Flexsteel Industries achieves 6.2% sales growth and improved margins, but warns of tariff impacts on future demand.

OPERATOR - (00:01:24)

Good day and welcome to the Flexsteel Industries first quarter fiscal year 2026 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal 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 then one on a touchtone phone. To withdraw your question, please press Star then two. 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.

Mike Ressler - Chief Financial Officer - (00:02:04)

Thank you and welcome to today's call to discuss Flexsteel Industries first quarter fiscal year 2026 financial results. Our earnings release which we issued after market close yesterday, Monday, October 20th 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 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 and with that, I'll turn the call over to Derek Schmidt.

Derek Schmidt - President and Chief Executive Officer - (00:03:58)

Derek, Good morning and thank you for joining us today. I am pleased to share with you our first quarter results. We continue to execute well and delivered strong sales growth and sizable year over year profit improvement in the quarter. While industry demand remains lackluster due to challenging macroeconomic conditions. We continued our growth momentum and delivered 6.2% sales growth in the quarter which represents our eighth consecutive quarter of year over year growth. Encouragingly, the sources of our growth remain diverse and balanced across our core market initiatives and new and expanded market efforts in our core new products and share gains with strategic accounts continue to drive growth in new and expanded markets. Growth is primarily driven by ramping sales in both our case goods and health and wellness product categories. We feel confident that our growth strategies are working and will continue to drive future sales increases propelled by focused investments in consumer research, new product development, innovation and marketing. While I'm pleased with the success of our consistent top line growth over the past two years, particularly considering industry headwinds, I'm also especially pleased with our progress driving meaningful year over year profitability improvement. Operating margin was 8.1% in the quarter, up 230 basis points compared to 5.8% in the prior year quarter and represents our 10th consecutive quarter of year over year adjusted operating margin improvement. The levers driving our consistent profit improvement are unchanged and working well and include benefits from sales growth leverage, effective cost control from strong operational execution and productivity gains, and disciplined product portfolio management including improved margin profiles from new products. As we look forward to the remainder of our fiscal year 2026, our outlook for industry demand in the broader economy is restrained while the US Economy remains resilient and the prospect of additional Fed interest rate reductions and the relatively strong labor market, albeit slowing, provides some optimism for economic growth. A weak housing market combined with shaky consumer confidence are expected to be headwinds for the industry near term. Based upon feedback from our retail partners weekly, consumer traffic and sales were especially uneven during the recent quarter, suggesting that consumer sentiment remains fragile given mounting concerns about inflation and slowing employment growth. Additionally, tariffs present a major risk to U.S. furniture demand near term. While we successfully took pricing and cost reduction actions to largely mitigate the adverse impact of the reciprocal tariffs announced in August. On September 29, the White House issued new and larger Section 232 tariffs on imported timber, lumber and their derivative products, including upholstered furniture. Although the new Section 232 tariffs will not stack on top of the existing reciprocal tariffs, they will be larger and have a broader impact on Flexsteel's business than the previous reciprocal tariffs. For context, in recent quarters the sourcing mix of our sales was roughly 70% from Asia, largely from Vietnam, which are mostly subject to a 20% reciprocal tariff, and the other 30% of our sales mix was manufactured at our facilities in Mexico and was exempt from tariffs as our product is USMCA compliant. Under the new Section 232 tariffs, there is no exemption for USMCA compliant product, so all of our upholstered furniture sourced both from Vietnam and Mexico will be subject to the new 25% tariff effective October 14, which will subsequently increase to 30% at the end of the calendar year. Over 90% of our sales are currently classified as upholstered furniture under the Harmonized Tariff Schedule Code, so most of our portfolio will eventually be subject to the 30% tariff. While the new Section 232 tariff will have a dramatic impact on Flexsteel's business, it is also expected to be highly disruptive to the entire US Furniture industry. While sourcing mix between furniture imports and domestic production varies by product category, it is generally estimated that imports comprise 65 to 70% of total U.S. furniture consumption. The availability of skilled labor in the U.S. produced furniture production is already lacking, so scaling domestic production will be challenging near. Term in our opinion. As such, we anticipate the tariff change to result in broad price increases for furniture in the US Dampen consumer demand and compress industry margins in the short term for suppliers, manufacturers and retailers. As a company, we've had to adjust to major external shifts several times over the past few years. For example, when 2019 tariffs were implemented on China, when upheaval occurred in global supply chains during the COVID pandemic, and when furniture demand dived following a remarkable pandemic driven surge. As we've demonstrated in the past, our company is agile and ready to respond to major shifts in market dynamics while remaining steadfast in our execution of our growth strategies and key investments to continue gaining market share. We entered this tumultuous period with a solid balance sheet, healthy profitability and a strong competitive position, and we are well situated to navigate this challenging environment