FLXS - NASDAQ

Good day, and welcome to the Flexsteel Industries Second Quarter Fiscal Year 2026 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mike Ressler, Chief Financial Officer for Flexsteel Industries. Please go ahead.

Thank you, and welcome to today's call to discuss Flexsteel Industries second quarter fiscal year 2026 financial results. Our earnings release, which we issued after market close yesterday, Monday, February 2, 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 prediction 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?

Good morning, and thank you for joining us today. I'm pleased to share our second quarter results and to spend some time discussing how Flexsteel is performing in an environment that continues to be highly dynamic. Industry demand remains uneven, tariff policy is evolving quickly and consumer behavior continues to shift. Against that backdrop, I'm encouraged not only by the financial results we delivered this quarter, but by how our organization is operating with agility, discipline and a clear focus on long-term value creation. During the quarter, we delivered strong year-over-year sales growth of 9% and meaningful profit improvement, extending the momentum we've built over the past 2 years. Importantly, this performance was achieved while navigating a very choppy external environment, underscoring the progress we've made building an organization that can adapt quickly to change without losing focus on execution. What's particularly encouraging is the quality and balance of our growth. We are performing well in our core business with new product introductions and share gains with strategic accounts. At the same time, we're seeing steady progress in newer and expanded markets, including health and wellness and case goods. The diversity of these growth drivers gives us confidence that our momentum is becoming more resilient and less dependent on any single product category, customer or market condition. What's notable this quarter is that our growth drivers are reinforcing one another and scaling more effectively across the portfolio. Our investments in consumer insights, product development and innovation are improving the effectiveness of new launches, while stronger partnerships with retailers are helping accelerate adoption of new products across multiple categories. This breadth of contribution gives us confidence that our growth is becoming more durable even as industry demand remains uneven. While we're encouraged by our continued sales growth, I'm equally pleased with the progress we're making on profitability. This quarter's operating margin of 7.6% and the continued year-over-year profitability improvement reflects the disciplined way our teams are managing the business amid a complex and changing environment. Our margin performance continues to benefit from a combination of sales leverage, productivity improvements and thoughtful product portfolio management. Importantly, these gains are increasingly structural in nature. Through consistent execution, we've strengthened our cost discipline, improved operational efficiency and enhanced the margin profile of new and existing products. This operating discipline has been particularly important as we've navigated significant external volatility. The ability to manage cost, adjust pricing thoughtfully and protect margins while continuing to invest in growth initiatives speaks to how the organization has evolved over the past several years. As we look ahead, while the U.S. economy continues to show areas of resilience, housing activity, consumer confidence and discretionary spending patterns remain inconsistent and continue to weigh on overall industry demand. Feedback from our retail partners suggests that consumer behavior remains highly variable with periods of engagement followed by pullbacks driven by economic uncertainty and inflation concerns. In this environment, visibility remains limited and demand patterns can shift quickly. That said, our teams are staying close to our customers and adjusting as conditions evolve. This flexibility, combined with disciplined execution, allows us to respond quickly to changes in demand while remaining focused on our long-term growth objectives. Tariffs continue to represent a significant source of uncertainty for the furniture industry and the policy environment remains fluid. As tariff structures evolve, the implications for sourcing, pricing and demand can change quickly, requiring companies to adapt in real time. Flexsteel has faced similar disruptions in the past from prior tariff cycles to global supply chain disruptions and rapid demand swings. And those experiences have shaped how we operate today. Our organization is built to respond decisively to external change while remaining disciplined in execution and capital allocation. While the current tariff environment presents meaningful challenges, we believe it also underscores why we've invested in building a more agile and disciplined operating model, including the ability to adjust pricing thoughtfully, manage cost, evaluate sourcing alternatives and maintain strong customer relationships, all which we believe will be critical in the periods ahead. We believe our agility, combined with disciplined execution and continued investment in our growth platforms, positions us to not only manage near-term volatility, but to continue gaining share over time. Looking further ahead, we are actively evaluating broader cost reduction opportunities and alternative supply chain options that can strengthen our position over the long term. While we expect tariffs and pricing actions to create pressure on both demand and margins in the second half of our fiscal 2026, we are confident in our ability to identify and execute the right actions to support profitable growth over time. We entered this period with a strong balance sheet, solid profitability and a clear strategic road map. Our focus remains on navigating near-term challenges while continuing to invest in the capabilities that drive long-term shareholder value. In summary, our second quarter results reflect an organization that is executing consistently today while positioning itself to compound growth and profitability over time, even in a volatile environment. With that, I'll turn the call over to Mike, who will give you some additional details on the financial performance for the second quarter and our financial outlook.

