UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C.  20549

FORM 10-Q

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

Securities Exchange Act of 1934

For the quarterly period ended September 30, 2010

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

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)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o   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).

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.

Common Stock - $1.00 Par Value

PART I FINANCIAL INFORMATION

Item 1.      Financial Statements

FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)

See accompanying Notes to Consolidated Financial Statements (Unaudited).

FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(Amounts in thousands, except per share data)

See accompanying Notes to Consolidated Financial Statements (Unaudited).

FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES    

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands)

SUPPLEMENTAL CASH FLOW INFORMATION – Cash paid during the period for:

(Amounts in thousands)

See accompanying Notes to Consolidated Financial Statements (Unaudited).

FLEXSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE PERIOD ENDED SEPTEMBER 30, 2010

1.      The consolidated financial statements included herein have been prepared by Flexsteel Industries, Inc. and Subsidiaries (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 three-month period ended September 30, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2011.  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.  Except to the extent updated or described below, the significant accounting policies set forth in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010, appropriately represent, in all material respects, the current status of accounting policies and are incorporated by reference. 

DESCRIPTION OF BUSINESS – Flexsteel was incorporated in 1929 and is one of the oldest and largest manufacturers, importers and marketers of 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, hospitality, health care and motor vehicle applications.  Featured as a basic component in most of the upholstered furniture is a unique steel drop-in seat spring from which our name “Flexsteel” is derived.  The Company distributes its products throughout the United States through the Company’s sales force and various independent representatives to furniture dealers, department stores, recreational vehicle manufacturers, catalogs, hospitality and healthcare facilities.  The Company’s products are also sold to several national and regional chains, 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 and warehouses in Indiana and manufacturing sources in Asia. DMI’s divisions are WYNWOOD, Homestyles and DMI Commercial Office Furniture. 

2.       INVENTORIES

The Company values inventory at the lower of cost or market.  Raw steel is valued on the last-in, first-out (“LIFO”) method.  Other inventories are valued on the first-in, first-out (“FIFO”) method.  Raw steel inventories valued on a LIFO basis would have been approximately $1.7 million higher at each period ended September 30, 2010 and June 30, 2010, if they had been valued on the FIFO method.  At September 30, 2010 and June 30, 2010 the total value of LIFO inventory was $2.4 million and $2.3 million, respectively. A comparison of inventories is as follows (in thousands):

3.          BORROWINGS AND CREDIT ARRANGEMENTS

The Company maintains a credit agreement which provides short-term working capital financing up to $15.0 million with interest of LIBOR plus 1% including $10.0 million of letters of credit availability. No amounts were outstanding at September 30, 2010 and June 30, 2010 under the working capital facility. 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 $2.6 million. The credit agreement contains financial covenants.  The primary covenant is an interest coverage ratio of 3.0 to 1.0. The ratio is computed as net income plus interest expense and stock-based compensation expense less dividends divided by interest expense.  In addition, the Company must maintain working capital of $60 million.  At September 30, 2010 , the Company was in compliance with all of the financial covenants contained in the credit agreement. 

An officer of the Company is a director at a bank where the Company maintains an unsecured $5.0 million line of credit at prime minus 1%, cumulative letter of credit facilities and where its routine daily banking transactions are processed.  No amount was outstanding on the line of credit at September 30, 2010 and June 30, 2010. 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 $0.7 million.  In addition, the Rabbi Trust assets are administered by this bank’s trust department.  The Company receives no special services or pricing on the services performed by the bank due to the directorship of this officer.

4.          STOCK-BASED COMPENSATION

The Company has two stock-based compensation methods available when determining employee compensation.

(1)       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 Company’s shareholders approved 500,000 shares to be issued under the plan.  No shares have been issued as of September 30, 2010.  The Committee selected consolidated operating results for organic net sales growth and fully-diluted earnings per share for the three-year performance periods beginning July 1, 2008 and ending on June 30, 2011, beginning July 1, 2009 and ending on June 30, 2012, and beginning July 1, 2010 and ending on June 30, 2013. The Committee has also specified that payouts, if any, for awards earned in these 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 and verification of results. The compensation cost related to the number of shares to be granted under each performance period is fixed on the grant date, which is the date the performance period begins.  The compensation cost related to the cash portion of the award is re-measured based on the award’s estimated fair value at the end of each reporting period.  The accrual 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 payroll and related accruals and other long-term liabilities. At September 30, 2010 and June 30, 2010, the Company accrued $0.3 million and $0, respectively, in payroll and related accruals for the short-term portion of estimated awards of stock and cash under the long-term incentive plan.  At September 30, 2010 and June 30, 2010, the Company accrued $1.0 million and $0.9 million, respectively, in other long-term liabilities for estimated awards of stock and cash under the long-term incentive plan.

If the target performance goals would be achieved, the total amount of compensation cost recognized over the requisite service periods would be $1.0 million (2009-2011), $1.1 million (2010-2012) and $0.9 million (2011-2013) based on the estimated fair values at September 30, 2010. 

(2)       Stock Option 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. 

At September 30, 2010, 508,950 shares were available for future grants.  It is the Company’s policy to issue new shares upon exercise of stock options.  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 September 30, 2010, June 30, 2010 and 2009 and the changes during the years then ended is presented below:

The following table summarizes information for options outstanding and exercisable at September 30, 2010:

5.          INCOME TAXES

In determining the quarterly provision for income taxes, the Company uses an estimated annual effective tax rate, which is based on the expected annual income, statutory tax rates and tax planning opportunities available to the Company in the various jurisdictions in which it operates.   This includes recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns to the extent pervasive evidence exists that they will be realized in future periods. The deferred tax balances are adjusted to reflect tax rates by tax jurisdiction, based on currently enacted tax laws, which are expected to be in effect in the years in which the temporary differences are expected to reverse.  In accordance with the Company’s income tax policy, significant or unusual items are separately recognized in the quarter in which they occur.

