Good morning, and welcome to the Flexsteel Industries’ Second Quarter Fiscal Year 2024 Earnings Conference Call. All participants will be in a 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 Mike Ressler, Chief Financial Officer for Flexsteel Industries. Please go ahead.

Thank you, and welcome to today’s call to discuss Flexsteel Industries’ second quarter fiscal year 2024 financial results. Our earnings release, which we issued after market close yesterday, February 5 is available on the Investor Relations section of our website at www.flexsteelindustries.com, under News and Events. I am here today with Jerry Dittmer, Chief Executive Officer; and Derek Schmidt, President. 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’d like to start by welcoming Mike Ressler, our new Chief Financial Officer. Mike has been with Flexsteel over 17 years in various accounting, finance and other cross functional roles, most recently as the Vice President of Manufacturing. His appointment as CFO reflects his leadership and contribution to the company’s transformation over the past several years. And I’m excited for Mike to further expand his positive impact on the company as CFO. I would also like to congratulate Derek Schmidt on his appointment to President and to the Board of Directors. Derek’s promotion reflects his leadership of the company’s operations and growth strategy and aligns with his expanded responsibilities since joining the company nearly four years ago. With that, I am very pleased to share with you our second quarter fiscal year 2024 results. While headwinds from macroeconomic challenges and shifts in consumer spending towards experiences and away from things persist in our industry, we continue to execute on our strategic initiatives and delivered sales growth of 7.5% when compared to the prior year quarter. In addition, our relentless focus on operational efficiency and cost savings propelled gross margin expansion and helped fund additional investment in growth initiatives while delivering significantly improved operating income when compared to both the same quarter of the prior year and our first quarter fiscal 2024. While we expect the business environment in the near term to remain challenged, our team isn’t deterred and remains intensely focused on continuing to profitably grow our business throughout the remainder of fiscal year 2024 and long term. We will continue our positive momentum going into the third quarter and are confident in our ability to grow sales, both compared to last year and the second quarter. I’ll now turn the call over to Derek to discuss our results and an update on our growth initiative. I’ll be back at the end of the call with some closing comments on what we see ahead.

Thank you, Jerry, and good morning, everyone. Like Jerry, I am very pleased with our second quarter results. We are competing well in our core business and executing our market expansion initiatives, resulting in both sales and profit growth even in a difficult business environment. As Jerry noted earlier, we grew our top line by 7.5% in the fiscal second quarter. This year-over-year sales comparison continues to be adversely impacted by the elimination of ocean freight surcharges which reduced revenue by approximately $3.5 million compared to the prior year quarter. As discussed in our first quarter call, in the prior year, we used this surcharge mechanism to pass through higher cost of ocean container delivery which were significantly inflated due to supply chain issues. Container delivery costs normalized throughout the last fiscal year and we subsequently eliminated this surcharge. Excluding the $3.5 million impact from this ocean freight surcharge elimination, sales growth related to unit volume and product mix was a robust 11.7%, further reinforcing our strong sales execution. Despite challenging industry conditions, we remain confident in our ability to continue our growth momentum into the second half of fiscal 2024 from both continued share gains in our core business and increasing momentum in our market expansion initiatives. In our core business, we expect to continue outperforming the industry by continuously improving and providing a differentiated customer experience, aligning ourselves with the strongest, most capable distribution partners, and driving a constant stream of relevant and compelling new product. We define our core business based upon where the majority of our current sales are derived from, which is product designed for primary living spaces like the living room, which are sold through independent furniture retailers and have a more traditional or transitional style that primarily appeals to Gen X and Baby…

Thanks Derek. For the quarter, net sales were $100.1 million, slightly above our guidance of $94 million to $100 million, provided during our first quarter fiscal 2024 earnings call. As Derek noted earlier sales growth related to unit, volume and mix, which when excluding prior year quarter ocean freight surcharges was a strong 11.7% in the quarter. And we feel we have sustainable growth momentum throughout the rest of fiscal 2024 and into fiscal 2025. From a profit perspective, the company delivered operating income of $4.6 million or 4.6% of sales in the second quarter, which exceeded our operating guidance range of 2% to 4%. A meaningful increase in our operating income was driven by an expansion of our gross margin to 21.9% in the quarter compared to 17% in the prior year quarter. Moving to the balance sheet and statement of cash flows. The company ended the quarter with $3.3 million in cash, working capital of $100.5 million and a balance on our revolving line of credit of $17.9 million. Our increased profit, combined with improved working capital levels, allowed us to pay down our debt by 46%, when compared to the fiscal first quarter. Looking forward, we reiterate the sales guidance release with our preliminary results announcement on January 11, 2024. And while we expect one-time costs related to the closure of our Dublin facility, will adversely impact GAAP operating income, we still expect to achieve our fiscal 2024 operating income guidance on an adjusted non-GAAP basis, when backing out the one-time costs associated with the facility closure. Specifically, for the fiscal third quarter we expect sales between $101 million and $106 million, which represents sales growth of 2% to 7%. Regarding profitability, we expect gross margin in the range of 21% to 22%. We expect gross margin…

Thanks Mike. While we remain cognizant of macroeconomic factors, which could impact our current outlook, I am optimistic about our ability to continue to gain share and confident we can maintain our profitable growth trajectory both in the near and long-term. We have great momentum and are well positioned to successfully deliver improved earnings and an even stronger balance sheet over the remainder of fiscal year 2024 and into fiscal year 2025. With that, we will open the call to your questions. Operator?

