FLEXSTEEL INDUSTRIES INC (FLXS) FY 2024 MD&A

Item 7. 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 Annual Report on Form 10-K.

Results of Operations

The following table has been prepared as an aid in understanding the Company’s results of operations on a comparative basis for the fiscal years ended June 30, 2024, 2023, and 2022. Amounts presented are percentages of the Company’s net sales.

Fiscal 2024 Compared to Fiscal 2023

Net sales were $412.8 million for the year ended June 30, 2024, compared to net sales of $393.7 million in the prior year, an increase of $19.1 million or 4.8%. Sales of products sold through retailers increased by $22.9 million or 6.7% primarily driven by growth with strategic customers and new product introductions. Sales of products sold through e-commerce channels decreased by ($3.8) million, or (7.5%) due to a decrease in consumer demand.

Gross margin as a percent of net sales for the year ended June 30, 2024, was 21.1%, compared to 18.0% for the prior fiscal year, an increase of 310 basis points (“bps”). The 310-bps increase was primarily driven by an increase of 240-bps primarily related to cost savings initiatives for materials, labor, and logistics, product portfolio management and disciplined promotional pricing and a 70-bps improvement on volume leverage of fixed cost structure.

Selling, general, and administrative (“SG&A”) expenses increased by $7.6 million in the year ended June 30, 2024, compared to the prior fiscal year. As a percentage of net sales, SG&A expense was 17.1% in fiscal year 2024 compared to 16.0% of net sales in the prior fiscal year. The increase of 110-bps is primarily due to an increase of 40-bps due to CEO transition costs associated with the revaluation of previously awarded equity awards, an increase of 40-bps due to higher incentive compensation, and an increase of 30-bps driven by investments in growth initiatives partially offset by cost leverage on higher sales volume.

There was $3.0 million in restructuring expenses recorded in the year ended June 30, 2024 associated with the previously announced closure of the Dublin, Georgia manufacturing facility. The $3.0 million primarily consists of $2.6 million in one-time employee termination benefits and other associated costs. All charges related to the restructuring activities were completed in fiscal year 2024. There were no restructuring expenses incurred in the prior fiscal year. See Note 5, Restructuring, of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.

During the year ended June 30, 2024, the Company completed the sale of the Starkville, Mississippi location which had been previously recorded as held for sale. The Company recorded a gain of $3.3 million related to the sale in the fiscal year. See Note 6, Assets Held For Sale, of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.

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Income tax expense was $5.0 million, or an effective rate of 32.3%, for the year ended June 30, 2024, compared to income tax benefit of ($5.6) million in the prior year, or an effective tax rate of (60.3%). The effective tax rate was impacted by the effect of state taxes, nondeductible stock compensation and foreign taxes, offset by a research & development credit benefit. The prior year tax rate was negative due to the reversal of a full valuation allowance on deferred tax assets. See Note 10, Income Taxes, of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.

Net income was $10.5 million, or $1.91 per diluted share for the year ended June 30, 2024, compared to net income of $14.8 million, or $2.74 per diluted share in the prior year.

Fiscal 2023 Compared to Fiscal 2022

Net sales were $393.7 million for the year ended June 30, 2023, compared to net sales of $544.3 million in the prior year, a decrease of ($150.6) million or (27.7%). Sales of products sold through retailers declined by ($142.5) million or (29.3%) primarily driven by consumer demand returning to pre-pandemic levels and competitive pressure to lower prices. Sales of products sold through e-commerce channels decreased by ($8.1) million, or (13.8%) due to a decrease in consumer demand.

Gross margin as a percent of net sales for the year ended June 30, 2023, was 18.0%, compared to 13.4% for the prior year period, an increase of 460 basis points (“bps”). The 460-bps increase was primarily driven by a 680-bps increase related to lower ancillary charges caused by domestic supply chain disruptions and higher per diem charges in the prior year, an increase of 40-bps primarily related to cost savings initiatives for materials, labor, and transportation, a decrease of 150-bps due to pricing promotions and inventory write-downs, and a decrease of 110-bps related to capacity growth investments in manufacturing and distribution.

Selling, general, and administrative (“SG&A”) expenses decreased by $3.9 million in the year ended June 30, 2023, compared to the prior fiscal year. As a percentage of net sales, SG&A expense was 16.0% in the fiscal year 2023 compared to 12.3% of net sales in the prior fiscal year. The increase of 370-bps is primarily due to an increase of 350-bps due to deleverage on year-over-year sales decline and an increase of 20-bps due to higher incentive compensation and investment in growth initiatives.

There were no restructuring expenses in the year ended June 30, 2023, as all restructuring activities were completed in the prior fiscal year. The prior fiscal year expenses were primarily for ongoing costs associated with our facilities listed as held for sale, professional fees, and former employee expenses as part of our previously announced comprehensive restructuring plan. See Note 5, Restructuring, of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.

