ETHAN ALLEN INTERIORS INC - Quarter Report: 2009 December (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 31, 2009

 

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:  1-11692

 

Ethan Allen Interiors Inc.

(Exact name of registrant as specified in its charter)

 

 

 

(203) 743-8000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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.   x Yes o No

 

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 during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).   o Yes o No

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   o Yes x No

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

At January 29, 2010, there were 28,916,929 shares of Class A Common Stock, par value $.01, outstanding.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

Item				Page
Part I — Financial Information
1.		Financial Statements as of December 31, 2009 (unaudited) and June 30, 2009 and for the three and six months ended December 31, 2009 and 2008 (unaudited)
		Consolidated Balance Sheets		2
		Consolidated Statements of Operations		3
		Consolidated Statements of Cash Flows		4
		Consolidated Statements of Shareholders’ Equity		5
		Notes to Consolidated Financial Statements		6
2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		25
3.		Quantitative and Qualitative Disclosures About Market Risk		37
4.		Controls and Procedures		37
Part II - Other Information
1.		Legal Proceedings		37
1A.		Risk Factors		37
2.		Unregistered Sales of Equity Securities and Use of Proceeds		37
3.		Defaults Upon Senior Securities		38
4.		Submission of Matters to a Vote of Security Holders		38
5.		Other Information		38
6.		Exhibits		38
		Signatures		39

 

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PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share data)

 

		December 31, 2009			June 30, 2009
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	76,138		$	52,960
Accounts receivable, less allowance for doubtful accounts of $1,153 at December 31, 2009 and $1,362 at June 30, 2009		12,581			13,086
Inventories (note 4)		141,991			156,519
Prepaid expenses and other current assets		10,536			21,060
Deferred income taxes		14,899			8,077
Total current assets		256,145			251,702
Property, plant and equipment, net		313,528			333,599
Goodwill and other intangible assets (notes 6 and 7)		45,128			45,128
Other assets		17,669			16,056
Total assets		$	632,470		$	646,485
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt (note 8)		$	43		$	42
Customer deposits		36,573			31,691
Accounts payable		23,236			22,199
Accrued compensation and benefits		30,151			29,533
Accrued expenses and other current liabilities (note 5)		26,100			28,998
Total current liabilities		116,103			112,463
Long-term debt (note 8)		203,165			203,106
Other long-term liabilities		25,323			24,993
Total liabilities		344,591			340,562
Shareholders’ equity:
Class A common stock, par value $.01, 150,000,000 shares authorized; 48,297,870 shares issued at December 31, 2009 and 48,334,870 shares issued at June 30, 2009		483			483
Class B common stock, par value $.01, 600,000 shares authorized; no shares issued and outstanding at December 31, 2009 and June 30, 2009		—			—
Preferred stock, par value $.01, 1,055,000 shares authorized; no shares issued and outstanding at December 31, 2009 and June 30, 2009		—			—
Additional paid-in capital		357,521			356,446
		358,004			356,929
Less: Treasury stock (at cost), 19,380,941 shares at December 31, 2009 and 19,380,941 shares at June 30, 2009		(583,220		)	(583,220		)
Retained earnings		511,927			531,747
Accumulated other comprehensive income (note 12)		1,168			467
Total shareholders’ equity		287,879			305,923
Total liabilities and shareholders’ equity		$	632,470		$	646,485

 

See accompanying notes to consolidated financial statements.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Operations (Unaudited)

(In thousands, except per share data)

 

		Three months ended December 31,						Six months ended December 31,
		2009			2008			2009			2008
Net sales		$	143,302		$	189,558		$	279,492		$	395,399
Cost of sales		74,278			87,757			152,159			181,657
Gross profit		69,024			101,801			127,333			213,742
Operating expenses:
Selling		33,801			48,721			67,406			104,023
General and administrative		39,729			42,967			79,709			89,025
Restructuring and impairment charge (credit), net (note 5)		777			26			1,589			(1,604		)
Total operating expenses		74,307			91,714			148,704			191,444
Operating income (loss)		(5,283		)	10,087			(21,371		)	22,298
Interest and other miscellaneous income, net		1,020			1,113			1,817			2,213
Interest and other related financing costs (note 8)		2,978			2,932			5,959			5,833
Income (loss) before income taxes		(7,241		)	8,268			(25,513		)	18,678
Income tax expense (benefit) (note 3)		(3,903		)	2,780			(8,596		)	5,768
Net income (loss)		$	(3,338	)	$	5,488		$	(16,917	)	$	12,910
Per share data (note 11):
Basic earnings per common share:
Net income (loss) per basic share		$	(0.12	)	$	0.19		$	(0.58	)	$	0.45
Basic weighted average common shares		28,917			28,739			28,922			28,721
Diluted earnings per common share:
Net income (loss) per diluted share		$	(0.12	)	$	0.19		$	(0.58	)	$	0.45
Diluted weighted average common shares		28,917			28,739			28,922			28,793

 

See accompanying notes to consolidated financial statements.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

 

