Good morning, and welcome to the Flexsteel Industries Second Quarter Fiscal Year 2023 Earnings Conference Call. I would now like to turn the conference over to Alejandro Huerta, 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 2023 financial results. Our earnings release, which we issued after market close yesterday, Monday, February 6, 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; and Derek Schmidt, Chief Operating 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 the 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. In spite of the challenging macroeconomic environment, I am pleased with our performance in the second quarter. I am encouraged by the progress we have made on our strategic initiatives and our ability to gain share in the market, allowing us to deliver sales for the quarter of $93.1 million, which was in the range of our guidance as our growth initiatives helped to partially offset the challenges posed by high retail inventories and waning consumer demand. With the softer demand level, we continued to prudently manage spending, deliver on our cost-saving initiatives, and offset competitive pricing pressures and inflationary costs to deliver adjusted operating income of $1.0 million. As discussed in previous quarters, we are committed to driving working capital efficiency and paying down debt, further strengthening our balance sheet. During the second quarter, we were successful in making strides in both as we have improved working capital by $9 million and reduced our outstanding debt by $10.9 million. In the near term, macroeconomic headwinds pose a challenge to industry growth. However, our commitment remains on delivering long-term profitable growth, and we are making pragmatic investments to support these plans. We recently announced a realignment in our organizational structure, reallocating more dedicated resources to new growth pursuits, expanding our sales force, adding sales leadership to gain market share, and investing in resources to support the expansion of product management, development, and engineering. As an organization, we are focused on navigating the challenges in the current environment while positioning ourselves to deliver on our long-term strategic initiatives. I'll now turn the call over to Derek to discuss our strategic initiatives and operational priorities before Alejandro takes you through further details of our financial results. 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. As Jerry emphasized, we are firmly committed to our strategic growth plans. Given the current economic uncertainty, many furniture manufacturers are responding by scaling back resources and investments, but we are gearing up for growth. We are managing expenses and cash flow prudently to stay nimble, but we remain on the path to success and are driving investments for future growth. I'd like to expand upon some of the recent growth investments Jerry highlighted earlier. First, we are realigning our leadership structure to accelerate new growth initiatives. Tim Newlin, who is a 25-year veteran of Flexsteel, has been named Vice President of Strategic Business Development. In his new role, Tim will leverage his experience and deep knowledge of the furniture industry to accelerate innovation and incubate new ideas that will expand Flexsteel's business models, brands, products, and channels in profitable and fast-growing areas of the market. David Crimmins expands his responsibilities as Vice President of Sales and Product. David has leadership responsibility for driving our omnichannel strategies in our core business across retail, big box, and e-commerce. Additionally, he will strengthen the integration of our product and sales teams to improve our new product speed to market and success rate. Second, we are strengthening resources and investments dedicated to each of our three major sales channels. For example, in our retail channel, we recently created a new role of Retail Sales Vice President, who is solely focused on driving continued market share gains in that channel. We are also expanding our retail field sales team by over 10% to promote stronger customer relationships and gain share. And we've committed to implementing a new CRM solution by mid- to late 2023 to improve our customers' experience. We are making similar investments to support the big box and e-commerce channels as well. Third and lastly, we are investing in our product development and engineering capacity to substantially increase both the number and speed of new product launches in the future. We're confident these collective structural changes and investments will make us more competitive and help drive profitable growth. Now, turning to our specific growth initiatives. Recall that our growth strategy for new business has three legs: new sales distribution, new product categories, and new consumer segments. We're making solid progress on all three fronts, and the growth potential of these pursuits will accelerate into the second half of the year. Let me share a few highlights. Beginning with new sales distribution, we've made a meaningful entry into big-box distribution this year with a major customer who will become a top 10 and potentially even a top 5 account for us. We are selling a broad set of Flexsteel products to them this year that span all three of our major product categories: motion furniture, stationary furniture, and case goods, and will include launches of our major new products this year, such as Flex, the Charisma brand, and some exclusive offerings tailored to this retailer. We also have market tests scheduled in the second half with several other large big-box retailers, which could evolve into meaningful revenue next fiscal year. Next is new consumer segments. Last quarter, we launched our new brand, Charisma, designed to serve customers, especially younger generations seeking good quality, stylish furniture at affordable prices. Initial retail adoption has been good, and we will extend the sales distribution of Charisma into e-commerce and big box in the second half of the year. Development is already underway to expand the product offering of Charisma, and we expect to show several new smaller stationary frames at the upcoming April High Point market. Last is new product categories. We remain on track for a third quarter launch of Flex, our small parcel contemporary modular furniture solution built to flex with people's ever-changing lives. Flex has been well received across all channels of our business and will be available for sale this quarter across four different distribution platforms, including direct-to-consumer, traditional retail, e-tailers, and big box customers. To protect our innovation, we filed both design and utility patents for this product. The other new product that we're extremely excited about is Decliner, our fleet solutions recliner, which begins shipping to customers in March. Customer feedback has been overwhelmingly positive, and we expect strong and broad sales distribution for this product across both traditional retail and adjacent channels. Development is already in progress to offer additional product enhancements, and we are committed to driving meaningful innovation in the health and wellness category to make Decliner a leader in this emerging space. The organization is intensely focused near term on ramping up sales for these growth initiatives, and we're excited to see the results in the coming quarters. From an operational viewpoint, we are executing well, maintaining strong service levels and continuing to deliver strong results from our cost savings initiatives. In the near term, these savings are being used to fund price reductions to respond to competitive pressures. While these pressures won't dissipate completely, we do expect the pricing environment to improve modestly in the second half of the fiscal year since both retailer and manufacturers' inventories have improved slightly. As a result, we expect more of our cost savings efforts to fall to the bottom line. With that, I'll turn it over to Alejandro to give you additional details on the financial performance for the second quarter and outlook for the third quarter of fiscal year '23.

