Flexsteel Industries, Inc. Aktie

Good morning, everyone, and welcome to the Flexsteel Industries Fourth Quarter Fiscal Year 2026 Earnings Conference Call. [Operator Instructions] Please also note that today's event is being recorded. At this time, I'd 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 Fiscal Year 2026 Financial Results. Our earnings release, which we issued after market close yesterday, Monday, August 17, 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 will 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?

Good morning, and thank you for joining us today. I am pleased to share our fourth quarter and fiscal year 2026 results. While the operating environment became increasingly challenging throughout the year, particularly during the second half, our team continued to execute at a high level and delivered another year of strong financial and strategic progress.

During fiscal year 2026, we generated sales of approximately $459 million, representing 4% growth over the prior year despite a weak and highly variable demand environment for furniture. We expanded adjusted operating margins to approximately 7.5%, generated record adjusted earnings per diluted share of $4.94, and produced more than $47 million of free cash flow. Our strong cash generation enabled us to return meaningful capital to shareholders through share repurchases, and we recently increased our dividend by 25% while maintaining a strong balance sheet.

These results are encouraging given the number of external challenges our industry faced during the year. Demand remained inconsistent, tariff policies continue to evolve, geopolitical events created heightened macroeconomic uncertainty, and inflationary pressures intensified as rising energy prices drove higher transportation and material costs. Despite these headwinds, our organization remained agile, disciplined and focused on execution.

I believe our performance this year demonstrates the resilience of our business model and the progress we've made strengthening our operating capabilities over the past several years. Turning to the fourth quarter. Net sales were modestly above the prior year period, continuing a streak of 11 consecutive quarters of year-over-year growth. While we are never satisfied with modest sales growth, the quarter must be viewed within the context of an increasingly difficult demand environment, which weakened significantly following the start of the war with Iran.

Consumer confidence remains subdued, affordability challenges continue to pressure discretionary spending, and ongoing uncertainty related to the conflict in the Middle East has weighed on economic sentiment. Even consumers shopping at higher price points have become increasingly value conscious in recent months. Importantly, many of the strategic initiatives driving our long-term growth continue to perform well.

Our Health and Wellness category once again delivered positive year-over-year growth, and we continue to make progress with strategic accounts and key new product introductions. While growth rates moderated along with the broader market, these initiatives continue to outperform the overall business and reinforce our confidence in the long-term opportunity ahead.

From a profitability perspective, we delivered adjusted operating margins of approximately 7.1% in the quarter. While this was below the prior year period, which benefited from an unusually large foreign currency gain, profitability was sustained sequentially from the third quarter and remained strong relative to both our historical performance and industry norms. Our results continue to reflect the benefits of disciplined product portfolio management, operational productivity improvements and prudent management of selling and administrative expenses while continuing to fund critical growth investments.

Beyond the financial results, I am particularly pleased with the strategic progress we made during fiscal year 2026. Over the past several years, we have invested heavily in strengthening our consumer insights capabilities, accelerating innovation, improving product development processes and expanding our marketing capabilities. During fiscal year 2026, we continued building on these investments and further strengthened our ability to bring relevant products to market that resonate with both consumers and retail partners.

We believe these capabilities are becoming increasingly important competitive advantages. Better consumer insights lead to better products, better products improve retail adoption and consumer demand and stronger marketing builds brand awareness and drives traffic to our retail partners. Together, these investments are helping us create a more durable growth platform, capable of generating long-term share gains across a variety of market conditions.

As we look ahead, however, we remain measured in our outlook for the near term. Consumer demand remains uneven. Inflationary pressures have increased and visibility remains limited. Rising energy costs are creating additional pressure across transportation, freight and raw material inputs. The tariff environment also remains highly fluid with uncertainty surrounding both future trade policies and potential changes to existing tariff structures. As a result, we expect industry conditions to remain challenging as we enter fiscal year 2027.

While the near-term environment may remain difficult, our strategy and priorities are unchanged. We will continue to operate with agility, maintain disciplined cost control, protect our strong financial position and invest in the capabilities that we believe will drive long-term growth and shareholder value creation. We have successfully navigated periods of disruption before, and I am confident that the combination of our balance sheet strength, operating discipline and strategic investments position us well to continue strengthening our competitive position over time.

