Good morning, and welcome to the Flexsteel Industries' Second Quarter Fiscal Year 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Derek Schmidt, Chief Financial Officer and Chief Operating Officer for Flexsteel Industries. Please go ahead.

Thank you, and welcome to today's call to discuss Flexsteel Industries' second quarter fiscal year 2021 financial results. Our earnings release, which we issued after market closed yesterday, Monday, January 25, is available on the Investor Relations section of our website at www.flexsteel.com, under News & Events. I am here today with Jerry Dittmer, President and Chief Executive Officer. On today's call, we will provide prepared remarks, and then we'll 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 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 forward-looking statements. Such risks and uncertainties include, but are not limited to, those that are described in the 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 contains the financial and other quantitative information to be discussed today as well as a reconciliation of the 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. Despite, facing a multitude of headwinds created by global supply chain disruptions related to COVID-19, we performed well in the second quarter, delivering strong top line results of $119 million, which represents year-over-year organic growth of almost 26% and solid GAAP net income of $8.5 million. And non-GAAP net income of $5.9 million. Overall demand for residential furniture remains very robust and we are gaining market share due in part to our lead time performance relative to competition. The actions taken at the end of fiscal year 2020 to refocus our organization solely on home furnishings and to reduce operational complexity through SKU rationalization have made us stronger and nimbler to meet recent surge in consumer demand for furniture. Sales results in home furnishing products sold through retail stores were especially encouraging with year-over-year growth of almost 29% in the quarter. Year-over-year order growth for retail sales was a blistering 60% in the first quarter. And that momentum carried into the second quarter with order growth of 49% versus prior year. As a result, our backlog for retail sales finished the second quarter at a record level of $101 million. Our teams are working feverishly to expand both manufacturing and sourcing capacity to meet this strong growth. And I'll elaborate on our capacity initiatives later in the call. Sales in our Home Styles product, which are sold through e-commerce channels, grew double-digits, but the pace of growth at 11% during the second quarter was notably lower than the growth performance in the first quarter of fiscal year 2021 and the fourth quarter of fiscal year 2020. The reduction in growth this quarter was largely a result of global supply chain disruptions, which constrained our inventories and ability to support higher sales.…

Thank you, Jerry, and good morning, everyone. Second quarter net sales were $119.1 million, up $16.2 million or 16% compared to $102.9 million in the prior year period. Despite the supply chain challenges, which Jerry mentioned, our sales results were at the high end of our $110 million to $120 million guidance range, driven by strong sales execution and favorable lead time performance relative to competitive alternatives. We saw increases in both our home furnishings products sold through retail stores of $22.4 million or 29% and products sold through e-commerce of $1.8 million or 11%. The sales increases were partially offset by a decline of $8 million due to the exit of our vehicle and hospitality product lines during the fourth quarter of fiscal 2020. Excluding these exited product lines, our organic growth was 26%. This growth was supported by a record backlog at the end of the first quarter and a very strong finish in December. From a profit perspective, we reported a fiscal second quarter net income of $8.5 million or $1.13 per diluted share that compared to a net loss of $5.4 million or minus $0.68 per diluted share in the prior year quarter. The reported net income included an $800,000 pre-tax restructuring expense, a $1.3 million pre-tax bad debt expense due to a customer bankruptcy and a $5.2 million pre-tax gain for the sale of our Dubuque, Iowa and Lancaster, Pennsylvania facilities. Excluding these three items, the second quarter non-GAAP adjusted net income was $5.9 million or $0.79 per diluted share as compared to a non-GAAP adjusted net loss of $1.5 million or minus $0.19 per diluted share in the second quarter last year. Please see the non-GAAP disclosure included in the earnings release for a detailed reconciliation of GAAP to non-GAAP adjusted net income. Gross…

Thanks. As Derek outlined, operating margins might be a bit choppy in the next few quarters due to the evolving situation with the global supply chain. But we take a longer term view of the potential of the business and feel good about the strategic progress we’ve made so far in fiscal year 2021, and have confidence in our long-term plan and ability to deliver consistent profitable growth. To accelerate our pursuit of new growth, we’ve recently recruited a new member to our leadership team in the role of Vice President, New Business Development. This position will be instrumental in building out meaningful consumer insights to uncover new business opportunities and will lead the charge in expanding Flexsteel’s reach into new consumer segments, product categories and price points. To realize our growth potential, we’re working plans to aggressively expand our overall supply chain capacity. On the manufacturing front, we added several new lines to both our Dublin, Georgia and Juarez, Mexico facilities in the first quarter. And we recently signed a new building lease for an additional production facility in Juarez, which should start initial production in March and ramp up capacity throughout the remainder of the calendar year. Additionally, we’ve recently retained consulting services to help us expand our global supply chain, diversify our sourcing country exposure and build a more resilient supply chain. Lastly, we’ve initiated a study of our DC network to not only determine optimal expansion plan, but also ensure we improve our fulfillment capabilities to better serve our existing customers and to rapidly grow our direct to consumer sales. The future of Flexsteel is exciting. We have a clear vision of where we want to go and a plan to get there. It all starts with building an organization that truly aspires to create a great experience for our customers each and every day. When we do that, we’ll grow faster than the market and deliver attractive returns to our shareholders. I look forward to sharing more of our progress in this journey in the quarters ahead. With that, we will open up the call to your questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Sandy Mehta of Evaluate Research. Please go ahead.

