UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D. C. 20549
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, 2005
or
o 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
FLEXSTEEL INDUSTRIES, INC.
Incorporated in State of Minnesota I.R.S. Identification No. 42-0442319
P.O. BOX 877DUBUQUE, IOWA 52004-0877Area 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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
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, 2005
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, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2006. 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, 2005, 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 $3.7 million and $3.6 million higher at December 31, 2005 and June 30, 2005, respectively if they had been valued on the FIFO method. At December 31, 2005 and June 30, 2005 the total value of LIFO inventory was $3.1 million and $3.3 million, respectively. A comparison of inventories is as follows (in millions):
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BORROWINGS AND CREDIT ARRANGEMENTS – At December 31, 2005, outstanding borrowings consisted of the following (in millions):
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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 $17.1 million with a weighted average fixed rate of 4.23% at December 31, 2005. The interest rate swaps are not utilized to take speculative positions. The Board of Directors established the Company’s policies with regard 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 an asset of $0.1 million as of December 31, 2005 and are reflected as non-current other assets 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, 2005 (in millions):
6. STOCK-BASED COMPENSATION – The Company has two stock-based compensation methods available when determining employee compensation.
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CONTINGENCIES – The Company has guaranteed the future lease payments of a third party ending August 2007. The annual minimum lease payments are approximately $0.2 million and the remaining minimum payments are approximately $0.4 million at December 31, 2005. 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 millions):
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EARNINGS PER SHARE – Basic earnings per share (EPS) is computed based upon the weighted-average number of common shares outstanding for each period. Diluted EPS is computed based on the weighted-average number of common shares and common equivalent shares. Common equivalent shares represent the effect of stock options during each period presented, which if exercised, would dilute EPS. In computing EPS for the quarters and six month periods ended December 31, 2005 and 2004, net income as reported for each respective period is divided by:
COMPREHENSIVE INCOME – The components of comprehensive income, net of income taxes, for the quarters and six months ended, were as follows (in thousands):
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 and income taxes.
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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 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. 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 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.
Income taxes – deferred income taxes result from temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements.
Revenue recognition – is upon delivery of product to our customer. Our ordering process creates persuasive evidence of the sale arrangement and the sales amount is determined. The delivery of the goods to our customer completes the earnings process. Net sales consist of product sales and related delivery charge revenue, net of adjustments for returns and allowances. 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, 2005 and 2004. Amounts presented are percentages of the Company’s net sales.
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Results of Operations for the Quarter Ended December 31, 2005 vs. 2004
Net sales for the quarter ended December 31, 2005 were $106.3 million compared to the prior year quarter of $105.1 million, an increase of 1.2%. Residential net sales were $69.6 million, compared to $70.6 million, a decrease of 1.5% from the prior year quarter. Residential net sales were down slightly from the prior periods due to lower demand at the retail level. Recreational vehicle net sales were $15.9 million, compared to $18.9 million, a decrease of 15.8% from the prior year quarter. The decline in recreational vehicle net sales is due primarily to a weaker wholesale market environment. Commercial net sales were $20.8 million, compared to $15.5 million in the prior year quarter, an increase of 34.1%. The increase in commercial net sales is primarily due to improved commercial office product offerings and improved industry performance for hospitality products.
Gross margin for the quarter ended December 31, 2005 was 18.5% compared to 19.4% in the prior year quarter. Gross margin erosion in the current quarter in comparison to the prior year quarter was caused by rampant increases in raw material costs, particularly those with petrochemical content, and transportation costs which the Company was able to partially offset through selected sell price increases.
Selling, general and administrative expenses as a percentage of net sales were 17.5% and 16.8% for the current quarter and prior year quarter, respectively. The increase in selling, general and administrative costs on a quarterly basis in comparison to prior year is due to the recording of approximately $0.4 million in stock-based compensation related to stock option grants as required under Statement of Financial Accounting Standards (“SFAS”) No. 123(R) Share-Based Payment, increases in royalties and general increases in other fixed expenses.
The effective tax rate was 43.1% and 38.9% in the current and prior year fiscal quarters, respectively. The Company anticipates its effective tax rate for the fiscal year to be approximately 39.2%. The primary difference between the federal statutory rate and the expected rate is the result of state taxes and application of SFAS No. 123(R) in recording compensation expense related to qualified incentive stock options for which the Company does not receive a tax benefit unless there is a disqualifying disposition.
The above factors resulted in current quarter net income of $0.5 million or $0.7 per share, compared to the prior year quarter of $1.6 million or $0.24 per share.
All earnings per share amounts are on a diluted basis.
Results of Operations for the Six Months Ended December 31, 2005 vs. 2004
Net sales for the six months ended December 31, 2005 were $203.7 million compared to $202.9 million in the prior year six months, an increase of 0.4%. Residential net sales were $127.7 million, compared to $129.6 million, a decrease of 1.5% from the prior year six months. Residential net sales were down slightly from the prior periods due to lower demand at the retail level. Recreational vehicle net sales were $34.2 million, compared to $40.7 million, a decrease of 19.1% from the prior year six months. The decline in recreational vehicle net sales is due primarily to a weaker wholesale market environment. Commercial net sales were $41.9 million, compared to $32.6 million in the prior year quarter, an increase of 22.2%. The increase in commercial net sales is primarily due to improved commercial office product offerings and improved industry performance for hospitality products.
Gross margin increased $0.6 million to $38.8 million or 19.1% of net sales in the current period from $38.3 million or 18.9% of sales in the prior year period. The gross margin improvement for the six-month period is a result of changes in product mix, primarily through increased sales of commercial office and other imported products, which were not significantly impacted by raw material cost increases.
