Good morning, and welcome to the Flexsteel Industries third quarter 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 for you to ask questions. To ask a question, you may press star then one on your touch-tone 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. Thank you.

Welcome to today's call to discuss Flexsteel Industries' third quarter fiscal year 2025 financial results. Our earnings release, which we issued after market close yesterday, Monday, April 21st, 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. We will then open the call to your questions. Before we begin, I would like to remind you that the comments on today's call 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.

Good morning. Thank you for joining us today to discuss our third quarter results. We continue to execute well and delivered strong results in the quarter. Our growth strategies are working and enabling us to continue our solid sales momentum as we delivered sales growth of 6.3% compared to the prior year quarter, which represents our sixth consecutive quarter of mid-single to low double-digit year-over-year growth. Encouragingly, the drivers of our growth remain broad-based as we grew in both our core markets and in our new and expanded market initiatives. Within core markets, we continue to see significant success from new product introductions that bring increasing value to consumers and from continued share gains with large strategic accounts, where we continue to enhance our advantaged customer experience. Our focus on new and expanded markets remains an important growth contributor, led by continued market penetration with our Z Kleiner lineup and ramping orders of new Casegoods products. The April High Point market begins this week, and we have an exciting lineup of new products to showcase. That includes 25 new groups spanning all areas of our business. We are expanding our Z Kleiner lineup, with additional SKUs adding new bedroom, dining, and occasional groups to our case goods offering, and adding a plethora of sleek, stylish products with improved functionality to our stationary and motion soft seating portfolio. New product has been an underpinning to our growth story over the past several years, and we remain aggressive in continually bringing fresh looks with improved value to our retail partners. I'm also especially pleased with our continued profitability improvement and strong cash generation.

Our adjusted operating margin of 7.3% in the quarter represents our eighth consecutive quarter of year-over-year improvement and our second highest quarterly adjusted operating margin over the past seven years. The levers driving our consistent profit improvement are unchanged and working effectively and include sales growth leverage, strong operational execution and productivity, and product portfolio management. Additionally, we delivered operating cash flow of $12.3 million in the quarter and bolstered our ending cash to $22.6 million. Our strong financial position is a competitive advantage in this period of heightened economic uncertainty.

As we look forward to the remainder of our fiscal year, we enter our fourth quarter under a very tough economic backdrop with substantial uncertainty following the release of the proposed US reciprocal tariffs on April 2nd. In the near term, we are assessing and developing responses to three key risks. First, the impact of tariffs on our business, including margins, pricing, and supply chain design. Second, the short-term volatility in demand largely influenced by tariff and economic uncertainty. And third, the midterm outlook for the US economy, consumer spending, and ultimately, consumer demand for furniture. I'll elaborate on each of these individually, beginning with tariffs. As we've shared previously, we have completely moved out of China for finished good product sourcing. And our primary tariff exposures now reside in Vietnam and Mexico. Currently, Vietnam production supports roughly 55% of our revenue, and our Mexican operations support almost 40% of sales. While we have seemingly avoided tariffs on Mexico for now, our product sourced from Vietnam is impacted by the 10% tariff which took effect on April 5th and remains in effect as the two sides negotiate a new trade agreement. Should the initial 46% reciprocal tariff rate that was announced on April 2nd but subsequently delayed 90 days ultimately go into effect on Vietnam goods, it will have wide-reaching implications both on Flexsteel's business and the overall US furniture industry. As context, Vietnam was the primary beneficiary of replacing China-made furniture after the US increased tariffs on China in 2019 and is currently the largest exporter of furniture to the US at 37% of furniture imports in 2024. While we have taken steps to identify alternative sources in other countries beyond Vietnam, the other major furniture exporters, like Cambodia, Thailand, Indonesia, and Malaysia, have similarly large proposed reciprocal tariffs leaving the overall industry heavily exposed to tariff risks. Our current belief is that a long-term 46% tariff on Vietnam is untenable for both countries and that the parties will negotiate a lower rate, although the timing of such a deal is difficult to predict. Exports make up a large percentage of Vietnam's GDP, and the US accounts for roughly 30% of their total exports, so Vietnam has significant incentive to negotiate. They have already expressed a strong desire to make a deal with the US and took preemptive actions to cut tariffs on US goods and increase commitments to purchase more US goods and services. While we await clarity on a potential US-Vietnam deal, we have taken several steps to minimize our short-term tariff exposure. Most notably, we have implemented modest tariff surcharges on new orders for some parts of our business effective April 9th, although these surcharges do not completely offset the 10% tariff on Vietnam imports. Furthermore, we have and will continue to look for cost efficiencies and other savings to partially offset the impact of tariffs. If Vietnam tariffs are implemented at significantly higher rates than the current 10% for an extended duration, we will take the necessary steps to realign our sourcing. While reconfiguring our global supply chain would not be easy or fast, and tariffs could have an adverse impact on margins in the short term, I do feel confident that we are prepared to swiftly optimize our network if required. The second risk mentioned is short-term demand volatility. Even prior to the recent tariff announcements, many of our retail partners noted considerably slower traffic, which likely reflects the sharp drop in consumer confidence over the past several months. As a result, we've seen a slowdown in incoming orders from retailers since the tariff announcement and even some large order cancellations. While we started the fourth quarter with a healthy backlog of $78.3 million that would normally give us strong confidence in continuing our momentum of year-over-year sales growth, the risk of continued muted retail orders and additional order cancellations only grows the longer the uncertainty around tariffs persists. As a result, our forecasted range of growth for the fourth quarter is broader than usual. The third risk, and likely the most significant, is the midterm outlook for the US economy and consumer spending. As a result of the new tariffs, many economists now expect significantly higher US inflation for the next year along with slower economic growth and even a likelihood of a recession if the higher proposed tariff rates are eventually implemented and sustained for an extended period. While we remain hopeful, the US administration can successfully negotiate with its trading partners to reduce or eliminate the reciprocal tariffs and minimize the impact on the US economy, our outlook for the industry over the next year is moderately pessimistic given the external challenges to consumer spending. As such, we are prepared to navigate multiple demand scenarios. And as we've demonstrated over the past few years, we can deliver share gains even in challenging industry conditions. To summarize, we are executing well on what we can control and remain confident that our strategies are working and we remain well-positioned to continue gaining share. I'm encouraged by our financial performance and believe that our financial strength will enable us to effectively navigate near-term market choppiness while continuing to smartly invest in key growth enablers like exceptional talent, product development, innovation, customer experience, and marketing, which are all critical to our continued industry outperformance and long-term shareholder value creation. 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 third quarter and the financial outlook for the fourth quarter.

