Flexsteel Industries, Inc. (FLXS) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Thank you for joining us at the Sidoti May 2021 MicroCap Conference. My name is Anthony Lebiedzinski. I'm the analyst that covers home furniture and other consumer retail names here under -- for Sidoti. We are very pleased to have with us the management team from Flexsteel Industries. Joining us is Jerry Dittmer, President, CEO as well as Derek Schmidt, CFO and COO. So we will have a total of 30 minutes for the presentation, which includes Q&A. [Operator Instructions] So with no further delay Jerry and Derek, please get started. Thank you.

All right. Thanks, Anthony. Good morning, everyone. I'm Derek Schmidt, I'm CFO and CEO of Flexsteel, and I'm joined here today with Jerry Dittmer, President and CEO. Before we begin, I just would like to remind everyone that comments on today's presentation will include forward-looking statements as described on this page. This presentation in its entirety will be available both on the Sidoti conference portal as well as our own website, www.flexsteel.com. At this point, I'll turn it over to Jerry to begin our presentation. Please go ahead, Jerry.

Thanks, Derek. We'll cover 4 topics today: company overview, our investment thesis, our growth initiatives and key financial highlights. There is also additional financial information, including GAAP to non-GAAP reconciliations contained in an Appendix for your independent review. We'll start with the overview. Flexsteel was founded in the late 1800s and is one of the top 10 furniture manufacturers in the U.S., employing over 1,600 team members. We currently go to market through 2 brands: Flexsteel, a premium price solution known for quality, durability and our proprietary Blue Steel Spring; and Home Styles, a value-oriented solution which is sold primarily through e-commerce channels. Both brands provide whole home product solutions. Our desire is to be a true omnichannel company. Roughly 85% of our sales are derived through retail distribution today with the remaining 15% coming from e-commerce. However, we expect e-commerce to make up a much larger portion of our business in the years ahead. So we are on track to deliver impressive results in our fiscal year 2021, which ends June 30th this year. We are projecting record home furnishing sales and a record non-GAAP EPS. One of our greatest strengths is the power of our sales distribution. We intend to sell furniture where ever people desire who buy it. We have a strong footprint in national retail as our products are sold to more than 1,300 unique customers and are represented in over 2,200 storefronts across the U.S. We are also expanding big box retail through our relationship with Sam's Club. For consumers who prefer to transact online, we have strong partnerships with the leading e-tailers for furniture with Wayfair, Amazon, Home Depot, being some of our largest. Additionally, we are starting to build direct-to-consumer capabilities to our Home Styles brand. We are earlier in our graphic consumer journey, but intend to incubate this go-to-market model as a future growth platform. Flexsteel is in the midst of a major organizational transformation, which began in fiscal year '19 when I joined the company as Flexsteel CEO. Over the past 2 years, we have taken aggressive steps to refocus our energies on our Home Furnishings business, where we have -- we believe we have significant right to win and can earn an attractive ROI. We exited the RV, hospitality and health care product lines, where we lack a clear competitive advantage. We also took bold steps to rationalize almost 50% of our product line, which greatly simplified our operations and key business processes. And we took large structural cost out of our business to become more financially agile. In fiscal year '21, we started the second phase of our transformation, where we have been focused on building a strong foundation for long-term profitable growth. It starts of building a winning leadership team, which we feel we now have. It also includes modernizing our major systems and business processes, expanding our supply chain, strengthening our digital and e-commerce capabilities and reimagining the customer experience as a source of competitive advantage for Flexsteel. Our focus moving forward into the third phase of our transformation will be to unleash the full potential of the company, which will be accomplished by continuing to penetrate and gain share in our core markets, but as importantly, to expand our addressable markets through a myriad of growth initiatives, we will expand on those shortly. The early results of our transformation are encouraging. We are projecting record home furnishing sales in fiscal year '21 of $463 million to $478 million, which represents more than 10% growth versus our previous historical highs. The profit results are also strong with our non-GAAP EPS forecasted to achieve a record performance in fiscal year '21 of $3 to $3.20 a share. As we look forward, we are motivated as an organization to a higher purpose and compelling vision. We exist to improve the lives of people who buy our products. We care about all the people who we impact. And as we aspire to double our business to over $1 billion in the next 5 years while achieving that result in a sustainable manner and accelerating our ESG initiatives. When we think about how we improve lives, we focus on the 3 seats, superior comfort, exceptional customer experience and relevant choice. It's the bar we set for ourselves, and it's a reason why customers choose Flexsteel. I'll now turn it back over to Derek.