		Six Months Ended
		December  31,
		2009			2008
Operating activities:
Net income (loss)		$	(16,917	)	$	12,910
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		18,330			12,808
Compensation expense related to share-based awards		1,075			984
Provision (benefit) for deferred income taxes		(8,967		)	(3,819		)
Restructuring and impairment charge (benefit), net		(161		)	(3,854		)
Loss (gain) on disposal of property, plant and equipment		(3		)	59
Other		110			102
Change in assets and liabilities, net of the effects of acquired businesses:
Accounts receivable		505			3,543
Inventories		14,528			(740		)
Prepaid and other current assets		7,969			10,769
Other assets		406			97
Customer deposits		4,882			(18,172		)
Accounts payable		1,037			13
Accrued expenses and other current liabilities		(2,275		)	81
Other long-term liabilities		330			926
Net cash provided by operating activities		20,849			15,707
Investing activities:
Proceeds from the disposal of property, plant & equipment		10,084			5,745
Capital expenditures		(5,315		)	(16,146		)
Acquisitions		—			(647		)
Other		19			(213		)
Net cash provided by (used in) investing activities		4,788			(11,261		)
Financing activities:
Payments on long-term debt		(21		)	(20		)
Proceeds from issuance of common stock		—			2
Payment of deferred financing costs		(193		)	—
Payment of cash dividends		(2,897		)	(13,525		)
Net cash used in financing activities		(3,111		)	(13,543		)
Effect of exchange rate changes on cash		652			(735		)
Net increase (decrease) in cash & cash equivalents		23,178			(9,832		)
Cash & cash equivalents - beginning of period		52,960			74,376
Cash & cash equivalents - end of period		$	76,138		$	64,544

 

See accompanying notes to consolidated financial statements.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

 Six months ended December 31, 2009

(Unaudited)

(In thousands, except share data)

 

		Common Stock			Additional Paid-In Capital			Treasury Stock			Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance at June 30, 2009		$	483		$	356,446		$	(583,220	)	$	467		$	531,747		$	305,923
Share-based compensation expense (note 10)		—			1,075			—			—			—			1,075
Dividends declared on common stock		—			—			—			—			(2,903		)	(2,903		)
Other comprehensive income (note 12):
Currency translation adjustments		—			—			—			677			—			677
Hedge amortization, net of tax and other		—			—			—			24			—			24
Net income (loss)		—			—			—			—			(16,917		)	(16,917		)
Total comprehensive income (loss)																	(16,216		)
Balance at December 31, 2009		$	483		$	357,521		$	(583,220	)	$	1,168		$	511,927		$	287,879

 

See accompanying notes to consolidated financial statements.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(1)        Basis of Presentation and Recent Accounting Pronouncements

 

Basis of Presentation

 

Ethan Allen Interiors Inc. (“Interiors”) is a Delaware corporation incorporated on May 25, 1989. The consolidated financial statements include the accounts of Interiors, its wholly owned subsidiary Ethan Allen Global, Inc. (“Global”), and Global’s subsidiaries (collectively “We”, “Us”, “Our”, “Ethan Allen”, or the “Company”).  All intercompany accounts and transactions have been eliminated in the consolidated financial statements.  All of Global’s capital stock is owned by Interiors, which has no assets or operating results other than those associated with its investment in Global.

 

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  In preparing these financial statements, the Company has evaluated events and transactions subsequent to December 31, 2009 through February 5, 2010, the date of public issuance of this Quarterly Report on form 10-Q.  Due to the inherent uncertainty involved in making those estimates, actual results could differ from those estimates.  Areas in which significant estimates have been made include, but are not limited to, revenue recognition, the allowance for doubtful accounts receivable, inventory obsolescence, tax valuation allowances, useful lives for property, plant and equipment and intangible assets, goodwill and indefinite-lived intangible asset impairment analyses, the evaluation of uncertain tax positions and the fair value of assets acquired and liabilities assumed in business combinations.

 

Recently Adopted Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued guidance now codified as FASB Accounting Standards Codification (“ASC”) Topic 105, “Generally Accepted Accounting Principles,” as the single source of authoritative nongovernmental U.S. GAAP.  ASC Topic 105 does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the ASC will be considered non-authoritative. These provisions of ASC Topic 105 became effective for the Company in the first quarter of fiscal 2010. The adoption of this pronouncement did not have an impact on the Company’s financial condition or results of operations, but will impact our financial reporting process by eliminating all references to pre-codification standards. On the effective date of this Statement, the ASC superseded all then-existing non-SEC accounting and reporting standards, and all other non-grandfathered non-SEC accounting literature not included in the ASC became non-authoritative. References to the pre-codification pronouncements are noted in parenthesis.

 

In September 2006, FASB issued guidance now codified as ASC Topic 820, “Fair Value Measurements and Disclosures,” (SFAS No. 157) which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements and does not require any new fair value measurements.   In February 2008, the FASB released additional ASC Topic 820 guidance (FSP No. 157-2), which delayed the effective date of the application of certain guidance related to non-financial assets and non-financial liabilities until July 1, 2009 for the Company, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis.  The Company adopted certain provisions of ASC Topic 820 effective July 1, 2008, except as it relates to those non-financial assets and non-financial liabilities excluded as noted above.  The Company adopted the provisions of ASC Topic 820 with respect to our non-financial assets and non-financial liabilities effective July 1, 2009. The implementation of this pronouncement did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

In December 2007, the FASB issued guidance now codified as ASC Topic 805, “Business Combinations” (SFAS No. 141(R), which replaced SFAS No. 141).  ASC Topic 805 establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. ASC Topic 805 is to be applied prospectively to business combinations for which the acquisition date is on or after an entity’s fiscal year that begins after December 15, 2008 (July 1, 2009 for the Company). The impact of this Statement on the Company’s financial position, results of operations and cash flows will be dependent on the terms, conditions and details of such acquisitions.