The third quarter net sales were $114 million, or growth of 6.3%, compared to net sales of $107.2 million in the prior year quarter. As Derek mentioned, this marks our sixth consecutive quarter of year-over-year sales growth and was near the high end of our guidance range of $110 to $115 million. The increase in sales was primarily driven by higher unit volumes, and to a lesser extent, pricing from ocean freight surcharges. From a profit perspective, GAAP operating loss was $5.1 million in the third quarter, driven by a $14.1 million non-cash impairment charge related to our leased facility in Mexicali, Mexico. In 2022, we commenced a 12-year lease at a manufacturing facility in Mexicali, Mexico to support strong demand that was elevated following the pandemic. Subsequently, US furniture demand reverted to pre-pandemic norms. And as a result, we pivoted to subleasing the space in the short term while maintaining the option to utilize the facility in the longer term. While we had previously secured multiple short-term sublease tenants, the facility is unoccupied, and substantial changes in trade relations between the US and Mexico in early 2025, as well as the US and the rest of the world, have caused foreign investment and expansion in Mexico to greatly diminish. As a result, we've concluded that the carrying amount of the ready-use asset associated with the lease is no longer fully recoverable and recorded an asset impairment charge of $14.1 million in the quarter. When excluding the $14.1 million impairment charge, as well as the $0.7 million gain from the sale of a building formerly part of our adjusted operating income was $8.3 million or 7.3% of net sales. The 7.3% adjusted operating margin exceeded the high end of our guidance range of 6.0% to 7.0% and is a 210 basis point increase from the prior year quarter. Our adjusted operating margin performance was driven by sales growth leverage, a favorable mix of new products with higher margins, ongoing operational efficiency, and disciplined spend controls as we navigate dynamic market conditions. From a balance sheet and cash flow perspective, the company generated $12.3 million of operating cash flow in the quarter and ended the quarter with cash on hand of $22.6 million. In the quarter, the company received $0.8 million in proceeds from the sale of a building that was previously part of our Huntingburgh, Indiana distribution center complex. We also invested an additional $1.4 million in CapEx, primarily for the modernization of ERP systems. We ended the quarter with $103.4 million of working capital. Moving to our outlook. As Derek noted, the tariff situation is very dynamic, and there is a high level of uncertainty from the potential impact of new trade policies on consumer demand in the furniture industry. We believe we have strategies in place to effectively navigate the current environment, but a significant change in macroeconomic factors could materially impact our outlook. For the fourth quarter, we expect sales between $109 and $116 million, reflecting a decline of 2% to positive 5% growth compared to the prior year quarter. We entered Q4 with a strong order backlog of $78.3 million and anticipate that many retailers will pull ahead demand and build inventory to avoid potential tariff increases. However, if consumer demand drops and sell-through at retail slows significantly, we would anticipate softer orders in the back half of the quarter, which will ultimately impact our sales. We expect gross margin between 21.0% and 22.0% in the fourth quarter. Our gross margin assumes 10% tariffs remain in effect on Vietnam imports for the remainder of the quarter and also assumes that our Mexico imports to the US will remain tariff-free under USMCA. Should tariff rates change on either Vietnam or Mexico, it could have a material impact on our gross margin in the quarter. We recently implemented modest surcharges on some parts of our business to partially offset the cost of tariffs but anticipate tariffs to have an overall dilutive impact on gross margins. We've worked closely with our supply chain partners to minimize the impact on retail pricing and consumer demand. We expect SG&A costs between $16.5 million and we will continue to prioritize high ROI investments in new product innovation and marketing to accelerate our growth strategy. We project operating margin in the range of 6.0% to 7.3% for the fourth quarter and expect free cash flow for the quarter in the range of $4 to $7 million. Near-term priorities for cash remain resourcing new innovation, customer experience initiatives, and funding capital expenditures. For the fourth quarter, we expect capital expenditures between $0.5 and $1.0 million, primarily for the modernization of our ERP systems and supply chain maintenance. Besides tariffs, the most significant drivers of variability in the fourth quarter guidance range are consumer demand and competitive pricing conditions, which will be shaped by macroeconomic factors. To reiterate, our outlook assumes no major changes from near-term US policy changes, including trade and tariffs, which could materially change our business forecast. If we gain better clarity and there is a material change in our outlook, we will update our guidance. As Derek noted, we have multiple strategies that we are working to both strengthen our supply chain agility and resilience and mitigate tariff risks.

