UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

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FORM 10-Q

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x Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the quarterly period ended March 31, 2008

or

o Transition Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the transition period from           to           

 

Commission file number 0-5151

 

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FLEXSTEEL INDUSTRIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

3400 JACKSON STREET

DUBUQUE, IOWA 52004-0877

(Address of Principal Executive Offices)  (Zip Code)

 

(563) 556-7730

(Registrant’s Telephone Number, Including Area Code)

 

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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, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer  o        Accelerated filer  x        Non-accelerated filer  o        Smaller reporting company  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.

 

 

 

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PART I FINANCIAL INFORMATION

 

 

FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited).

 

 

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FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited).

 

 

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FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited).

 

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FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE PERIOD ENDED MARCH 31, 2008

 

 

DESCRIPTION OF BUSINESS – Flexsteel was incorporated in 1929 and is one of the oldest and largest manufacturers, importers and marketers of residential, recreational vehicle and commercial upholstered and wooden furniture products in the country. Product offerings include a wide variety of upholstered and wood furniture such as sofas, loveseats, chairs, reclining and rocker-reclining chairs, swivel rockers, sofa beds, convertible bedding units, occasional tables, desks, dining tables and chairs and bedroom furniture. The Company’s products are intended for use in home, office, motor home, travel trailer, watercraft, health care and hotel applications. Featured as a basic component in most of the upholstered furniture is a unique drop-in seat spring. The Company primarily distributes its products throughout the United States through the Company’s sales force to furniture dealers, department stores, recreational vehicle manufacturers, and hospitality and healthcare facilities. The Company’s products are also sold to several national and regional retailers, some of which sell on a private label basis.

 

The Company has one active wholly-owned subsidiary, DMI Furniture, Inc. (“DMI”), which is a Louisville, Kentucky-based, manufacturer, importer and marketer of residential and commercial office furniture with manufacturing plants and warehouses in Indiana and manufacturing sources in Asia. DMI’s divisions are WYNWOOD, Homestyles and DMI Commercial Office Furniture. The Company has two inactive wholly owned subsidiaries: (1) Desert Dreams, Inc., which owned and leased a commercial building to an unrelated entity until the building was sold in June 2007 and (2) Four Seasons, Inc.

 

 

 

 

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The Company has credit facilities of $50.2 million with banks, with borrowings at differing rates based on the date and type of financing utilized.

 

The credit agreement provides for a $41.0 million unsecured credit facility and provides the Company with flexibility between long-term and short-term financing. The short-term portion of the credit facility provides working capital financing up to $20.0 million, of which $1.0 million was outstanding at March 31, 2008 with interest selected at the option of the Company at prime (5.25% at March 31, 2008) or LIBOR (2.70% at March 31, 2008) plus 0.625%. The short-term portion also provides overnight credit when required for operations at prime minus 1.0% (4.25%), of which no amount was outstanding at March 31, 2008. The short-term line of credit expires June 30, 2008. The long-term portion of the credit facility provides up to $20.0 million, of which $20.0 million was outstanding at March 31, 2008, and expires September 30, 2012. Variable interest is set monthly at the option of the Company at prime or LIBOR plus 0.75%. The credit facility also provides $1.0 million to support letters of credit issued by the Company, of which $40,000 was outstanding at March 31, 2008. All interest rates are adjusted monthly, except for the overnight portion of the short-term line of credit, which varies daily at the prime rate minus 1%. On March 31, 2008, the Company had effectively fixed the interest rates at 4.5% on approximately $15.0 million of its long-term debt through the use of interest rate swaps.

 

The credit agreement contains certain restrictive covenants that require the Company, among other things, to maintain an interest coverage ratio, leverage ratio, and limitations on capital disposals, all as defined in the credit agreement. At March 31, 2008, the Company was in compliance with all financial covenants contained in the credit agreement.

 

The Company financed the purchase of delivery equipment through a five-year fixed rate note at 4.99%. The note requires payments through December 2010. The delivery equipment purchased with the note proceeds secures the note.