Thank you, Derek. Good morning, everyone. For the second quarter, net sales were $93.1 million, down approximately $48.6 million or 34.3% compared to $141.7 million in the prior year period. While down from the prior year, our sales results were within our guidance of $87 million to $97 million provided during our first quarter earnings call. From a profit perspective, in the second quarter, the company delivered operating income of $3.8 million or adjusted operating income of $1.0 million or 1.0% of sales, which was within our guidance range of negative 1.5% to positive 1.5% for the quarter. We recorded net income of $2.9 million and earnings per diluted share of $0.53. Adjusted net income for the quarter, which excludes the one-time benefit related to the settlement of the Indiana EPA litigation, was $0.4 million, and adjusted income per diluted share was $0.08. Gross margin as a percent of net sales in the second quarter was 17.0%. The over 1,000 basis point improvement from the prior year quarter was largely driven by effectively reducing ancillary charges, prudently managing costs, and navigating competitive pricing pressures, partially offset by volume decline, deleveraging of fixed costs, and continued inflation in domestic transportation charges. Operating income was also supported by a $2.7 million reduction of SG&A expense, mainly through reduced compensation expense and control of other SG&A spending. Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $1.8 million and working capital of $107.1 million, which represents a reduction of $9.0 million during the quarter, primarily driven by a $10.6 million decrease in inventory. The result of the strong working capital management was solid operating cash flow of $11.6 million during the quarter. As previously communicated, debt reduction is a key priority. And in the quarter, we reduced our outstanding borrowings by approximately 36.1% or $10.9 million. Looking forward, guidance for third quarter sales is between $93 million and $103 million. While our strategic growth initiatives will begin to drive meaningful revenue in the second half of the year, the continued macroeconomic challenges will continue to put pressure on our core product offerings. However, we are optimistic that our growth initiatives will help to offset the soft consumer demand and result in quarter-over-quarter growth in the second half of the fiscal year. Regarding profitability, the impact of our growth initiatives will allow for profit margins to improve sequentially each quarter in the second half of the year. However, competitive pricing pressures, along with continued slumping demand, will temper our profitability expansion. We will continue to focus on practical spending levels in line with lower sales levels but invest in our growth strategies to drive long-term profitability. As such, we are projecting operating income as a percentage of sales in the range of 1.0% to 2.5% for the third quarter, with the largest drivers of variability in the range being consumer demand, competitive pricing conditions, and macroeconomic headwinds. We expect gross margins in the range of 16.5% to 18% in the third quarter as our growth initiatives and cost savings initiatives will drive margin expansion. However, we see this being partially offset by continued pricing pressures in the market due to the compressed demand previously discussed. If sales continue to improve as expected during the remainder of the fiscal year, gross margins should sequentially improve quarter-over-quarter to between the mid- to upper teens. We intend to prudently control SG&A costs and expect SG&A costs between $15 million and $16 million in the third quarter, which is higher than the second quarter as we are actively investing in our growth initiatives discussed by Derek. Regarding our cash flow outlook for the second half of the fiscal year, we expect working capital to be a source of cash, largely driven by a modest reduction in inventory, partially offset by a growing accounts receivable balance due to the higher revenue. However, the timing of the working capital reduction will be heavily weighted in quarter 4 as we expect working capital to be a modest use of cash in quarter 3 as accounts receivables grow in line with sales, and we deepen our inventory positions of our best-selling fast-moving SKUs. For the third quarter, we expect capital expenditures between $1 million and $1.5 million as we invest in the expansion of our ERP capabilities. We also may continue to opportunistically repurchase shares at a modest spending level if the stock price remains at a significant discount to our view of the intrinsic value. We continue to forecast our debt levels at the end of fiscal 2023 in the range of $4 million to $12 million. The effective tax rate for fiscal 2023 is expected to be in the range of 27% to 28%, excluding the impact of any revaluation of deferred tax asset valuation allowances. Now I'll turn the call back over to Jerry to share his perspectives on our outlook.

