The Company accounts for its leases in accordance with ASU No. 2016-02, Leases (Topic 842) (“ASC 842”). ASC 842 requires lessees to (i) recognize a right-of-use asset (“ROU asset”) and a lease liability that is measured at the present value of the remaining lease payments on the Consolidated Balance Sheets, (ii) recognize a single lease cost, calculated over the lease term on a straight-line basis and (iii) classify lease-related cash payments within operating and financing activities. The Company made an accounting policy election to not recognize short-term leases on the Consolidated Balance Sheets and all non-lease components, such as common area maintenance, were excluded. At any given time during the lease term, the lease liability represents the present value of the remaining lease payments,

and the ROU asset is measured as the amount of the lease liability, adjusted for pre-paid rent, unamortized initial direct costs, and the remaining balance of lease incentives received. Both the lease ROU asset and liability are reduced to zero at the end of the lease term.

The Company leases distribution centers and warehouses, manufacturing facilities, showrooms, and office space. At the lease inception date, the Company determines if an arrangement is, or contains a lease. Some of the Company’s leases include options to renew at similar terms. The Company assesses these options to determine if the Company is reasonably certain of exercising these options based on relevant economic and financial factors. Options that meet these criteria are included in the lease term at the lease commencement date.

For purposes of measuring the Company’s ROU asset and lease liability, the discount rate utilized by the Company was based on the average interest rates effective for the Company’s line of credit. Some of the Company’s leases contain variable rent payments, including common area maintenance and utilities. Due to the variable nature of these costs, they are not included in the measurement of the ROU asset and lease liability.

On August 20, 2021, Flexsteel entered into a lease agreement for the construction of a 507,830 square foot manufacturing facility in Mexicali, Mexico. The lease commencement date under ASC 842 guidance was July 1, 2022, the date the lessor made the building available for use by the Company for purposes of completing any leasehold improvements required by the Company prior to beginning operations. The 12-year lease ends on June 30, 2034, with options for two five-year extensions. Annual base rent under the lease is $3.2 million plus taxes, insurance and common area maintenance costs. As of March 31, 2024, the Company has not begun operations in the Mexicali facility. On May 3, 2023, the Company entered into a sublease with a third party for 105,000 square feet of the Mexicali facility with a term of 12 months. Annual rent net of broker's fees under the sublease is $1 million, plus a proportionate share of taxes, insurance, and common area maintenance. On October 2, 2023, the Company entered into a sublease with a third party for 339,413 square feet of the facility with an initial term of 12 months with four 6-month extensions. Annual rent net of broker's fees under the sublease is $2.2 million, plus a proportionate share of taxes, insurance, and common area maintenance.

At March 31, 2024, the Company determined that no impairment indicators exist with regard to the Mexicali lease given the current and expected sublease tenants and plans for future operations in the facility. At March 31, 2024, the right-of-use asset associated specifically with the Mexicali lease is $30.5 million and associated lease liability is $32.1 million. Sublease income net of broker's fees received from the sub-tenant is offset against operating lease expense in the Company’s Consolidated Statements of Income.

The components of the Company’s leases excluding the impact of sublease income reflected on the Company’s Consolidated Statements of Income were as follows:


	Three Months Ended				Nine Months Ended
	March 31,				March 31,
(in thousands)	2024		2023		2024		2023
Operating lease expense	$	2,394	$	2,700	$	7,202	$	8,066
Variable lease expense		518		482		1,488		1,390
Total lease expense	$	2,912	$	3,182	$	8,690	$	9,456

Other information related to leases and future minimum lease payments under non-cancelable operating leases were as follows:


	Nine Months Ended
	March 31, 2024			March 31, 2023
(in thousands)
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows paid for operating leases	$	7,069		$	6,575

Cash received from subleasing of operating lease:
Operating cash flows received from subleasing of operating lease	$	1,975		$	—

Right-of-use assets obtained in exchange for lease liabilities:
Operating leases	$	797		$	35,305

Weighted-average remaining lease term (in years):
Operating leases		8.4			9.4

Weighted-average discount rate:
Operating leases		3.1	%		2.9	%

Future minimum lease payments under non-cancelable operating leases were as follows:


	March 31, 2024
Remaining payments in FY2024	$	2,432
FY2025		9,418
FY2026		9,208
FY2027		9,378
FY2028		9,144
Thereafter		37,040
Total future minimum lease payments	$	76,620
Less imputed interest		9,113
Lease liability	$	67,507