With that, I'll turn the call over to Mike, who will provide additional details on our fourth quarter financial performance and outlook for Q1 fiscal year 2027.

Thanks, Derek. For the fourth quarter, net sales were $115.4 million or growth of 0.7% compared to net sales of $114.6 million in the prior year quarter. The increase was driven by a $2.9 million increase in sales of soft seating products, partially offset by a $1.8 million sales decline in our ready-to-assemble products sold under the homestyles brand. Sales of Flexsteel branded bedroom, dining and occasional case goods products were down roughly $0.3 million in the quarter.

Sales order backlog at the end of the period was $70.1 million, an increase of approximately 5.5% compared to the same period in the prior year. On a sequential basis, backlog is down approximately 11.8% from third quarter. The sequential decline in backlog aligns with historical patterns driven by softer demand leading into the summer season.

From a profit perspective, the company delivered GAAP operating income of $16.3 million or 14.2% of sales in the fourth quarter compared to operating income of $14 million or 12.2% of sales in the prior year quarter. GAAP operating margin of 14.2% includes a 780 basis point benefit from IEEPA tariff refunds received in the quarter and a negative 70 basis point impact from costs related to the exit of our homestyles branded ready-to-assemble product category, including employee separation costs and inventory liquidations and write-downs.

Excluding the impact of these items, adjusted operating margin was 7.1% of sales in the current quarter compared to adjusted operating margin of 9.0% of sales in the prior year quarter. Prior year quarter adjusted operating margin included a 160 basis point benefit from favorable foreign currency translation. Regarding refunds received for previously paid IEEPA tariffs, the company evaluated the appropriate accounting and business considerations for those funds. And based on the facts and circumstances of the matter, reported a reduction to cost of goods sold in the period.

Priorities for cash and liquidity include funding investments in consumer insights, innovation, new products and marketing to execute our growth strategy and strengthen our competitive advantage. During the quarter, the company made the decision to exit the ready-to-assemble product category, which has become increasingly competitive, difficult to sustain a competitive advantage, and no longer generates attractive returns.

Over the next 3 to 6 months, we expect to monetize remaining inventory and prepare our Huntingburg, Indiana distribution center for sale, which currently only services the ready-to-assemble category and is not required to support our long-term growth priorities.

Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $16.7 million, working capital of $94.6 million and no bank debt. Cash flow generated from operations in the quarter totaled $24.3 million, driven by strong net income and effective working capital management. During the quarter, the company repurchased roughly 1.3 million shares of outstanding stock for $62.6 million and paid $1.1 million in cash dividends or $0.20 per share.

Turning to our outlook for Q1 fiscal year 2027. We project net sales of $111 million to $115 million or 1% to 4% growth versus the prior year quarter. We anticipate sales growth from soft seating products to outweigh sales declines from the ready-to-assemble homestyles branded product category that we are exiting. The key determinant to our top line forecast with the largest variability will be consumer demand.

From a profitability perspective, the company expects operating margin in the range of 6.5% to 7.0%. Since the beginning of the conflict in the Middle East, we have experienced material supply chain inflation driven by elevated energy prices, including impacts to raw materials, sourced finished products, domestic transportation and inbound ocean freight. The company implemented a wide range of initiatives and pricing in the market.

We anticipate our mitigation actions to mostly offset cost inflation. However, we may experience some dilution to gross margins and operating margins in the quarter depending on the effectiveness of our actions and the ultimate severity of supply chain inflation. With that, I'll turn the call back over to Derek to share his closing perspectives.

Thanks, Mike. Fiscal year 2026 was a year that demonstrated both the strength of our strategy and the resilience of our organization. We delivered sales growth, expanded margins, generated record earnings, produced strong free cash flow and returned significant capital to shareholders despite operating in one of the most uncertain environments our industry has faced in recent years.

