Flexsteel reports 3.4% sales growth amid tariff uncertainties, boosting cash flow and adjusted margins while navigating a choppy market environment.

OPERATOR - (00:00:00)

Please hold for the start of the conference call. And welcome to the Flexsteel Industries fourth quarter and fiscal year 2025 earnings conference call. All participants will be in a listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions to ask a question you may press star and then one on your touchtone phones. To withdraw your questions you may press star and two. Please also note today's event is being recorded. I would now like to turn the conference call over to Mike Ressler, Chief Financial Officer for Flexsteel Industries.

Mike Ressler - Chief Financial Officer - (00:02:55)

Please go ahead. Thank you and welcome to today's call to Discuss Flexsteel Industries fourth quarter and fiscal year 2025 financial results. Our earnings release which we issued after market close yesterday, Monday, August 18th is available on the Investor Relations section of our website at www.flexsteel.com under News and Events. I'm here today with Derek Schmidt, 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 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 10K as updated by our subsequent quarterly reports on Form 10Q 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'll turn the call over to Derek Schmidt.

Derek Schmidt - President and Chief Executive Officer - (00:04:52)

Derek, Good morning and thank you for joining us today. I am pleased to share with you our fourth quarter and fiscal year 2025 results. We continue to execute well and delivered strong results in the quarter while soft market conditions and tariff uncertainty remain industry headwinds. We continued our growth momentum and delivered 3.4% sales growth in the quarter which represents our seventh consecutive quarter of year over year growth positively. The drivers of our growth remain diverse as we grew in both our core markets and our new and expanded market initiatives. Within core markets, we continue to grow successfully with strategic accounts where we are continuously improving and differentiating the customer experience and from new product introductions that are resonating well with both retailers and consumers. The major contributors of growth in new and expanded markets remain market penetration in the health and wellness category led by our ZKliner products and development in the case goods category where retail placements of new product are expanding. I'm also pleased with our continued profitability improvement and strong cash generation. Our adjusted operating margin of 9% in the quarter represents our ninth consecutive quarter of year over year improvement and a 340 basis point improvement over the prior year quarter. The levers driving our profit improvement are unchanged and working effectively and include sales growth, leverage, strong operational execution and productivity and product portfolio management. Additionally, we delivered free cash flow of $19.1 million in the quarter and bolstered our ending cash to $40 million. Compared to our competitors, our strong financial position remains an advantage in this period of choppy demand and elevated uncertainty in many aspects. Fiscal year 2025 was a very successful year for Flexsteel, and I'm proud of the team's accomplishments. I firmly believe that our greatest advantage is our talent and culture. We made great strides in the past year recruiting, developing and promoting high potential talent who drive our strong execution and in strengthening our culture and employee engagement which fosters an environment where people can thrive and be their best and the results are impressive. For the year, we delivered sales growth of 7% in a challenging industry environment, expanded adjusted operating margins by 270 basis points to 7.1%, increased adjusted operating profit by 71% to $31.2 million and generated $45 million of free cash flow which enabled us to increase our dividend twice in the past 12 months and build a healthy cash balance of $40 million. As important as the financial results is the progress we've made in developing our strategic capabilities and strengthening our competitive advantages, as these are the key determinants of our ability to continue profitably gaining share in the years ahead. Let me share some highlights of our strategic progress and how we intend to build upon them in fiscal year 2026 in our core markets. We expect the drivers of our growth to continue to come from strategic accounts and new products. For strategic accounts, we've completed a deep customer segmentation and Voice of the Customer study. We're leveraging this work to tightly align our resources to strengthen support for our most