Flexsteel Industries, Inc. — Form 10-Q Summary
Period note: The request metadata says 2017 Q2, but the filing covers the quarter and six months ended December 31, 2018 (Flexsteel fiscal 2019 Q2). Comparisons below are against the periods ended December 31, 2017. Unless noted, amounts are in millions.
Business context and reporting period
Flexsteel manufactures, imports and markets residential and contract furniture in the United States and Canada. Its products serve home, hotel, healthcare, recreational vehicle, marine and office markets. The unaudited statements cover the three and six months ended December 31, 2018.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2018 | Prior-year quarter | Six months ended Dec. 31, 2018 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $118.4 | $129.4 | $231.8 | $249.2 |
| Gross margin | $21.5; 18.2% | $27.4; 21.2% | $43.3; 18.7% | $53.5; 21.5% |
| Operating income | $2.1 | $7.7 | $3.7 | $17.5 |
| Net income | $1.6 | $6.2 | $2.9 | $12.4 |
| Diluted EPS | $0.20 | $0.78 | $0.36 | $1.56 |
Quarterly sales declined 8.5%; residential sales fell 10.3% to $99.4 million while contract sales rose 2.2% to $19.0 million. For the six-month period, residential sales declined 8.1% to $195.4 million and contract sales edged down 0.5% to $36.4 million.
For the six months, operating cash flow was $10.9 million, versus $1.3 million in the prior year. Investing cash outflow was $9.5 million, including $17.5 million of capital expenditures; financing cash outflow was $3.6 million, primarily dividends. Cash and equivalents were $25.6 million at December 31, 2018, and investments were $8.0 million. Working capital was $136.9 million, down from $148.7 million at June 30, 2018.
The company had no debt outstanding. Its $10 million working-capital facility had $8.7 million available after $1.3 million of letters of credit and expires June 30, 2019. A separate $10 million line was undrawn and matures December 31, 2019. Management said available cash, investments, operating cash flow and credit facilities should meet fiscal 2019 needs. Capital expenditures are estimated at $2 million for the rest of fiscal 2019.
Material changes and unusual items
- Quarterly gross margin fell 3.0 percentage points. Management attributed the decline to higher labor costs (about 130 basis points), raw materials, principally polyurethane and plywood (about 60 basis points), Dubuque facility relocation costs (about 40 basis points), and ASC 606 rebate presentation (about 80 basis points); sell-price increases partly offset these pressures.
- SG&A was 16.4% of quarterly sales versus 15.2% a year earlier. The six-month comparison also reflects CEO transition expenses of $0.7 million and $1.3 million of severance and related costs for the former CEO. The prior-year six-month results included a $1.8 million gain on sale of a facility.
- Adoption of ASC 606 in fiscal 2019 had no material effect on the financial statements. The company reported that some rebates are now presented as reductions of revenue, adversely affecting reported margins.
- Six-month capital spending included $13.3 million for the new Dubuque manufacturing facility. The company expects the relocation to be completed in fiscal Q3 2019.
Outlook, commentary and risks
- SAP system: Management reported progress in system stabilization and customer service recovery but said the prior fiscal 2020 rollout timeline is no longer achievable. It is reassessing the system design, remaining rollout, cost and timing, with a go-forward plan expected by fiscal year-end. The balance sheet includes $26 million of SAP system net book value; the reassessment could result in a significant impairment.
- Tariffs: A 10% U.S. tariff on Chinese goods took effect September 24, 2018, with a potential increase to 25% in March 2019. Approximately 44% of fiscal 2018 sales were imported from China. Management warned that tariffs could weaken orders and margins, and that inability to reduce sourcing costs or pass on price increases could harm sales, earnings and liquidity.
- Operations and demand: Residential sales were affected by lower ecommerce and home-furnishings volume. Ecommerce volume was recovering after disruption from the partial SAP implementation, but management said recovery depends on sustained delivery performance. Labor costs and service levels remained operational priorities.
- Environmental matter: Flexsteel continues to record a $3.6 million liability for remediation at the Lane Street groundwater Superfund site. The EPA issued an order requiring remedial work; the parties had not finalized an administrative consent order as of January 25, 2019. The company disputes responsibility and is evaluating legal defenses and insurance recovery. The EPA previously demanded $5.5 million in remediation and past response costs.
- Management reported compliance with credit covenants and effective disclosure controls. The filing cautions that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Confirm the intended reporting period: the filing is for fiscal 2019 Q2, not 2017 Q2.
- Track SAP reassessment results, remaining implementation costs and any impairment against the $26 million carrying value.
- Monitor tariff changes, sourcing mitigation, customer pricing and resulting order volumes and margins.
- Review recovery in ecommerce and residential demand, manufacturing productivity, labor costs and Dubuque relocation completion.
- Follow EPA negotiations, remediation estimates and potential insurance recoveries relating to the $3.6 million environmental liability.
- Assess cash generation, capital spending, facility expirations and dividend capacity as fiscal 2019 progresses.