As we enter fiscal year 2027, we recognize that many of those external challenges remain. Demand conditions continue to be uneven, inflationary pressures are building and geopolitical and trade-related uncertainty remain elevated. While these factors may create near-term volatility, they do not change our long-term outlook for the business. Our focus remains squarely on what we can control, serving customers exceptionally well, driving innovation and product development, strengthening our brand, improving productivity and allocating capital thoughtfully.

We believe our strong balance sheet, disciplined operating model and continued investment in long-term growth initiatives position us well to navigate the current environment while continuing to create value for our shareholders. With that, we'll open the call to your questions. Operator?

[Operator Instructions] Our first question today comes from Anthony Lebiedzinski from Sidoti.

So first, can you talk about the impact of pricing versus unit volumes in the quarter? I know it varies by product category, but if you could give us some additional details, that would be very helpful.

Anthony, yes. So obviously, pricing in Q4 of this year was meaningfully higher than what it was in the prior year. On average, I would say pricing was up probably 10% to 11%. What we're encouraged by is given the magnitude of pricing that we had to take throughout the year to cover a variety of cost pressures that we did see unit volume declines, but not to the level that more than offset the pricing action.

Areas where unit volumes are up and what's really encouraging within some of our strategic growth areas such as our Health and Wellness category, the Zecliner product we have, the new Zen chairs, those are performing very well as also seeing nice unit volume growth with strategic accounts. Areas where I would say volumes are probably underperforming or where we're down a little bit is the made-to-order category, which we've kind of talked about, that category continues to be more challenged at retail. And then obviously, case goods down a little bit. We're encouraged by the momentum we're gaining at the retail channel, but we've kind of scaled some of our growth ambitions across the national accounts for case goods.

And then I have a 2-part question here. So as far as it relates to the homestyles brand, can you give us a sense as to how much annual sales you were doing with the brand? And then I guess the second part here is that I assume that homestyles was not contributing to the bottom line. Is that correct? And if so, how should we think about the bottom line impact as you exit from homestyles?

Yes, Anthony. So the homestyles business, that category has been challenged for a while, particularly got even more challenged when tariffs went into effect. But if you were to peel homestyles out of our business, our growth in the quarter would have been closer to 2.3%. So just around $12 million in sales this year.

As far as profitability goes, it was lower performing in terms of gross profit versus our category average. So as we kind of work ourselves out of that, we will have some decline in sales, but I would expect a little bit of improvement in our overall portfolio profitability, but relatively modest given the small amount of sales that contributed to the company.

Anthony, I'll just add. So I mean, as you start to think about your modeling, homestyles was probably roughly about $12 million of sales in fiscal year '26. So that will go away. What we're encouraged by overall sales for fiscal year '26 were up about 4%. If you were to take the homestyles drag out, we would have been closer to 6.5%, kind of closer to 7%. And we feel really good about that performance given the challenging environment that we operated in.

And then Derek, I thought your quote was interesting in your press release when you talked about that even consumers shopping at higher price points have become increasingly value conscious. So with that in mind, how are you adapting your product portfolio and marketing messaging to try to take advantage of this?

Yes. Maybe a little bit of context, Anthony. I would say that the upper income consumers are still shopping and they're still buying. But I think they're more cognizant of the external landscape and the economic environment and a bit more cautious. That said, we're actually not changing our strategy, we're not changing our marketing message. Those are consumers we understand. We understand their needs, their problems, and we're driving innovation to meet their needs better than the competitive alternatives.

And our marketing message is around why that innovation is differentiated and why it serves their needs better than the competition. So I don't think we're changing anything strategically or in our marketing message. But certainly, we're keeping a strong pulse on the health of the consumer across different income levels. But I think it's not surprising given the external environment, rising inflation that consumers across all income levels are a bit more cautious.

Yes. And then so as we think about gross margins, it looks like excluding the tariff refunds and the onetime exit costs related to homestyles, you guys were at about 23% for the fourth quarter. I know you mentioned that with the exit of homestyles, that should be a bit of a lift for the gross margin. But I know there are some pressures on ocean freight costs and other costs as well. So as we think about the different puts and takes about the gross margin, how do we think about the gross margins kind of on a go-forward basis?

