Good day, and welcome to the Flexsteel Industries third quarter fiscal year 2026 earnings conference call. All participants will be in 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 to ask questions. To ask a question, you may press star then one on a 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 Michael 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 20th, is available on the investor relations section of our website at www.flexsteel.com under News and Events. I'm here today with Derek Schmidt, President and Chief Executive Officer. On today's call, we will provide prepared remarks, and then we 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. 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 dynamic. 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 of 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, one 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 continued 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 to ocean freight and product costs 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 foam for upholstered furniture. Not only is this further elevating prices on this key furniture input, but most North American foam 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 to 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 evolve. 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. 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, and 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 asset associated with our Mexicali lease, offset by a $0.8 million gain on sale of a building in Huntingburg, 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 in 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 1st. 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 costs, 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 roadmap.
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?
We will now begin the question- and- answer session. To ask a question, you may press star then one on your touch-tone phone. 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 question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Anthony Lebiedzinski with Sidoti. Please go ahead.
Thank you, and good morning, everyone, and thanks for taking the question. Certainly nice to see the better- than- expected profitability in the quarter. Just wondering if you guys maybe could 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 was?
Morning, 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, and it had a meaningful impact on their business, which translates to lower replenishment orders for stock to Flexsteel. 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. That was probably one of the things that stood out to us in terms of how the weather played a role in that. Then we talked about it in the call.
March orders, we've seen more of just a, I would say more of a broader pullback as we're starting to, I think, feel the effects of consumer confidence and all the things going on in the Middle East and the economic uncertainty.
The only thing I'd add to that, Anthony, in terms of March, difficult to really determine whether it's something that's more structural, longer- term or temporary. Clearly, though, given what Mike cited around conflict in the Middle East, rising energy costs, we're seeing more cautious consumer behavior and more conservative inventory management from our retail partners. 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, thanks. Just in terms of the pricing versus unit volumes, can you give some additional color as to what the impact of those two things were in the quarter?
Yeah, Anthony. The tariff pricing we took, it was meaningful in the quarter. Somewhere around 11% of our sales composition is from pricing we took to partially offset tariff surcharges. 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. 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 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?
Yeah, Anthony. 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%-45% range, kind of at a company level. I would say you dive deeper down into the categories and that looks a little bit different. 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.
Yeah. To add to that, Anthony, it's not surprising. Certainly we see higher margins in the portfolios where we have differentiated innovation that clearly meets an underserved or unmet consumer need. That's a huge focus for us in terms of continuing that investment. 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. Can you just give a comment as far as the competitive landscape? 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?
Yeah, I think, Anthony, you're absolutely right. Even though we're certainly in a challenging period, 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, and 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 will inevitably have to pull back on investments. Again, I think that will further highlight our advantages. That's the way we're thinking about it, Anthony.
I always say every market's a growth market. We've got an opportunity here, I think, to continue to gain share. 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. I think if we just continue to do that and execute that well, we'll continue to gain share.
Absolutely. Okay. 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? What do you plan to do with the cash that you have more than what you've historically had?
Yeah. Anthony, inventory came down. We talked about 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. We would expect inventory to probably grow here in the quarter modestly. We've got several new product collections that perform 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 goes, 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 in those growth initiatives that we believe will create long-term value. Obviously, we've talked about returning excess cash to shareholders through dividends and buybacks, kind of based on 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 Flexsteel 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.