restructuring and profit improvement plan, and immediately started the job of executing some tough but necessary decisions.
I’m very pleased to report that we have made tremendous progress restructuring our company since we announced our plan on April 1.
Hand in hand with our mission to unlock the potential of Flexsteel, it was also critical to mobilize the entire organization by installing new leadership in key positions and bringing on top tier talent in high risk areas to drive a culture of winning through change. We now have the energized team necessary to turn our plan and vision into reality.
Now I’ll summarize where we stand in the process. Since May 15, we completed the close of our Riverside, California manufacturing facility, which is now under a non-binding letter of intent with the sale expected to close before the end of September.
We exited the custom design hospitality product line, which will wrap up in 2020 as we fulfill remaining orders. The commercial office product line exit was completed at the end of July.
With the exit of the commercial office product line, we consolidated warehousing operations at our Huntingburg, Indiana facilities, going from three to two warehouses, and are holding for sale the vacated property. On June 18, we provided additional visibility on the entire scope and cost of our restructuring plan to investors.
At that time, we announced the closure of our Harrison, Arkansas operations, which consisted of two underutilized manufacturing plants. With all its product lines transitioned to other facilities, the closure of Harrison was finalized on August 16 and both properties were listed for sale.
In conjunction with these actions, we also implemented a broader reduction in forces across the company. To drive the overall restructuring plan, we developed six key work streams, and here’s an update on how we’re moving forward.
Regarding network and logistics optimization, as previously mentioned, we closed the Riverside and Harrison locations and other opportunities for consolidation are being analyzed and considered based on plant performance and capabilities.
Following the initial focus on optimizing our manufacturing footprint, we are also assessing distribution and logistics and will provide more details when appropriate. SG&A optimization is another key work stream. To date, we have reduced ongoing SG&A costs based on reductions in the workforce.
We plan to reinvest a portion of the savings into key functions such as product development, global sourcing, and sales and operations planning. Our objective is to improve cost and working capital management and to generate sustainable and profitable growth.
With global sourcing and procurement, we are developing and deploying sourcing strategies for each key spending category, and we have identified opportunities for cost savings through resourcing, value-added specification changes, and supplier negotiations.
Sourcing is highly reliant on robust processes, strong product development, engineering capability and cadence. We have a lot of work to do in these areas to achieve our full potential. It is a top priority and we’re seeing early signs of improving outcomes.
Total restructuring charges recorded in the fourth quarter were $10 million, of which case used for restructuring within the quarter was $3.8 million. In addition, we impaired inventory of $7.7 million related to our exit from the commercial office and custom design hospitality product lines.
Moving on to our ERP system status and future plans, over the past year our team has successfully stabilized the ERP system.
In our view, the ERP system functioned as designed; however, it was the scope of the project, the lack of upfront planning, the design itself, software development, and the implementation that was flawed, not practical and, in many cases, totally unusable in the context of our future ERP needs.
That means that many of the components designed and developed will either not be used or will not be required in the future. Having completed our analysis and right-sized evaluation of the ERP asset on our books, as painful and necessary as it was, we now have a go-forward plan to share with you.
Our team has gained a strong knowledge and capability working within the new system environment and it would be regressive to switch midstream to an entirely new platform; therefore, we plan to reboot the ERP system project on the same platform with a very different approach, including significantly reducing the scope, customization and complexity.
Guided by our six work streams, we have a clear path for transformation, business simplification, and reduced complexity. In February, I created the position of CIO and was fortunate to bring Mike McClaflin on board.
I worked with Mike for many years and have seen firsthand his capability at scoping, transforming, designing and implementing new ERP systems successfully. He has deep into-the-situation analysis and go forward thinking with the team since starting at the end of February.
Our plan is to fully execute the project with limited additional capital of $1.5 million to $2 million per year and keep our total operational IT expenses under 2.5% of sales through the implementation of the new scope I’m proud of what the team has accomplished so far and truly appreciate their tremendous support, positive attitude and relentless pursuit of solutions, and feel confident that their can-do spirit will continue.