 

In June 2008, the FASB issued guidance now codified as ASC Topic 260, “Earnings Per Share” (EITF 03-6). Under ASC Topic 260, unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing earnings per share. The implementation of this pronouncement did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

(2)        Interim Financial Presentation

 

In our opinion, all adjustments, consisting only of normal recurring adjustments necessary for fair presentation, have been included in the consolidated financial statements. The results of operations for the three and six months ended December 31, 2009 are not necessarily indicative of results that may be expected for the entire fiscal year. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K/A for the year ended June 30, 2009.

 

(3)        Income Taxes

 

The Company reviews its expected annual effective income tax rates and makes changes on a quarterly basis as necessary based on certain factors such as changes in forecasted annual operating income; changes to actual or forecasted permanent book to tax differences; impacts from future tax audits with state, federal or foreign tax authorities; or impacts from tax law changes.  The Company identifies items which are not normal and are nonrecurring in nature and treats these as discrete events. The tax effect of discrete items is recorded in the quarter in which the discrete events occur. Due to the volatility of these factors, the Company’s consolidated effective income tax rate can change significantly on a quarterly basis.

 

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  All of the unrecognized tax benefits, if recognized, would be recorded as a benefit to income tax expense. Our continuing practice is to recognize interest and penalties related to income tax matters as a component of income tax expense.

 

The Company’s consolidated effective tax rate was 33.7% and 30.9% for the six months ended December 31, 2009 and 2008, respectively. In the current quarter, the effective tax rate is primarily related to the tax benefit on the current quarter loss. The tax benefit is partially offset by the foreign valuation allowance on the Canadian net operating losses, by state valuation allowance on certain state net operating losses and by state income tax expense in states where the Company’s subsidiaries file on a separate company basis. The prior period effective tax rate benefited from a one time adjustment of $0.7 million made in the first quarter of fiscal 2009.

 

The Company conducts business globally and, as a result, the Company or one or more of its subsidiaries files income tax returns in the U.S., various state, and foreign jurisdictions. In the normal course of business, the

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Company is subject to examination by the taxing authorities in such major jurisdictions as Canada, Mexico and the U.S. As of December 31, 2009, certain subsidiaries of the Company are currently under audit from 2001 through 2007 in the U.S. It is reasonably possible that some of these audits may be completed during the next twelve months. While the amount of uncertain tax benefits with respect to the entities and years under audit may change within the next twelve months, it is not anticipated that any of the changes will be significant.

 

A valuation allowance must be established for deferred tax assets when it is more likely than not that they will not be realized. In prior periods, the Company established a valuation allowance for the state deferred tax assets and Canadian net operating losses in its Retail segment. As of December 31, 2009, after considering both positive and negative evidence, management’s assessment is that a valuation allowance is not needed for the Company’s other deferred tax assets.  Due to the economic times and recent losses, management will continue to assess the realizability of the tax assets based on actual and forecasted operating results on a quarterly basis, as required under ASC topic 740.  It is possible during the current fiscal year, that the realization of tax assets is not reasonably assured due to a of lack of available objective evidence.  Management would then record a valuation allowance against the tax assets which would result in a non-cash charge to earnings.

 

(4)        Inventories

 

Inventories at December 31, 2009 and June 30, 2009 are summarized as follows (in thousands):

 

		December 31, 2009			June 30, 2009
Finished goods		$	114,025		$	130,180
Work in process		7,290			7,476
Raw materials		20,676			18,863
		$	141,991		$	156,519

 

Inventories are presented net of a related valuation allowance of $2.2 million at both December 31, 2009 and June 30, 2009.

 

(5)        Restructuring and Impairment Charges

 

In recent years, we have announced and executed plans to consolidate our operations as part of an overall strategy to maximize efficiencies and maintain our competitive advantage.

 

In fiscal 2009, the Company consolidated several operations. Upholstery plants in Eldred, Pennsylvania and Chino, California were consolidated into the Maiden, North Carolina operations. Sawmill and dimension mill production in Andover, Maine was transferred to the Beecher Falls, Vermont site.  All remaining case goods plants are being converted to produce custom case goods products. Wholesale distribution locations, and several retail service centers were consolidated. For these actions, the Company estimates pre-tax restructuring, impairment, accelerated depreciation and other related charges will ultimately approximate $31 million ($24 million wholesale, $7 million retail), consisting of an $18 million impact from long-lived assets, $8 million in employee severance and other payroll and benefit costs, and $5 million in other associated costs.   In the current fiscal year, total costs were $0.2 million of restructuring credits and $6.6 million in accelerated depreciation charges for Wholesale, and $1.3 million of restructuring charges for the Retail segment. Cumulative charges to date for these actions totaling $20.7 million have been classified in the Statement of Operations as restructuring and impairment charges, and $6.6 million of accelerated depreciation was recorded in cost of sales.  Adjustments to the restructuring reserve in the current period consist primarily of gains on the sale of equipment sold and adjustments on non-cancellable leases.  The activity in the restructuring reserve related to these plans is presented in the following table (in thousands) and is classified with accrued expenses and other current liabilities in the Consolidated Balance Sheets.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Fiscal 2009 plans:

 

		Three months ended December 31, 2009
		Balance at September 30, 2009			New charges (credits)			Utilized			Adjustments			Balance at December 31, 2009
Employee severance and other payroll and benefit costs		$	2,556		$	7		$	(1,968	)	$	43		$	638
Other associated costs		543			965			(196		)	(48		)	1,264
Write down of long-lived assets		—			—			427			(427		)	—
		$	3,099		$	972		$	(1,737	)	$	(432	)	$	1,902

 

Fiscal 2009 plans:

 