Thanks, Jerry. Next I will discuss our investment thesis. First, a compelling industry outlook; second, the opportunity for significant share growth in addressable market expansion; third, an experienced management team; fourth, our financial strength and discipline; and fifth, an attractive valuation relative to our industry. I'll quickly touch on each of these points. We believe the outlook for our industry is compelling as macroeconomic factors suggest favorable conditions to support continued industry expansion. GDP is improving. Housing starts are skyrocketing, unemployment is falling, disposable incomes are rising and consumer confidence is strengthening. From a longer-term view, we also expect with significant change in demographics in purchasing power shift to Millennials and Gen Zs to drive substantial churn in demand for furniture well into the future. Secondly, the opportunity to gain share in our industry is very compelling. We operate in a highly fragmented industry with no dominant player. We've been growing faster than the industry so far in our fiscal year 2021, and we believe our product and customer experience strategies, combined with our strong sales execution, position us well to continue those share gains. In addition to gaining share, within our current addressable market, we are also focused on significantly expanding our addressable market over the coming years through a myriad of different growth initiatives including addressing new consumer segments, like Millennials and Gen Zs, addressing lower price points, establishing new brands, pursuing new product categories like outdoor, work-from-home and gaming, providing solutions with more modern and contemporary styles and further expanding our sales distribution. We estimate that our current addressable market is approximately $27 billion, with a market share of 1.7%, but the addressable market through these growth strategies could grow up to $59 billion. As Jerry noted earlier, we have a strong management team, which is the third component of our investment thesis. 8 out of our 10 executive officers have joined the company in the past 2.5 years, each bringing deep experience and diverse perspectives. In total, our management team is leveraging 185 years of furniture experience to accelerate the company's transformation. The fourth pillar of our investment thesis is our financial condition, which we believe is a clear strength. First, we carry no debt, have a healthy cash balance, we can pursue sizable opportunistic investments or acquisitions through increased debt if and when warranted. Second, our capital philosophy is disciplined. Our top priority for capital right now is reinvesting for growth through both P&L investments on the new capabilities as well as through higher inventory levels to support increased sales. The next priority for capital is acquisitions. While we are acquisitive, we are also disciplined in our pursuits to ensure acquisitions both fit strategically, but also create shareholder value. Next on the list is dividends, which we are committed to. Flexsteel has paid cash dividends each year since 1938, and our dividend that we paid here this past March, was the 317th consecutive quarterly cash dividend. Lastly, we'll remain opportunistic with share repurchases when we have excess cash, and when the stock is trading in at a material discount versus our view of intrinsic value. We also believe an intent to run the business with relatively low fixed capital requirements. Future capital requirements or expenditures are forecasted to support IT and system modernization, as Jerry noted earlier, as well as new equipment for expanded manufacturing and distribution centers. But we really don't anticipate any significant cash outlays for the foreseeable future and, as such, anticipate strong cash generation to fully fund our growth ambitions. We're also focused and committed to shareholder value creation, and we will only invest capital when we have a clear line of sight to generating returns in excess of our cost of capital. As demonstrated in the past 2 years, we sold numerous underperforming assets as part of our restructuring efforts and have returned that capital efficiently to shareholders, largely through share repurchases made at a significant discount to our current share price. The last component of our investment thesis is our valuation. Based upon current year guidance, we're trading at an attractive PE multiple of 13.5 to 14.5. Additionally, we continue to trade at price multiples at the low end of our publicly traded industry peer group despite our strong sales performance and earning growth momentum in fiscal year 2021. I'll now turn it back over to Jerry to give you more details on our growth initiatives.