Yes, Anthony, in our Q1 outlook, we guided 6.5% to 7% operating margin. The biggest factors there would be the impact of all these cost pressures on our gross margin. So clearly, we've had inflation on raw material inputs from poly to plywood to steel, freight costs, transportation costs and fuels impacting the cost to get raw materials and everything into our plants.

We've experienced cost inflation on our sourced finished product. Certainly, seen recent spikes in ocean freight rates to bring finished product in. So there's a lot of moving parts. It's super dynamic. What I would tell you is like we've done in the past, we're going to continue to approach it from multiple angles.

We've implemented cost savings initiatives to help mitigate it, and we've also implemented a modest amount of pricing, what we believe is -- can be absorbed in the market, but we'll obviously watch what we see on unit volume demand given we want to be very competitive in the market. So our target is to continue to mitigate the impact of that stuff. But certainly, the severity of what happens with inflation could certainly impact gross margins, and that's kind of why we gave you that range in the operating margin for the quarter.

The thing I'd add, Anthony, I wouldn't necessarily characterize our guidance range of 6.5% to 7% as a new normal or even a floor. As you're well aware, I mean, we've made some substantial structural improvements to the profitability of the business over the past couple of years through product portfolio management, productivity, cost discipline, improved execution. And longer term, we remain confident in that structural profitability improvements that we've made. I just think the near-term external environment will determine the pace of further improvement on our margin structure.

And then as far as SG&A, that came in slightly ahead of our estimates. I know you guys continue to focus on driving innovation and consumer research and consumer insights. So how do we think about just SG&A going forward here as we look to update the models?

Anthony, what I would tell you is we're going to continue to be prudent in managing SG&A spending, but we're also going to continue to invest in those things that are enabling us to gain share and strengthen our competitive advantage. So think about it in terms of probably high 15%, low 16 percentage range for your model.

And lastly for me, just as we think about capital allocation, so in fiscal '26, you bought back a lot of your stock and you raised the dividend 25%. So going forward, how do we think about your capital allocation priorities?

Yes. So I would say relatively intact. We want to continue to maintain a strong balance sheet, give us flexibility to operate in the dynamic environment that we're in. We're going to continue to fund the investments that we talked about that are driving our organic growth. And then if you look out beyond that, as you think about M&A and things like that, we'll continue to evaluate investment opportunities, but they certainly would need to deliver ROI above our cost of capital. And if those things don't exist, we'll return excess capital to shareholders through dividend and repurchases based on the cash and capital needs of the business.

Our next question comes from Balzhan Tleuzhanova from Freedom Broker.

Congrats, both of you on this quarter -- strong quarter. Yes. My question was about capital allocation, but Anthony asked this question. So I have no question anymore.

[Operator Instructions] We do have an additional question from Donald Hall from DMH Advisors.

I believe I heard that in the fourth quarter, you are exiting the ready-to-assemble category of your product line?

Correct.

Can you give us an idea of the magnitude that has on your revenue? Is it 10% of revenue...

Yes, it is -- yes, we addressed that. Anthony asked that question. This year was approximately $12 million.

$12 million, okay.

Correct.

And then I believe I heard that in the first quarter, you expect revenue to increase 1% to 4% in spite of that withdrawal. Did I hear that correctly?

Correct. Yes.

And I'm showing no additional questions, we'll be ending today's question-and-answer session. I'd like to turn the floor back over to the management team for any closing remarks.

All right. In closing, I want to thank our employees for their hard work, commitment and outstanding execution throughout fiscal year 2026. I believe the accomplishments we delivered this year from strong financial performance to meaningful strategic progress are a direct reflection of the talent, dedication and resilience of our team.

And while we enter fiscal year 2027 facing a continued uncertain environment, we do so from a position of strength. We have a strong balance sheet, a resilient operating model, a clear strategy and a team that has repeatedly demonstrated its ability to adapt and execute through changing conditions. I remain highly confident in our ability to navigate these challenges while continuing to strengthen our business, gain share over time and create long-term value for our customers and shareholders.

Thank you again for joining us today and for your continued interest in Flexsteel, and we look forward to updating you on our progress next quarter.