		Six months ended December 31, 2009
		Balance at June 30, 2009			New charges (credits)			Utilized			Adjustments			Balance at December 31, 2009
Employee severance and other payroll and benefit costs		$	3,864		$	103		$	(3,372	)	$	43		$	638
Other associated costs		654			1,377			(719		)	(48		)	1,264
Write down of long-lived assets		—			54			373			(427		)	—
		$	4,518		$	1,534		$	(3,718	)	$	(432	)	$	1,902

 

In fiscal 2008, we announced a plan to consolidate the operations of certain Ethan Allen-operated retail design centers and retail service centers. In connection with this initiative, we permanently ceased operations at ten design centers and six retail service centers which, for the most part, were consolidated into other existing operations.  Costs for these actions in the current fiscal year totaled $0.5 million, all for the Retail segment, due to non-cancellable lease adjustments and net losses on the sale of real estate. Cumulative charges to date for these actions total $6.0 million, all of which have been classified in the Statement of Operations as restructuring and impairment charges of the Retail segment.

 

Activity in the Company’s restructuring reserves related to these plans is summarized in the table below (in thousands) and is classified with accrued expenses and other current liabilities in the Consolidated Balance Sheets:

 

Fiscal 2008 plans:

 

		Three months ended December 31, 2009
		Balance at September 30, 2009			New charges (credits)			Utilized			Adjustments			Balance at December 31, 2009
Employee severance and other payroll and benefit costs		$	359		$	—		$	(10	)	$	—		$	349
Other associated costs		2,577			68			(353		)	170			2,462
		$	2,936		$	68		$	(363	)	$	170		$	2,811

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Fiscal 2008 plans:

 

		Six months ended December 31, 2009
		Balance at June 30, 2009			New charges (credits)			Utilized			Adjustments			Balance at December 31, 2009
Employee severance and other payroll and benefit costs		$	369		$	—		$	(20	)	$	—		$	349
Other associated costs		2,892			68			(706		)	208			2,462
Write down of long-lived assets		—			—			(212		)	212			—
		$	3,261		$	68		$	(938	)	$	420		$	2,811

 

(6)           Business Acquisitions

 

There were no acquisitions completed during the six months ended December 31, 2009.

 

In October 2008, we acquired, in a single transaction, one Ethan Allen retail design center from an independent retailer for consideration of approximately $0.3 million of cash and forgiveness of receivables.  As a result of this acquisition, we recorded additional inventory of $0.2 million and goodwill of $0.1 million.  In August 2008, we acquired in two transactions, two Ethan Allen retail design centers from independent retailers for consideration of approximately $0.6 million of cash and forgiveness of receivables, assumed customer deposits of $0.7 million and other liabilities of $0.2 million.  As a result of this acquisition, we recorded additional inventory of $0.7 million and goodwill of $0.7 million.

 

All acquisitions are subject to a contractual holdback or reconciliation period, during which the parties to the transaction may agree to certain normal and customary purchase accounting adjustments.

 

Goodwill associated with our acquisitions represents the premium paid to the seller related to the acquired business (i.e. market presence) and other fair value adjustments to the assets acquired and liabilities assumed.  Further discussion of our goodwill and other intangible assets can be found in Note 7.

 

A summary of our allocation of purchase price accounting for acquisitions during the three and six months ended December 31, 2008 is provided below (in thousands).

 

		Three months ended December 31, 2008			Six months ended December 31, 2008
Business segment		Retail			Retail
Total consideration		$	344		$	911
Fair value of assets acquired and liabilities assumed:
Inventory		157			826
PP&E and other assets		11			60
Customer deposits		94			(561		)
A/P and other liabilities		14			(186		)
Goodwill		$	68		$	772

 

(7)        Goodwill, Other Intangible Assets and Goodwill Impairment

 

At both December 31, 2009 and June 30, 2009, we had goodwill and other indefinite-lived intangible assets of $25.4 million and $19.7 million, respectively, all of which is included in the Wholesale segment.  The indefinite-lived intangible assets represent Ethan Allen trade names.  The Company previously had goodwill in the Retail segment, all of which was considered impaired and written off during the third quarter of fiscal 2009.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

In accordance with ASC Topic 350, “Intangibles-Goodwill and Other” (SFAS No. 142), we do not amortize goodwill or other indefinite-lived intangible assets but, rather, we conduct an annual impairment analysis of goodwill and other indefinite-lived intangible assets the first of April each fiscal year, unless events occur or circumstances change that would more likely than not reduce the fair value of the goodwill or other indefinite-lived intangible assets below their carrying value. In determining whether an interim test is appropriate, management considers several factors including changes in the Company’s stock price, financial performance, third party ratings on its long-term debt, and expected financial outlook of the business. Methods employed to value the enterprise and the Company’s retail and wholesale segments include the market approach and the income approach, which are reconciled with the total market capitalization of the Company. These valuation methods use historical revenues and cash flows, as well as Company and external analysts’ financial projections and apply discount rates, weighted average cost of capital rates, total invested capital multiples, and premium control multiples. Fair value of our trade name is valued using the relief-from-royalty method. Significant factors used in trade name valuation are royalty rates, future growth and discount rates, and expense rates.

 

The Company performed impairment evaluations during the second and third quarters of fiscal 2009 as a result of sudden and dramatic changes in the business climate and the Company’s performance, and determined as of March 31, 2009 that the $48.4 million of goodwill in the Retail segment was considered impaired and fully written off at that time.  In the fiscal quarter ended June 30, 2009, the Company performed its annual impairment test and concluded there was no additional impairment.