Thank you. [Operator Instructions] The first question is from Anthony Lebiedzinski with Sidoti & Company, LLC. Please go ahead.

Yes. Good morning and thank you for taking the questions. So first, a nice job in a tough environment for sure. So you guys talked about – a lot about the market share gains in your core business. Just broadly speaking, is it – are you doing more business with your existing clients? Or are you signing up new accounts? I mean just wanted to get a better sense as to where those share gains are coming from?

Yes, Anthony, thanks for the question. This is Jerry. Yes, a lot of our growth is in our core strategic accounts and in our core business. Obviously, we're still out signing up new folks at all times, but most of it has come from us going deeper and getting more placements with our core accounts.

That's very helpful. So the unit volume increase certainly is even more impressive than your total sales gains. So I guess in terms of your guidance going forward, how should we think about the split between unit volumes versus pricing?

Yes. I think, Anthony, its Derek. Going forward, so in the third quarter, as we – let's break pricing out between the surcharge impact and then just kind of normal pricing. So in the third quarter, there's about $2 million of impact of the ocean freight surcharge elimination, and then that comparison goes away in the fourth quarter. What we are assuming in terms of pricing is status quo, likely for the remainder of the calendar year. The only caveat to that is as you're likely aware, ocean freight container rates have gone up substantially. They've actually almost doubled since the beginning of December. So if they stay at that rate, we will have to consider certainly turning back on some types of surcharge mechanism. But all that aside, we would expect that the majority of the go-forward growth is related to the unit volume and mix and not pricing.

Understood. Yes, thanks Derek. Yes, and I was going to ask about the ocean freight costs, so those have gone up certainly from the bottom here. Okay. But at this point, you have not passed along any higher sort of charges because of the Red Sea conflict? So, okay, understood. All right. And then I guess I just wanted to dig in a little bit deeper in terms of the gross margin improvement, obviously a very strong year-over-year. Maybe if you could just kind of parse out maybe over the kind of the puts and takes as to what drove that; I know you talked about some cost savings initiatives. Obviously, you have fixed cost leverages there as well. So maybe if you could just go over some of the details behind the gross margin improvement and your confidence level about being able to sustain that?

Anthony, this is Mike. Yes. So I think as Derek highlighted, we have kind of four-key drivers of the gross margin improvement. One, cost savings, so we've taken some actions to reduce structural costs. In the prior year we took a distribution center off-line, which lowered our structural costs. In addition, on the cost savings side, we have pretty strong operations team that are executing save initiatives both in our sourcing, manufacturing and then also in our logistics and distribution network. We feel like those processes are sustainable here going forward. The second thing, Derek mentioned was introduction of new products and using product life cycle management to improve profit kind of on a go-forward basis. So we're leveraging our cost savings initiatives as well as kind of our value engineering activities to continue to bring out new products that have a better margin profile than the legacy products we have that we're discontinuing. And then kind of the third piece would be the volume leverage. As we're really thoughtful about reinvesting back into our structural costs, so that way we get to leverage on our sales growth initiatives. And then lastly, we've just been able to be more strategic around our promotional activities as it relates to moving – slower moving inventory and things like that.

The one thing I'll add, Anthony, is I think the magnitude of impact from those four levers will change over time. I think in the near-term as Mike alluded to, operationally we're executing really well. Lots of cost savings from that. And I think the pricing discipline has been a really big profit lever in the near-term. As we look at the quarters ahead and the years ahead, what are going to be the main drivers of gross margin improvement going forward are going to be the product life cycle management. So as we've explained, again, we've raised the hurdle rates on new product as that becomes a larger and larger amount of our portfolio that's going to raise the overall margin profile. And then I think the operating leverage from growth. So, so again, I think the mix of drivers will kind of evolve here over the coming quarters and coming years, but we still feel confident in terms of our ability to continue to expand margins.

Understood. Yes. Thank you for that. And then I guess so – as far as the Dublin, Georgia facility closure here, you mentioned that it's going to result in annualized cost savings of – at the bottom end of that is $4 million. But I noticed that you didn't change your guidance for fiscal 2025. Is this just function of you guys trying to be conservative? Or just wondering if you will be reinvesting those savings elsewhere? How should we think about that?

Anthony, this is Mike. So when we built our fiscal 2025 guidance ranges, we modeled out several different structural cost change scenarios, and we still feel good about what we put out there for our fiscal 2025 guidance range on both top line as well as from an operating income perspective.