And with that, ladies and gentlemen, we'll be concluding today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.

Good day, and welcome to the Flexsteel Industries Third Quarter Fiscal Year 2026 Earnings Conference Call. [Operator Instructions] 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 third quarter fiscal year 2026 financial results. Our earnings release, which we issued after market close yesterday, Monday, April 20, and 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 will 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 that 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?

Good morning, and thank you for joining us today. As we reflect on our third quarter performance, we are operating in an environment that continues to be increasingly uncertain and dynamics. Over the course of the quarter, we saw a meaningful shift in demand patterns driven by a combination of factors, including severe weather early in the quarter and more recently, heightened macroeconomic uncertainty stemming from the conflict in the Middle East. These conditions have impacted consumer confidence, increased volatility in financial markets and contributed to rising energy costs, all of which are influencing both demand and our cost structure.

Against this backdrop and a strong prior year comparison, we delivered relatively stable year-over-year sales performance in the quarter and maintained solid operating margins of approximately 7%. While our year-over-year growth moderated this quarter, I'm encouraged by how our teams continue to execute and manage the business with discipline. Our results reflect the progress we've made building a more resilient operating model, 1 that allows us to respond quickly to changing conditions while maintaining focus on long-term value creation.

Importantly, our underlying growth drivers remain intact. Our strategic accounts, new product introductions and health and wellness category all continued to perform well during the quarter. although at more moderate growth levels than we've experienced in recent periods. This gives us confidence that while near-term demand is under pressure, the foundational elements of our growth strategy are working.

Demand trends were uneven throughout the quarter. January and February were impacted by unusually severe weather across several regions. In March, we saw a more noticeable slowdown in orders as macroeconomic uncertainty increased. Overall, orders were down approximately 2.4% in the quarter and we continue to see variability in consumer traffic and purchasing behavior. Retail partners are responding cautiously managing inventory levels closely and taking a more measured approach to replenishment.

From a profitability standpoint, we continue to benefit from the operating discipline and productivity improvements we've implemented over the past several years. However, we are beginning to see cost pressures increase, particularly related to higher fuel and energy costs stemming from the developments in the Middle East. These pressures are impacting domestic transportation costs immediately and are expected to expand the ocean freight and product cost later in the fourth quarter and into the first quarter of fiscal year 2027.

As we consider potential actions to mitigate these impacts, including pricing and cost initiatives, we are being thoughtful given the current sensitivity of the consumer and the broader demand environment. Compounding near-term supply pressures is a fire last month at a large chemical factory in Texas that is hindering production of polyol, a key chemical used in the production of phone for upholstered furniture. Not only is this further elevating prices on this key furniture input, but most North American phone manufacturers are now on allocation from chemical suppliers for polyol which could lead to product shortages and extended manufacturing lead times for furniture as soon as May.

In addition to these supply chain and macroeconomic pressures, the tariff environment remains highly fluid and uncertain. We are closely monitoring potential new tariffs being pursued by the administration and how they may interact with existing Section 232 tariffs on upholstery furniture. There is also uncertainty around future trade negotiations, including USMCA, which could impact our operations and sourcing in Mexico. These factors represent additional variables that could influence both demand and our cost structure in future periods.

As we look ahead, we do expect near-term conditions remain challenging. Demand is likely to remain uneven, and we currently anticipate fourth quarter sales to be relatively flat with prior year levels and operating margins similar to third quarter performance. The duration and severity of these challenges will depend on how macroeconomic conditions, geopolitical events and trade policy evolves. That said, our strategy and focus remains unchanged. We are operating with agility, maintaining disciplined cost control and continuing to invest in the capabilities that support our long-term growth strategy.

These include investments in consumer insights, innovation, product development, marketing and customer experience, areas that we believe are critical to sustaining share gains over time. We believe our strong balance sheet and improved operating model positions us well to navigate this period of uncertainty, while continuing to strengthen our competitive position and drive long-term shareholder value.

And 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 our financial outlook.