Thanks, Derek. To achieve our long-term growth potential, we realize that we need to be disciplined with our strategies. We have 5 overarching principles that guide our strategic thinking. First, we will focus only on large and growing market segments where we have a clear right to win and won't be distracted by smaller niche market opportunities. Second, our go-to-market approach is based on building powerful brands that are tuned and tailored to meet a specific consumer needs in each market segment that we prioritize. Third, we intend to build and sustain a competitive advantage across our brand portfolio based upon deep customer insights combined with a passionate commitment to create an exceptional customer experience for both our consumers and sales distribution partners. Fourth, we will protect and grow share in our core markets while aggressively pursuing new growth in expanded markets, which I'll expand upon momentarily. And fifth, we will build strong and scalable strategic capabilities that are foundational to deliver our long-term growth objectives. Currently, we're investing money in market research to meaningfully segment the furniture consumer by buying preferences and purchasing journeys. What we understand is that our large, growing consumer segments that our current brands don't serve and likely can't be repositioned to serve. As such, our strategic thinking has evolved around developing new brands to meet the needs of those consumer segments focused on modern, on trend design, which are value-oriented and intended for smaller living spaces or our premium price with customization options and expanded durability. To address the needs of these new targeted consumer segments, we envision expanding our portfolio of brands based on our market research. We expect to launch at least 1 new brand within the next 18 months that is focused on modern, on trend styles that fit within smaller living spaces, which will be sold both through specialty retailers and direct-to-consumer. Additional brands may follow and supported by our market research and strong conviction that we have a right to win in these areas. Our growth plans also involve expanding the product categories where we compete. We have a very strong position in living room furniture and a solid presence in bedroom and kitchen dining. As the space needs in the modern home evolve, we will pivot to develop a leadership position in growing categories like outdoor, gaming and technology, home accessories and work-from-home solutions. The expansion of our sales distribution, both in retail and e-commerce, is also a critical component to our long-term growth strategy. From a retail view, the majority of our product today is sold through traditional retail furniture stores. However, there are opportunities to expand our distribution to include home improvement stores, electronic stores and mattress stores as well as big box retailers such as Sam's Club, where we will complete a successful in-store trial of one of their top-selling kitchen storage solutions. On the e-commerce side, the majority of our sales today go through the big pure-play e-tailers like Wayfair, Amazon and Home Depot. We believe that we have significant growth runway with these large e-tailers through aggressive product development and increased investment in content and ad dollars, where we also have additional opportunities to further expand our online presence through specialty e-tailers, furniture e-tailers who have brick-and-click capabilities, of which we've activated over 100 this fiscal year and also direct-to-consumer sales. We do believe we are advantaged in the market and can sustain that advantage, which stems from 5 components, which I'll now go through. First, our large and growing assortment of relevant product. We are committed to product development and innovation to keep our value propositions compelling. Second, as previously shared, we have a very strong sales distribution footprint, including an omni-channel presence. Third, with our previous structural cost reductions and simplification efforts, we now have an efficient operating model, combined with a diverse supply chain, which includes multi-country global sourcing and North American manufacturing capacity. Fourth, we are investing aggressively and rapidly growing our digital capabilities to become more disruptive. And fifth, a business is financially strong and capable of generating solid cash flow going forward. Key to supporting our growth is expanding our global supply chain, and we want to make sure any unanticipated supply chain shocks in the future are taken care of. Unlike many of our competitors, we have a blended supply chain model, which includes a robust network of global suppliers, combined with a strong North American footprint of manufacturing and distribution facilities. This hybrid model allows us to get more agility to respond to market opportunities and supply chain disruptions when we arise -- when we do arise. We are currently expanding our global supply chain base and diversifying our country exposure in the process. We also recently invested in a third manufacturing facility in Juarez, Mexico, which will significantly expand our manufacturing capacity and will begin operations within the next few months and once Home improves. And we have also partnered with several leading transportation companies, who can quickly scale to support our growth and our needs for both global and domestic transportation services. We operate in a digitally driven world where consumers have access to more information and products than ever before and is only growing. We are aggressively investing in our digital capabilities to compete effectively in this new world. We are building digital capabilities to mine deep customer insights that will allow us to provide exceptional customer experiences. We are building a powerful digital platforms and content that will engage with customers on their terms with an effortless interaction. And we will leverage big data and analytics to continuously improve our customers' experiences and to rapidly adjust to changing market conditions. Lastly, we are committed to being a responsible company and contributing to the well-being of our environment in our society and with our governance. As part of our core values and the right thing to do, while we are very early in our ESG journey, we are dedicated to making the investments necessary to continuously improve across all these fronts. You can expect to hear more from us on our progress, as we formalize our ESG program and accelerate our investments in these areas. Next, Derek will wrap us up with a quick snapshot of key financial highlights.

Thanks, Jerry. Some quick highlights for our third quarter, which ended March 31, 2021. Home furnishing sales growth was very robust at 33%, and retail order growth gained momentum, growing 131% year-over-year. We entered the fourth quarter with a record high retail backlog of $140 million, and we delivered strong year-over-year profit improvement while continuing our investments. Our growth momentum is building as seen on the left-hand side, as year-over-year growth has sequentially improved each quarter throughout FY '21, largely driven by the growth in our retail channel, as shown in the middle chart. E-commerce sales continue to grow solidly as well. Our record e-commerce sales results in Q1 did deplete inventory levels, which resulted in lower growth in the second quarter, but we are beginning to replenish inventory and are seeing growth gains improve as a result. Sorry. Year-over-year order growth in retail is even more impressive and is outpacing sales with Q1 growth at 61%, Q2 growth at 49% and Q3 growth at 131%. Our third quarter orders have also increased sequentially versus the second quarter by 22%. The result is a record level backlog heading into our fourth quarter. We do anticipate working down the backlog towards the end of the calendar year and into 2022, as we ramp up global supplier capacity in our new manufacturing facility in Juarez. We have outlined ambitious growth goals for ourselves going forward. While these objectives are aspirational, we are developing a detailed road map to make these goals achievable. We strive to double the size of our company over the next 5 years, which implies a 15% plus annual compounded growth rate while simultaneously expanding gross margins of 23% and adjusted operating margins of 8%. If we can achieve these goals, we'd expect EPS to grow at a rate of 1.5x sales growth over the same period. There are many factors and risks involved in these assumptions, but the growth plans that Jerry outlined earlier are paramount to achieving these aspirations. Similar to our sales growth road map, we also have clearly defined the sources of gross margin expansion over the same 5-year period. Scaled leverage and improved margins for new products are 2 of the most important drivers. Jerry?

