Good morning, and welcome to the Flexsteel Industries Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. All participants’ will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Derek Schmidt, Chief Operating Officer and Interim Chief Financial Officer for Flexsteel Industries. Please go ahead.

Thank you, and welcome to today's call to discuss Flexsteel Industries fourth quarter and fiscal year 2023 financial results. Our earnings release, which we issued after market close yesterday, Monday, August 21, is available on the Investor Relations section of our website at www.flexsteel.com, under News and 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 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 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 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 the reconciliation of GAAP to non-GAAP measures. And with that, I will turn the call over to Jerry Dittmer. Jerry?

Good morning, and thank you for joining us today. I am pleased to share with you our fourth quarter and fiscal year 2023 results. We continued our strong momentum in the fourth quarter, delivering sales of $105.8 million, which was within our guidance range and represents sequential quarter-over-quarter growth of 6.8% compared to the third quarter. While we continue to face market headwinds in the form of pricing pressure and slowing consumer demand, we are executing well, and our growth initiatives are adding meaningful revenue to offset these challenges. Our growth initiatives, along with a continued focus on operational efficiency and controlling costs, enabled us to expand our gross margins and deliver operating income for the quarter of $4.2 million or 4%, which was in the upper range of our guidance. While economic uncertainty and market headwinds will remain a challenge in fiscal year 2024, I am encouraged by the positive impact of our strategic priorities and excited to continue our momentum in fiscal year 2024. Looking back on fiscal year 2023, it was a very challenging yet exciting year. Coming off a year in 2022 of record high sales due to post-COVID demand, we were faced with slowing consumer demand, which was compounded by a glut of retail inventory that was ordered to meet expected post-COVID demand but backlogged due to supply chain disruptions. At the same time, the industry experienced pervasive price reductions as many manufacturers and retailers quickly dropped prices in response to lower ocean freight and other cost inputs, forcing others to follow suit. The imbalance between supply and demand further intensified pressure to lower prices in order to remain competitive. And while ocean container rates began to return to normal levels, fuel prices surged. Despite the significant decline in year-over-year sales caused by these challenges,…

Thank you, Jerry, and good morning, everyone. Like Jerry, I'm optimistic about the trajectory of our business and feel great about the momentum we've built with our growth initiatives. A few noteworthy highlights to share. With respect to new sales distribution, we continue to execute well and gain momentum with big-box customers most notably Costco. Big box represented approximately 5% of our total sales in the fourth quarter and is expected to grow faster than our other channels in fiscal year 2024 as we expand the breadth of product offerings and optimize our marketing and demand generation efforts within this channel. As important, we are building Flexsteel brand awareness with a different consumer audience through big box, which we feel will have positive, long-term growth benefits across all our channels. In new product categories, we had good, early success with flex, which is our small parcel, contemporary, modular furniture solution. Flex was initially launched in the big-box channel last quarter, and we've accelerated distribution expansion to make flex available across a wide variety of selling platforms, including e-commerce partners like Amazon; Wayfair; Overstock, which recently rebranded itself as Bed Bath & Beyond; homedepot.com; and our own direct-to-consumer site, www.flexsteelstore.com. In addition, we are aggressively expanding flex into brick-and-mortar retail with our strongest, independent retail partners. New product additions will be released in October with additional plans developed to meaningfully expand the line over the next 18 months. Zecliner, our new sleep solutions recliner, has become a home run. Over 500 retailers have placed the product with strong initial sales. We've also signed up multiple regional sleep store chains with more anticipated in fiscal year 2024. We expanded the line in April and have more innovation planned for release in October. This is an exciting category, and our plan is to…

Thanks. While economic uncertainty remains, I am confident that our long-term growth outlook remains promising. Our team's commitment to profitable growth and the foundations we have put in place have positioned us to successfully deliver improved earnings and an even stronger balance sheet in fiscal year 2024. We are focused on our strategic growth initiatives, investing in future innovation and delivering sustainable profit through operational efficiencies while continuing to reduce inventory levels and pay down debt. In summary, we're enthusiastic about fiscal year 2024 and the long-term growth opportunities for the company while being mindful that we still face near-term economic uncertainty. With that, we will open up the call to your questions. Operator?

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Budd Bugatch of Water Tower Research. Please go ahead.

Thank you. Good morning, Jerry. Good morning, Derek. Thank you for taking my questions.

Yes, good morning, Budd.

Just can you talk a little bit about the revenue pattern and the way it materialized during the quarter? How did it look year-over-year? And maybe talk about units versus price as it came out for the first -- for the fourth quarter?