The successful execution of our restructuring and ERP plans are critically important to the long term future of the company; however, I recognize we cannot restructure our way to long term prosperity.
To achieve our full potential, it is critically important to us to stabilize the top line despite external headwinds and reestablish growth at or above marketing industry levels.
Over the next year, we will continue implementing new processes and procedures to focus on our product development activities more intensely on consumer needs, desires and needs to open up new channels of distribution, and to expand our existing distribution through new partnerships.
We are already seeing some positive results in these initiatives and here are just a few examples. As you may recall in our Home Styles product line, the initial implementation of the ERP system resulted in disastrous consequences with our ecommerce customers.
We are starting to see positive indications from the work we’ve done stabilizing the business, injecting new leadership and reestablishing relationships with key customers. We saw some strong sequential growth from Home Styles in the fourth quarter and expect to see more improvement as we gain momentum.
We are extremely committed to not only recovering lost ground but also expanding the business opportunity, and it’s very important in growing sales channels. To that end, we have very exciting product launches coming this year and we believe it’s going to gain quite a bit of traction in the channel.
For competitive reasons, we can’t say anything more at this time but are very excited about the opportunity this new product offers us and our channel partners.
In our traditional retail channel, we continue leveraging our great products and North American manufacturing capability to drive more performance like we saw this quarter in our manufactured recliners, motion and case goods, which demonstrated moderate to strong growth year over year.
We are also working on expanding distribution within retail by engaging in some key partnerships that will increase opportunities for consumers to buy Flexsteel products in the coming months.
During the calls with investors, some of you have asked, what should we expect when we are finished? During those discussions, I said we would set a bar in the next conference call where we can hold us accountable. Looking at the historical profitability of Flexsteel, the high end of the range has been 7%-plus EBIT margin.
Our first bar is to get to this level of profitability by the end of 2021 on a run rate basis. Rest assured, we won’t stop there and believe once we have a solid foundation built with all the fundamentals in place, this business has upside potential never before attainable.
The business decisions and investments we are making right now will give us the capability to reach growth and profitability heights not yet seen before in Flexsteel’s long and storied history. Now, I will turn the call over to Marcus to discuss our financials and operations..
Thank you Jerry. As Jerry just discussed, since our third quarter conference call in late April, we took significant strides [indiscernible] our control and return the company to profitability.
That said, our financial results for the fourth quarter and year end sharply reflect both the measures we are taking to turn our business around and the outside pressures our industry is experiencing. What we feared most became a reality on May 10, the 10% tariff increase to a 25% tariff on all our products imported from China.
As you know, Flexsteel has significant exposure with approximately 42% of fiscal year-to-date sales sourced from China. Suffice it to say the tariff has had an adverse effect on fourth quarter earnings.
Net sales decreased 11% to $100 million with our residential business, accounting for the biggest shortfall based on the softer demand that was triggered by the tariff and related price increases.
Also contributing to lower sales but to a much lesser degree was our exit from two contract business lines, custom design hospitality and commercial office. We reported a fiscal fourth quarter net loss of $19.9 million or $2.52 per share that compares to net income of $2.2 million or $0.28 per diluted share in the prior year quarter.
The reported net loss includes $10 million of pre-tax restructuring expenses, a $7.7 million impairment of inventory related to the exit of commercial office and custom design hospitality product lines, a $2.6 million pre-tax ERP business information system impairment charge, and a $2.6 million pre-tax valuation allowance for foreign value added tax.
Excluding these expenses, which totaled $22.9 million, non-GAAP adjusted net loss was $2.2 million or $0.28 per share compared with non-GAAP adjusted net income of $2.2 million or $0.28 per diluted share in the year ago quarter. Net sales for the quarter were $100.2 million, down 11.4% compared to a year ago.
Home furnishing sales, which represented approximately 74% of our total business in fiscal ’19, were down 12% during the fourth quarter due primarily to the adverse impact of the tariff on Chinese manufactured furniture.
The largest category within home furnishings, which accounts for the bulk of China-sourced product, is down 26% in units in the fourth quarter and down 12% in units fiscal year to date 2019 versus ’18. This decline in units sourced from China largely reflects the immediate impact the tariff is having on our business.