During the year ended June 30, 2023, the Company recorded income of $2.8 million as a result of insurance proceeds received related to the settlement of the environmental remediation liability. See Note 13 Commitments and Contingencies, of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.

Income tax benefit was ($5.6) million, or an effective rate of (60.3%), for the year ended June 30, 2023, compared to income tax expense of $4.1 million in the prior year, or an effective tax rate of 68.6%. The effective tax rate was primarily impacted by the release of our valuation allowance on deferred tax assets. See Note 10, Income Taxes, of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.

Net income was $14.8 million, or $2.74 per diluted share for the year ended June 30, 2023, compared to net income of $1.9 million, or $0.28 per diluted share in the prior year.

Liquidity and Capital Resources

Working capital (current assets less current liabilities) on June 30, 2024, was $95.0 million compared to $115.5 million on June 30, 2023. The $20.5 million decrease in working capital was due to a decrease in inventory of $25.5 million, an increase in other liabilities of $4.2 million, an increase in accounts payable of $1.1 million partially offset by an increase of $6.1 million in trade receivables, an increase of other current assets of $2.8 million, and an increase in cash of $1.4 million. Capital expenditures were $4.8 million for the fiscal year ended June 30, 2024.

A summary of operating, investing, and financing cash flow is shown in the following table:

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Net cash provided by operating activities

For the year ended June 30, 2024, cash provided by operating activities was $31.9 million, which primarily consisted of net income of $10.5 million, adjusted for non-cash items including depreciation of $4.0 million and stock-based compensation of $4.6 million, offset by $1.5 million in deferred income taxes, accounts receivable allowance recoveries of $0.2 million, and gain from the sale of capital assets of $2.8 million. Net cash provided by operating assets and liabilities was $17.2 million and was primarily due to a decrease in inventory of $25.5 million due to inventory optimization initiatives, an increase in accounts payable of $1.4 million due to timing of inventory purchases, and an increase in other liabilities of $4.4 million offset by an increase in other assets of $8.2 million and an increase in accounts receivable of $5.9 million due to higher net sales.

For the year ended June 30, 2023, cash provided by operating activities was $23.0 million, which primarily consisted of net income of $14.8 million, adjusted for non-cash items including depreciation of $4.6 million and stock-based compensation of $3.2 million, offset by $7.2 million in deferred income taxes, accounts receivable allowance recoveries of $0.4 million, and gain from the sale of capital assets of $0.3 million. The $7.2 million change in deferred income taxes primarily relates to the release of our valuation allowance on deferred tax assets. Net cash provided by operating assets and liabilities was $8.3 million and was primarily due to a decrease in inventory of $19.1 million due to inventory optimization initiatives, a decrease in accounts receivable of $3.3 million due to lower net sales, offset by a decrease in accounts payable of $7.3 million due to lower inventory purchases, an increase in other assets of $5.3 million, and a decrease in other liabilities of $1.5 million.

Net cash (used in) investing activities

For the year ended June 30, 2024, net cash used in investing activities was $0.6 million, primarily due to capital expenditures of $4.8 million partially offset by proceeds of $4.2 million from the sale of capital assets.

For the year ended June 30, 2023, net cash used in investing activities was $4.5 million, primarily due to capital expenditures of $4.8 million partially offset by proceeds of $0.3 million from the sale of capital assets.

Net cash (used in) financing activities

For the year ended June 30, 2024, net cash used in financing activities was $29.9 million, primarily due to proceeds from lines of credit of $367.8 million, offset by payments on lines of credit of $391.3 million, dividends paid of $3.2 million, $1.7 million for treasury stock purchases, and $1.5 million for tax payments on employee vested restricted shares netted with proceeds from the issuance of common stock.

For the year ended June 30, 2023, net cash used in financing activities was $17.4 million, primarily due to proceeds from lines of credit of $363.8 million, offset by payments on lines of credit of $373.3 million, $3.7 million for treasury stock purchases, dividends paid of $3.2 million, and $1.0 million for tax payments on employee vested restricted shares netted with proceeds from the issuance of common stock.

Financing Arrangements

Line of Credit

On August 28, 2020, the Company entered a two-year secured $25.0 million revolving line of credit with Dubuque Bank and Trust Company, with an interest rate of 1.50% plus LIBOR, subject to a floor of 3.00%. The revolving line of credit was secured by essentially all the Company’s assets, excluding real property, and required the Company to maintain compliance with certain financial and non-financial covenants. This line of credit was subsequently canceled in the first quarter of the fiscal year 2022.

