SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D. C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934 [No Fee Required]For the quarterly period ended December 31, 2004or[ ] Transition Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934 [No Fee Required]For the transition period from to Commission file number 0-5151
Incorporated in State of Minnesota I.R.S. Identification No. 42-0442319
FLEXSTEEL INDUSTRIES, INC.P. O. BOX 877DUBUQUE, IOWA 52004-0877
Area code 563 Telephone 556-7730
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X. No .
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X. No .
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS (UNAUDITED)
See accompanying Notes to Consolidated Financial Statements (Unaudited).
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FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
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FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)FOR THE PERIOD ENDED DECEMBER 31, 2004
The consolidated financial statements included herein have been prepared by Flexsteel Industries, Inc. (the Company or Flexsteel), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The information furnished in the consolidated financial statements includes normal recurring adjustments and reflects all adjustments, which are, in the opinion of management, necessary for a fair presentation of such consolidated financial statements. Operating results for the six-month period ended December 31, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2005. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements for the year ended June 30, 2004, and the notes thereto, included in Flexsteel’s Annual Report on Form 10-K as filed with the SEC.
INVENTORIES – Are stated at the lower of cost or market. Raw steel, lumber and wood frame parts are valued on the last-in, first-out (“LIFO”) method. Other inventories are valued on the first-in, first-out (“FIFO”) method. Inventories valued on the LIFO method would have been approximately $4,359,000 and $3,018,000 higher at December 31, 2004 and June 30, 2004, respectively. A comparison of inventories is as follows (in thousands):
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BORROWINGS AND CREDIT ARRANGEMENTS – At December 31, 2004, outstanding borrowings consisted of the following (in thousands):
DERIVATIVE INSTRUMENTS & HEDGING ACTIVITIES – Related to its variable debt, the Company has interest rate swaps utilized to hedge against adverse changes in interest rates. The notional principal amounts of the outstanding interest rate swaps totaled $13.1 million with a weighted average fixed rate of 3.9% at December 31, 2004. The interest rate swaps are not utilized to take speculative positions. The Board of Directors established the Company’s policies with regards to activities involving derivative instruments. Management, along with the Board of Directors, periodically reviews those policies, along with the actual derivative related results. The Company recorded the fair market value of its interest rate swaps as cash flow hedges on its balance sheet and has marked them to fair value through other comprehensive income. The fair values of the swaps were a liability of $0.1 million as of December 31, 2004 and are reflected as other long-term liabilities on the accompanying consolidated balance sheet.
ACCRUED WARRANTY COSTS – The Company estimates the amount of warranty claims on sold product that may be incurred based on current and historical data. The actual warranty expense could differ from the estimates made by the Company based on product performance. The following table presents the changes in the Company’s product warranty liability for the six months ended December 31, 2004 (in thousands):
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STOCK OPTIONS – The Company has stock option plans for key employees and directors that provide for the granting of incentive and nonqualified stock options. Under the plans, options are granted at an exercise price equal to the fair market value of the underlying common stock at the date of grant, and may be exercisable for up to 10 years. All options are exercisable when granted. At December 31, 2004, 285,700 shares were available for future grants. The Company applies Accounting Principles Board (APB) Opinion No. 25 and related interpretations in accounting for its stock option plans, as permitted under Statement of Financial Accounting Standards (SFAS) No. 123 and SFAS No. 148, also see Note 12. Accordingly, no compensation cost has been recognized for its stock option plans. Had the compensation cost for the Company’s incentive stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the fair-value methodology of SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the following pro forma amounts:
CONTINGENCIES – The Company has guaranteed the future lease payments of a third party ending August 2007. The annual minimum lease payments are approximately $230,000 and the remaining minimum payments are approximately $620,000 at December 31, 2004. The Company has not been required to make any payments and has not recorded any amount in its financial statements related to this guarantee.