The external environment is exceptionally dynamic right now, as major influences on the US economy and outlook for consumer spending can change daily. Until there is greater clarity and confidence in the stability of both the outlook for US trade policy and economic growth, we expect business conditions to remain volatile and challenging. As a company, we face similar unpredictability over the past five years, and as a result, we've learned to adapt to and thrive in new situations, albeit trying. As a company, we have two main priorities near term to ensure we remain competitive and can continue to outperform. First, we will stay hyper-focused on executing our strategy. They are working and enabling us to deliver strong sales growth and financial results, and we won't veer from that formula that has supported our success over the past few years. While we will certainly manage spending prudently to quickly respond to changing consumer demand in this dynamic environment, we will not diminish our commitment to providing an exceptional customer experience and investing in new products, innovation, and marketing, as these are foundational to our strategies and continued success. Second, we will continue to strengthen our supply chain agility and planning to minimize tariff risks. We have strong relationships throughout our value chain and have confidence that we can work collaboratively with our partners in the short term to address the effect of tariffs while minimizing the impact on consumer prices. In the long term, we remain assured of our ability to reconfigure and optimize our supply chain if required due to permanent changes in global trade policies. In summary, Flexsteel is financially strong. We are navigating a turbulent time for the industry, but we enter this period of rising uncertainty advantaged with excellent sales momentum, good profitability, and a strong balance sheet and cash generation. While challenging business conditions present risks, we also see great opportunities to strengthen our competitive position and customer value proposition by aggressively investing for long-term growth at a time when we anticipate that other competitors may pull back investments in response to slowing demand. We have confidence that we can thrive in periods of disruption and maintain our focus on positioning the company for sustainable long-term profitable growth. With that, we will open the call to your questions. Operator, thank you very much.

We will now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you're 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 questions, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Anthony Lebiedzinski with CLT and Company. Please go ahead.

Morning, Derek, and good morning, Mike. Certainly nice to see these sales and earnings outperformance in the quarter. So I have a few questions here. First, as far as just the quarter, as the March quarter progressed, just wondering if you guys saw any notable changes month to month in terms of your order patterns or, you know, the delivered sales. Just wanted to get a better sense of as to how the cadence of the quarter was.

Hey, Anthony. It's Derek. I'll start. In terms of March, typically, from a seasonality perspective, March is a bit light from an order perspective relative to the other two months in the quarter. So what's typical is we did see orders slow down in March, but compared to prior year, the year-over-year growth was still pretty consistent with the other periods in the quarter. What I will emphasize though, and I mentioned this in my earlier comments, following the April 2nd announcement of tariffs, we have seen a significant slowdown in orders since that period. I think retailers, for the most part, are in wait-and-see mode. They're trying to understand where the trade discussions are gonna go, how it's gonna impact consumers. And so we saw some of this behavior during the pandemic. I'm hoping that this week at High Point Market, we'll get better clarity from retailers on certainly how they're feeling, what their intentions are. We'll be looking to sift out, you know, what retailers wanna stay on the offense, and which ones are gonna play a little bit more defensive posture in this period. But there certainly, I'd say, nothing remarkable in March, but certainly a step function change here in April following the tariff announcements.