Thanks. I'm optimistic about our future. Slowing economic growth and waning consumer demand are obvious challenges for the industry. However, we continue to make prudent investments to ensure our profitable growth and success long term. In the near term, we remain focused on delivering on our strategic initiatives, controlling costs, and generating cash flow to pay down debt and preserve liquidity while sensibly investing in growth opportunities. With that, we will open the call to your questions. Operator?

Our first question will come from Anthony Lebiedzinski of Sidoti and Company.

Good morning, guys, and thank you for taking the question. Yes, you've done a very good job of reducing your own inventories. And Derek, you mentioned, I believe, that inventories overall and at the retail level have improved slightly. So what is your sense as to when inventories overall in the retail channel will get back to so-called normal levels?

Yes, Anthony, this is Jerry. Good question. We just wrapped up our West Coast market in Vegas, where we spoke with several hundred dealers and assessed the situation. The response is that it's still somewhat unstable. Some people are placing orders, and they are noticing their inventories decreasing. However, many still have inventory on hand. Foot traffic has decreased slightly, which means that inventories are not depleting as quickly as expected. It could take anywhere from 3 to 6 months or possibly the entire calendar year, depending on the retailer. Some have seen a significant reduction, while others mentioned it could take another 6 to 9 months to lower their stock.

Got it. Okay. So it sounds like a mixed bag there, okay. But it sounds like also we are past the peak levels as well. So that's good to hear.

Correct.

Do you have any ballpark estimate as to how much of the various growth initiatives you guys talked about? How much did that contribute to the quarter in terms of operating performance?

Yes, I won't comment on the quarter, but we have provided guidance in the past and in our current forecast for all of our incremental growth initiatives is between $30 million and $40 million of revenue in the full fiscal year.

Got it. Yes. And then as far as margins for those initiatives, whether the big box rollout or Charisma or Flex, are the margins for those products comparable to the company average? Or how would you characterize that?

Anthony, it's Alejandro. Really good question. We're driving the growth initiatives to drive accretion in our margin overall.

It's encouraging to hear. Regarding the overall operating margins, it's nice to see a significant improvement compared to last year. In fiscal '21, the operating margin was around 6.5%. I understand that the operating environment has changed considerably since then. However, it appears that ocean freight costs have decreased and labor rates have become more stable. While you've provided guidance for Q3, looking ahead to fiscal '24, I know you haven't released guidance yet. Broadly speaking, how should we anticipate the operating margin will evolve going forward?

Anthony, it's Derek. So as we look out for the balance of the second half, we are starting to work through some of our higher-cost inventories. And so we'll see margins stabilize and sequentially improve throughout the quarter. We expect a similar trend in fiscal year '24. Sequential improvement kind of year-over-year. We do plan on investing more behind our growth initiatives. So I stated earlier in the call, we're adding roles dedicated to our strategic growth initiatives. We're expanding capacity around new product development. So some of the incremental margin improvement year-over-year will be tempered by higher investments, which we believe will have a phenomenal ROI and will drive long-term profitable growth.

Got it. Yes. Thanks for the update, Derek. And then any update on the Mexicali facility. Where are you guys with that?

Yes. So certainly, in the near term, we do not foresee a need to utilize that, and we're still evaluating and pursuing opportunities to potentially sublease that in the near term, but still keep it as a long-term option to support our growth.

Got it. Okay. All right. Well, thank you, and the best of luck going forward.

Thanks, Anthony.

Our next question will come from JP Geygan of Global Value Investment Corporation.

It sounds like you had some very interesting developments, particularly Decliner beginning to ship in March and the imminent launch of Flex. You addressed the impact on margins with Anthony, but can you discuss both of those initiatives? And then the expected impact of your strategic growth plans on the overall business, revenue, margins, or product penetration, but really more broadly.

Okay. I think as we look at all of our growth initiatives. Recall that we've kind of split them out in these three legs: new consumer segments, new sales distribution, new product categories. I think the impact of these growth initiatives on the company longer term will position Flexsteel where the market is going to grow. We're still certainly dedicated to our traditional retail channel, as obvious by the investments that we mentioned earlier. But in two to three years, a much larger proportion of our sales will come from the big box channel and e-commerce. A larger proportion of our sales will come from more modern, stylish furniture that is geared towards younger generations. And I think what you'll find is that we're pivoting toward differentiated innovation as a competitive advantage as a company. And I think Flex and Decliner are good examples of that in the near term. And we're going to continue to challenge ourselves on how we bring meaningful innovation that's different from the competitive set because there's a lot of furniture out there. So I think everything that we have going on near term is really an example of how we're trying to transform the company for the long term.