We have worked very hard with our suppliers to provide concessions that would mitigate as much as possible the pass-through pricing to retail. Unfortunately, despite these efforts, pass-through price increases were necessary, especially since the implementation of the 25% tariff.
We believe the tariff impact stretched our retail partners’ pricing to the consumer to uncomfortable levels, which in turn squelched demand for our import products.
Currently, we are working with our supply base to aggressively move the supply chain to other countries in an effort to eliminate the tariff impact and return our pricing to historical levels, with a goal of restoring more normalized demand in home furnishings.
Outside of the tariff impacts and some positive comps in our manufactured recliner and motion products, we saw overall softness in the traditional retail market which also contributed to our underlying top line performance. On the contract front, total sales were off $2.2 million or 13%.
As planned, we exited two products lines which were non-core and subscale, and they accounted for approximately $1.6 million of the sales decline. While we exited the custom design hospitality product line, we still expect to ship at modest levels through the end of the calendar year.
The commercial office inventory was liquidated during the quarter and wrapped up at the end of July. For fiscal 2019, net sales declined 9.3% to $443.6 million versus sales of $489.2 million in fiscal 2018.
The lower sales in fiscal 2019 were a function of the significant ongoing impact of the failed ERP implementation on our ecommerce products, which declined 25% versus the prior year.
The negative impact of the tariff created an approximate 10% sales gap in our large and leading product category and, as I just discussed, the exit of the two contract products lines and the generally softer demand across traditional retail versus the prior year.
Turning now to profitability results for the quarter, gross margin as a percent of net sales in the fourth quarter was 5.3% versus reported 15.1% in the prior year quarter. There was quite a bit of noise that had an impact on both this year and last year’s quarterly results.
The fourth quarter of fiscal 2019 included a charge for inventory impairment which was approximately 760 basis points, related to the discontinuance of commercial office and custom design hospitality and the valuation allowance for foreign VAT, which accounted for about 260 basis points.
The fourth quarter of fiscal 2018 included the year-to-date portion of the correction for the volume re-base previously misclassified as selling, general and administrative expenses, which accounted for 250 basis points.
The key drivers of the remaining approximate 200 basis point deterioration in gross margin were higher costs due to inefficiencies in distribution and manufacturing labor, which was about 100 basis points, a favorable adjustment to insurance reserves in the prior year due to claims history trends representing about 80 basis points, and a higher cost structure of the new Dubuque manufacturing facility which represented about 60 basis points, offset by some favorable price and mix representing 30 basis points.
Selling, general and administrative expenses were 18.8% of net sales compared with 12.7% of net sales in the prior year quarter. Approximately 250 basis points were due to the year-to-date reclassification of volume re-base as a reduction of price that occurred in the fiscal fourth quarter of 2018.
The remaining year-over-year increase in SG&A reflected lower volume - 190 basis points, incentive stock compensation - 30 basis points, and a difficult comparison due to a recording of a reduction in cash and long term incentives in the fourth quarter of fiscal 2018 driven by business underperformance, representing about 160 basis points.
Regarding taxes, during the quarter we reported a tax benefit of $6.5 million or an effective tax rate of 24.7% during the fourth quarter, compared to tax expense of $700,000 in the prior year quarter or an effective tax rate of 23.5%.
The tax benefit was primarily a result of the large impairment and restructuring charges and the associated net operating losses.
Now turning to the balance sheet, during the fiscal year 2019 we generated $6.7 million in cash from operations and ended fiscal 2019 with $22.2 million in cash, cash equivalents and investments, down from $43.7 million at year end fiscal 2018.
Working capital, current assets minus current liabilities, at June 30, 2019 was $118.2 million compared to $149 million last year. Changes in working capital include decreases of $16 million in investments and $5.6 million in cash and cash equivalents, and a $5.7 million increase in accrued liabilities.