 

An officer of the Company is a director at one of the banks where the Company maintains a $4.0 million line of credit, cumulative letter of credit facilities of $5.2 million and where its routine daily banking transactions are processed. The Company is contingently liable to insurance carriers under its comprehensive general, product and vehicle liability policies, as well as some workers’ compensation, and has provided letters of credit in the amount of $5.2 million. The Company receives no special services or pricing on the services performed by the bank due to the directorship of this officer. At March 31, 2008, no amount was outstanding on this line of credit.

 

 

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(1) Management Incentive Plan – This plan provides for shares of common stock to be awarded to key employees based on targeted rate of earnings to common equity as established by the Board of Directors. Shares awarded to employees are subject to the restriction of continued employment, with one-third of the stock received by the employee on the award date and the remaining shares vested after one and two years. Under the plan no shares were awarded, granted or vested during the nine-months ended March 31, 2008 and 2007. As of March 31, 2008, there were no unvested shares outstanding. There were no shares and 50 shares forfeited in the nine months ended March 31, 2008 and 2007, respectively. At March 31, 2008, 69,407 shares were available for future grants.

 

(2) 2007 Long-Term Management Incentive Compensation Plan – The plan provides for shares of common stock and cash to be awarded to officers and key employees based on performance targets set by the Nominating and Compensation Committee of the Board of Directors (the “Committee”). The Committee has selected consolidated operating results for organic net sales growth and fully-diluted earnings per share for the two-year transition period beginning July 1, 2007 and ending on June 30, 2009 and the three-year performance period beginning July 1, 2007 and ending on June 30, 2010. The Committee has also specified that payouts, if any, for awards earned under the 2007-2009 and 2007-2010 performance periods will be 60% stock and 40% cash. Awards will be paid to participants as soon as practicable following the end of the performance periods, verification of results, and subject to the negative discretion of the Committee. As the payouts of these awards are subject to the negative discretion of the Committee the grant date is not established until the awards are paid. Accordingly, compensation cost is re-measured based on the award’s estimated fair value at the end of each reporting period prior to the grant date to the extent service has been rendered in comparison to the total requisite service period. Further, the accrual of compensation cost is based on the probable outcomes of the performance conditions. The portion of the accrued award payable in stock is classified within equity and the portion of the accrued award payable in cash is classified within liabilities.

 

The fair value of the equity portion of the award is estimated each period based on the market value of the Company’s common shares reduced by the present value of expected dividends to be paid prior to the service period, discounted using a risk-free interest rate. In the period the grant date occurs, cumulative compensation cost will be adjusted to reflect the cumulative effect of measuring compensation cost based on the fair value at the grant date. Under the plan the number of shares that could be awarded to key executives if the target performance goals are met is 55,542 shares and 88,873 shares if the maximum performance goals are met. No compensation costs were accrued at March 31, 2008. If the target performance goals would be achieved the total amount of stock compensation cost recognized over the requisite service periods would be $0.6 million based on the estimated fair values at March 31, 2008. At March 31, 2008, 500,000 shares were available for awards. 

 

(3) Stock Options Plans - The stock option plans for key employees and directors 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.

 

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In December 2007 and 2006, the Company issued options for 120,000 and 135,000 common shares at exercise prices of $12.40 and $12.63 (the fair market value on the date of grant), respectively. The options were immediately available for exercise and may be exercised for a period of 10 years. In accordance with the provisions of SFAS No. 123(R) the Company recorded compensation expense of $0.2 and $0.3 million during the quarter ended December 31, 2007 and 2006, respectively. The Company also recorded reductions in its income tax expense of $0.1 million related to the issuance of the options in both quarters ended December 31, 2007 and 2006. The assumptions used in determining the compensation expense and related income tax impacts are discussed below.

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in fiscal 2008 and 2007, respectively; dividend yield of 4.2% and 4.1%; expected volatility of 19.5% and 21.6%; risk-free interest rate of 3.3% and 4.5%; and an expected life of 5 and 6 years, respectively. The expected volatility and expected life are determined based on historical data.