Actually, if you were to look at the quarter, Budd, we started probably the quarter a little bit slow in April and then saw a really nice pick up in May and June kind of around Memorial Day Holiday. So I feel like we finished the quarter strong. It's interesting. Year-over-year, total net sales were down 15%. Unit growth was actually up 2% year-over-year. So all the decline in the net sales number was related to pricing, of which a large amount of that pricing decline was related to ocean freight surcharges. So if you remember, if you go back 12 months ago in Q4 of fiscal year ‘22 is when we had peak ocean freight rates, probably our surcharges were at their peak. And then we virtually -- I mean we eliminated those ocean surcharges here in our most recent fourth quarter. So there was a big revenue decline related to that. But we feel good about our momentum in the market, the fact that we had positive year-over-year unit growth and then we're anticipating carrying that momentum into Q1 and expect to have mid-single-digit unit growth in the upcoming quarter as well.

So Budd, most of that pricing is behind us. We will see some of that as the year goes on. There will be probably $4 million, $5 million of it we'll see here in this first quarter from the pricing actions, and that's because we -- in May when we took the last of our ocean freight charges away. So it would be pretty encouraging, probably the most encouraging thing we really saw in the fourth quarter was our unit volume being up year-over-year. That was very encouraging.

I agree. I'm painfully aware of what happened to ocean freight during the post-pandemic time frame. And historically, much of your sales were retailer-based and special orders. Now with the big-box strategy, I take it that there's a lot more placed on stock. How is -- how did that balance unfold during the quarter? And what do you see going forward on that?

Yes. In terms of, again, unit volume, we feel good about really performance in both traditional retail, as well as kind of our e-commerce pursuits, including big box. So I think we're competing well in kind of both channels. Obviously as we alluded to in our opening remarks, we expect that big box will grow faster than the other channels given the fact that, again, this is a relatively kind of new probe for us. But beyond that, we're not seeing really any material kind of changes in mix.

And are you seeing better reports from your retailers? You have a wide swath of retailers throughout the country? How is their demand looking? What can you see from that from your incoming order book?

Yes, Budd, so our retailers are not panicking at all. They're actually -- it's pretty strong, especially year-over-year. And as Derek said, both the retail and the big box are both up year-over-year, especially on the order side, which is very encouraging. Obviously, we are worried like everybody about what's going to happen if there's going to be an economic slowdown. But right now, we really haven't seen that. So we're pretty encouraged where we're at right now.

Yes. Orders for the fourth quarter, actually, total company were up 20% year-over-year. So again, we feel like we're competing well. As Jerry alluded to, most retailers will tell us that traffic is a bit slow. So the fact that we're seeing pretty robust year-over-year order growth would suggest certainly that we're gaining some share and we have good momentum.

I'll ask just a couple of more, but let some others have at it. Just the gross margin progress was notable. Can you give us a little bit of color on that? You called it from operational efficiencies. How does it look like with the material labor and overhead? What's -- where were those efficiencies and the reduced inventory write-downs, give us some color on that and maybe a walk from quarter-to-quarter or year-to-year?

Yes. So from a productivity and operational efficiency standpoint, Budd, we made really good gains across all the aspects of our supply chain. So that's manufacturing, that's global sourcing, that's logistics. So we have three strong leaders in each of those areas, and they're doing a great job executing from my viewpoint in terms of just constantly driving cost savings. They've been doing that all fiscal year ‘23. Unfortunately, a lot of that got used to fund some price concessions in the market. So good momentum on that front. And I'm sorry, Budd, the second part of your question? Operational efficiencies?

Right. Yes, what do you see going forward on that? How far can you take the gross margin level?

Yes. Again, we've talked about near-term, mid-term, certainly, our goal is to get our gross margins at or above kind of 20%. Continued operational efficiency will be a really important part of that. The other piece that you noted, which was in the press release is year-over-year reduction in inventory kind of write-downs. If you remember in fiscal year '24, Q4, we had a lot of inventory. We put reserves against some of that because demand was slowing. So that comment as it relates to fiscal year '23, Q4 was simply -- there was a negative kind of comparison in fiscal year '22. So overall, we feel good about our inventory levels, the quality of inventory. So no concerns on that front. So I think as we go forward, we feel pretty confident around our ability to continue to expand overall margins throughout fiscal year '24, and the big levers there are two-fold. It's continued operational efficiencies and then second, volume leverage.