important customers and we've mobilized aggressive plans to elevate our value proposition by delivering a customer experience that is truly advantaged and differentiated. We're confident that we can continue to drive meaningful share gains with with these strategic accounts. On the new product front, we are ramping and broadening our consumer insights capabilities to drive bigger, bolder innovation and bolster more relevant on trend designs. We are also improving the standardization of our product platforms and commonization of parts to accelerate speed to market for new product development. Lastly, we've successfully invested in building stronger marketing capabilities over the past several years and plan to continue to scale marketing to drive more brand awareness and demand generation. By driving more innovation, stronger product relevance, faster product launches and more powerful marketing, we believe that new products will remain a key source of growth in the new year. Turning to new and expanded markets, our primary focus is on further penetrating the health and wellness and case good product categories and broadening our distribution with national accountants. We're encouraged by our initial success in health and wellness with our ZKliner sleep chair and we intend to lead this new category with bolder, faster innovation and new product development this year. We also expect to broaden our health and wellness positioning with new solutions that address consumer needs beyond just sleep in case goods. We built a strong supply chain with superior capabilities that we'll leverage to launch a meaningful expansion of compelling new product in fiscal year 2026, further supported by increased investment in marketing. Lastly, we intend to broaden our sales distribution to ensure that the flexsteel brand is positioned everywhere consumers want to buy furniture by expanding our business with Wayfair and Costco and developing new partnerships with Macy's and other key national accountants. To summarize, we have clearly defined growth strategies, have or are building advantage capabilities to differentiate ourselves, and have aligned our talent and resources to successfully execute the plans to deliver on these priorities. While I'm confident in the strategies mentioned and our ability to execute, we do anticipate that difficult industry conditions will persist in the near term and we must remain agile to effectively navigate the choppy environment and macro uncertainty largely stemming from tariffs. Tariffs represent a major risk to both demand and margins in the new year. To overcome the demand risk, we will continue delivering an exceptional customer experience differentiated to innovative new products, high ROI marketing investments and deeper penetration in the new or expanded markets. The margin risk from tariffs, notably the 20% tariff on imports from Vietnam, will require a multifaceted approach to mitigate, including supply chain adjustments, new cost savings initiatives and limited pricing actions. We have strong partners in our value chain, both suppliers and customers, and are working collaboratively with them to address the effects of tariffs while minimizing the impact on consumer prices and demand. On the supply side, we've been actively working with existing suppliers to expand their geographical capabilities beyond Vietnam while simultaneously identifying new suppliers in other countries. These moves will enable us to move quickly to optimize our supply chain once the tariff situation stabilizes. We have also been working closely with our suppliers to identify new cost savings and efficiencies to offset part of the tariff burden, and we have identified new sources of productivity and structural cost reduction within our own operations to further mitigate the financial risk of tariffs. While these efforts are expected to be meaningful, they alone will not offset all the tariff exposure. As such, we partnered with our retailers to understand consumers price sensitivity and subsequently announced tariff surcharges ranging from 4% to 8.5% effective August 1 that will further reduce our tariff exposure without significantly impacting unit demand. The situation with tariffs remains dynamic and we will continually evaluate and pursue options to minimize the margin impact on our business without diluting our growth momentum. Our team is agile and is well positioned to navigate subsequent changes in the tariff environment or effects on the economy and consumer demand. I'll be back momentarily to share my closing thoughts. With that, I'll turn the call over to Mike who will give you some additional details on the financial performance for the fourth quarter and the financial outlook for the first quarter of fiscal year 2026.