 

The weighted-average grant date fair value of stock options granted during fiscal 2008 and 2007 was $1.63 and $1.98, respectively. The cash proceeds, income tax benefit and aggregate intrinsic value of options (the amount by which the market price of the stock on the date of exercise exceeded the market price of stock on the date of grant) exercised during the three months and nine months ended March 31, 2008 and 2007 were not material.

 

At March 31, 2008, 381,700 shares were available for future grants. The Company does not anticipate that additional options will be granted during fiscal 2008. It is the Company’s policy to issue new shares upon exercise of stock options. The Company does not expect to repurchase any shares during fiscal year 2008 related to stock option exercises. The Company accepts shares of the Company’s common stock as payment for the exercise price of options. These shares received as payment are retired upon receipt.

 

A summary of the status of the Company’s stock option plans as of March 31, 2008, and the changes from June 30, 2006, are presented below:

 

 

The following table summarizes information for options outstanding and exercisable at March 31, 2008:

 

 

 

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The Company adopted the provisions of FIN 48 on July 1, 2007. As a result of the implementation of FIN 48, the Company recognized an adjustment in the liability for unrecognized income tax benefits of $0.1 million, which is reported as a cumulative effect of a change in accounting principle and is reported as an adjustment to the beginning balance of retained earnings. At the adoption date of July 1, 2007, the Company had approximately $0.8 million of gross liabilities related to unrecognized tax benefits (composed of $0.6 million of gross unrecognized tax benefits and accrued interest and penalties of $0.2 million) and related deferred tax assets of approximately $0.2 million. At March 31, 2008, the Company had approximately $0.8 million of gross liabilities related to unrecognized tax benefits (composed of $0.6 million of gross unrecognized tax benefits and accrued interest and penalties of $0.2 million) and related deferred tax assets of approximately $0.2 million, all of which would affect our effective tax rate if recognized. The Company does not expect that there will be any positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within twelve months. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

 

 

Consistent with prior periods and upon adoption of FIN 48 the Company records interest and penalties related to income taxes as income tax expense in the Consolidated Statements of Income. As of July 1, 2007 and March 31, 2008, we had approximately $0.2 million of accrued interest and penalties related to uncertain tax positions.

 

The Company is subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. Generally, tax years 2004–2007 remain open to examination by the Internal Revenue Service or other taxing jurisdictions to which we are subject.

 

 

 

 

 

 

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The components of accumulated other comprehensive income, net of income taxes, are as follows (in thousands):

 

 

 

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective as of the beginning of the Company’s 2009 fiscal year. The Company is currently evaluating the impact of adopting SFAS No. 157 on its consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The provisions of SFAS No. 159 are effective as of the beginning of the Company’s 2009 fiscal year. The Company is currently evaluating the impact of adopting SFAS No. 159 on its consolidated statements.

 

 

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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 the Company should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this quarterly report on Form 10-Q.

 

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. Ultimate results may differ from these estimates under different assumptions or conditions. 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. Ultimate results may differ from these estimates under different assumptions or conditions.

 

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 LIFO method. Other inventories are valued on the 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, but not less than annually. 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 has warranty coverages with respect to the original purchases of its products that range from three months to lifetime. 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 – the Company accounts for income taxes in accordance with the provisions of FIN 48, Accounting for Uncertainty in Income Taxes and SFAS No. 109, Accounting for Income Taxes. In the preparation of the Company’s consolidated financial statements, management calculates income taxes. This includes estimating the Company’s current tax liability as well as assessing temporary differences resulting from different treatment of items for tax and book accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet. These assets and liabilities are analyzed regularly and management assesses the likelihood that deferred tax assets will be realized from future taxable income. The Company adopted the provisions of FIN 48 on July 1, 2007. The impact of the adoption is discussed in Note 7, income taxes.

 

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Revenue recognition – is upon delivery of product to our customer. The Company’s ordering process creates persuasive evidence of the sale arrangement and the sales amount is determined. The delivery of the goods to its 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 nine months ended March 31, 2008 and 2007. Amounts presented are percentages of the Company’s net sales.