Selling, general and administrative expenses as a percentage of sales were 17.7% and 16.8% for the current year and prior year, respectively. The increase in selling, general and administrative costs on a year-to-date basis in comparison to prior year is due to the recording of approximately $0.4 million in stock-based compensation related to stock option grants as required under SFAS No. 123(R), increases in royalties and general increases in other fixed expenses.
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During the six months ended December 31, 2004, the Company recorded a net gain (after tax) of $0.4 million or $0.06 per share on the sale of a former manufacturing facility.
The effective tax rate was 39.2% and 39.1% in the current and prior six-month period, respectively.
The above factors resulted in current fiscal year to date net income of $1.5 million or $0.22 per share compared to $2.8 million or $0.42 per share in the prior year period, a decrease of $1.3 million or $0.22 per share from the prior year six-month period.
Liquidity and Capital Resources
Working capital (current assets less current liabilities) at December 31, 2005 was $87.3 million, which includes cash, cash equivalents and investments of $3.4 million. Working capital increased by $2.0 million from June 30, 2005. Inventories increased $18.5 million primarily to meet current and anticipated future demand for import product. Accounts receivable increased $1.8 million due to expected timing fluctuations in collections. Short-term borrowings increased by $14.5 million and accounts payable increased $5.3 million to meet cash requirements related to increase in inventories and accounts receivable.
Net cash used in operating activities was $11.2 million in the six months ended December 31,2004. Net cash provided by operating activities was $2.1 million in the six months ended December 31, 2004. Fluctuations in net cash provided by operating activities were primarily the result of changes in net income, accounts receivable, inventories, accounts payable and notes payable.
Capital expenditures were $3.1 million and $2.5 million during the first six months of fiscal 2006 and 2005, respectively. During the next six months, it is anticipated that approximately $1.0 million will be used for the acquisition of capital assets. 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. During fiscal 2006, the Company has begun the process of obtaining an extension or refinancing their working capital line of credit that expires June 29, 2006. The Company believes that they will be able to successfully refinance or extend the terms of the current agreement prior to its expiration date; however, there can be no assurance that the Company will be successful in these endeavors or that completion of such extension or refinancing will be on terms acceptable to the Company.
Outlook
Flexsteel Industries, Inc., and the furniture industry in general, continue to be impacted by increases in raw material and energy costs. The second quarter ended December 31, 2005, was dominated by news of unprecedented cost increases for poly foam and other materials with petrochemical content, which are major components in our seating products, as well as increases or expected increases in other key components such as fabric, steel and plywood. At the same time, U. S. furniture manufacturers are faced with competition and pricing pressures from imported products. The Company expects these challenging business conditions to continue to have an impact on its results of operations through the remainder of the fiscal year.
In response to the aforementioned challenges, the Company will implement sell price increases for seating products, as warranted, and continue to explore cost control opportunities in all facets of its business. The Company believes it has the necessary inventories, product offerings and commitments in place to take advantage of opportunities for expansion of certain markets, such as commercial office and hospitality. The Company believes that its strategy of providing furniture from a wide selection of domestically manufactured and imported products is sound business practice and will continue.
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Item 3. Quantitative and Qualitative Disclosures 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, 2005 and 2004, 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, 2005, a hypothetical 100 basis point increase in short-term interest rates would decrease annual pre-tax earnings by approximately $150,000, assuming no change in the volume or composition of debt at December 31, 2005. The Company has effectively fixed the interest rates on approximately $17.1 million of its long-term debt through the use of interest rate swaps at 4.23%, and fixed the interest rate on an additional $2.0 million through fixed rate equipment financing. The estimated earnings reduction takes the interest rate swaps and fixed interest financing into account. As of December 31, 2005, the fair value of the swaps is an asset of approximately $0.1 million and is included in non-current other assets.
Tariffs – The Company has exposure to actions by governments, including tariffs. Tariffs are a possibility on any imported or exported products. The annual review of the tariffs related to wooden bedroom furniture manufactured in the People’s Republic of China by the U.S. Department of Commerce began January 4, 2006. According to the Department of Commerce’s schedule, the preliminary administrative review is expected to last 245 days from the end of January 2006, and the final review will be completed 372 days from the end of January 2006. The preliminary review can be extended 120 days and the final review can be extended by 60 days. The Company continues to review alternate sources of product supply to minimize the impact of the tariffs. The tariffs apply to less than 3% 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 changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2005, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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.
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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.
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders on December 12, 2005, Proposal 1 set forth in the Board of Directors’ definitive Proxy Statement dated November 1, 2005 was approved and adopted by the stockholders as follows:
Proposal 1 (Election of Directors): Thomas E. Holloran: For 5,574,815, Withheld 117,975, Abstentions and Broker Non-votes 34,779. K. Bruce Lauritsen: For 5,648,630, Withheld 44,160, Abstentions and Broker Non-votes 34,779. L. Bruce Boylen: For 5,686,734, Withheld 6,056, Abstentions and Broker Non-votes 34,779. Ronald J. Klosterman: For 5,621,951, Withheld 70,839, Abstentions and Broker Non-votes 34,779. The names of each Director whose term of office as a Director continued after the meeting are as follows: K. Bruce Lauritsen, Ronald J. Klosterman, Jeffrey T. Bertsch, Mary C. Bottie, L. Bruce Boylen, Lynn J. Davis, Thomas E. Holloran, James R. Richardson, Patrick M. Crahan, Robert E. Deignan and Eric S. Rangen.
Item 5. Other Information
The registrant filed the following reports on Form 8-K during the quarter ended December 31, 2005:
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 thereunto duly authorized.
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