SUPPLEMENTAL CASH FLOW INFORMATION – Cash paid during the period for (in thousands):
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SEGMENTS – The Company has operated in two reportable operating segments: (1) Furniture Products and (2) Retail Stores. The Furniture Products segment involves the distribution of manufactured and imported products consisting of a broad line of upholstered and wooden furniture for residential, recreational vehicle, and commercial markets. The Company’s products are sold primarily throughout the United States by the Company’s internal sales force and various independent representatives. The Retail Stores segment involved the operation of retail furniture stores that offered the Company’s residential products for sale directly to consumers. The retail stores were closed in fiscal 2004. Accordingly, only results for the prior year three-month and six-month periods are shown below. No single customer accounted for more than 10% of sales in either of the Company’s two segments.
EARNINGS PER SHARE – Basic earnings per share of common stock is based on the weighted average number of common shares outstanding during each fiscal year. Diluted earnings per share of common stock takes into effect the dilutive effect of potential common shares outstanding. The Company’s only potential common shares outstanding are stock options, which resulted in a dilutive effect of 80,535 shares and 71,761 shares in the quarters ended and 77,998 and 83,258 shares in the six months ended December 31, 2004 and 2003, respectively. The Company calculates the dilutive effect of outstanding options using the treasury stock method. Options to purchase 15,895 shares and 18,222 shares of common stock were outstanding during the six months ended December 31, 2004 and December 31, 2003, respectively, but were not included in the computation of diluted earnings per share as their exercise prices were greater than the average market price of the common shares.
COMPREHENSIVE INCOME – In accordance with the provisions of SFAS No. 130, the Company has elected to report comprehensive income in its Consolidated Statement of Changes in Shareholders’ Equity. For the six months ended December 31, 2004 and 2003, other comprehensive income (loss), net of tax, was approximately $0.1 million and $0.3 million, respectively.
ACCOUNTING DEVELOPMENTS – In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R) (revised 2004), “Share-Based Payment”, which amends FASB Statement No. 123 and will be effective for public companies for interim or annual periods beginning after June 15, 2005. The new standard will require the Company to expense employee stock options and other share-based payments. The Company is currently evaluating how it will adopt the standard and evaluating the effect that the adoption of SFAS 123(R) will have on its financial position and results of operations.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
GENERAL:
The following analysis of the results of operations and financial condition of Flexsteel Industries, Inc. and Subsidiaries (the Company) should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this document.
CRITICAL ACCOUNTING POLICIES:
The discussion and analysis of the Company’s consolidated financial statements and results of operations are based on consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these consolidated financial statements requires the use of estimates and judgments that affect the reported results. Actual results may differ from these estimates under different assumptions or conditions.
Use of estimates – the Company uses estimates based on the best information available in recording transactions and balances resulting from business operations. Estimates are used for such items as collectability of trade accounts receivable, inventory valuation, depreciable lives, self-insurance programs, warranty costs, income taxes, and revenue recognition.
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Allowance for doubtful accounts – the Company establishes an allowance for doubtful accounts through review of open accounts, and historical collection and allowances amounts. The allowance for doubtful accounts is intended to reduce trade accounts receivable to the amount that reasonably approximates their fair value due to their short-term nature. The amount ultimately realized from trade accounts receivable may differ from the amount estimated in the consolidated financial statements based on collection experience and actual returns and allowances.
Inventories – the Company values inventory at the lower of cost or market. Raw steel, lumber and frame parts are valued on the last-in, first-out (“LIFO”) method. Other inventories are valued on the first-in, first-out (“FIFO”) method. Changes in the market conditions could require a write down of inventory.
Valuation of long-lived assets – the Company periodically reviews the carrying value of long-lived assets and estimated depreciable or amortizable lives for continued appropriateness. This review is based upon projections of anticipated future cash flows and is performed whenever events or changes in circumstances indicate that asset carrying values may not be recoverable or that the estimated depreciable or amortizable lives may have changed. These evaluations could result in a change in estimated useful lives in future periods.