Mike Ressler - Chief Financial Officer - (00:13:57)

Thanks, Derek. For the fourth quarter, net sales were $114.6 million or growth of 3.4% compared to net sales of $110.8 million in. The prior year quarter. As Derek mentioned, this marks our seventh. Consecutive quarter of sales growth compared to. The prior year periods and near the upper end of our guidance range of 109 to 116 million dollars. The increase was primarily driven by higher unit volume of soft seating products, partially offset by lower unit volume and our Homestyles branded Ready to Assemble category. Sales order backlog at the end of the period was $66.5 million, an increase of $6.9 million compared to the prior year ending backlog of $59.5 million. From a profit perspective, the company delivered GAAP operating income of $14.0 million or 12.2% of sales in the fourth quarter. The GAAP operating margin includes a $3.7 million pre tax gain on the sale of an ancillary building formerly part of our Huntingburg, Indiana distribution center complex. When adjusted for the impact of this gain the company delivered adjusted operating income of $10.3 million or 9% of sales in the fourth quarter, which was above the top end of our guidance range of 6.0 to 7.3% of sales. The outperformance to our guidance range was primarily due to $1.9 million in favorable foreign currency translation over peso denominated assets in Mexico resulting from the peso significantly strengthening against the US Dollar in the quarter. Tariffs had a net dilutive impact to operating margin in the current quarter, roughly 40 basis points when compared to the prior year period. Moving to the balance sheet and statement of cash flows, the company ended the quarter with a cash balance of $40 million, working capital of $110.4 million and no balance on our line of credit. During the quarter, we increased safety stock of our top sellers to hedge against higher tariff rates and enter the first quarter of fiscal year 2026 well positioned to continue delivering exceptional service levels to our customers. Looking forward, we believe we have the. Strategies in place to effectively navigate the current environment, but a significant change in macroeconomic factors could materially impact our outlook for the first quarter. We expect sales between 105 and $110 million or growth of 1 to 6%. The main drivers of variability in sales for the first quarter will be consumer demand and price realization from tariff surcharges in response to higher tariff rates. While we believe we have taken the appropriate pricing actions to minimize the impact of tariffs while maintaining competitive consumer price points, there is still risk and uncertainty around the impact of higher consumer prices on unit demand. We expect gross margins between 21.5 and 22.5% in the first quarter, with the largest drivers of variability being top line sales and the effectiveness of our tariff mitigation efforts. Our gross margin assumes the 20% tariff on Vietnam imports that went into effect in August remain in place and that our Mexico imports remain tariff free under usmca. As Derek mentioned, we have a multifaceted approach to mitigating the impact of tariffs and we'll remain agile and continue working closely with our supply chain partners and customers to navigate the dynamic environment. We expect that our collective tariff mitigation actions will nearly offset the cost of tariffs in the quarter. Given the high level of economic uncertainty and challenging market conditions, we will prudently manage SG and A spending and be mindful of adding structural costs to the business. With that said, we will continue to make high ROI investments in new product innovation and marketing to maintain our growth momentum and project SG and a cost between 16.8 and $17.3 million. For the quarter, we are projecting operating income as a percentage of sales in the range of 5.5 to 7.0% for the first quarter. Regarding our cash flow outlook, our fiscal first quarter is normally a period with heavy outflow due to the timing of incentive compensation payouts, annual insurance premiums and prepaid software and service agreements. With that, we expect free cash flow for the quarter in the range of negative 5 million to $0. Near term priorities for cash remain resourcing our strategic priorities and funding capital expenditures. We may be opportunistic with share repurchases at modest spending levels if the stock price is at a significant discount to our view of intrinsic value. For the first quarter, we expect capital. Expenditures between 1.0 and $1.5 million. The effective tax rate for fiscal 2026 is expected to be in the range of 25 to 27%. Now I'll turn the call back over to Derek to share his perspectives on our outlook.

Derek Schmidt - President and Chief Executive Officer - (00:19:36)

Thanks Mike. I am pleased with Our fiscal year 2025 results and strategic progress, and our team is intensely focused on executing the growth strategies and profit improvement initiatives to deliver strong financial results again in fiscal year 2026. We also recognize that the external environment is dynamic and we must remain agile to respond to material shifts in tariff policy, consumer spending and other external influences on our business. I am confident that the company is well positioned to both execute plans to gain share while improving profitability and to effectively navigate unpredictable changes in the external landscape. In summary, Flexsteel, is financially strong, competing well and gaining share. I'm encouraged by Our fiscal year 2025 results and growth momentum, excited about our future, and confident in our ability to continue creating significant value for our customers and shareholders. With that, we will open the call to your questions. Operator.

OPERATOR - (00:20:46)

Ladies and gentlemen, at this time we'll begin that question and answer session. If you would like to ask a. Question, please press star and 1. Using a touchtone telephone to withdraw your questions, you may press star and 2. If you are using a speakerphone, we do ask that you please pick up the handset prior to pressing the keys to ensure the best sound quality. Once again, that is Star and then one to join the question queue. We'll pause momentarily to assemble the roster and our first question today comes from Anthony Lubodzinski from Sidonia and company. Please go ahead with your question.

Anthony Lubodzinski - Analyst - (00:21:30)

Good morning everyone and thanks for taking the questions and certainly nice to see the strong finish to the fiscal year. So my first question is in terms of the pricing actions or surcharges, to be more precise, that you have taken already. I know it's still early. I believe you took those actions on August 1st. But can you just comment on the initial reaction or just really want to better understand the elasticity of demand that you have observed thus far given the surcharges that you put in place?