Yes. Good morning and congratulations on the strong income performance in the quarter. Several furniture companies have talked about price increases to offset some of the shipping and other costs and you have alluded to that as well. And you said that many of those price increases we will see during the third quarter. Would that – with the price increases once they’re fully implemented, would that fully offset some of these increases in shipping costs and other supply chain costs, please? Thank you.

Yes. Sandy, this is Jerry and Derek can fill in the blanks behind me. They will not. And I’ll tell you why is that it’s such a fluid time right now. The price increases are happening all the time. We’re looking at both putting price increases and surcharges for the freight, but the price increases are coming in non-stop. And so what we’re doing is we put some in, we plan to continue to put some in, we’re hoping this does diminish over time. I wouldn’t say that we’re necessarily behind. But we’re definitely not ahead of it. And our retailers and customers obviously are having a struggle with passing these on, out into the marketplace to the end users. So this is a very fluid thing. So the quick answer is no, we do not have them all covered, but we will continue to look at pricing actions. We used to look at pricing actions once a year, now we look at them once a week and we’re going to continue to look at them the best we need to.

Yes. Sandy, as Jerry alluded to, the fact is – so when we started to see significant inflation, both in terms of materials, transportation, labor and the ocean freight, we took pricing actions back in November that will largely be realized here in mid February, kind of early March. Since that time, freight rates, ocean freight rates have continued to increase. We’ve gotten additional increases from various kind of suppliers of both materials and finished goods. So again, we’re constantly evaluating those and pushing pricing back to our customers where it makes sense. But there is a lag from the time that we announced pricing to the time we work through our backlog and we actually realized that. So in most cases, that’s a two- to three-month lag on the manufacturing side.

And the $20 million of repurchases, can you comment at what average price? And with your stock price appreciation, how do you look at repurchases going forward vis-à-vis dividends or special dividends? Thank you so much.

Yes. So let me answer your second question first. Our priority for capital deployment first and foremost is to invest back in the business. We see attractive kind of opportunities to reinvest. We’re going to invest in inventory support, new products, product category expansion, new sales distribution. We’re going to continue to make investments in manufacturing and DC machinery and equipment to support capacity expansion. Assuming though, after we make those investments, we still have excess cash. Then we’ll return capital back to shareholders either in the form of higher dividends or share repurchases. And we have a constant dialogue with our Board and they give consideration not only to shareholder preferences, but tax considerations. And as it specifically relates to share repurchases, we look at the price of stock relative to our intrinsic value. So, we have a dialogue every quarter with the Board regarding our view of intrinsic value. So we update that quarterly. And just from a governance standpoint, we actually had two external firms validate that view of intrinsic value. So, in terms of your question around kind of share repurchases, it depends upon the attractive investment opportunities that we have to invest back in the business, but we have excess cash and the stock is trading at a significant discount to our belief over intrinsic value, then we’ll continue to use that as a mechanism to return cash to our shareholders.

And this is Jerry. The answer to your other question you asked about the average price. And you’ll see this and we file our Q at the end of the week that we’ve paid an average price per share of $21.31 over the last six months or repurchasing the shares.

Great. Thank you so much.

The next question comes from Mike Hughes of SGF Capital. Please go ahead.

Good morning. Thanks for taking my questions. The first one, just if you could talk a little bit more about the capacity expansion plans in Mexico on the labor front. Because I know a number of your peers have actually announced the last few months that they plan to start producing some case goods in Mexico. So is that tightening the labor market there?

Yes. This is Jerry. So I’m not really – we look at all different parts of Mexico and really have a couple things. One is we’re looking at other OEM suppliers. The capacity we mentioned in our statements here a little bit earlier had to do with us. Going -- we’ve now gone from one to three plants in the Juarez area, and there appears to be more than enough adequate labor for us going forward.