Self-insurance programs – the Company is self-insured for health care and most workers’ compensation up to predetermined amounts above which third party insurance applies. The Company purchases specific stop-loss insurance for individual health care claims in excess of $150,000 per plan year, with up to a $1.0 million individual lifetime maximum. For workers’ compensation the Company retains the first $350,000 per claim and purchases excess coverage up to the statutory limits for amounts in excess of the retention limit. The Company is contingently liable to insurance carriers under its comprehensive general, product, and vehicle liability policies, as well as some workers’ compensation. Losses are accrued based upon the Company’s estimates of the aggregate liability of claims incurred using certain actuarial assumptions followed in the insurance industry and based on Company experience. The actual claims experience could differ from the estimates made by the Company.
Warranty – the Company estimates the amount of warranty claims on sold product that may be incurred based on current and historical data. The actual warranty expense could differ from the estimates made by the Company based on product performance.
Revenue recognition – the Company recognizes revenue upon delivery of product to customers. Our ordering process creates persuasive evidence of the sale arrangement and the sales amount is determined. The delivery of the goods to our customer confirms our reasonable assurance of collectability. Net sales consist of product sales and related delivery charge revenue, net of adjustments for returns and allowances. The actual amounts for returns and allowances could differ from the estimated amounts. Shipping and handling costs are included in cost of goods sold.
Overview
The following table has been prepared as an aid in understanding the Company’s results of operations on a comparative basis for the three months and six months ended December 31, 2004 and 2003. Amounts presented are percentages of the Company’s net sales.
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Results of Operations for the Quarter Ended December 31, 2004 vs. 2003
Net sales for the fiscal quarter ended December 31, 2004 were $105.0 million compared to the prior year quarter of $109.1 million, a decrease of 3.7%. Residential net sales were $70.6 million, compared to $75.8 million, a decrease of 6.9% from the prior year quarter. Recreational vehicle net sales were $18.9 million, compared to $20.0 million, a decrease of 5.4% from the prior year quarter. Commercial net sales were $15.5 million, compared to $13.3 million in the prior year quarter, an increase of 16.8%.
Gross margin for the quarter ended December 31, 2004 was 19.4% compared to 21.3% in the prior year quarter. The decreased gross margin percentage reflects increased costs for materials, especially steel and component parts that have steel content, and petroleum related expenses, including poly foam and fuel. The adverse impact of the aforementioned factors on gross margin for the second quarter was approximately $0.9 million or 0.8% of net sales.
Selling, general and administrative expenses as a percentage of net sales were 16.8% and 16.9% for the current quarter and prior year quarter, respectively.
The effective tax rate was 38.9% and 39.8% in the current and prior fiscal quarters, respectively.
The above factors resulted in current quarter net income of $1.6 million or $0.24 per share, compared to the prior year quarter of $3.0 million or $0.46 per share, a decrease of $1.4 million or $0.22 per share.
All earnings per share amounts are on a diluted basis.
Results of Operations for the Six Months Ended December 31, 2004 vs. 2003
Net sales for the six months ended December 31, 2004 were $202.9 million compared to $186.0 million in the prior year six months, an increase of 9.1%. Flexsteel acquired DMI Furniture, Inc. (DMI) in a business combination accounted for as a purchase as of September 17, 2003. The net sales and operating results being reported for the prior year includes the net sales and operating results of DMI for the period September 18, 2003 through December 31, 2003. The net sales reported above include $58.0 million and $35.2 million of DMI for the six months ended December 31, 2004 and 2003, respectively.
Gross margin decreased $1.8 million to $38.3 million or 18.9% of sales in the current period from $40.1 million or 21.5% of sales in the prior year period. Lower gross margin percentage in the current period reflects increased costs of approximately $2.0 million or 1.0% of net sales, for steel and component parts that have steel content and petroleum related items including fuel and poly foam.
Selling, general and administrative expenses as a percentage of sales were 16.8% and 17.4% for the current year and prior year, respectively. The decrease in the percentage of selling, general and administrative expenses on a fiscal year-to-date basis is primarily due to the discontinuation of the Company’s retail stores.
During the first quarter of fiscal 2004, the Company recorded a gain on the sale of a former manufacturing facility of $0.6 million.