On September 8, 2021, the Company, as the borrower, entered into a credit agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association (the “Lender”), and the other lenders party thereto. The Credit Agreement has a five-year term and provides for up to an $85 million revolving line of credit. Subject to certain conditions, the Credit Agreement also provides for the issuance of letters of credit in an aggregate amount up to $5 million which, upon issuance, would be deemed advances under the revolving line of credit. Proceeds of borrowings were used to refinance all indebtedness owed to Dubuque Bank and Trust and for working capital purposes. The Company’s obligations under the Credit Agreement are secured by substantially all its assets, excluding real property. The Credit Agreement contains customary representations, warranties, and covenants, including a financial covenant to maintain a fixed coverage ratio of not less than 1.00 to 1.00. In addition, the Loan Agreement places restrictions on the Company’s ability to incur additional indebtedness, to create liens or other encumbrances, to sell or otherwise dispose of assets, and to merge or consolidate with other entities.

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On April 18, 2022, the Company, as the borrower, entered a first amendment to the September 8, 2021, Credit Agreement (“First Amendment to the Credit Agreement”), with the Lender, and the lenders party thereto. The first amendment to the Credit Agreement changed the definition of the term "Payment Conditions" and further defines default or event of default and the calculation of the Fixed Charge Coverage Ratio.

Subject to certain conditions, borrowings under the Credit Agreement initially bore interest at LIBOR plus 1.25% or 1.50% per annum. On May 24, 2023, the Company entered into a second amendment to the Credit Agreement (“Second Amendment to the Credit Agreement”) with the lender to transition the applicable interest rate from LIBOR to Secured Overnight Financing Rate (“SOFR”). Effective as of the date of the Second Amendment to the Credit Agreement, borrowings under the amended Credit Agreement bear interest at SOFR plus 1.36% to 1.61% or an effective interest rate of 6.70% on June 30, 2024.

As of June 30, 2024, there was $4.8 million outstanding under the Credit Agreement, exclusive of fees and letters of credit.

Letters of credit outstanding at the Lender as of June 30, 2024, totaled $1.0 million.

See Note 9 Credit Arrangements of Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

Contractual Obligations

The following table summarizes our contractual obligations on June 30, 2024, and the effect these obligations are expected to have on our liquidity and cash flow in the future (in thousands):

Outlook

Our focus for fiscal 2025 will be to remain financially agile with strong liquidity, continue building our foundation for profitable long-term growth in both retail and e-commerce sales channels, build global supply chain resiliency, expand sourcing, manufacturing, and distribution capacity to support future growth, strengthen digital capabilities, re-imagine the customer experience, and build strong culture and talent.

Critical Accounting Policies

The discussion and analysis of our consolidated financial statements and results of operations are based on consolidated financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the United States of America. Preparation of these consolidated financial statements requires the use of estimates and judgments that affect the reported results. We use estimates based on the best information available in recording transactions and balances resulting from business operations. Estimates are used for such items as the collectability of trade accounts receivable and inventory valuation. Ultimate results may differ from these estimates under different assumptions or conditions.

Allowance for Credit Losses – We establish an allowance for credit losses to reduce trade accounts receivable to an amount that reasonably approximates their net realizable value. Our accounts receivable allowance consists of an allowance for expected credit losses which is established through a review of open accounts, historical collection, and historical write-off amounts. The amount ultimately realized from trade accounts receivable may differ from the amount estimated in the consolidated financial statements.

Inventories – We value inventory at the lower of cost or net realizable value. Our inventory valuation reflects markdowns for the excess of the cost over the amount expected to be realized and considers obsolete and excess inventory. Markdowns establish a new cost basis for the Company’s inventory. Subsequent changes in facts or circumstances do not result in the reversal of previously recorded markdowns or an increase in that newly established cost basis.

Valuation of Long-Lived Assets – We periodically review 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. For assets held for sale, if the net book value of the asset is greater than its estimated fair value less cost to sell, an impairment is recorded for the excess of net book value over the estimated fair value less cost to sell. We recorded no impairments in the fiscal years 2024 and 2023.

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Restructuring Costs – The Company groups exit or disposal cost obligations into three categories: Involuntary employee termination benefits, costs to terminate contracts, and other associated costs. Involuntary employee termination benefits must be a one-time benefit, and this element of restructuring cost is recognized as incurred upon communication of the plan to the identified employees. Costs to terminate contracts are recognized upon the effectiveness of the termination agreement with the provider. Other associated restructuring costs are expensed as incurred. Any inventory impairment costs as a result of restructuring activities are accounted for as costs of goods sold.

Income Taxes - In determining taxable income for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments affect the calculation of certain tax liabilities and the determination of the recoverability of certain deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent years, and our forecast of future taxable income. In estimating future taxable income, we develop assumptions including the amount of future pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.

At June 30, 2024 the Company determined that based on the weight of available evidence, we will be able to recover our deferred tax assets. The realization of our deferred tax assets is primarily dependent on future taxable income in the appropriate jurisdiction. Any reduction in future taxable income including but not limited to any future restructuring activities may require that we establish a valuation allowance against our deferred tax assets. Establishing a valuation allowance or an increase in the valuation allowance could result in additional income tax expense in such a period and could have a significant impact on our future earnings. Refer to Note 10 Income Taxes of Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for more information.