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.
There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our 2008 annual report on Form 10-K.
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 ended September 30, 2008 and 2007. Amounts presented are percentages of the Company’s net sales.
Net sales for the quarter ended September 30, 2008 were $91.4 million compared to the prior year quarter of $100.9 million, a decrease of 9.4%. Residential net sales were $62.0 million, slightly less than prior year quarter net sales of $62.7 million. Recreational vehicle net sales were $5.9 million, compared to $15.7 million, a decrease of 62.1% from the prior year quarter. Commercial net sales were $23.5 million, compared to $22.5 million in the prior year quarter, an increase of 4.3%.
Gross margin for the quarter ended September 30, 2008 was 18.7% compared to 19.6% in the prior year quarter. The decrease in gross margin percentage is primarily due to under-absorption of fixed manufacturing costs on significantly lower sales volume and higher material costs.
Selling, general and administrative expenses for the quarter ended September 30, 2008 were 18.3% compared to 17.4% in the prior year quarter. This percentage increase is due to under-absorption of fixed costs on the lower sales volume and an increase in bad debt expense of approximately $0.2 million.
During the current quarter the Company announced the closure of its New Paris, IN recreational vehicle seating manufacturing facility and the end of residential furniture manufacturing at its Lancaster, PA facility. The Company recorded pre-tax charges during the current quarter of approximately $1.4 million, or $0.13 per share after tax related to facility consolidations. The Company anticipates that manufacturing consolidation will be completed by December 31, 2008 and estimates total pre-tax facility consolidation charges in the first half of fiscal year 2009 will be in the range of $2.0 million to $2.5 million.
The effective income tax rate was 35.4% and 36.9% in the current and prior year fiscal quarters, respectively. The Company anticipates its effective income tax rate for the fiscal year to be approximately 35.7%. 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 loss of $0.7 million or $0.11 per share, compared to the prior year quarter net income of $1.2 million or $0.18 per share.
All earnings per share amounts are on a diluted basis.
Liquidity and Capital Resources
Operating Activities:
Working Capital (current assets less current liabilities) at September 30, 2008 was $94.5 million. Net cash provided by operating activities was $2.2 million for the three months ended September 30, 2008. Significant changes in working capital from June 30, 2008 to September 30, 2008 included decreased accounts receivable of $2.7 million, decreased inventory of $1.9 million and decreased accounts payable of $2.5 million. The decrease in receivables is related to timing of shipments to customers and the related payment terms. The decrease in inventory is due to lower purchases to support lower sales volume. 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.
Investing Activities:
Capital expenditures were $0.2 million for the quarter ended September 30, 2008. Depreciation and amortization expense was $1.1 million and $ 1.2 million for the fiscal quarters ended September 30, 2008 and 2007, respectively. The Company expects that capital expenditures will be approximately $2.5 million for the remainder of the 2009 fiscal year.
Financing Activities:
Net cash used in financing activities was $4.3 million during the quarter ended September 30, 2008. Borrowings were lower by $3.5 million due to reduction in accounts receivable and inventory. Dividends of $0.9 million were paid during the quarter.
Management believes that the Company has adequate cash, cash equivalents, and credit arrangements to meet its operating and capital requirements for fiscal year 2009. 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
The impact of the slowdown of the U. S. economy, where most of our products are sold, has magnified as the news media reports of job losses or layoffs related to cutbacks and closings over a broad spectrum of industries, including the furniture industry. With instability in the financial markets despite government relief efforts, rising prices throughout our supply chain and a changing political landscape, prospects for a recovery appear to be moving further into the future.
In response to these conditions, we continue to adjust our operations and workforce to bring production capacity in line with current and expected demand for our products. Our workforce has been reduced approximately 15% over the past year through layoffs and attrition. As announced in September, we have proceeded with the closing of two long-established manufacturing operations. Our Lancaster, PA facility has produced and distributed high quality residential furniture for over fifty years. As demand tightens and foreign sourced products continue to gain acceptance as providing
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better value at the retail level, we no longer require this manufacturing capacity for residential products. Our New Paris, IN facility has been an integral part of our success in supplying quality recreational vehicle seating for over twenty-five years. With the recreational vehicle seating industry experiencing such a drastic decline in demand, as reflected by our 62% decrease in recreational vehicle seating net sales from the prior year period, we can no longer support our current capacity. While these are difficult decisions to make, we expect annual pre-tax cost savings of $3.5 million to $4.0 million going forward, and will continue to pursue cost savings in all aspects of our operations.
While we expect that current business conditions will persist for most, if not all, of fiscal year 2009, we remain optimistic that our strategy of a wide range of quality product offerings and price points to the residential, recreational vehicle and commercial markets combined with our conservative approach to business will be rewarded over the longer-term.
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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, 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.
Foreign Currency Risk –During the three-months ended September 30, 2008 and 2007, the Company did not have sales, purchases, or other expenses denominated in foreign currencies. As such, the Company is not exposed to material 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 September 30, 2008, a hypothetical 100 basis point increase in short-term interest rates would decrease annual pre-tax earnings by approximately $0.1 million, assuming no change in the volume or composition of debt. On September 30, 2008, the Company had effectively fixed the interest rates at 5.0% on approximately $10.0 million of its long-term debt through the use of interest rate swaps. As of September 30, 2008, the cumulative fair value of the swaps is a liability of approximately $0.2 million and is included in other current 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.
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Item 4. | Controls and Procedures |
(a)Evaluation of disclosure controls and procedures. As of the end of the period covered by this Quarterly Report on Form 10-Q, we conducted an evaluation, under the supervision and with the participation of our management, including our chief executive officer (“CEO”) and chief financial officer (“CFO”) of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the CEO and CFO concluded that our disclosure controls and procedures were not effective as of September 30, 2008 because they are not yet able to conclude that we have remediated the material weakness in internal control over financial reporting identified in Item 9A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2008.
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(b)Changes in internal control over financial reporting.As of June 30, 2008, our assessment of the effectiveness of our internal control over financial reporting identified a material weakness in our internal control over financial reporting. The material weakness is related to the design and operating effectiveness of controls over the Company’s material consolidated subsidiary’s reconciliation of accounts payable records to the general ledger.
During the first quarter of fiscal year 2009, we have implemented the following remediation steps to address the material weakness discussed above:
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| • | Simplified the account structure surrounding the accounts payable transactions by reducing the number of general ledger accounts used to record accounts payable, |
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| • | Improved the accounts payable reconciliation process by revising the automatic postings to accounts payable, and |
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| • | Enhanced the quarterly management review and approval of the accounts payable reconciliation process with our subsidiary associates. |
We believe these remediation steps will correct the material weakness discussed above. We will assess the effectiveness of our remediation efforts in connection with our management’s tests of internal control over financial reporting in conjunction with our fiscal year 2009 testing procedures. Except as discussed above, we have not identified any changes in our internal control over financial reporting during the first quarter of 2009 that have materially affected, or are 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.
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, 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, 2008.
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
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, 2008.
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| 31.1 | Certification by Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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| 31.2 | Certification by Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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| 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. |
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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| | | FLEXSTEEL INDUSTRIES, INC. |
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Date: | October 24, 2008 | | | By: | /S/ Timothy E. Hall | |
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| | | | | Timothy E. Hall |
| | | | | Chief Financial Officer & |
| | | | | Principal Financial Officer |
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