 

In fiscal 2010, the Company concluded for the first and second quarters that no interim impairment test was required.  During the six months ended December 31, 2009, although business performance was slightly below management’s expectations, our sales, gross profit, operating income, net income and other indicators improved from the previous quarter, and our long-term outlook has not changed.  The Company’s average quarterly stock price increased 12% (from $12.11 for the quarter ended June 30, 2009, to $13.53 for the quarter ended December 31, 2009), and cash balances increased to $76.1 million at December 31, 2009 from $53.0 million at June 30, 2009.

 

There can be no assurance that the outcome of future reviews will not result in substantial impairment charges.  Impairment assessment inherently involves judgments as to assumptions about expected future cash flows and the impact of market conditions on those assumptions.  Future events and changing market conditions may impact our assumptions as to prices, costs or other factors that may result in changes in our estimates of future cash flows.  Although we believe the assumptions we use in testing for impairment are reasonable, significant changes in any of our assumptions could produce a significantly different result.

 

(8)        Borrowings

 

Total debt obligations at December 31, 2009 and June 30, 2009 consist of the following (in thousands):

 

		December 31,			June 30,
		2009			2009
5.375% Senior Notes due 2015		$	199,078		$	198,997
Industrial revenue bonds		3,855			3,855
Other debt		275			296
Total debt		203,208			203,148
Less current maturities		43			42
Total long-term debt		$	203,165		$	203,106

 

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Notes to Consolidated Financial Statements (Unaudited)

 

In September 2005, we completed a private offering of $200.0 million in ten-year senior unsecured notes due 2015 (the “Senior Notes”). The Senior Notes were offered by Global and have an annual coupon rate of 5.375% with interest payable semi-annually in arrears on April 1 and October 1 of each year.  We have used the net proceeds of $198.4 million to expand our retail network, invest in our manufacturing and logistics operations, and for other general corporate purposes.

 

On October 23, 2009, the Company expanded to $60 million the three-year senior secured asset-based revolving credit facility (the “Facility”) established on May 29, 2009.  The Facility provides revolving credit financing of up to $60 million, subject to borrowing base availability.  At the Company’s option, revolving loans under the Agreement bear interest at an annual rate of either:

 

(a) London Interbank Offered rate (“LIBOR”) plus 3.25% to 4.25%, based on the average availability, or

(b) the higher of (i) a prime rate, (ii) the federal funds effective rate plus 0.50%, or (iii) a LIBOR rate plus 1.00% plus, in each case, an additional 2.25% to 3.25%, based on average availability.

 

The Facility is secured by all property owned, leased or operated by the Company in the United States excluding any real property owned by the Company and also excludes any intellectual property owned by the Company unless availability is less than or equal to $17.5 million, and contains customary covenants which may limit the Company’s ability to incur debt; engage in mergers and consolidations; make restricted payments (including dividends); sell certain assets; and make investments.

 

At December 31, 2009, we had no revolving loans, and $12.5 million in trade and standby letters of credit outstanding under the Facility. Remaining availability under the revolver totaled $47.5 million subject to limitations set forth in the agreement noted above. We are in compliance with the terms and conditions of the agreement and as a result, the coverage charge ratio, or other restricted payment limitations did not apply.  As of December 31, 2009, we are in compliance with all covenants of our credit facility.

 

(9)        Litigation

 

Environmental Matters

 

We and our subsidiaries are subject to various environmental laws and regulations. Under these laws, we and/or our subsidiaries are, or may be, required to remove or mitigate the effects on the environment of the disposal or release of certain hazardous materials.

 

During the fiscal year ending June 30, 2009, our liability with respect to three active sites currently listed, or proposed for inclusion, on the National Priorities List (“NPL”) under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”), where we and/or our subsidiaries had been named as a Potentially Responsive Party (“PRP”) located in Southington, Connecticut; High Point, North Carolina; and Atlanta, Georgia has been resolved.

 

In each case we were not a major contributor based on the very small volume of waste generated by us in relation to total volume at those sites and were able to take part in de minimus settlement arrangements.  Specifically, with respect to the Southington site, our volumetric share is less than 1% of over 51 million gallons disposed of at the site and there are more than 1,000 PRPs.  With respect to the High Point site, our volumetric share is less than 1% of over 18 million gallons disposed of at the site and there are more than 2,000 PRPs, including more than 1,000 de minimis parties (of which we are one). With respect to the Atlanta site, a former solvent recycling/reclamation facility, our volumetric share is less than 1% of over 20 million gallons disposed of at the site by more than 1,700 PRPs.

 

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Notes to Consolidated Financial Statements (Unaudited)

 

In addition to the now settled actions discussed above, in July 2000, we were notified by the State of New York (the “State”) that we may be named a PRP in a separate, unrelated matter with respect to a site located in Carroll, New York.   In May, 2009, we were notified by the State that it had conducted an initial environmental study and that we have been named as a PRP.  We believe that we are not a major contributor; however, a review of the initial environmental study is ongoing.

 

Liability under CERCLA may be joint and several. As such, to the extent certain named PRPs are unable, or unwilling, to accept responsibility and pay their apportioned costs, we could be required to pay in excess of our pro rata share of incurred remediation costs. Our understanding of the financial strength of other PRPs has been considered, where appropriate, in the determination of our estimated liability.

 

As of December 31, 2009, we believe that established reserves related to these environmental contingencies are adequate to cover probable and reasonably estimable costs associated with the remediation and restoration of these sites.  We believe our currently anticipated capital expenditures for environmental control facility matters are not material.

 

We are subject to other federal, state and local environmental protection laws and regulations and are involved, from time to time, in investigations and proceedings regarding environmental matters.  Such investigations and proceedings typically concern air emissions, water discharges, and/or management of solid and hazardous wastes. We believe that our facilities are in material compliance with all such applicable laws and regulations.