Thanks, Derek. In closing, we appreciate your time today. The future for Flexsteel is really exciting. Our transformation is on track. We're delivering strong sales and profit results, and we have an aggressive growth agenda backed by an experienced leadership team committed to winning. And with that, I'd love to open it up for questions.

All right. Thank you very much, Jerry and Derek, great presentation. [Operator Instructions] So I'll get started here on my end. So as far as the growth objectives longer term, the $1 billion in sales that you expect to achieve, I assume that's all organic growth. If you could just maybe touch on that, and I'll have a couple of other questions as well.

Yes. Thanks, Anthony. Yes. At this point, that is. Acquisitions, obviously, is one of the 5 pillars that we put out there. But right now, our belief is that, that $1 billion in the next 5-plus years would all be organic.

Got it. Okay. Perfect. Okay. And then as far as the long-term objective, as far as the operating margins are concerned, so it looks like that's going to be mostly through gross margin expansion. And I assume that the rest would be just leveraging your existing cost structure. As you look to grow the business, how should we think about as far as growth in sales as far as that?

Yes. You're absolutely correct, Anthony. The 2 probably biggest levers in terms of the gross margin expansion are leveraging fixed costs as our top line kind of grows. But also we expect that we will continue to reshape the margin look of our overall product portfolio as we introduce new products. So our expectation is the new products in the years ahead will have a much more attractive margin profile than the existing portfolio.

Got it. Okay. Perfect. Okay. And then we do have one question here from the audience. So as far as usage of free cash flow, how should we think about that? And then as far as what you're looking to do is obviously, you touched on really looking to grow organically here, but just if you -- while on that subject, maybe you can expand as far as what you would look for in potential acquisitions?

Yes. In terms of uses of cash, in the near term, probably our biggest priority is [ building ] inventory. As we've outlined, we have aggressive sales and ambitions. And that's going to require us to make sure that we've got the product on hand when consumers want it. And so we're aggressively purchasing new inventory at this point. And I would foresee that ramp-up in inventory, extending itself at least over the next kind of 12 months. We will expand our manufacturing and DC kind of footprint as we grow. I expect to do that in a capital-light manner or likely through leases to give us more financial flexibility. So I don't believe that will be a significant use of cash in the near term. As it relates to acquisitions, our primary considerations are does it fit with our strategies. So if you go back to what Jerry outlined, our intention to expand in different consumer segments, different price points, different styles, different brands. If there's an acquisition target that accelerates our progress against one of those strategic pillars, we'll certainly consider it. However, ultimately, we're about shareholder value creation. And so we're cognizant about what to look at, given the pretty significantly high multiples in the market today. But we're constantly looking and where's ever that intersection, it should fit in shareholder value creation, we'd absolutely pursue such an opportunity.

Got it. And then we have another question here from the audience. So how should we think about required working capital as you grow the business?

Yes, I think it's proportionate to our current working capital relative to sales.

Got it. Okay. And then looking at the overall industry, there have been numerous supply chain constraints, and there's been a lot of inflation as well. Can you talk about what you're seeing now as far as those supply chain issues, whether it's foam or plywood and just kind of tie that into inflation? And what is your pricing power?

Yes. So definitely really difficult. And why I say that is if every day we see something, we've gone from ocean container rates and one of our main DCs being $3,500 to going to $8,000 to $12,000. The last week or 2, they've been spot market between $16,000 and $18,000. So it's a 500% increase. So it's been quite difficult. We pass those on where we can. It's difficult for the retailers to take them because a lot of that -- some of that's going to be going into inventory, and we need to know when those rates are going to potentially go down or this is the new run rate. Other items, just about everything is at some type, whether it's plywood, whether it's steel, controls, just about every part, weather, fabrics, everything has had some type of an increase, our pricing power has been such that we've been able to pass those on, but it's painful for us and the retailers. And at some point, obviously, that does have to hit the consumer, and we're starting to see that over the last several months. So yes, we're behind a little bit because they're coming so fast, but it is something that we continue to put out there and work with our retailers on as best we can.

Got it. Okay. Well, thank you very much. It looks like that's all the time that we have for this presentation. So again, thank you, Jerry and Derek, for attending the Sidoti conference presentation here, and thank you for those of you joining us through the Zoom presentation here. So you may now disconnect, and everyone, please have a nice day. Thank you.

Thanks, Anthony. Thanks, everyone who joined us.

Thank you.

Take care. Thanks.