 

 

Results of Operations for the Quarter Ended March 31, 2008 vs. 2007

 

Net sales for the quarter ended March 31, 2008 were $98.1 million compared to the prior year quarter of $104.1 million, a decrease of 5.7%. Residential net sales were $60.9 million for the quarter ended March 31, 2008, compared to $59.5 million in the prior year quarter, an increase of 2.5%. Recreational vehicle net sales were $14.0 million for the quarter ended March 31, 2008, compared to $17.6 million in the prior year quarter, a decrease of 20.6%. The decline in recreational vehicle net sales was due primarily to a weaker wholesale market environment. Commercial net sales were $23.2 million for the quarter ended March 31, 2008, compared to $27.0 million in the prior year quarter, a decrease of 14.0%.

 

Gross margin for the quarter ended March 31, 2008 was 18.4% compared to 19.7% in the prior year quarter. The gross margin percentage decrease is primarily due to an approximate $1.3 million aggregated impact related to increases in raw material costs, fuel related transportation costs and under absorption of fixed manufacturing costs on the lower sales volume in the current quarter.

 

Selling, general and administrative (“SG&A”) expenses were 16.8% and 17.6% of net sales for the quarters ended March 31, 2008 and 2007, respectively. This decrease in SG&A expenses for the current quarter compared to the prior year quarter is primarily due to lower performance based compensation accruals.

 

The quarter ended March 31, 2007 includes a $0.4 million gain on the sale of land.

 

Operating income for the current quarter was $1.5 million compared to $2.6 million in the prior year quarter reflecting the aforementioned factors.

 

The effective tax rate was 34.6% and 36.4% in the current and prior year fiscal quarters, respectively. The primary difference between the federal statutory rate and the expected effective rate is the result of state taxes.

 

The above factors resulted in current quarter net income of $0.8 million or $0.13 per share, compared to the prior year quarter of $1.5 million or $0.23 per share. The prior year quarter included an after tax gain of $0.3 million or $0.04 per share from the sale of land.

 

All earnings per share amounts are on a diluted basis.

 

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Results of Operations for the Nine Months Ended March 31, 2008 vs. 2007

 

Net sales for the nine months ended March 31, 2008 were $305.0 million compared to $311.1 million in the prior year nine months, a decrease of 2.0%. Residential net sales were $191.1 million for the nine months ended March 31, 2008, compared to $188.2 million in the prior year nine months, an increase of 1.6%. Recreational vehicle net sales were $44.5 million for the nine months ended March 31, 2008, compared to $48.4 million in the prior year nine months, a decrease of 8.0%. The decline in recreational vehicle net sales was due primarily to a weaker wholesale market environment. Commercial net sales were $69.3 million for the nine months ended March 31, 2008, compared to $74.5 million in the prior year quarter, a decrease of 6.9%.

 

Gross margin increased $1.2 million to $59.9 million or 19.6% of net sales in the current period from $58.7 million or 18.9% of net sales in the prior year period. A portion of the gross margin improvements realized during the first half of the current fiscal year have been offset by the aforementioned cost increases experienced in our third fiscal quarter. The Company is committed to adjusting its selling prices to reflect the additional costs that it has experienced, however, there will be a time lag in realization of results.

SG&A expenses were 17.3% and 17.0% of net sales for the current and prior nine-month periods, respectively. The percentage increase in SG&A expenses for the current nine-month period in comparison to the prior year nine-month period was primarily a result of a change in revenue on a period over period basis.

The nine months ended March 31, 2007 includes a $0.4 million gain on the sale of land.

 

Operating income for the nine months ended March 31, 2008 is $7.0 million compared to $6.2 million in the prior year nine-month period reflecting the aforementioned factors.

 

The effective income tax rate was 36.4% and 36.6% in the current and prior nine-month periods, respectively. The primary difference between the federal statutory rate and the expected effective rate is the result of state taxes.

 

The above factors resulted in net income of $3.9 million or $0.59 per share for the nine months ended March 31, 2008 compared to $3.5 million or $0.53 per share in the prior year period, an increase of $0.4 million or $0.06 per share from the prior year nine-month period. The prior year period included an after tax gain of $0.3 million or $0.04 per share from the sale of land.