The effective tax rate was 39.1% and 39.6% in the current and prior six-month period, respectively.
The above factors resulted in current fiscal year to date net income of $2.8 million or $0.42 per share compared to $4.9 million or $0.75 per share in the prior year period, a decrease of $2.1 million or $0.33 per share from the prior year six-month period.
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Liquidity and Capital Resources
Working capital (current assets less current liabilities) at December 31, 2004 was $88.2 million, which includes cash, cash equivalents and investments of $2.7 million. Working capital increased by $4.9 million from June 30, 2004 with operations generating $3.1 million and an increase in long-term borrowings of $1.8 million.
Net cash provided by operating activities was $2.1 million and $8.4 million in the six months ended December 31 2004 and 2003, respectively. Fluctuations in net cash provided by operating activities were primarily the result of changes in net income, inventories and notes payable. The increase in inventories reflects higher levels of finished goods, primarily from imported products. In addition, current fiscal year cash flows from operations were impacted by a decrease in accrued payroll and related items due to incentive payments and other timing differences.
Capital expenditures were $2.5 million and $3.2 million during the first six months of fiscal 2005 and 2004, respectively. Current quarter expenditures were incurred primarily for manufacturing and delivery equipment. During the next six months, it is anticipated that approximately $2.0 million will be used for additional manufacturing equipment. Cash generated from operations and available lines of credit are expected to provide funds necessary for projected capital expenditures.
The Company has adequate cash, cash equivalents, short-term investments and credit arrangements to meet its operating and capital requirements. In the opinion of management, the Company’s liquidity and credit resources provide it with the ability to react to opportunities as they arise, the ability to pay quarterly dividends to its shareholders, and ensures that productive capital assets that enhance safety and improve operations are purchased as needed.
Outlook
Margin pressures that started near the end of calendar year 2003 have continued throughout 2004. The cost of steel and component parts that have steel content and petroleum related items, including fuel and poly foam, have remained high or have continued to increase in cost. The Company initiated actions during the fourth quarter of fiscal year 2004 and first quarter of fiscal year 2005 in response to these cost increases. These actions included a review of the Company’s selling prices, margins and production capacity levels resulting in selected price increases and implementation of cost control measures for inventories and capital assets. These actions have contributed to an improved gross margin for the second quarter when compared to the first quarter of the current fiscal year. At the same time, many furniture manufacturers, including Flexsteel, are dealing with competition and pricing pressures from imported products.
As a result of these changes in the marketplace and world economy, the Company continues to believe that pursuit and refinement of its “blended” strategy is fundamentally sound, offering customers domestically manufactured goods, products manufactured utilizing imported component parts, and ready-to-deliver imported products. The Company believes that it best serves customers by offering products from each of these categories to assist customers in reaching specific consumers with varied price points, styles, and product categories. This blended focus on products allows the Company to provide a wide range of options to satisfy customer requirements. Additionally, management believes this strategy offers the Company the most financial and operational flexibility with which to respond to ever-changing market and regulatory conditions.
The uncertainties in the national and international economic and political fronts appear to have the U. S. consumers taking a wait and see attitude toward furniture purchases. The Company anticipates that these trends may continue through the remainder of the fiscal year. Due to current reduced residential sales levels, the Company has excess production capacity. The Company will continue its initiatives, including review and potential adjustment to the Company’s selling prices, production capacity levels and cost control measures for inventories, capital assets, and selling, general and administrative expenses.
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Item 3. Quantitative and Qualitative Information About Market Risk
General – Market risk represents the risk of changes in value of a financial instrument, derivative or non-derivative, caused by fluctuations in interest rates, foreign exchange rates and equity prices. As discussed below, management of the Company does not believe that changes in these factors could cause material fluctuations in the Company’s results of operations or cash flows. The ability to import furniture products can be adversely affected by political issues in the countries where suppliers are located and disruptions associated with shipping distances. Other risks related to furniture product importation include government imposition of regulations and/or quotas; duties and taxes on imports; and significant fluctuation in the value of the U. S. dollar against foreign currencies. Any of these factors could interrupt supply, increase costs and decrease earnings.