Can you discuss your entry into the big box segment, particularly the impact on margins, both short term and longer term? And then other nuances perhaps like inventory or storage requirements or fulfillment requirements and any challenges you faced thus far?

Yes, I believe that the margin profile for big box stores is better than our current portfolio average. As Alejandro mentioned, we anticipate that our growth initiatives will contribute to long-term margin expansion, including within the big box segment. Currently, the majority of our sales through that channel are online, and we are not necessarily aligning our inventory with retail stores. We expect this to change in the future, but it mainly remains an online business. There have been valuable learnings about the expectations of that channel, which I think will ultimately strengthen our company. We are reevaluating our factory audits, quality programs, and fulfillment services. This process will push us to develop capabilities that will benefit other areas of the business and lead to accelerated growth.

Yes, JP, this is Jerry. We are accustomed to distributing products to various dealers across the country due to our extensive distribution network. This situation remains consistent. Currently, we are engaged in deep trials with three to four major retailers, and they are yielding positive results. Derek mentioned valuable insights, which we are gaining primarily because much of this product doesn’t go through our typical distribution channels; most is sold online. We also have upcoming trials with several large chain stores. The exciting aspect is that the insights we are gaining will significantly benefit our core business by helping us achieve better balance. A lot of this involves products we already have, and we are also working on developing new products tailored for these channels.

Understood. That's helpful. How should we expect your capital allocation priorities to change, if at all, as you focus on strategic growth? And in particular, how much debt are you comfortable carrying in your capital structure? And how do you intend to modulate dividends and the share repurchases?

This is Alejandro. JP, good question. We've talked about this. First and foremost, we're focused on paying down our debt, with the outlook of somewhere between $4 million and $12 million by the end of fiscal year 2023. That doesn't mean we're not opportunistically looking for growth opportunities to invest in, but we're measuring those against an ROI profile. So first and foremost, we want to pay down debt and then look for strategic opportunities to invest, whether that be equipment, machinery capabilities, or even expansion from a production perspective. And at this time, we're not thinking about changing our dividend outlook for our investors. But, obviously, that's something we discuss with our board on a very regular basis, and we'll continue to have those discussions. But we want to add the best value possible back to our shareholders.

JP, just to add to Alejandro's comments. As we think longer term, again, our intent is to start to build up both cash as well as debt capacity to pursue strategic acquisitions. Long term, or, I guess, mid-term, we would be comfortable going up to 3 to 3.5x EBIT in terms of debt levels to pursue the right acquisition. But we do want to continue to strengthen the balance sheet so that we can pursue those opportunities if the right one comes along.

The other question you had, JP, was in regards to our share repurchase. We will continue to look at that and be opportunistic if our stock stays at a level that we feel is a very good investment for our shareholders. We will continue to do that.

Okay. And then one final point of clarification. Derek, you alluded to an ROI expectation on your strategic growth initiatives before. Can you put any sort of color around that?

Yes. I can share that we assess all our investments in relation to our cost of capital. We are confident that our capital deployment will lead to the creation of shareholder value. While I won't provide specific ROI figures, I want to assure you that we believe these initiatives are beneficial.

Okay, appreciate your time and thanks for taking my questions, and congratulations on a nice quarter.

Thanks, JP.

The next question comes from John Deysher of Pinnacle.

Just to confirm, the product that's going into the big box retailers, that's your brand, correct? You're not doing any type of private labeling...

We're actually doing a combination of both. Sometimes they are using their own brands, sometimes they are using our brands, and we are also planning to introduce some new labels that we may use in the future.

Currently, though, John, the vast majority of what is flowing through big box today is Flexsteel branded, but we are exploring some other white label options for what I'll call lower-cost products.

Okay. White Label is private label?

Correct.

Okay. All right. So you'll be able to discuss that more as you get through the process of testing and all of that, correct?

Yes. Correct.

Okay. Fair enough. The other question is, what was the backlog at the end of the quarter?

Roughly $60 million. It's been, I think, since the beginning of the year, kind of floating between $55 million and $60 million. So it's stabilized and back to normal levels.

Okay. Very good. Thanks, and good luck.

Thank you.

Thank you.

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

Thank you. In closing, I would again like to thank all our Flexsteel employees for their outstanding performance and service during the second quarter. We are really excited about our future and what everyone is bringing with us. I would also like to thank you for participating in today's call. Thank you for those that asked questions. And please reach out with any additional ones. We look forward to updating you on our next call. Thanks, everybody. Have a great day.

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