while continuing to invest and gain shareholders. While we're hopeful that either Vietnam, Mexico, or both reach trade agreements with the US that lessen the tariff exposure on furniture, we are aggressively pursuing a multi pronged response plan to mitigate as much of the tariff impact on our business as possible. In the short term, we increased tariff surcharges on our impacted products this month to partially offset the increased cost of tariffs. We were thoughtful in our pricing decisions to maintain our competitiveness versus other market alternatives and to minimize demand declines. We are also prudently pulling back on discretionary expenses while still funding our most critical growth investments. In the midterm, we are evaluating larger structural cost reduction opportunities and alternative supply chain sources. In the near term, we expect the net impact of the tariff change in our subsequent pricing response will adversely impact demand and dilute margins. However, I'm confident that we will identify and execute the right strategies in the mid to long term to continue our current trajectory of profitable growth and shareholder value creation. Despite the near term turmoil from tariffs and challenging industry conditions, I remain optimistic about the fundamental drivers of long term industry growth and Flextil's position to continue gaining share. We remain committed to our existing strategies and investments to pursue new growth, many of which will be highlighted at the upcoming High Point Furniture Market which kicks off this week. We will be showcasing another impressive round of new product introductions at Market. In total, we're introducing 26 new product groups and 226 unique SKUs. New product has been a significant catalyst for our recent growth and the magnitude of introductions in this market combined with successful new product launch at April Market will put calendar 2025 on track for a record year of new product activations. There are many elements driving our new product success, but it starts with our increased investment in consumer insights. We listen closely to consumers and we leverage that feedback to ensure every design is shaped by real insights and proven demand. That's why our furniture connects with everyday life. It's comfortable, durable and stylish in ways that matter to consumers. Right now, those consumer insights are also driving our innovation and there will be several new innovations revealed this week at Market. We're introducing our new sub brand Pulse which offers power motion furniture with a built in immersive sound system that transforms seating into a high performance entertainment experience. With precision tune, theater quality audio and synchronized vibration integrated directly into the furniture, Pulse surrounds you in sound that you can feel. Pulse was specifically developed with innovative engineering to differentiate our solutions through superior sound quality, ease of wireless connectivity and dynamic acoustic distribution to optimize sound by applications such as movies, music and gaming. We also continue to innovate in the health and wellness category where our research shows growing demand for premium wellness oriented seating. While we continue to expand our Z cliner lineup of solutions to address consumers need for improved sleep, we are expanding beyond sleep to innovate in other health and wellness areas such as restoration. We're introducing our new Zen series which will lead the way in creating a sanctuary in the home. People today are pulled in every direction, work, family, constant noise and they rarely have a space to reset. What makes Zen unique is that it looks and feels like a beautiful living room furniture while giving consumers a spa like experience at home. It's our way of helping consumers find their Zen a perfect balance of everyday style and restorative wellness. The Zen series will bridge the gap between wellness and design, position between massage and traditional recliners. Zen provides consumers with a place to reset in their home with a perfect blend of comfort style and built in wellness technologies like heat massage and ventilation. Lastly, we remain committed to growing our case goods business through our statements sub brand positioned for its superior quality, design and durability. Consumer research has validated these attributes as top considerations when purchasing case goods furniture. We're introducing seven new collections at market, all developed with distinct on trend designs and unique features including lighting, discrete power and hidden casters and custom finishes and hardware. In addition to our investments in consumer insights, innovation and new products, we are also elevating our success through powerful marketing in three distinct but complementary ways. First, we are using our consumer insights to tailor marketing positioning and messaging to support product launches targeting specific consumer needs. We've seen great success in retail adoption and consumer engagement from these efforts. Second, we are investing in driving consumer traffic to the stores of our retail partners. Flexsteel is invested in paid search, paid social and email demand generation activities to engage consumers and direct them to retail stores. We are partnering with our retailers in unique value added ways to capture more consumers and mutually increase sales. And third, we're investing to improve the in store brand experience as we drive more consumers to retail stores. We are devoting time and energy to offering stronger point of sale materials to support the in store experience. Our point of sale items clearly display our brand and value proposition, helping educate consumers and guide their shopping journey. As a result, we've seen exponentially higher sales of products supported by our point of sale materials and versus those that aren't. To summarize, I'm proud of our team's strong start to fiscal year 2026, encouraged by our outstanding execution of our growth strategies and investments and confident in our ability to navigate the challenging conditions with tariffs near term to ensure we maintain our long term trajectory of profitable growth. 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 first quarter and our financial outlook.