Thanks, Derek. For the second quarter, net sales were $118.2 million or growth of 9% compared to net sales of $108.5 million in the prior year quarter. This marks our ninth consecutive quarter of year-over-year sales growth. The increase was primarily driven by higher unit volume in sourced soft seating products and pricing from tariff surcharges, partially offset by lower unit volume in our made-to-order soft seating products and homestyles branded ready-to-assemble products. Sales order backlog at the end of the period was $82.4 million, which includes estimated tariff surcharges. From a profit perspective, the company delivered GAAP operating income of $9.0 million or 7.6% of sales in the second quarter. The prior year quarter GAAP operating income of $11.7 million included a $5 million gain from the sale of our former Dublin, Georgia manufacturing facility. Current quarter operating income increased 35% or 150 basis points compared to adjusted operating income of $6.7 million or 6.1% of sales in the prior year quarter. The increase is driven by favorable sales mix of higher-margin new products, partially offset by continued investments in growth initiatives. The impact of tariffs on operating margin in the quarter was largely mitigated through a combination of pricing actions and cost savings initiatives. Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $36.8 million and working capital of $126 million and no bank debt. The increase in working capital was primarily driven by higher cost inventory due to tariffs and an intentional increase in safety stock of top-selling products ahead of tariffs that were previously scheduled to increase on January 1. In addition, accounts receivable increased due to timing of sales in the quarter. Given the level of uncertainty regarding both demand and the impact of tariffs on our business, we believe it is appropriate to continue our pause on providing any forward-looking guidance. However, as Derek alluded to earlier, we expect some margin dilution in the second half of the fiscal year relative to the second quarter as we are now selling higher cost inventory burdened with 25% tariffs. 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.

Thanks, Mike. As we look ahead, we recognize that the external environment is likely to remain unpredictable in the near term. Tariff policy continues to evolve, consumer demand patterns remain uneven and macroeconomic visibility is limited. However, these conditions reinforce rather than diminish the importance of the progress we've made strengthening our organization. Flexsteel is agile, disciplined and well positioned to respond to change. Our teams are moving quickly and thoughtfully as conditions evolve, balancing near-term actions with a clear focus on long-term value creation. We are managing risk, protecting profitability and continuing to invest in the growth platforms that support sustained share gains. Periods of disruption often create opportunity for companies that are prepared to act decisively while maintaining strategic focus. We believe our combination of operating discipline, financial strength and investment in innovation and consumer-led growth positions us well, not just to navigate the current environment, but to emerge stronger over time. With that, we'll open the call to your questions. Operator?

[Operator Instructions] The first question comes from Anthony Lebiedzinski with Sidoti.

So first, it's really great to see the sales and earnings increase in a still choppy demand environment. So first, I guess, as we think about the revenue increase on a consolidated basis, can you talk about unit volumes and pricing as far as how that impacted the quarter?

Yes, Anthony, what I would tell you is you're correct in that the environment has been very choppy. But in terms of the breakdown, tariff revenue in the quarter was roughly, give or take, $9 million to $10 million, about $9.5 million. So when you look at it kind of from a unit volume perspective, we are relatively flat versus the prior quarter, but certainly had categories within the business where unit volumes were up in other areas kind of where we've seen unit volumes down in certain areas.

I'll just -- I'll add to Mike's comment. I think what we're pleased with is that we saw really nice unit volume gains in many areas of our soft seating business. So despite the fact that we took pricing, we're still seeing good unit growth in that area. That was offset by, I think, unit volume declines in made-to-order seating, which that category has been soft. And then as you know, we've got this homestyles ready-to-assemble business, and that has been struggling. Sales were down almost 50% in that area. But the core of the portfolio is operating really well despite the fact that we pushed through tariff pricing, which we find very encouraging.

Yes, absolutely. So as we think about new product introductions, can you share roughly what portion of your sales is now coming from new products? And as we think about the outlook going forward, can you talk about the pipeline for new products?

