ETHAN ALLEN INTERIORS INC - Quarter Report: 2009 September (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 September 30, 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 October 30, 2009, 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 September 30, 2009 (unaudited) and June 30, 2009 and for the three months ended September 30, 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		24
3.	Quantitative and Qualitative Disclosures About Market Risk		33
4.	Controls and Procedures		34
Part II - Other Information
1.	Legal Proceedings		34
1A.	Risk Factors		34
2.	Unregistered Sales of Equity Securities and Use of Proceeds		34
3.	Defaults Upon Senior Securities		34
4.	Submission of Matters to a Vote of Security Holders		34
5.	Other Information		34
6.	Exhibits		35
	Signatures		36

 

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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)

 

		September 30, 2009			June 30, 2009
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	72,452		$	52,960
Accounts receivable, less allowance for doubtful accounts of $1,243 at September 30, 2009 and $1,362 at June 30, 2009		13,053			13,086
Inventories (note 4)		146,661			156,519
Prepaid expenses and other current assets		12,075			21,060
Deferred income taxes		7,750			8,077
Total current assets		251,991			251,702
Property, plant and equipment, net		320,184			333,599
Goodwill and other intangible assets (notes 6 and 7)		45,128			45,128
Other assets		21,262			16,056
Total assets		$	638,565		$	646,485
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt (note 8)		$	42		$	42
Customer deposits		38,885			31,691
Accounts payable		21,077			22,199
Accrued compensation and benefits		26,989			29,533
Accrued expenses and other current liabilities (note 5)		31,203			28,998
Total current liabilities		118,196			112,463
Long-term debt (note 8)		203,136			203,106
Other long-term liabilities		25,449			24,993
Total liabilities		346,781			340,562
Shareholders’ equity:
Class A common stock, par value $.01, 150,000,000 shares authorized; 48,297,870 shares issued at September 30, 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 September 30, 2009 and June 30, 2009		—			—
Preferred stock, par value $.01, 1,055,000 shares authorized; no shares issued and outstanding at September 30, 2009 and June 30, 2009		—			—
Additional paid-in capital		356,969			356,446
		357,452			356,929
Less: Treasury stock (at cost), 19,380,941 shares at September 30, 2009 and 19,380,941 shares at June 30, 2009		(583,220		)	(583,220		)
Retained earnings		516,716			531,747
Accumulated other comprehensive income (note 12)		836			467
Total shareholders’ equity		291,784			305,923
Total liabilities and shareholders’ equity		$	638,565		$	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 September 30,
		2009			2008
Net sales		$	136,190		$	205,841
Cost of sales		77,881			93,900
Gross profit		58,309			111,941
Operating expenses:
Selling		33,605			55,302
General and administrative		39,980			46,058
Restructuring and impairment charge, net (note 5)		812			(1,630		)
Total operating expenses		74,397			99,730
Operating income (loss)		(16,088		)	12,211
Interest and other miscellaneous income, net		797			1,100
Interest and other related financing costs (note 8)		2,981			2,901
Income (loss) before income taxes		(18,272		)	10,410
Income tax expense (benefit) (note 3)		(4,693		)	2,988
Net income (loss)		$	(13,579	)	$	7,422
Per share data (note 11):
Basic earnings per common share:
Net income (loss) per basic share		$	(0.47	)	$	0.26
Basic weighted average common shares		28,926			28,703
Diluted earnings per common share:
Net income (loss) per diluted share		$	(0.47	)	$	0.26
Diluted weighted average common shares		28,926			28,847

 

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)

 

		Three Months Ended
		September 30,
		2009			2008
Operating activities:
Net income (loss)		$	(13,579	)	$	7,422
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		12,697			6,318
Compensation expense related to share-based awards		523			394
Provision (benefit) for deferred income taxes		(5,197		)	(1,850		)
Restructuring and impairment charge (benefit), net		266			(3,854		)
(Gain) loss on disposal of property, plant and equipment		(470		)	(5		)
Other		55			66
Change in assets and liabilities, net of the effects of acquired businesses:
Accounts receivable		33			931
Inventories		9,858			(561		)
Prepaid and other current assets		6,427			9,192
Other assets		186			84
Customer deposits		7,194			(5,312		)
Accounts payable		(1,122		)	(550		)
Accrued expenses and other current liabilities		(332		)	5,253
Other long-term liabilities		456			547
Net cash provided by operating activities		16,995			18,075
Investing activities:
Proceeds from the disposal of property, plant & equipment		5,935			5,729
Capital expenditures		(2,488		)	(11,093		)
Acquisitions		—			(375		)
Other		6			(249		)
Net cash provided by (used in) investing activities		3,453			(5,988		)
Financing activities:
Payments on long-term debt		(10		)	(10		)
Proceeds from issuance of common stock		—			2
Payment of deferred financing costs		(22		)	—
Payment of cash dividends		(1,448		)	(6,331		)
Net cash used in financing activities		(1,480		)	(6,339		)
Effect of exchange rate changes on cash		524			(207		)
Net increase in cash & cash equivalents		19,492			5,541
Cash & cash equivalents - beginning of period		52,960			74,376
Cash & cash equivalents - end of period		$	72,452		$	79,917