 

All earnings per share amounts are on a diluted basis.

 

Liquidity and Capital Resources

 

Working Capital:

Working capital (current assets less current liabilities) at March 31, 2008 was $103.3 million. Significant changes in working capital from June 30, 2007 to March 31, 2008 included decreased accounts receivable of $15.7 million, increased inventory of $5.9 million and decreased accounts payable of $3.9 million. The decrease in receivables is related to lower shipment volume and improved collections, as well as the timing of shipments to customers and the related payment terms. The increase in inventory is due primarily to the timing of purchases of finished goods to meet our forecasted customer requirements and new product introductions. The decrease in accounts payable is due to the timing of inventory purchases from suppliers, the related payment terms and the timing of payments.

 

The Company expects that due to the nature of our operations that there will be continuing fluctuations in accounts receivable, inventory, accounts payable, and cash flows from operations due to the following: (i) we purchase inventory from overseas suppliers with long lead times and depending on the timing of the delivery of those orders inventory levels can be greatly impacted and (ii) we have various customers that purchase large quantities of inventory periodically and the timing of those purchases can significantly impact inventory levels, accounts receivable, accounts payable and short-term borrowings. As discussed below, the Company believes it has adequate financing arrangements and access to capital to absorb these fluctuations in operating cash flow.

 

Operating Activities:

Net cash provided by operating activities was $11.4 million for the nine months ended March 31, 2008. Cash from operating activities was used to reduce borrowing by $5.9 million, pay dividends of $2.6 million, increase cash on hand by $2.2 million and purchase capital assets of $1.0 million. Depreciation and amortization expense was $3.4 million and $4.0 million for the nine-month periods ended March 31, 2008 and 2007, respectively.

 

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Investing Activities:

Capital expenditures, primarily manufacturing equipment, were $1.0 million for the nine-month period ended March 31, 2008. The Company expects that capital expenditures will be less than $1.0 million for the remainder of fiscal year 2008.

 

Financing Activities:

Net cash used in financing activities was $8.4 million during the quarter ended March 31, 2008. Net cash used by financing activities was $7.0 million during the nine months ended March 31, 2007. Short-term borrowings decreased by $5.5 million in the quarter ended March 31, 2008 primarily due to the decrease in accounts receivable. During the nine months ended March 31, 2007, short-term borrowings decreased $4.1 million to meet cash requirements related to decreases in inventory.

 

Management believes that the Company has adequate cash, cash equivalents and credit arrangements to meet its operating and capital requirements for fiscal 2008. 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. The Company has begun the process of obtaining an extension or refinancing its working capital line of credit that expires June 30, 2008. The Company believes that it 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

 

Consumers in the United States are paying higher amounts for food. Fuel prices are increasing almost on a daily basis. The unemployment level has increased and in many cases homes have declined in value. Current events on a national level, including the mortgage credit crisis and the upcoming presidential election, contribute to uncertainty for consumers, as well. International events, such as the war in Iraq, also give consumers pause. As a result, consumer confidence continues to decline. These events are creating a very challenging business climate for the products that we sell.

 

In the face of these challenges, the order rate for our residential products has declined during our third fiscal quarter. We anticipate that our fourth fiscal quarter shipments will be lower than the prior year quarter due to lower order backlogs and declining order rates. Consumer demand for recreational vehicles continues to be weak, creating lower order and production levels by most of the Original Equipment Manufacturers that we provide product to, and as a result the demand for our products is lower than in the prior year. We expect that this reduced demand for residential and recreational vehicle products will continue through the balance of calendar year 2008. Orders and shipments of our commercial office and hospitality products have slowed along with the overall commercial market from the relatively high levels experienced in the prior year. We expect shipments to be lower than the prior year through the balance of the fiscal year.