Mike Ressler - Chief Financial Officer - (00:16:59)

Thanks Derek. For the first quarter, net sales were $110.4 million or growth of 6.2% compared to net sales of $104 million in. The prior year quarter. As Derek mentioned, this marks our eighth consecutive quarter of sales growth compared to prior year periods and exceeded the upper end of our guidance range of $105 to $110 million. The increase was driven primarily by our sourced soft seating products, partially offset by lower unit volume in our made to order soft seating products and Homestyles-branded ready to assemble category. The current quarter includes roughly $2.4 million in pricing from tariff surcharges. Sales order backlog at the end of the period was $66.7 million, which was relatively flat to backlog at the end. Of the prior quarter. From a profit perspective, the company delivered GAAP operating income of $9.0 million or 8.1% of sales in the first quarter. The GAAP operating margin exceeded the top end of our guidance range of 6.0 7.3% of sales. The outperformance to our guidance range was primarily due to leverage on our fixed cost due to higher sales and $0.7 million in favorable foreign currency translation on our peso denominated assets in Mexico resulting from the peso strengthening against the US Dollar in the quarter. As Derek mentioned, through price actions and cost reduction initiatives, we were largely able to mitigate the impact of tariffs in the quarter. Moving to the balance sheet and statement of cash flows, the company ended the quarter with a cash balance of $38.6 million, working capital of $116.9 million and no bank debt. Higher profit and effective working capital management offset annual cash outflows for cash incentives software and insurance renewals. Given the level of uncertainty regarding the impact of tariffs on our business, we believe it is appropriate to pause on providing any forward looking guidance at this time. As the impact of tariffs, pricing actions, consumer demand and our cost savings efforts become clearer, we will continue to share more information. With that, I'll turn the call back over to Derek to share his closing perspectives.

Derek Schmidt - President and Chief Executive Officer - (00:19:32)

Thanks Mike. While macro conditions will likely continue to suppress industry growth in the near term and the new Section 232 tariffs on furniture will exacerbate demand uncertainty. I believe that our exceptional talent combined with our continued growth investments will enable us to effectively navigate the difficulties ahead while keeping us well positioned to drive attractive top line growth and earnings. Long term organization is nimble and our teams are moving urgently on a balanced response plan to tariffs to minimize the adverse financial impact on the company while still maintaining our growth focus and pace of investments to support continued share gains. We are also staying on the offense. Most of the U.S. Furniture industry will. Be negatively impacted by the new tariffs. To varying degrees and in times of disruption such as this, we will seek for opportunities to move faster and think more boldly than our competition to further strengthen our position. With that we will open the call to your questions Operator.

OPERATOR - (00:20:37)

We will now begin the question and answer session. To ask a question, you may press Star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Anthony Labedzinski with Sidoti. Please go ahead.

Anthony Labedzinski - Equity Analyst - (00:21:07)

Good morning, everyone, and thank you for taking the questions. So certainly an impressive quarter given the operating environment. Derek, you mentioned about in the press release as well as on the call about uneven demand during the quarter. I was wondering if you could elaborate more. Obviously, we had Labor Day in the middle of that quarter, so maybe you could just kind of speak to that as to the trends that you observed as you went from early July through the end of September. Would love to hear your thoughts on that.