We had several scenarios, even though we had not made a decision in terms of closing Dublin at the time we provided 2025 guidance. There was multiple options to drive manufacturing efficiency, which as Mike said, we built into that fiscal year 2025 guidance. I think we'll be in a better position here at the end of this fiscal year, early next to determine if there's potential additional savings beyond what we've estimated that would meaningfully change our fiscal year 2025 guidance.

Understood. Well, thank you very much and best of luck and I'll pass it on to others.

Thanks, Anthony.

Thanks, Anthony.

The next question is from Budd Bugatch with Water Tower Research. Please go ahead.

Good morning, Jerry. Good morning, Derek. And congratulations to you Mike, and to you Derek as well. A couple of questions on the order book if I could. Can you talk a little bit about the quality of orders in terms of the product vitality, how much of that's new business? I know you said most of it's coming from existing strategic accounts, but I was curious as to what you're seeing in terms of new placements, increased penetration in those accounts and with new product versus old product?

Yes. So at the highest level, Budd, a lot of them are getting new placements on the floor. We do have, obviously, our flex and Zecliner products are doing very well, and those obviously are also driving a big piece of that.

The other color that I'll add, Budd, is that we actually measure internally what our sales, the percent of our overall sales from new products. And we measure new products over the last kind of three years, and that's close to 25%. So we feel good that we are driving relevant new product that's resonating with the market. And we would expect going forward that new product would make up at least 25% of our overall sales, if not more, going forward.

And Derek, that's pretty much a classic definition of product vitality there. So when you look at that on a weighted or a continuing moving average, how has that changed over the last 12 months to 18 months?

It's definitely increased. We've been more aggressive around launching new products and that trajectory will continue.

Okay. So if you looked at it basically on – just on a one – instead of a one year basis instead of a three, it would be higher than 25%, would be that weighted – that moving average, is that the way to read that answer?

Well, it's difficult to compare one, I mean, one year versus three year because you've got a lot more product in the three year. But if you look at that three-year percentage, what it is today, and if you were to rewind and go back 12 months ago, it was lower than the 25%. So again – and we do expect going forward that number to increase throughout time.

Okay.

Does that help?

I think so. I always try to put numbers to things. I know you – the color is qualitative and the numbers are quantitative. And that's definitely a weakness of the analytical community, wanting to be more quantitative and wanting numbers. I'm also curious as to the change in the composition of costs and how to look at maybe something like a contribution margin going forward with taking Dublin out and the facilities left, what's the variable cost structure look like the MLO and D&T [ph] kind of components of cost on a normalized basis. And what does the fixed cost component look like?

Yes. It doesn't change that meaningfully from what we've shared previously with you, Budd. If you look at the composition of the $4 million to $4.5 million savings from Dublin, a little less than $2 million of that is from structural cost reduction. The rest of it is efficiencies around variable costs.

So looking at the – I think, and correct me if I'm wrong, my memory is – I'm old and my memory is faulty. But I do believe you told us a couple of years ago that I think that the target gross margin was in the low 20s. We seem to be there. What's that look like going forward?

Yes. From a gross margin perspective, certainly, we're striving, we're aspiring to 23% or more kind of in the mid -long term. And we've raised the…

There is mid long term have a…

Three to five years.

Three to five years.

Three to five years, yes, to get.

All right. And if I – do I read the guidance right, that for 2025, you're saying that you're going to have no debt? Is that the way to read that? I was trying to make sure I understood the table.

Yes, that's correct.

So you do want debt down to zero. And once debt to zero, what's the use of cash look like? What's your thought process?

Yes. In terms of capital allocation, Budd, so I laid out earlier in the call these pursuits to expand our penetration in new markets. We would look for value enhancing acquisitions that would accelerate our penetration into one of those three areas. Either help us address the needs of younger consumers, expand our product category penetration beyond the living room, or expand our sales distribution beyond the independent retailer. So the areas that we've kind of talked about in terms of acquisition priorities would be potential outdoor company, a direct-to-consumer company, or a company with a modern mid-price lifestyle kind of brand. So we would expect to start to potentially accumulate some cash in the balance sheet and more proactively look for value enhancing acquisitions.

And does that take you out of manufacturing or into retail or into or out of furniture or out of…

No, we're squarely focused on residential furniture. Certainly in the midterm, we do not desire to be in retail ourselves. So this is again, this is leveraging our core competence and bringing in new capabilities within furniture wholesaling for lack of a better term.

Okay. All right. Thank you very much. Congratulations on the quarter, and best of luck for the balance of the fiscal year and beyond.

Thanks, Budd.

Thanks.

[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.

Great. Thank you. In closing, I'd like to thank all our Flexsteel employees for their dedication and outstanding performance during the quarter. And thanks to all of you for participating in today's call. Please contact us if any additional questions. And we look forward to updating you on our next call. Everybody, have a great day. Thanks.

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