 

The Company continues to focus on the processes that it can control regardless of the level of consumer confidence and national and international macroeconomic circumstances that we face. We will continue to review our allocation of capital resources in relation to business conditions and to explore cost control opportunities in all facets of our business. The Company believes it has the necessary inventories, product offerings and marketing strategies in place to take advantage of opportunities for expansion of market share, especially for our residential products. We believe that consumers will continue to value a broad selection of designs, as well as a wide range of fabrics and leathers. Based on this, the Company anticipates continuing its strategy of providing furniture from a wide selection of domestically manufactured and imported products.

 

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, disruptions associated with shipping distances and negotiations with port employees. 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.

 

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Impairment of long-lived assets – Accounting rules require that long-lived assets be evaluated for impairment whenever events or changes in circumstances indicate that its carrying value may not be recoverable. We have substantial long-lived assets, consisting mainly of property, plant and equipment, which based upon such events or changes in circumstances, there could be a write-down of all or a portion of these assets and a corresponding reduction in our earnings and net worth. At March 31, 2008, no impairment of long-lived assets has been identified.

 

Foreign Currency Risk – During the nine-months ended March 31, 2008 and 2007, the Company did not have sales, purchases, or other expenses denominated in foreign currencies, nor did it have any material active subsidiaries located in foreign countries. 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 March 31, 2008, a hypothetical 100 basis point increase in short-term interest rates would decrease annual pre-tax earnings by approximately $60,000, assuming no change in the volume or composition of debt. On March 31, 2008, the Company had effectively fixed the interest rates at 4.5% on approximately $15.0 million of its long-term debt through the use of interest rate swaps and fixed the interest rate on an additional $1.5 million through fixed rate equipment financing. The estimated earnings reduction takes the interest rate swaps and fixed interest financing into account. As of March 31, 2008, the cumulative fair value of the swaps is a liability of approximately $0.5 million and is included in other liabilities.

 

Tariffs – The Company has exposure to actions by governments, including tariffs. Tariffs are a possibility on any imported or exported products.

 

Inflation – Increased operating costs are reflected in product or services pricing with any limitations on price increases determined by the marketplace. The impact of inflation on the Company has not been significant during the past three years because of the relatively low rates of inflation experienced in the United States. Raw material costs, labor costs and interest rates are important components of costs for the Company. Inflation or other pricing pressures could impact any or all of these components, with a possible adverse effect on our profitability especially where increases in these costs exceed price increases on finished products. In recent years, the Company has faced strong inflationary and other pricing pressures with respect to steel, fuel and health care costs, which have been partially mitigated by pricing adjustments.

 

Item 4.   Controls and Procedures

 

(a)   Evaluation of disclosure controls and procedures. Based on their evaluation as of the end of the period covered by 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(e) or 15d-15(e)) under the Securities Exchange Act of 1934, as amended) were effective as of the date of such evaluation.

 

(b)   Changes in internal control over financial reporting. During the quarter ended March 31, 2008, there were no significant changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that has materially affected, or is reasonably likely to materially affect the Company’s 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.

 

Statements, including those in this quarterly report on Form 10-Q, 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 our 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 and distribution channels, the product mix of sales, pricing pressures, the cost of raw materials and fuel, foreign currency valuations, actions by governments including taxes and tariffs, inflation, 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. For further information regarding these risks and uncertainties, see the “Risk Factors” section in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2007.

 

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We specifically decline 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 1A.   Risk Factors

 

There has been no material change in the risk factors set forth under Part 1, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2007.

 

Item 6.   Exhibits

 

 

 

 

SIGNATURES

 

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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EXHIBIT 31.1

CERTIFICATION BY CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302

OF THE SARBANES-OXLEY ACT OF 2002

 

I, Ronald J. Klosterman, certify that:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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EXHIBIT 31.2

CERTIFICATION BY CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 302

OF THE SARBANES-OXLEY ACT OF 2002

 

I, Timothy E. Hall, certify that:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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EXHIBIT 32

 

 

CERTIFICATION BY

CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the quarterly report of Flexsteel Industries, Inc. (the “Company”) on Form 10-Q for the quarter ended March 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Ronald J. Klosterman, Chief Executive Officer, and Timothy E. Hall, Chief Financial Officer, of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:

 

 

 

 

 

 

 

 

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