Capital expenditures for the 12 months ended June 30, 2019 were $21.3 million, including $16.4 million for the Dubuque, Iowa manufacturing facility. As we’ve mentioned previously, we expect $5 million to $6 million of ongoing capex. The company currently maintains $20 million in a revolver which $18.7 million remained available at June 30, 2019.
We are considering several financing options to provide additional liquidity through the restructuring and transformation process. As we disclosed in our press release last night, we are expecting to close on the sale of the Riverside manufacturing facility by the end of September, which will create additional liquidity.
Each quarter, our board reviews capital allocation. At this time, the board has no plans to change the level of dividend. As Jerry said at the top of the call, we’ve made tremendous progress mobilizing the organization and restructuring our company to drive transformation and business simplification.
The cost and infrastructure of this business needed serious attention. We are fully engaged in this activity across the board, but to reach the bar that Jerry laid out in his remarks, it’s imperative we get our growth story back on track.
To that end, our commercial teams are laser focused on expanding distribution, bringing a disciplined and more robust approach to product development, and driving delivery speed, all of which are important to our partners and consumers. With that, I’ll open the call for questions..
[Operator instructions] The first question today comes from JP Geygan with Global Value. Please go ahead..
Good morning, and thank you for that comprehensive update. I just have a few follow-up questions. As you think about your turnaround through fiscal year 2021, you said in your press release that you’ve targeted a 7% EBIT margin.
You talked a little bit about how you make progress towards that number, but I’m hoping you might elaborate on how you achieve this, and maybe more specifically where we should expect revenue relative to recent sales data..
This is Jerry. At this point, we have really kind of told you everything in our prepared comment, the press release, the 8-K, etc. Where it’s going to come from, you’ve heard in my prepared comments a little bit about some different channels, some different distribution. That’s where it’s really going to come from.
Do we know exactly where it’s going to come from? Absolutely not, so at this point in time there’s not a lot of other details we could really share at this point. .
Okay. As a follow-on to that question, you did talk about new product launches.
I wouldn’t typically expect you to issue an 8-K upon the new product launch, but how might you communicate that to the marketplace?.
Well, we’d do it like we would any - we go to four major shows a year, two in Las Vegas and two in High Point. We’d also do it via our Home Styles business, working with our major customers there. New products is part of the life blood of residential furniture, and we really at least four times a year are introducing new products. .
Okay, great.
Moving on, can you help us reconcile the numbers you provided in your 8-Ks in mid-May and mid-June about your projected restructuring costs with the numbers you’ve provided in yesterday’s press release, and where you are to date?.
Marcus, do you have any light you can shed on that?.
Yes, so far we’ve--I think on the call, JP, it’d be tough for me to go through the detail of that, but essentially we’ve incurred about $10 million of restructuring charges so far to date, plus the $7.7 million for the inventory impairment, so that totals about $17.7 million versus what we had provided earlier on the May 15 call.
At the next report out, we will provide a more detailed understanding of where we’re at progress-wise..
Okay. My back of the envelope math puts you somewhere between roughly $17 million and $23 million remaining in your restructuring program.
Without committing you to a specific number, am I somewhere in the ballpark?.
Yes, you’re somewhere in the ballpark..
Okay.
Has your allocation between cash and non-cash charges changed significantly?.
No..
Okay. My final question is in your June 8-K, you announced that you expected proceeds from the sale of real estate of $45 million to $55 million.
Is that still a valid assumption, and if so, should we expect that from the sale of the four properties you’ve already announced or should we expect additional sales?.
We have no reason to change our estimate that we put out there originally, and it will not all come from one sale, no. .
Okay, great. Thank you for the update..
Again, if you have a question, please press star then one. Since there appears to be no further questions, this concludes our question and answer session. I would like to turn the conference back over to Jerry Ditmer for any closing remarks..
Thank you for participating in today’s call. Before signing off, I wanted to recognize the tremendous contribution and dedication that our employees have shown as we continue this journey together to reenergize our company.
We know there is still hard work ahead but we are fully committed to realizing Flexsteel’s full potential and are very excited about our future. We are grateful for the support of our shareholders, and as pledged, we will keep you informed on our progress as it unfolds. Everyone have a great day. Thanks..
This conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..