Thanks, Derek. For the third quarter, net sales were $115.1 million or growth of 1% compared to net sales of $114 million in the prior year quarter. The increase was primarily driven by pricing from tariff surcharges, offset by lower unit volume, particularly in our made-to-order ready to assemble in case goods categories. Sales order backlog at the end of the period was $79.5 million. The backlog is up approximately 1.5% compared to the same period in the prior year. On a sequential basis, backlog is down approximately 3.5% from second quarter. From a profit perspective, the company delivered GAAP operating income of $8.2 million or 7.1% of sales in the third quarter compared to an operating loss of $5.1 million in the prior year quarter.

The prior year quarter GAAP operating loss included a $14.1 million impairment charge on the right-of-use assets associated with our Mexicali lease, offset by a $0.8 million gain on the sale of a building in Honeyberg, Indiana. Current quarter operating margin decreased 20 basis points compared to adjusted operating margin of 7.3% of sales in the prior year quarter. The decrease is primarily driven by higher SG&A investments and consumer insights, innovation, demand generation and customer experience, which we believe will be catalysts for future growth. The impact of tariffs on operating margin in the quarter was mitigated through a combination of cost savings initiatives, operational efficiencies and pricing actions.

Moving to the balance sheet and statement of cash flows. The company ended the quarter with a cash balance of $57.3 million, working capital of $142.2 million and no bank debt. Cash flow from operations in the quarter was $22.1 million, primarily due to a $14.5 million reduction in inventory. As mentioned last quarter, we brought in elevated levels of inventory prior to the anticipated tariff increase on January 1. During the quarter, we normalized our inventory stocking position while maintaining high service levels. 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 operating environment has become more complex and uncertain over the past several months. The combination of geopolitical and macroeconomic volatility, rising energy costs and supply chain disruptions is creating near-term pressure on both demand and cost with limited visibility into how conditions may develop in the near term. Despite this, our strategy remains clear and our focus remains unchanged. Our teams are operating with discipline and urgency, adapting to evolving conditions, managing costs responsibly and staying focused on the initiatives that we believe will drive long-term growth. I'm proud of how our organization continues to perform in the face of heightened uncertainty.

Additionally, we are navigating this period from a position of strength with a solid balance sheet, an improved operating model and a clear strategic road map, which gives me confidence in our ability to manage through these near-term challenges while continuing to build a stronger, more competitive business over time and deliver long-term shareholder value.

With that, we'll open the call to your questions. Operator?

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

Thank you, and good morning, everyone. Certainly nice to see the better-than-expected profitability in the quarter. Just wondering if you guys maybe could -- maybe try to put a number as far as the impact of the severe weather on your sales, any way to kind of put that into context as to what you think that that was?

Anthony, it's really hard to put a specific number on it. But what I would tell you is we got direct feedback from several of our large retailers that were impacted in it had a meaningful impact on their business, which translates to lower replenishment orders for stock to Flex deal. So hard to put a number on it, but we certainly heard a lot from retailers on the impact of their business.

What I would tell you is January, February, we've seen just really choppy demand on a week-over-week basis. So that was probably 1 of the things that stood out to us in terms of how the weather played a role in that. And then we talked about it in the call. But March orders, we've seen kind of more of just -- I would say, more of a broader pullback as we're starting to, I think, field effects of consumer confidence and all the things going on in the Middle East and the economic uncertainty.

And the only thing I'd add to that, Anthony. I mean in terms of March, difficult to really determine whether it's something more structural longer term or temporary. Clearly, they'll given what Mike cited around conflict in the Middle East, rising energy costs, I mean we're seeing more cautious consumer behavior and more conservative inventory management from our retail partners. So difficult at this point to determine whether there's a structural change in demand, but more of a period of, I think, heightened uncertainty, where visibility is pretty limited and conditions, I think, can shift quickly here depending on how things unfold on the geopolitical stage.

Got you. Okay. And then just in terms of the pricing versus unit volumes, can you give some additional color as to what the impact of those 2 things were in the quarter?