Derek Schmidt - President and Chief Executive Officer - (00:21:44)

Yeah, what I was referring to there, Anthony, was really, I mean, weekly store traffic and sales, as well as our orders were very volatile. And to give you with an example, the weeks leading up to Labor Day were extremely weak. The week and the week after kind of Labor Day, extremely strong. And then immediately after that, demand and store traffic dropped again. So it's been difficult for us to get a strong pulse on really the overall health of, I think, you know, the furniture consumer because there's been so much volatility, especially on a week to week basis, that that typically isn't normal, certainly in our business or kind of the industry. And I would certainly probably attribute that to, number one, the uncertainty around tariffs. But then again, there's some uncertainty around just the overall macro environment. And so I think, you know, consumer confidence, as I mentioned, is a bit shaky. And so it's not entirely surprising that we saw stronger sales around a holiday period. I think price-sensitive consumers are looking for deals in this type of macroeconomic environment. And I think that will be true as we go into the holidays as well.

Anthony Labedzinski - Equity Analyst - (00:23:17)

Understood. Okay. All right. And then, you know, thinking about the new tariffs, you mentioned, the putting in place tariff surcharges. Can you comment on as far as, like what the level of the surcharges was? And I know you're not giving guidance, but maybe you could just help us think about like, as far as the impact of those surcharges may have on your sales and you know, gross margins, if any, any kind of, you know, additional help would be certainly beneficial.

Derek Schmidt - President and Chief Executive Officer - (00:23:53)

Yeah, Anthony, I'll give you two perspectives. You know, because we have, we operate different businesses. We have our in stock source product business, and then we've better made order business out of our Juarez facility. So on our in stock source business when the 20% tariff, reciprocal tariff was in place, we had an 8.5% price surcharge on those products and that increased to 15% to eventually cover when the tariff goes to 30%. So effectively we're headed toward a 30% tariff and we're passing half of that increase along through surcharges. And then similarly on our made to order business out of our Juarez facilities, I mean, you understand prior to the October 14th section 232 tariffs going to place, we are USMC compliant. So there was no tariff on that part of our business that is increasing to 30% here by the end of the calendar year. So we did, similar to our source business, put a 15% pricing surcharge on those products.

Anthony Labedzinski - Equity Analyst - (00:25:06)

Okay, so I guess it's entirely about the impact.

Derek Schmidt - President and Chief Executive Officer - (00:25:10)

Yeah, yeah. I think certainly there will be some demand decline as a result of these price increases, not only for Flex Steel, but I think across the industry. Certainly on the source side, we're seeing all of our competitors take similar, if not larger price increases in the market. So I think that will certainly impact demand to what magnitude I think is to be determined here in the coming weeks and coming months.

Anthony Labedzinski - Equity Analyst - (00:25:42)

Understood. Okay. And I know you guys have done a great job regarding focusing on new products. Can you speak to like, regarding, like you guys have a target regarding, you know what percent of your sales you want to come from new products or how do we think about that? And regarding pricing on those new products relative to the core business, how should we think about that?

Derek Schmidt - President and Chief Executive Officer - (00:26:10)

Yeah, I think our long term goal. Is 30 to 40% of sales being derived from new products. And we define that as new products launch within the last three years. To give you context here, in the first quarter our sales comprised a little over 50% from new products. So we are certainly delivering on that goal. We know it's a huge catalyst for the success we've had over the last two years. And we're investing aggressively in terms of how we think about pricing when we introduce new products. We're constantly trying to outperform ourselves. So really the intent is to constantly bring new, improved value to our retailers and to our consumers. So we're focused on better quality, better comfort, better functionality at a better value. And so in terms of price, it's really, we're looking to bring better, better value to the market at similar, if not lower prices than our current product.

Anthony Labedzinski - Equity Analyst - (00:27:23)

Gotcha. All right. And then you've done a nice job also with your case goods business. Certainly Understand, it's a relatively small piece of the overall business. But thinking about, you know, going forward, your company have a target as far as how much you want to increase case goods. You know, what percent of sales could that be at some point?

Derek Schmidt - President and Chief Executive Officer - (00:27:49)

What I want to tell you, Anthony, we do have internal goals. I'm hesitant to share that too publicly just for competitive reasons. The case goods category, to be honest. Has been more challenged than other product categories in the industry over the last couple years. That said, it's still a very, very large category for overall U.S. furniture consumption. And I'm really pleased with the magnitude and quality of new product that we've come up with over the last several years. So I still, I feel strongly that we're well positioned here to gain our fair share. And I do believe that it's going to be a critical growth driver in the years to come. And I think, you know, as we start to scale those more significantly, I think we'll be more open to sharing details around how we think about our portfolio composition.