Okay. And then second question, where are your lead times now? And you’ve mentioned that you have shorter lead times than your competitors, which is resulting in market share gain. So how do you convert the short-term market share gains to long-term market share gains?

Yes. So as in current state, our lead times for manufactured product are running kind of in that 15- to 17-week timeframe, which is much longer certainly than we desire long-term, but our competitors in some cases are out, six months or even longer. So we believe that we’re still competing from my point of advantage. I think our belief is that we have to continue to aggressively expand our capacity to keep those lead times down. And we will gain kind of mind with share both consumers as well as our retail sales associates, if we can perform better than the competitive alternatives. And that’s how we gained, share long-term.

Okay. Thank you very much.

The next question comes from JP Geygan of Global Value Investment Corporation. Please go ahead.

Hey, good morning, and congratulations on the strong quarter, the success of your restructuring plans is evidenc]e in your financial results. I just have a few questions today and I think you've touched on aspects of all of them, but first, I think this is a question for Derek. You discussed reinvestment in the business, dividends and stock repurchases, but can you address capital allocation more generally, including your appetite for acquisition?

Yes, we're still very much an acquisitive company. What I would tell you at the moment though is that the companies that are probably highly attractive to us that are in growing segments, e-commerce, et cetera, have significant price premiums. So certainly, while we're looking at acquisitions, we want to make sure that any deal that we would do would have a clear path to shareholder value creation. So we'll be disciplined in terms of kind of what we pursue. And our intent is to keep enough dry powder on the balance sheet, so that if the right acquisition does come along at the right price, we have the capability to pursue that. So between our cash on hand in available credit, we feel like, we want to keep enough capacity in our back pocket to pursue such opportunities. And beyond that, like I said, capital deployment, it is – we are going to continue to reinvest back in the business to expand in areas that have attractive returns. We've talked here I think, extensively about our plans to expand supply chain. That includes not only manufacturing capacity expansion, but also expanding our DCs. And so we would deploy capital to support those endeavors.

Was there a follow-up, Mr. Geygan?

Yes, please. Thank you. You've got into CapEx of $2 million to $3 million for fiscal year 2021. I presume that you've spoken to many of the growth strategies that you have in mind, but other than your DC capacity, your supply chain capacity, particularly your Juarez addition, can you speak to anything else that falls into the category of growth strategies, particularly new product development?

Yes. I think most of our growth kind of investment is going to P&L rather than CapEx. But there's really kind of four key areas as we start to think about investments. One is clearly around new product development and I think you'll find here in the coming year or two years, we're going to have a very healthy and attractive pipeline of new products that start to reach potentially categories that we haven't participated in. They're going to reach price points that allow us to touch, I think different consumers than what we've gone after in the past. And you'll see products with different styling, more modern, more transitional that appeal to, again, other consumer segments than maybe we've targeted in the past. We're going to continue to aggressively invest around e-commerce and digital capabilities. We believe that that channel is absolutely critical to our long-term success. And we're going to build the talent and the capabilities to kind of support that area. We're going to continue to invest in supply chain capabilities and talent while we're certainly expanding manufacturing capacity, our suppliers have a critical role, and we want to continue to make sure that we've got the talent, tools and capabilities to kind of grow that aspect of our business. And I think the fourth area that we're going to invest in is expanded sales distribution, pursuing alternative kind of distribution channels than maybe what we've traditionally gone after.

Great. That helps a lot. Final question is, can you characterize your inventory right now? How much of that is available to be sold in the short-term versus tied up in transit versus stuck in a warehouse in Asia if any?

Yes. So if you look at the balance sheet, it looks like quarter-over-quarter, our inventory is up $16 million, from the beginning of the year was up $22 million. The reality is almost all of that increase in inventory is either on the water, on a boat coming from Asia or it's in transit. It's either sitting on a boat at a port or it's en route on a train. So given all the supply chain challenges that Jerry went through earlier, our challenge right now is we we've got a lot of orders out there. We've got inventory in motion. We just need to receive it in our DCs so that we can get it up to consumers. So the balance sheet is a bit misleading because we have so much in transit right now.

Great. Thanks for your comments. That's all for me.

Great. Thank you.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Jerry Dittmer for any closing remarks.

Thanks Andrew. In closing, I would like to thank all our Flexsteel employees for their outstanding performance and service during the second quarter. I couldn't be more proud. We have strong momentum and are executing well. The supply chain issues will diminish in time and we plan to continue our strategic investments for long-term profitable growth. I would like to thank all of you today, who did participate on today's call. We thank you for your questions, and please reach out if you have additional ones. We look forward to updating you all in our next call. Thanks again. Everybody, have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.