Yes, Anthony. So the tariff pricing we took, it was meaningful in the quarter. So somewhere around 11% of our sales composition is from pricing we took to partially offset tariff surcharges. And obviously, that was largely offset by unit volume declines. Encouragingly, there were categories where we actually did have unit volume increases in some of our key growth areas like strategic accounts and health and wellness. So that gives us confidence that our structural growth strategies are intact and working albeit with a more challenging external environment.

Understood. You also did a nice job with your gross margins, which were -- you cited favorable impact or favorable mix of higher-margin products. Can you share more color on this? And do you expect this to continue?

Yes, Anthony. I mean, we've talked about product portfolio, life cycle management being a significant driver in terms of our operating margin improvement over the last several years as well as a catalyst for cost mitigation and maintaining margins going forward. I would say the mix of new product sales is probably somewhere in that 40% to 45% range. kind of at a company level.

And I would say you dive deeper down into the categories, and that looks a little bit different. But I'd say, overall, I feel good about what we're doing in terms of focusing on bringing new product to market with better cost and profit profiles, and we're going to continue to focus on that as we move forward.

And to add to that, Anthony, not surprising, we're -- certainly, we see higher margins in the portfolios where we have differentiated innovation that clearly meets an underserved or unmet consumer need. And that's a huge focus for us in terms of continuing that investment. So I believe that if we can continue to execute well on that front around innovation, around the consumer insights, we'll continue to see certainly favorable margins from our new product portfolio.

Got you. And then can you just give a comment as far as the competitive landscape, I mean do you think that given all the disruptions that you're seeing, could this perhaps be an instance where the silver lining here is that you are able to gain market share?

Yes. I think, Anthony, you're absolutely right. Even though we're certainly in a challenging period, a very dynamic period that in the event that the Middle East conflict were to drag out or disruption in the energy markets would continue, I think that's going to be a huge drag certainly on the industry. As we've stated, I believe we're in a position of strength that we're well capitalized. We've got a strong balance sheet.

We have the luxury of being profitable and being able to continue our growth investments. And I believe that is a competitive advantage that should enable us to continue to gain share in this environment where some competitors who are not in the strongest financial position, we'll inevitably have to pull back on investments. And again, I think that will further highlight our advantages. So that's the way we're thinking about it, Anthony. It's we say every market is a growth market, and we've got an opportunity here, I think, to continue to gain share. And we can't control what's happening in the external environment, but we'll continue to focus on executing what we can, which is delivering value to consumers through innovation, putting powerful marketing and customer experience for our retailers. And I think we just continue to do that and execute that well, we'll continue to gain share.

Absolutely. Okay. And then so as you mentioned, you have a strong balance sheet. You had a really strong cash flow quarter. Your inventory was down 15% on a sequential basis. I know you touched on this in your prepared remarks. But just maybe can you give us a sense as to where you think inventories might end at the end of the fiscal year? And what do you plan to do with the cash which you have more than what you've historically had?

Yes, Anthony, inventory came down. We talked about -- there was a -- we bought ahead in some of our best sellers ahead of anticipated tariff increases. And this quarter was largely about kind of bringing those stocking levels back in line kind of with what our targets are based on the needs of the business while maintaining really high service levels, would expect inventory to probably grow here in the quarter modestly. We've got several new product collections that performed really well at market that are starting to flow, and we hope to get those things in stock, so we can start fulfilling orders.

As far as cash flow, our capital allocation strategy remains intact. Number one, we want to maintain a strong balance sheet and gives us flexibility to navigate near-term kind of market challenges, but also optionality to reinvest back into the business and those growth initiatives that we believe will create long-term value. And honestly, lastly, we've talked about returning excess cash to shareholders through dividends and buybacks kind of based on the needs of the capital needs of the business.

All right. Well, it sounds good. Thank you very much, and best of luck.

All right. Thank you, Anthony.

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 Flexi employees for their hard work and dedication in driving the company's solid performance during the third 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 the next call. Thank you.

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

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.

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

Good day, and welcome to the Flexsteel Industries First Quarter Fiscal Year 2026 Earnings Conference Call. [Operator Instructions] 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, 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 20, 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?

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 lacklustre 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 2 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 and the broader economy is restrained.