Understood. And Derek, you mentioned in your prepared remarks how you're focused on the new products, which you've talked about this previously, but, you know, just having an advantaged customer experience. So, you know, with that in mind, do you guys have a goal of that as far as how much of your revenue you want to derive from new products? Has that changed, you know, given the tariff announcements that we've heard?

No. I think, you know, as I've noted in the past, Anthony, it's a big part of our overall success strategy. If you look at our sales for both the quarter as well as year to date, I mean, over half of our sales currently are from new products that have been launched in the last couple of years. So it's a huge driver of our continued growth. And what I'll emphasize is that as we think about navigating through this period of uncertainty, and you know this, Anthony, because you know us, we're gonna be very prudent in terms of where we add structural costs, how we manage spending. What we will not pull back though is our commitment to driving new product introductions, innovation, spending on marketing, because it is so core to our overall strategy. So to your question, yeah, we're gonna continue to be very aggressive around bringing new product and innovation to the market, you know, regardless of the environment.

That's encouraging to hear. And then, you know, just thinking about the tariffs, so you guys have put in some tariff surcharges. We're just wondering if you could perhaps quantify what's embedded in your guidance and just curious to know if you've seen any of your notable competitors respond with their own tariff surcharges or, you know, just curious as to what you're seeing from the competition.

Yeah. Anthony, this is Mike. Yeah. We've seen competitors implement surcharges, and obviously, they vary based on their supply chains, etcetera. Within our guidance, you know, it assumes that the current 10% Vietnam tariff we have in place remains intact. We've implemented a modest surcharge on some of our dealer direct product categories where customers are importing containers. We've ultimately held our pricing on our made-to-order product that we manufacture in Mexico as well as pricing on our product that we fulfill out of our warehouses. We typically carry forward a, you know, six to probably ten or twelve weeks of safety stock. So in the quarter, we don't expect that there will be a substantial impact in terms of the tariffs around our overall profitability. There will be a minor amount of dilution to our operating margins. But we would expect if those tariffs remain intact and or if they change, there would be a larger impact, you know, into the Q1 timeframe.

Gotcha. And then just thinking about product sourcing, so obviously, as you called out, you know, Mexico. In the past, you guys have talked about, you know, other countries kind of all over. So are you, it sounds like you are kind of speeding up that process a bit, I guess, in terms of looking at other potential sources. If you could maybe, you know, kind of expand on that and then kind of, you know, and then you know, if you were to do more sourcing out of other countries, do you think your gross margins could be comparable to what you've been posting here lately or, you know, how should we think about that?

Yeah. The situation's fairly dynamic as you can appreciate, Anthony. So what we have done and what we'll continue to do is look for as many alternative sources as possible. So what we've already lined up is, you know, potential suppliers in other Southeast Asian countries. So depending on ultimately where trade negotiations go, country by country, certainly, we'll have some agility to reshape our portfolio based upon a kind of tariff-optimized mix. We've more aggressively started to seek out potential suppliers in other parts of the world, granted that aren't as maybe sophisticated in terms of furniture supply chain and don't have the infrastructure. But again, I think we are taking the appropriate steps to make sure, again, we have options. And as soon as we have more clarity ultimately on where the trade policy and tariff discussions go, I think we can move fairly quickly to optimize our supply chain given ultimately where things land. And I think in terms of your discussion around kind of margins, you know, depending on the magnitude ultimately of where tariffs land, it will determine the margin impact. As Mike kind of suggested, you know, near term, they're gonna be slightly dilutive. Certainly, if tariffs end up being much larger than 10%, they'll be even more dilutive. What we anticipate attempting to do though is working with our value chain partners, and that's retailers, that's suppliers, to collectively figure out how do we minimize the tariff impact to consumers in this kind of economic environment. I think, you know, consumer spending is gonna be challenged, and so it's certainly in our mutual best interest to figure out how we minimize passing certainly any significant pricing on to consumers. So that would be our approach.

Gotcha. Alright. Well, you know, it does sound like you guys certainly are well-prepared and could have some market share gains given all the disruptions. So I think that's all I had here. You know, best of luck to you guys and look forward to seeing you at High Point.

Sounds good. Thanks, Anthony.

Thank you. Again, if you have a question, please press star then one. To ask a question. This concludes our question and answer session. I would like to turn the conference back over to Derek Schmidt for any closing remarks.

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 third quarter. I'm also thankful to all of you for participating on 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.

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