The other thing, too, Budd and there are two things is the inventory will continue to come down. We don't feel that there'll be growth during this fiscal year in inventory even as our revenue goes up. And probably the only thing we really, that's kind of an uncontrolled one right now, is obviously the peso versus the dollar is having a negative effect on us here in the short term and maybe even longer term. We saw about $1 million last year, and we'll see probably a good $400,000 this year in this first quarter as the peso and the dollar aren't really moving in the best direction for us.

I see. And you did talk about inventory as a source of cash and is it, what, $122 million at the end of the year? Do you think -- what's the goal for the end of fiscal ‘24? Is it $100 million back to where it was maybe before pandemic time frame?

Yes, I think in that range. Our goal would even be a little bit better than that but that would -- definitely our goal.

And so that would get your funded debt down to just about zero, if not at zero?

Correct. I mean we stated it's $0 million to $15 million, but our ultimate goal, obviously, is to get that down to zero.

Got it. Thank you very much. I’ll let others ask questions and come back in the queue, if possible.

Thanks, Budd.

[Operator Instructions] The next question comes from Anthony Lebiedzinski of Sidoti & Co. Please go ahead.

Good morning and thank you for taking the questions.

Good morning, Anthony.

Yes, good morning. So just curious as far as the revenue impact from the growth initiatives. I know, Derek, you talked about the big-box impact for the quarter. But just overall, when we look at collectively big-box expansion as well as Zecliner and flex and others, how much of that you think contributed to the fourth quarter sales? And then the kind of -- how should we think about that as far as outlook for fiscal '24?

Yes. In terms of the fourth quarter, a little less than $10 million was derived from kind of growth initiatives. So going into certainly fiscal year '24, we feel good about the momentum there. As it relates to fiscal year '24, we would estimate that our growth initiatives would contribute probably another -- on an annual basis, another at least $30 million to $40 million over and above what we delivered here in fiscal year '23.

We're hoping, Anthony, that the plan is for that to be maybe the rise of somewhere in that 15% range going forward on an annual basis.

Got it. Yes, thanks for that. And then certainly, a terrific job with gross margin expansion. I know for the upcoming quarter here, it looks like there will be a little bit of a sequential decrease because of, I guess, lower revenue. But overall, do you think you can get above 20% at some point later this fiscal year? Or is that not doable just yet?

If we do it sequentially, I think the answer would be yes. I mean, obviously, our revenue will be down in that $10 million type range, so that does have an effect here in the first quarter. But historically, our second, third, fourth quarters are stronger quarters, and so the plan will be to continue to take that upward. And maybe for the year, it'll average close to that 20%. But hopefully, by the end of the fiscal year, we will be above that 20%.

Okay. Very good. And then as far as inventories at retail, I would like to hear your perspective. I know you talked about last year having a glut of inventory at the retail level. What's your sense now as far as inventory levels to your customers?

From where we're at or from where our retailers are at?

As far as where the retailers are at. I mean so last year, obviously, there was this big glut of inventory just as demand started to slow down. But fast forward a year later, I mean, do you feel like your retail customers have, in general, appropriate inventory levels or built maybe too much? Or just wanted to get a better perspective from you?

Yes, it's a good question. So our retailers for the most part, especially our strong retailers are in a good place. Of course, the everyone is a little bit cautious not sharing what's going to happen from an economic standpoint. But most of our retailers are in a decent place. A lot of their caution comes from store traffic is what's really down. Sales are hanging in there pretty well and most of the folks coming in are coming in to buy. But true retail traffic is down. And as that correlates into inventories, people are a little bit cautious. But for the most part, retailers are in good place, and we're seeing a lot of good -- they sell through, the orders come back our way, which is good.

Okay. That's good to hear. And then -- so by fiscal -- by the end of fiscal '24, you could potentially be debt free. So as you move beyond that, what would you say would be your cash flow priorities as you look to be -- it looks like debt free by the end of '24.

Yes. The main one, of course, will be to continue with our growth initiatives because we plan on taking a lot of our growth initiatives and doing more with each one of them coming out with new products, enhancements, things like that. Obviously, we'll continue to look at acquisitions if there's things that are favorable there but those are really the main two.

Got it. Well, thank you very much and best of luck.

Thanks, Anthony.

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

Great. Thanks. In closing, I want to thank all of our Flexsteel employees for their dedication and outstanding performance during the fiscal year. I'm also thankful to all of you, Budd and Anthony, for participating in today's call. We really appreciate that. Obviously, you can please contact us if you have any additional questions, and we look forward to updating you on our next call. Thanks, everyone, for listening and participating today.

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