Derek Schmidt - President and Chief Executive Officer - (00:22:10)

Hey, Anthony, it's Derek. I'll take that question and Mike can add in. I think certainly you're aware of the current environment. It's challenging from a consumer perspective. And so we were very sensitive to how much price we could push into the market. We have collaborated very closely with our retailers to understand again, their view on what they believe price points changes, how they might impact demand. And we certainly fully considered that. What I will share with you is that we have benchmarked the pricing surcharges that we push through the market, which as we've explained, range between 4 and 8.5%. We are actually at the low end of the competitive set in terms of what others have pushed out in the market. So we believe that. I'm not sure if we're advantaged, but we're certainly not disadvantaged. The other important thing to note, Anthony, is that simultaneously with the tariff surcharges that we put in place, we we actually reduced existing ocean freight surcharges largely to keep retail prices of our product relatively stable at retail. So again, we pushed through a turf surcharge, but we've also simultaneously pulled back on ocean freight surcharge. And so we're trying to minimize the retail price impact to consumers given the challenging environment. And I believe we're well positioned, given that approach to continue growing and gaining share in this environment, despite some of the challenges. Macroeconomic challenges.

Anthony Lubodzinski - Analyst - (00:24:07)

Understood. Okay. And then you also talked about that you're looking to do or planning to do some new cost savings initiatives to deal with the tariffs. So can you expand on that and whether any of these new initiatives are factored into your first quarter guidance for margins?

Derek Schmidt - President and Chief Executive Officer - (00:24:29)

Hey, Anthony, in terms of cost savings, you know, we're aggressively pursuing cost savings across our entire supply chain. Supply chain, whether it's within our own manufacturing operations, within our international freight, our domestic logistics organization, our sourcing team is working closely with our suppliers in Asia on secondary supply chains over there. So it's really a multifaceted approach in those cost savings as well as, you know, the surcharge is what we're looking at to try to neutralize the impact of tariffs. And I would say that we do have you know, those ongoing cost savings and incremental savings kind of baked into our outlook here for Q1 and into the future. I mean, as it stands right now, Anthony, I mean, we remain relatively confident that the culmination of the cost savings initiatives, working collaboratively with our partners and the modest pricing actions taken in totality, we believe that we can largely offset the margin impact from tariffs as it stands today.

Anthony Lubodzinski - Analyst - (00:25:38)

That's very encouraging. And in terms of new product innovation, it's something that you guys have talked. About for a while. That being said, are you focusing on that more so now than you have previously, or is this, would you say it's just more or less kind of a continuation of the recent trends?

Derek Schmidt - President and Chief Executive Officer - (00:25:59)

Yeah, Anthony, I would describe it as a continuation. I think we've been relatively aggressive over the last year or two years in terms of investing in innovation, driving relevant new product development, and we're going to continue to that pace. It's been, I think, a key part of our growth success and we intend on keeping that intensity.

Anthony Lubodzinski - Analyst - (00:26:23)

Understood. Okay. And then, you know, your inventories came in actually lower than expected, even though I think, Derek, you said that you brought in some additional safety stocks. So just curious, you know, given with everything that's going on, how should we think about inventories going down forward here?

Derek Schmidt - President and Chief Executive Officer - (00:26:43)

Hey, Anthony, we feel really good about our overall inventory position and our ability to serve our customers, particularly on a unit volume perspective. We continue to kind of reposition, you know, our inventory to top sellers, et cetera, and work out of, you know, maybe some of kind of the legacy, lower performing, less profitable SKUs. So from a unit perspective, you know, we would, we feel like we're in a really good spot and that we would kind of maintain those levels. Obviously, if we see a change in the demand signals, you know, we'll pivot and adjust accordingly. We will see a little bit of, you know, incremental cost as we start to bring inventory in with higher tariff rates on them, but wouldn't anticipate a significant movement in our overall inventory at this point in time. Gotcha.

Anthony Lubodzinski - Analyst - (00:27:32)

Okay. And lastly for me. So just wondering if you had have any updated thoughts on your capital allocation strategy given your growing cash position. I know you've raised the dividend twice last fiscal year, but other than that, just wondering if you have any other additional thoughts on that.

Derek Schmidt - President and Chief Executive Officer - (00:27:52)

Yeah, Anthony, I would just say our allocation strategy remains intact. We've talked about 70% of operating cash flow reinvested back in the business, 30% return to shareholders. We're certainly financially responsible and if there's not an investment opportunity that, you know, yields a return above our cost of capital, we won't pursue that. And we'll certainly, you know, leverage dividends and our share buybacks to return capital to shareholders based on kind of the capital needs of the business.