 

Regulations issued under the Clean Air Act Amendments of 1990 required the industry to reformulate certain furniture finishes or institute process changes to reduce emissions of volatile organic compounds. Compliance with many of these requirements has been facilitated through the introduction of high solids coating technology and alternative formulations. In addition, we have instituted a variety of technical and procedural controls, including reformulation of finishing materials to reduce toxicity, implementation of high velocity low pressure spray systems, development of storm water protection plans and controls, and further development of related inspection/audit teams, all of which have served to reduce emissions per unit of production. We remain committed to implementing new waste minimization programs and/or enhancing existing programs with the objective of (i) reducing the total volume of waste, (ii) limiting the liability associated with waste disposal, and (iii) continuously improving environmental and job safety programs on the factory floor which serve to minimize emissions and safety risks for employees. We will continue to evaluate the most appropriate, cost effective, control technologies for finishing operations and design production methods to reduce the use of hazardous materials in the manufacturing process.

 

(10)     Share-Based Compensation

 

On October 10, 2007, the Company’s Board of Directors and M. Farooq Kathwari, our Chairman, President and Chief Executive Officer, agreed to the terms of a new employment agreement expiring on June 30, 2012 (the “Agreement”).  Pursuant to the terms of the Agreement, Mr. Kathwari was awarded options to purchase 150,000 shares of our common stock on October 10, 2007, options to purchase an additional 90,000 shares on July 1, 2008, and options to purchase an additional 60,000 shares on July 1, 2009, in each case at the closing stock price on the grant date.  The 2007 grant was issued at an exercise price of $34.03, and vests in three equal installments on each June 30 of 2008, 2009 and 2010.  The 2008 grant was issued at an exercise price of $24.62, and vests in two equal installments on each of June 30, 2009 and 2010.  The 2009 grant was issued at an exercise price of $10.68 and vests on June 30, 2010. All options awarded under the Agreement have a contractual term of 10 years.

 

In connection with the Agreement, Mr. Kathwari received an award of 20,000 restricted shares with vesting based on continuing service and the performance of the Company’s stock price during the 32 month period subsequent to the award date as compared to the Standard and Poor’s 500 index.  On July 1, 2008, an additional award of 20,000 restricted shares with the same vesting conditions (over a 36 month period) was granted.  Mr. Kathwari received, as

 

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Notes to Consolidated Financial Statements (Unaudited)

 

per the Agreement, an additional grant of 20,000 restricted shares on July 1, 2009 with the same 36 month vesting, continuing service and performance conditions.

 

Also in connection with the Agreement, Mr. Kathwari received on November 13, 2007 an award of 15,000 restricted shares.  These shares are service-based with 3,000 shares vesting on June 30 for each of the years 2008 through 2012.

 

On November 12, 2009, the Company awarded options to purchase 83,500 shares of our common stock to a large group of associates at the closing stock price on the grant date of $11.74.  These grants vest in four equal annual installments on the anniversary date of the grant.

 

(11)     Earnings Per Share

 

Basic and diluted earnings per share are calculated using the following weighted average share data (in thousands):

 

		Three Months Ended				Six Months Ended
		December 31,				December 31,
		2009		2008		2009		2008
Weighted average common shares outstanding for basic calculation		28,917		28,739		28,922		28,721
Effect of dilutive stock options and other share-based awards		—		—		—		72
Weighted average common shares outstanding adjusted for dilution calculation		28,917		28,739		28,922		28,793

 

As of December 31, 2009 and 2008, stock options to purchase 2,251,389 and 2,287,725 common shares, respectively, were excluded from the respective diluted earnings per share calculation because their impact was anti-dilutive.

 

(12)     Comprehensive Income

 

Total comprehensive income represents the sum of net income and items of “other comprehensive income or loss” that are reported directly in equity.  Such items, which are generally presented on a net of tax basis, may include foreign currency translation adjustments, minimum pension liability adjustments (i.e. gains and losses) on certain derivative instruments, and unrealized gains and losses on certain investments in debt and equity securities.  We have reported our total comprehensive income in the Consolidated Statements of Shareholders’ Equity.

 

Accumulated other comprehensive income, comprised of losses on certain derivative instruments and accumulated foreign currency translation adjustments, totaled $1.2 million at December 31, 2009 and $0.5 million at June 30, 2009.  Losses on derivative instruments are the result of cash flow hedging contracts entered into in connection with the issuance of the Senior Notes (see Note 8).  Foreign currency translation adjustments are the result of changes in foreign currency exchange rates related to our operation of five Ethan Allen owned retail design centers located in Canada and our cut and sew plant located in Mexico.  Foreign currency translation adjustments exclude income tax expense (benefit) given that the earnings of non-U.S. subsidiaries are deemed to be reinvested for an indefinite period of time.

 

(13)     Financial Instruments

 

ACS Topic 820, “Fair value measurements and disclosures” (SFAS No. 157) defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or

 

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Notes to Consolidated Financial Statements (Unaudited)

 

liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk including our own credit risk.

 

In addition to defining fair value, ASC Topic 820 expands the disclosure requirements around fair value and establishes a fair value hierarchy for valuation inputs. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market. Each fair value measurement is reported in one of the three levels which is determined by the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

 

·      Level 1 — inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.

·      Level 2 — inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·      Level 3 — inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

 

The following section describes the valuation methodologies we use to measure different financial assets and liabilities at fair value.