 

See accompanying notes to consolidated financial statements.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Three Months Ended September 30, 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)		—			523			—			—			—			523
Dividends declared on common stock		—			—			—			—			(1,452		)	(1,452		)
Other comprehensive income (note 12):
Currency translation adjustments		—			—			—			357			—			357
Hedge amortization, net of tax and other		—			—			—			12			—			12
Net income (loss)		—			—			—			—			(13,579		)	(13,579		)
Total comprehensive income (loss)																	(13,210		)
Balance at September 30, 2009		$	483		$	356,969		$	(583,220	)	$	836		$	516,716		$	291,784

 

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 September 30, 2009 through November 9, 2009, 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 definite lived 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 are effective for interim and annual periods ending after September 15, 2009 and, accordingly, are effective for the Company for the current fiscal reporting period. 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

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

implementation of this pronouncement did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

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

 

All intercompany accounts and transactions have been eliminated in the consolidated financial statements.  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 months ended September 30, 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.  Essentially 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 income tax rate was 25.7% and 28.7% for the three months ended September 30, 2009 and 2008, respectively. The current effective tax rate, resulting in a tax benefit, was adversely affected by the valuation allowances against certain state and Canadian deferred tax assets. The prior period effective tax rate benefitted from a one time adjustment of $0.7 million made in the prior year quarter.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

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 Company is subject to examination by the taxing authorities in such major jurisdictions as Canada, Mexico and the U.S. As of September 30, 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.

 

(4)      Inventories

 

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

 

 

Inventories are presented net of a related valuation allowance of $2.2 million at both September 30, 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 production efficiencies and maintain our competitive advantage.

 

In fiscal 2009, the Company made several announcements on changes to our operations as we continue to improve the structure of our business especially in light of the recent economic downturn.  In January 2009, the Company announced a plan to consolidate the operations of its Eldred, Pennsylvania upholstery manufacturing plant and several of its retail service centers. In June 2009, the Company announced the consolidation of its Chino, California operations into its Maiden, North Carolina facility and the consolidation of its Andover, Maine sawmill and dimension mill to its Beecher Falls, Vermont sawmill and dimension mill operations. For these fiscal 2009 actions, the Company estimates pre-tax restructuring, impairment, accelerated depreciation and other related charges will ultimately approximate $31 million, 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.  By segment, we expect $24 million in costs for the wholesale segment and $7 million for the retail segment.  Total costs for these 2009 actions in the current fiscal year by segment are $0.2 million of restructuring charges and $6.6 million in accelerated depreciation for Wholesale, and $0.4 million of restructuring charges for Retail. Cumulative charges to date for these actions totaling $20.2 million have been classified in the Statement of Operations as restructuring and impairment charges and $6.6 million of accelerated depreciation recorded in cost of sales. Approximately 800 employee positions and 140 contract worker positions have been or will be eliminated due to these actions.

 

In fiscal 2008, we announced a plan to consolidate the operations of certain Company-operated retail design centers and retail service centers. In connection with this initiative, we have permanently ceased operations at ten design centers and six retail service centers which, for the most part, were consolidated into other existing operations.  We also implemented our design team concept across the Retail division at the end of fiscal 2008.  Costs for the January 2008 actions in the current fiscal year by segment totaled $0.2 million, all of which was for the Retail segment, mostly due to net losses on the sale of real estate. Cumulative charges to date for these actions total $5.8 million, all of which have been classified in the Statement of Operations as restructuring and impairment charges of the Retail segment.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

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

 