Anthony Lubodzinski - Analyst - (00:28:27)

Understood. Well, thank you very much and best of luck.

Derek Schmidt - President and Chief Executive Officer - (00:28:30)

Thanks, Anthony.

OPERATOR - (00:28:38)

Once again, if you would like to ask a question, please press Star. And then one. Our next question comes from Phil Deselem from Teton Capital Management. Please go ahead with your question.

Phil Deselem - Analyst - (00:28:51)

Great. Thank you. We have two questions. First of all, demand. How would you characterize demand given that the housing market has been slower and yet people are staying in homes longer and yet there's this idea of confidence level specifically tight around tariffs being a headwind? Are you seeing behaviors, whether it be month to month or week to week, tied to any of the news in the market that you can see changing demand? What insights do you have that you can share beyond what you've already discussed?

Derek Schmidt - President and Chief Executive Officer - (00:29:47)

Good morning, Bill. Great question. The way I would characterize demand right now is choppy. Typically, the summer months for the furniture industry tend to be. Softer. What we've kind of universally heard from our retailers is that retail traffic has indeed been soft this summer. It's been a bit kind of sporadic, unpredictable. We will see here in a couple weeks. The Labor Day is typically one of the bigger furniture holiday selling periods. So I think, you know, we'll get a stronger pulse on the state of the consumer here in a couple weeks, depending on what we see from Labor Day. But the best way I could characterize it here is choppy. And most of our retailers would certainly attribute that choppiness to the fact that there's been uncertainty around tariffs. There's concerns around potentially increasing inflation because of tariffs. Interest rates kind of still remain relatively high to where they've been here in the last several years. So I think there's still several challenges and roadblocks to unleashing more substantive kind of consumer spending. But overall, as we start to think about the midterm long term, we're still bullish. We believe that housing demand is strong, that at some point here that demand has to be fulfilled. We believe that the economy is still on relatively strong footings right now and that we're hopeful that we'll see an economic recovery here, certainly in the midterm, and a surge in kind of furniture demand, and we believe that we're positioned for that. But to your point, I think in the near term, things are going to remain choppy until we get more clarity on ultimately how tariffs are going to impact inflation and what's going to happen to interest rates.

Phil Deselem - Analyst - (00:32:04)

All right, thank you for that. And then relative to the peso strengthening, are we doing the math correctly, that the 300 basis point benefit to gross margin, that that equates to roughly $3.4 million. If we tax effect that, it's about 45 cents benefit. If we were to do a constant currency comparison to last year, 75 cents on a, on an operating basis, it would be like 95 cents versus 75 cents. Is that, is that the right way to think about those numbers?

Mike Ressler - Chief Financial Officer - (00:32:42)

Well, Bill, what I would do is in the current quarter, so Q4 results, we had about a $1.9 million benefit in the current quarter as it relates to our translation gain. On an adjusted basis, our operating margin would have been probably closer to 7.3%, which was near the top end of our guidance range. And just to maybe put a little bit more color on that, Bill, normally when the currency is relatively stable, the translation exposure and our operating exposure are a natural hedge. It was just, I think in this last period, we saw a abnormally large movement between the peso and the US Dollar, which is why we had a net favorable translation. But if you look over the entire year, translation was relatively relatively neutral. It just happened to be significant in the quarter given the large fluctuation in the currency rate.

Phil Deselem - Analyst - (00:33:48)

Understood. Thank you both and congratulations on another step forward. Great quarter.

Derek Schmidt - President and Chief Executive Officer - (00:33:57)

Thanks, Bill.

OPERATOR - (00:34:00)

Once again, if you would like to ask a question, please press star and then 1. To withdraw your questions, you may press star and 2. And ladies and gentlemen, at this time and showing no additional questions, I'd like to turn the floor back over to management for any closing remarks. Thank you.

Derek Schmidt - President and Chief Executive Officer - (00:34:23)

In closing, I want to thank all. Of our Flex Seal employees for their. Dedication and outstanding performance during the fiscal year. I'm also thankful to all of you for participating in today's call. Please contact us if you have any additional questions and we look forward to updating you on our next earnings call. Thank you and have a good day.

OPERATOR - (00:34:44)

Ladies and gentlemen. With that, we'll conclude today's conference call and presentation. We do. Thank you for joining. You may now disconnect your lines.