Yes. In terms of where our sales are being derived from, Anthony, I mean, over the last, I would say, 6 to 8 quarters, we've been consistently 30% to 40% of our overall sales is coming from new products. So it is a substantial driver, I think, of our ability to continue to gain share. In terms of new product pipeline, I'm reluctant to give too many details just because competitors can -- in this environment, especially with AI, can rapidly kind of clone, I think, what we're doing. What I will convey, though, is that we have a really exciting and focused pipeline of new product coming here over the next 3 markets, so 18 months. So I feel really good about the pipeline and our ability to continue to bring products that are relevant to consumers and ultimately will drive traffic to our retailers, which is one of the areas that I think that we're differentiating ourselves from in this environment.

And then -- so I guess, looking at the strategic accounts, which we've spoken about in previous calls, so it's not new, but -- and you've done well with that. So as we think about going forward, are there additional retailers that you think you may be underpenetrated in or have potential new wins? How do we think about that? I just wanted to get a better understanding of what's more to come as far as potential expanded distribution for you guys?

Yes. I think we've shared, Anthony, what we deem strategic accounts represents about 20 large independent retailers that we believe are progressing their omnichannel capabilities and are well positioned to continue to gain share in the overall market. And so we've really aligned our business model around serving those 20 accounts in a differentiated manner. To address your question, the vast majority of those 20 customers, we already have very strong relationships. There are a handful that were, I'll call emerging relationships, which we believe there's pretty significant growth potential and that we've been working for the last year or so. I still believe that there is ample room for strategic accounts to drive exponential growth. And that's obviously both share gains with existing accounts and the handful of other retailers that were probably underpenetrated or under-indexed with. So again, we are going to continue to, I think, put investment, continue to refine our value proposition to those retailers because we believe that there's substantial growth in the years ahead.

Got you. And then -- so as we think about the tariffs, you said that they were largely mitigated with price actions and also just cost savings. So as far as your confidence level to be able to offset that going forward, how do we think about that? And then just another question as far as the gross margin. I know a couple of the recent quarters were impacted by favorable currency impact. I didn't see anything about that this quarter. So I just wanted to make sure that there wasn't anything there.

Yes. Anthony, on the tariffs in the current quarter, we've talked about we're very measured in our approach, right? We understand we want to be very cognizant of the consumer and sensitivity to pricing. But through our pricing actions and all the cost savings initiatives the team has been aggressively working on, largely able to mitigate it in the quarter. With that said, the current quarter inventory is probably burdened with, give or take, a 20% tariff level. So as we think about kind of the back half of the year, we would expect some dilution to margins as our cost of sales becomes fully burdened with the tariff. I'd say the biggest variable that's really hard to predict is the impact on unit demand. If we're able to kind of hold unit demand and obviously, that would certainly minimize the potential impact on the dilution in the back half. And in terms of FX, really not a material impact in gross margins in the quarter. We have a little bit of a benefit from the revaluation of our VAT receivable, but that was largely offset by the impact on our operating expenses.

The one thing I'll add, Anthony, to Mike's comment regarding kind of tariff impact on margin. So as Mike alluded to, again, we would expect here in the next couple of quarters, certainly for there to be some margin dilution as we roll through higher cost inventory. That said, we are working on other cost initiatives that we would expect would offset that tariff impact in the midterm.

Understood. And my last question is just the tax rate came in a little bit higher than we expected. Was there anything unusual here? And how do we think about the tax rate here on a go-forward basis for the balance of the fiscal year?

Yes, Anthony, there was a little bit of an impact in the quarter as it relates to kind of our return of provision true-up related to foreign taxes, but I would expect kind of the tax rate going forward to be closer to kind of what the full year tax rate is reflecting.

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

Thank you. In closing, I want to reiterate my confidence in the direction of our business and the strength of our organization. I'm proud of how our teams are performing, staying focused, adapting quickly and executing at a high level despite external uncertainty. And it's that combination of agility and discipline, which is a core strength of Flexsteel, and it gives me confidence in our ability to continue building value over the long term. I want to thank our employees for their continued hard work and commitment, and I appreciate our shareholders and partners for their ongoing support. Thank you for joining us today, and we look forward to updating you on our progress next quarter.