 

The Company partially adopted ASC Topic 820 on July 1, 2008 due to the fact that a portion of ASC Topic 820 was previously deferred for one year for all nonfinancial assets and nonfinancial liabilities that were not recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  On July 1, 2009, the Company adopted the deferred portion of ACS Topic 820.  There was no impact to the Company’s financial position or results of operations resulting from the adoption of the deferred portion of ACS Topic 820.  The Company has now fully adopted ASC Topic 820.

 

Cash Equivalents

 

Cash equivalents consist of money market accounts and mutual funds in U.S. government and agency securities.  We use quoted prices in active markets for identical assets or liabilities to determine fair value.  This pricing methodology applies to our Level 1 cash equivalents.  We do not hold any Level 2 or Level 3 investments in our cash equivalents.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

At December 31, 2009, the Company’s assets and liabilities measured at fair value on a recurring basis consist of $70.0 million in cash equivalents, which were valued using Level 1 inputs.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

We measure certain assets, including our cost and equity method investments, at fair value on a nonrecurring basis. These assets are recognized at fair value when they are deemed to be other-than-temporarily impaired. During the six months ended December 31, 2009, we did not record any other-than-temporary impairments on those assets required to be measured at fair value on a nonrecurring basis.

 

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Notes to Consolidated Financial Statements (Unaudited)

 

(14)     Segment Information

 

Our operations are classified into two operating segments: wholesale and retail.  These operating segments represent strategic business areas which, although they operate separately and provide their own distinctive services, enable us to more effectively offer our complete line of home furnishings and accessories.

 

The wholesale segment is principally involved in the development of the Ethan Allen brand, which encompasses the design, manufacture, domestic and offshore sourcing, sale and distribution of a full range of home furnishings and accessories to a network of independently owned and Ethan Allen owned design centers as well as related marketing and brand awareness efforts.  Wholesale revenue is generated upon the wholesale sale and shipment of our product to all retail design centers, including those owned by Ethan Allen.  Wholesale profitability includes (i) the wholesale gross margin, which represents the difference between the wholesale sales price and the cost associated with manufacturing and/or sourcing the related product, and (ii) other operating costs associated with wholesale segment activities.

 

The retail segment sells home furnishings and accessories to consumers through a network of Company owned design centers.  Retail revenue is generated upon the retail sale and delivery of our product to our customers.  Retail profitability includes (i) the retail gross margin, which represents the difference between the retail sales price and the cost of goods purchased from the wholesale segment, and (ii) other operating costs associated with retail segment activities.

 

Inter-segment eliminations result, primarily, from the wholesale sale of inventory to the retail segment, including the related profit margin.

 

We evaluate performance of the respective segments based upon revenues and operating income. While the manner in which our home furnishings and accessories are marketed and sold is consistent, the nature of the underlying recorded sales (i.e. wholesale versus retail) and the specific services that each operating segment provides (i.e. wholesale manufacturing, sourcing, and distribution versus retail selling) are different.  Within the wholesale segment, we maintain revenue information according to each respective product line (i.e. case goods, upholstery, or home accessories and other).

 

A breakdown of wholesale sales by these product lines for the three and six months ended December 31, 2009 and 2008 is provided as follows:

 

		Three Months Ended				Six Months Ended
		December 31,				December 31,
		2009		2008		2009		2008
Case Goods		42	%	42	%	41	%	42	%
Upholstered Products		44		40		44		41
Home Accessories and Other		14		18		15		17
		100	%	100	%	100	%	100	%

 

Revenue information by product line is not as easily determined within the retail segment. However, because wholesale production and sales are matched, for the most part, to incoming orders, we believe that the allocation of retail sales by product line would be similar to that of the wholesale segment.

 

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Notes to Consolidated Financial Statements (Unaudited)

 

Segment information for the three and six months ended December 31, 2009 and 2008 is set forth as follows:

 

		Three Months Ended						Six Months Ended
		December 31,						December 31,
		2009			2008			2009			2008
Net sales:
Wholesale segment		$	84,499		$	108,848		$	165,780		$	230,143
Retail segment		107,123			147,183			210,273			303,053
Elimination of inter-company sales		(48,320		)	(66,473		)	(96,561		)	(137,797		)
Consolidated Total		$	143,302		$	189,558		$	279,492		$	395,399
Operating income (loss):
Wholesale segment (1)(2)		$	1,022		$	8,580		$	(3,638	)	$	20,465
Retail segment (3)(4)		(9,792		)	(3,185		)	(21,141		)	(6,237		)
Adjustment of inter-company profit (5)		3,487			4,692			3,408			8,070
Consolidated Total		$	(5,283	)	$	10,087		$	(21,371	)	$	22,298
Capital expenditures:
Wholesale segment		$	835		$	682		$	1,636		$	2,314
Retail segment		1,992			4,371			3,679			13,832
Acquisitions (6)(7)		—			272			—			647
Consolidated Total		$	2,827		$	5,325		$	5,315		$	16,793

 

		December 31,			June 30,
		2009			2009
Total assets
Wholesale segment		$	273,045		$	276,250
Retail segment		383,676			397,877
Inventory profit elimination (8)		(24,251		)	(27,642		)
Consolidated Total		$	632,470		$	646,485

 

(1)     Operating income (loss) for the wholesale segment for the three months ended December 31, 2009 includes a pre-tax restructuring and impairment net recovery of $0.4 million.

(2)     Operating income (loss) for the wholesale segment for the six months ended December 31, 2009 and 2008 include a pre-tax restructuring and impairment net recovery of $0.2 million and charges of $0.4 million, respectively.

