FLXS - NASDAQ

Good morning, everyone, and welcome to the Flexsteel Industries Fourth Quarter and Fiscal Year 2025 Earnings Conference Call. [Operator Instructions] 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. 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 18, is available on the Investor Relations section of our website at www.flexsteel.com under News & 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 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?

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

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 period and near the upper end of our guidance range of $109 million to $116 million. The increase was primarily driven by higher unit volume of soft seating products, partially offset by lower unit volume in 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 pretax 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 of our peso- denominated assets in Mexico, resulting from the peso significantly strengthening against the U.S. dollar in the quarter. Tariffs had a net dilutive impact to operating margin in the current quarter of 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 is 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 million 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 charges 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&A spending and be mindful of adding structural cost 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&A costs between $16.8 million 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 million 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.

Thanks, Mike. I'm 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 Instructions] And our first question today comes from Anthony Lebiedzinski from Sidoti & Company.

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 1. But can you just comment on the initial reaction or just really wanted to better understand the elasticity of demand that you have observed thus far given the surcharges that you put in place?

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 pushed 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 actually reduced existing ocean freight surcharges largely to keep retail prices of our product relatively stable at retail. So again, we pushed through a tariff 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.

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?

Anthony, in terms of cost savings, we're aggressively pursuing cost savings across our entire 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. And those cost savings as well as the surcharges, what we're looking at to try to neutralize the impact of tariffs. And I would say that we do have those ongoing cost savings and incremental savings kind of baked into our outlook here for Q1 and into the future.

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.

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?

Yes. Anthony, I would describe it as a continuation. I think we've been relatively aggressive over the last year or 2 years in terms of investing in innovation, driving relevant new product development, and we're going to continue that pace. It's been, I think, a key part of our growth success, and we intend on keeping that intensity.

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

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 our inventory to top sellers, et cetera, and work out of maybe some of kind of the legacy lower performing less profitable SKUs. So from a unit perspective, we would -- we feel like we're in a really good spot in that we would kind of maintain those levels. Obviously, if we see a change in the demand signals, we'll pivot and adjust accordingly. We will see a little bit of 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.

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

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 yields a return above our cost of capital, we won't pursue that, and we'll certainly leverage dividends and our share buybacks to return capital to shareholders based on kind of the capital needs of the business.

[Operator Instructions] Our next question comes from Bill Dezellem from Tieton Capital Management.

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 a confidence level, specifically tied 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?

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 of weeks. The Labor Day is typically one of the bigger furniture holiday selling periods. So I think we'll get a stronger pulse on the state of the consumer here in a couple of 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. 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.

All right. 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 $0.45 benefit. If we were to do a constant currency comparison to last year's $0.75 on an operating basis, it would be like $0.95 versus $0.75. Is that the right way to think about those numbers?

So 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 an abnormally large movement between the peso and the U.S. dollar, which is why we had a net favorable translation. But if you look over the entire year, translation was relatively neutral. It just happened to be significant in the quarter given the large fluctuation in the currency rate.

Understood. Congratulations on another step forward great quarter.

Thanks, Bill.

[Operator Instructions] And ladies and gentlemen, at this time, I'm showing no additional questions, I'd like to turn the floor back over to management for any closing remarks.

Thank you. In closing, I want to thank all of our Flexsteel employees for their dedication and outstanding performance during the fiscal year. I'm also thankful to all of you 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.