Foreign Currency Risk – During the six-month periods ended December 31, 2004 and 2003, the Company did not have sales, purchases, or other expenses denominated in foreign currencies. As such, the Company is not exposed to market risk associated with currency exchange rates and prices.
Interest Rate Risk – The Company’s primary market risk exposure with regard to financial instruments is changes in interest rates. At December 31, 2004, a hypothetical 100 basis point increase in short-term interest rates would decrease annual pre-tax earnings by approximately $130,000, assuming no change in the volume or composition of debt at December 31, 2004. The Company has effectively fixed the interest rates on approximately $13.1 million of its long-term debt through the use of interest rate swaps, and the above estimated earnings reduction takes these swaps into account. As of December 31, 2004, the fair value of these swaps is a liability of approximately $0.1 million and is included in other liabilities.
Tariffs – The Company has exposure to actions by governments, including tariffs. A petition filed by the American Furniture Manufacturers Committee of Legal Trade in October 2003 resulted in tariffs on wooden bedroom furniture manufactured in the People’s Republic of China ranging from 0% to 198.1%. These tariffs are subject to annual review by the U.S. Department of Commence. The tariffs are applied at differing rates to the various manufacturers supplying products to the Company ranging from 0% to 8.6%. The Company is reviewing alternate sources of product supply to minimize the impact of the tariffs. The tariff applies to less than 6% of the Company’s net sales.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Based on their evaluation as of the filing date of this Quarterly Report on Form 10-Q, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(b) under the Securities Exchange Act of 1934, as amended) were effective as of the date of such evaluation to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, nor were there any significant deficiencies or material weaknesses in the Company’s internal controls. As a result, no corrective actions were required or undertaken.
CAUTIONARY STATEMENT RELEVANT TO FORWARD-LOOKING INFORMATION FOR THE PURPOSE OF “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company and its representatives may from time to time make written or oral forward-looking statements with respect to long-term goals or anticipated results of the Company, including statements contained in the Company’s filings with the Securities and Exchange Commission and in its reports to stockholders.
Statements, including those in this report, which are not historical or current facts, are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. There are certain important factors that could cause results to differ materially from those anticipated by some of the statements made herein. Investors are cautioned that all forward-looking statements involve risk and uncertainty. Some of the factors that could affect results are the cyclical nature of the furniture industry, the effectiveness of new product introductions, the product mix of sales, the cost of raw materials, foreign currency valuations, actions by governments including taxes and tariffs, the amount of sales generated and the profit margins thereon, competition (both foreign and domestic), changes in interest rates, credit exposure with customers and general economic conditions.
The Company specifically declines to undertake any obligation to publicly revise any forward-looking statements that have been made to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
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PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders on December 14, 2004, Proposals 1and 2 set forth in the Board of Directors’ definitive Proxy Statement dated November 10, 2004 were approved and adopted by the stockholders as follows:
Proposal 1 (Election of Directors): Jeffrey T. Bertsch: For 5,815,128, Withheld 105,836, Abstentions and Broker Non-votes 33,767. Lynn J. Davis: For 5,920,217 Withheld 747, Abstentions and Broker Non-votes 33,767. Eric S. Rangen: For 5,835,217, Withheld 85,747, Abstentions and Broker Non-votes 33,767. The names of each Director whose term of office as a Director continued after the meeting are as follows: K. Bruce Lauritsen, Jeffrey T. Bertsch, L. Bruce Boylen, Lynn J. Davis, Thomas E. Holloran, James R. Richardson, Patrick M. Crahan, Robert E. Deignan and Eric S. Rangen.
Proposal 2 (Appointment of Deloitte & Touche LLP as Independent Auditors): For: 5,914,565, Against: 29,963, and Abstain: 10,203.
Item 5. Other Information
The registrant filed the following reports on Form 8-K during the quarter ended December 31, 2004:
Item 6. Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned officer thereunto duly authorized.
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