(3)     Operating income (loss) for the retail segment for the three months ended December 31, 2009 includes pre-tax restructuring and impairment charges of $1.2 million.

(4)     Operating income (loss) for the retail segment for the six months ended December 31, 2009 and 2008 include pre-tax restructuring and impairment charges of $1.8 million and a net recovery of $2.0 million, respectively.

(5)     Represents the change in the inventory profit elimination necessary to adjust for the embedded wholesale profit contained in Ethan Allen-owned design center inventory existing at the end of the period.

(6)     Acquisitions for the three months ended December 31, 2008 include the purchase of one retail design center.

(7)     Acquisitions for the six months ended December 31, 2008 include the purchase of three retail design centers.

(8)     Represents the wholesale profit contained in Ethan Allen-owned design center inventory that has not yet been realized. These profits are realized when the related inventory is sold.

 

There were 50 independent retail design centers located outside the United States at December 31, 2009. Less than five percent of our net sales were derived from sales to those retail design centers.

 

(15)     Subsequent Events

 

Ethan Allen declares quarterly cash dividend

 

Ethan Allen’s Board of Directors has declared a quarterly cash dividend of $0.05 per share, which will be payable to shareholders of record as of April 9, 2010 and paid on April 26, 2010.

 

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Notes to Consolidated Financial Statements (Unaudited)

 

16)       Recent Accounting Pronouncements

 

In June 2009, the FASB released additional guidance on ASC Topic 810, “Consolidation” (SFAS No. 167) which will revise previous guidance applicable to variable interest entities (“VIEs”). The new guidance will require ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, as opposed to reconsideration only when specific events occurred, as under present rules. The new guidance will also replace the quantitative approach previously required for determining the primary beneficiary of a VIE with a qualitative approach, and changes some disclosure requirements. This revised guidance is effective for fiscal years beginning after November 15, 2009 (July 1, 1010 for the Company).  The Company is currently evaluating the impact, if any, on our financial statements and results of operations.

 

(17)     Financial Information About the Parent, the Issuer and the Guarantors

 

On September 27, 2005, Global (the “Issuer”) issued $200 million aggregate principal amount of Senior Notes which have been guaranteed on a senior basis by Interiors (the “Parent”), and other wholly owned domestic subsidiaries of the Issuer and the Parent, including Ethan Allen Retail, Inc., Ethan Allen Operations, Inc., Ethan Allen Realty, LLC, Lake Avenue Associates, Inc. and Manor House, Inc. The subsidiary guarantors (other than the Parent) are collectively called the “Guarantors”.  The guarantees of the Guarantors are unsecured.  All of the guarantees are full, unconditional and joint and several and the Issuer and each of the Guarantors are 100% owned by the Parent. Ethan Allen (UK) Ltd. (which was legally dissolved in October 2009), and our other subsidiaries which are not guarantors are called the “Non-Guarantors”. During the quarter ended December 31, 2008, we determined that our international subsidiaries in Canada and Mexico are non-guarantors. The Company has reclassified, for all prior periods presented, the financial results of these international subsidiaries to reflect their non-guarantor status.

 

The following tables set forth the condensed consolidating balance sheets as of December 31, 2009 and June 30, 2009, the condensed consolidating statements of operations for the three and six months ended December 31, 2009 and 2008, and the condensed consolidating statements of cash flows for the six months ended December 31, 2009 and 2008 of the Parent, the Issuer, the Guarantors and the Non-Guarantors.

 

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Notes to Consolidated Financial Statements (Unaudited)

 

CONDENSED CONSOLIDATING BALANCE SHEET

(In thousands)

December 31, 2009

 

		Parent			Issuer			Guarantors			Non-Guarantors			Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents		$	—		$	72,802		$	2,125		$	1,211		$	—		$	76,138
Accounts receivable, net		—			12,002			324			255			—			12,581
Inventories		—			—			161,489			4,753			(24,251		)	141,991
Prepaid expenses and other current assets		—			19,580			5,220			635			—			25,435
Intercompany		—			781,359			228,088			(3,663		)	(1,005,784		)	—
Total current assets		—			885,743			397,246			3,191			(1,030,035		)	256,145
Property, plant and equipment, net		—			6,667			301,352			5,509			—			313,528
Goodwill and other intangible assets		—			19,740			25,388			—			—			45,128
Other assets		—			16,972			693			4			—			17,669
Investment in affiliated companies		597,334			(53,551		)	—			—			(543,783		)	—
Total assets		$	597,334		$	875,571		$	724,679		$	8,704		$	(1,573,818	)	$	632,470
Liabilities and Shareholders’ Equity
Current liabilities:
Current maturities of long-term debt		$	—		$	—		$	43		$	—		$	—		$	43
Customer deposits		—			—			34,783			1,790			—			36,573
Accounts payable		—			8,143			14,773			320			—			23,236
Accrued expenses and other current liabilities		1,568			36,599			17,808			276			—			56,251
Intercompany		307,887			597			691,982			5,318			(1,005,784		)	—
Total current liabilities		309,455			45,339			759,389			7,704			(1,005,784		)	116,103
Long-term debt		—			199,078			4,087			—			—			203,165
Other long-term liabilities		—			10,455			14,729			139			—			25,323
Deferred income taxes		—			—			—			—			—			—
Total liabilities		309,455			254,872			778,205			7,843			(1,005,784		)	344,591
Shareholders’ equity		287,879			620,699			(53,526		)	861			(568,034		)	287,879
Total liabilities and shareholders’ equity		$	597,334		$	875,571		$	724,679		$	8,704		$	(1,573,818	)	$	632,470

 

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