While the U.S. 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 upholstery 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 upholstery 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 U.S. 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 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 U.S., dampen consumer demand and compressed 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 died 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 share. While we're hopeful that either Vietnam or Mexico or both reach trade agreements with the U.S. that lessen the tariff exposure to furniture, we are aggressively pursuing a multipronged 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 and our subsequent pricing response to 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 Flexsteel'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 tuned theater quality audio and synchronized vibration integrated directly into the furniture, Pulse surrounds you and 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 application, 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 Zecliner 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, positioned 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 7 new collections at market, all developed with distinct on-trend designs and unique features, including lighting, discrete power, 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 3 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 has invested in paid search, paid social and e-mail 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 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.

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 million 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% to 7.3% of sales. The outperformance to our guidance range was primarily due to leverage on our fixed costs 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 U.S. dollar in the quarter.

As Derek mentioned, through pricing 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.

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.

Our 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 look for opportunities to move faster and think bolder than our competition to further strengthen our position.

With that, we will open the call to your questions. Operator?

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

So certainly an impressive quarter given the operating environment. Derek, you talked about in the press release as well as on the call about uneven demand during the quarter. I was wondering if you could provide more details. 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 saw as you went from early July through the end of September. I would love to hear your thoughts on that.

Yes. What I was referring to there, Anthony, was really, I mean, weekly store traffic in sales as well as our orders were very volatile. And to give you 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, the furniture consumer because there's been so much volatility, especially on a week-to-week basis that typically isn't normal, certainly in our business or kind of the industry.

And I would certainly probably attribute that to I mean, number one, the uncertainty around tariffs. But then, again, there's some uncertainty around just the overall macro environment. And so I think consumer confidence, like I said, is a bit shaky. And so it's not entirely surprising that we saw stronger sales around the holiday period. I think strain 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.

Understood. Okay. All right. And then thinking about the new tariffs, you talked about putting in place tariff surcharges. Can you comment 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 gross margins, if any -- any kind of additional help would be certainly beneficial.

Yes, Anthony, I'll give you 2 perspectives because we have different businesses. We have our in-stock source product business and then we've got our made-to-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 cover eventually 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 14, Section 232 tariffs going into place, we are USMC compliant. So there was no tariff on that part of our business. That is going 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.

Okay. So I guess it's too early to tell about the impact.

Yes, yes. I think certainly, there will be some demand decline as a result of these price increases, not only for Flexsteel, 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.

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

Yes. I think our long-term goal is 30% to 40% of sales being derived from new products, and we define that as new products launched within the last 3 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 2 years, and we're investing aggressively.

In terms of how we think about pricing, when we introduce new products, we're constantly trying to cannibalize ourselves. So really, the intent is to constantly bring new improved value to our retailers and to our consumers. So we're aiming for 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 value to the market at similar, if not lower prices than our current product.

Got you. All right. And then you've guys have done a nice job also with your case goods business. I certainly understand it's a relatively small piece of the overall business. But thinking about going forward, do you guys have a goal in mind as far as how much you want to increase case goods? What percent of sales could that be at some point?

What I will 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 of 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 the quality of new product that we've come out 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 as we start to ramp those up more significantly, I think we'll be more open to sharing details around how we think about our portfolio composition.

Got you. Okay. And my last question. So 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?

Yes, Anthony, in the quarter, there were a couple of discrete items. Number one, just a change in reserve for 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, we expect the rate to be a little bit -- a couple of hundred basis points higher kind of for the remainder of the year.

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

Two questions. First of all, relative to your comment that the 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 secondarily, I was a little confused when you referenced you had products that were USMCA compliant, but it sounds like the recent tariffs are changing that dynamic. Would you provide, I guess, some fuller picture and fill in the blanks on the dynamics there, please?

Yes. 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, 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 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's 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 plethora of competitive information, but we're seeing some of our main competitors go as high as 21% and 25% relative 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.

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?

Certainly, it's a possibility. I think, Bill, it's too early to speculate on that. As I noted in my comments earlier, we're 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 get a better pulse 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 5, 6, 7 weeks here to really get our arms around how the consumer is going to respond to these pricing changes in the market.

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 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.

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