The components of the gross liabilities related to unrecognized tax benefits and the related deferred tax assets are as follows (in thousands):

The recognition of the above amounts would impact the Company’s effective tax rate.  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.  The Company records interest and penalties related to income taxes as income tax expense in the Consolidated Statements of Operations.

6.          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 and estimated long-term incentive compensation plan shares during each period presented, which if exercised or issued, would dilute EPS.  In computing EPS for the three months ended September 30, 2010 and 2009, net income as reported for each respective period is divided by (in thousands):

7.          COMPREHENSIVE INCOME

The components of comprehensive income, net of income tax expense, for the three months ended, were as follows (in thousands):

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

8.          LITIGATION

From time to time, the Company is subject to various legal proceedings, including lawsuits, which arise out of, and are incidental to, the conduct of the Company’s business.  The Company does not consider any of such proceedings that are currently pending, individually or in the aggregate, to be material to its business of likely to result in a material adverse effect on its consolidated operating results, financial condition, or cash flows.

9.          ACCOUNTING DEVELOPMENTS

No accounting pronouncements have been adopted or have become effective during the first quarter of fiscal 2011 that impact the Company.

10.      FACILITY CLOSING COSTS

During the quarter ended September 30, 2010, the Company announced the planned closure of a manufacturing operation.  The Company plans to close the facility in mid-November 2010 and estimates that the facility closing costs will range from $1.0 million to $1.5 million.  The Company recorded pre-tax charges for facility closing costs of $1.0 million during the quarter ended September 30, 2010. The charges represent employee separation costs of $0.6 million and other closing costs of $0.4 million with no future benefit to the Company and are classified as “Facility Closing Costs” in the Consolidated Statements of Operations. The $1.0 million is included in other current liabilities at September 30, 2010.

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:

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 2010 annual report on Form 10-K.

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 ended September 30, 2010 and 2009.  Amounts presented are percentages of the Company’s net sales.

Results of Operations for the Quarter Ended September 30, 2010 vs. 2009

The following table compares net sales in total and by area of application for the quarter ended September 30, 2010 to the prior year quarter.

Gross margin for the quarter ended September 30, 2010 was 22.5% compared to 21.8% in the prior year quarter.  The improvement in gross margin percentage is primarily due to better coverage of fixed costs on the higher sales volume. 

Selling, general and administrative expenses were $14.9 million or 17.1% of net sales and $14.1 million or 18.6% of net sales for the quarters ended September 30, 2010 and 2009, respectively. The percentage improvement is due to better absorption of fixed costs offsetting the $0.8 million increase related to the higher sales volume. 

The current year quarter included a pre-tax charge of approximately $1.0 million related to the planned closing of a manufacturing operation.  Excluding this charge, operating income was at an all-time high for a first fiscal quarter.

Operating income for the current quarter was $3.7 million compared to operating income of $2.4 million in the prior year quarter reflecting the aforementioned factors. 

The effective income tax expense rate for the current fiscal quarter was 38.2% compared to an income tax expense rate of 40.3% in the prior year fiscal quarter.  The effective rates include the federal statutory rate as well as the effect of the various state taxing jurisdictions.

The above factors resulted in current quarter net income of $2.3 million or $0.34 per share, compared to net income of $1.4 million or $0.21 per share in the prior year quarter.

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, 2010 was $93.2 million.  Net cash used in operating activities was $3.6 million during the first quarter ended September 30, 2010. This use of cash was primarily related to increases in inventories of $5.8 million and receivables of $2.0 million offset by net income of $2.3 million, an increase in accounts payable of $1.1 million and depreciation of $0.7 million. 

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:

Net cash used in investing activities was $0.2 million during the three-month period ended September 30, 2010.  The Company expended $0.4 million for the purchase of capital assets. The Company expects that capital expenditures will be approximately $3.0 million for the remainder of the 2011 fiscal year.

Financing Activities:

Net cash used in financing activities was $0.2 million during the three-month period ended September 30, 2010.  Dividends of $0.3 million were paid during the three-month period offset by cash received from the exercise of stock options.

Management believes that the Company has adequate cash and credit arrangements to meet its operating and capital requirements for fiscal year 2011.  In the opinion of management, the Company’s liquidity and credit resources provide it with the ability to react to opportunities as they arise, to pay quarterly dividends to its shareholders, and to purchase productive capital assets that enhance safety and improve operations.

Outlook

Our balance sheet remains strong reflecting working capital in excess of $93.0 million and no bank borrowings.  We had a sales increase for the current quarter over the prior year quarter due in part to a strong backlog going into the quarter.  Our incoming order rate has slowed during the quarter and remains soft as we move into our second quarter, consistent with the furniture industry in general. 

Residential furniture remains a highly deferrable item and can be adversely impacted by factors, such as, low levels of consumer confidence, a depressed market for housing, limited consumer credit and high unemployment.  We believe that commercial product sales are at or near the bottom of the downward cycle and should level off.   We do not anticipate significant improvements in commercial markets before the second half of fiscal year 2011. 

We remain committed to our core strategies, which include a wide range of quality product offerings and price points to the residential and commercial markets, combined with a conservative approach to business.  We will maintain our focus on a strong balance sheet through emphasis on cash flow and improving profitability.  We believe these core strategies are in the best interest of our shareholders.

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, 2010 and 2009, 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.  The Company does not have any debt outstanding at September 30, 2010.

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, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective as of September 30, 2010.

(b) Changes in internal control over financial reporting.  During the quarter ended September 30, 2010, there were no significant changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that has materially affected, or is reasonable 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, 2010.

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 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, 2010.

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.