Anthony Labedzinski - Equity Analyst - (00:28:47)

Gotcha. Okay, and my last question, so, you know, the tax rate was lower than last year and lower than what we had expected. Was there anything significant in the quarter and to affect that and how do we think about the tax rate for the balance of the year?

Derek Schmidt - President and Chief Executive Officer - (00:29:06)

Yeah, Anthony, in the quarter, there were a couple discrete items. Number one, just change in reserve for uncertain tax positions or uncertain tax positions. And then also a little bit higher R&D tax credit and lower foreign taxes were kind of the driver. But I would just say on a go forward basis, you know, we expect. The rate to be a little bit. You know, a couple basis. A few hundred basis points higher, kind of for the remainder of the year.

Anthony Labedzinski - Equity Analyst - (00:29:34)

Understood. Well, thank you. Best of luck and look forward to seeing Sandbag. Yeah, look forward to seeing the new products in High Point.

Derek Schmidt - President and Chief Executive Officer - (00:29:43)

All right, see you on Friday. Thanks.

OPERATOR - (00:29:48)

Again. If you have a question, please press Star then one. Our next question comes from Bill Dazellem with Tieton Capital. Please go ahead.

Bill Dazellem - Analyst - (00:29:59)

Thank you. Two questions. First of all, relative to your comment that competition is responding in a similar or larger way, would you please quantify the magnitude of price increases that you are seeing relative to your 8 and 15%? And then secondly, I was a little confused when you mentioned you had products that were USMCA compliant, but it sounds like the recent tariffs are changing that dynamic. Would you provide, I guess, a fuller picture and fill in the blanks on the dynamics there, please?

Derek Schmidt - President and Chief Executive Officer - (00:30:47)

Yeah, maybe. Bill, I'll start with Your last question and then move to your first one in terms of the USMCA compliance. So when the reciprocal tariffs were put in place, the, you know, there was an exemption for USMCA compliant product with Section 232 tariffs. That includes the ones that the White House have put on aluminum steel. There is no exemption for USMCA compliance. So again, it's a matter of how the new proclamation was written. Certainly our hope is that as Mexico, Canada continue to negotiate with the U.S. Administration that they can influence and potentially, you know, get an exemption for USMCA compliant. But as of now, the way the proclamation is written, there is no exemption. So that's why the change it specifically how the tariffs were written. In terms of your first question regarding. Pricing competitiveness for our source products, again, I described how we're going from a current 8.5% surcharge up to 15. We've gotten a range of competitive information, but we're seeing some of our main competitors go as high as 21% and 25% compared to our 15%. Now there's some other competitors that are slightly lower, but by and large, we're seeing the competitive set pass through these latest Tariff increases almost 100% to retailers and to consumers. So that at least gives us some confidence here that we are not weakening our competitive position versus other alternatives in the market.

Bill Dazellem - Analyst - (00:32:49)

Taking that one step further, have you heard from any portion of your retail customers that because you are taking prices up 15% versus these higher numbers that you may be getting more business from them?

Derek Schmidt - President and Chief Executive Officer - (00:33:09)

Certainly it's a possibility. I think, Bill, it's too early to speculate on that. As I noted in my comments earlier, going into our semiannual high point market this week, we will have the opportunity to converse with hundreds of our retailers. And so I think we'll gain a better understanding on how they're feeling about the changes and their view on how they think it's going to impact consumer demand. But I think it's going to take us probably another five, six, seven weeks here to really fully understand how the consumer is going to respond to these pricing changes in the market.

Bill Dazellem - Analyst - (00:33:52)

Great. Thank you. Congratulations on a good quarter.

Derek Schmidt - President and Chief Executive Officer - (00:33:55)

All right, thanks, Bill.

OPERATOR - (00:34:00)

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

Derek Schmidt - President and Chief Executive Officer - (00:34:08)

In closing, I want to thank all of our Flexsteel employees for their hard work and dedication in driving the company's strong performance during the first quarter. 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 call. Thank you and have a great day.

OPERATOR - (00:34:30)

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