		Balance June 30, 2009			New charges (credits)			Utilized			Adjustments			Balance September 30, 2009
Fiscal 2009 Actions
Employee severance, other payroll and benefit costs		$	3,864		$	96		$	(1,404	)	$	—		$	2,556
Other plant exit costs		654			412			(523		)	—			543
Write down of long-lived assets		—			54			(54		)	—			—
		$	4,518		$	562		$	(1,981	)	$	—		$	3,099
Fiscal 2008 Actions
Employee severance, other payroll and benefit costs		$	369		$	—		$	(10	)	$	—		$	359
Other plant exit costs		2,892			—			(353		)	38			2,577
Write down of long-lived assets		—			—			(212		)	212			—
		$	3,261		$	—		$	(575	)	$	250		$	2,936

 

(6)      Business Acquisitions

 

There were no acquisitions completed during the three months ended September 30, 2009.

 

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.

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

A summary of our allocation of purchase price accounting for acquisitions during the three months ended September 30, 2008 is provided below (in thousands).

 

 

(7)      Goodwill, Other Intangible Assets and Goodwill Impairment

 

At both September 30, 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.

 

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.

 

During the quarter ending September 30, 2009, the business performance was consistent with management’s expectations, revenues and operating costs were on plan, the Company’s average quarterly stock price increased 13% (from $12.11 for the quarter ended June 30, 2009, to $13.69 for the quarter ended September 30, 2009), and cash reserves increased to $72.5 million at September 30, 2009 from $53.0 million at June 30, 2009. The Company considered these and other factors and concluded that an interim impairment test was not required.

 

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

 

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

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 September 30, 2009 and June 30, 2009 consist of the following (in thousands):

 

		September 30,			June 30,
		2009			2009
5.375% Senior Notes due 2015		$	199,037		$	198,997
Industrial revenue bonds		3,855			3,855
Other debt		286			296
Total debt		203,178			203,148
Less current maturities		42			42
Total long-term debt		$	203,136		$	203,106

 

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 May 29, 2009, the Company entered into a three-year, $40 million senior secured asset-based revolving credit facility (“the “Facility”). The Facility provides revolving credit financing of up to $40 million, subject to borrowing base availability, and includes an accordion feature which, if exercised, would provide up to an additional $20 million of financing.    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 September 30, 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 $27.5 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 September 30, 2009, we are in compliance with all covenants of our credit facility.

 

On October 23, 2009, the Facility was expanded to $60 million. See Note 15 - Subsequent Events for additional details.

 

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(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.

 

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 September 30, 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

 

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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 Mr. Kathwari 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 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.

 

(11)    Earnings Per Share

 

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

 

		Three Months Ended
		September 30,
		2009		2008
Weighted average common shares outstanding for basic calculation		28,926		28,703
Effect of dilutive stock options and other share-based awards		—		144
Weighted average common shares outstanding adjusted for dilution calculation		28,926		28,847

 

As of September 30, 2009 and 2008, stock options to purchase 2,251,389 and 1,813,855 common shares, respectively, were excluded from the respective diluted earnings per share calculation because their impact was anti-dilutive.

 

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(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 $0.8 million at September 30, 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 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

 

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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 September 30, 2009, the Company’s assets and liabilities measured at fair value on a recurring basis consist of $59.7 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 three months ended September 30, 2009, we did not record any other-than-temporary impairments on those assets required to be measured at fair value on a nonrecurring basis.

 

(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).

 

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A breakdown of wholesale sales by these product lines for the three months ended September 30, 2009 and 2008 is provided as follows:

 

 

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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Segment information for the three months ended September 30, 2009 and 2008 is set forth as follows:

 

		Three Months Ended
		September 30,
		2009			2008
Net sales:
Wholesale segment		$	81,281		$	121,295
Retail segment		103,150			155,870
Elimination of inter-company sales		(48,241		)	(71,324		)
Consolidated Total		$	136,190		$	205,841
Operating income (loss):
Wholesale segment (1)		$	(4,660	)	$	11,885
Retail segment (2)		(11,349		)	(3,052		)
Adjustment of inter-company profit (3)		(79		)	3,378
Consolidated Total		$	(16,088	)	$	12,211
Capital expenditures:
Wholesale segment		$	801		$	1,632
Retail segment		1,687			9,461
Acquisitions (4)		—			375
Consolidated Total		$	2,488		$	11,468

 

		September 30,			June 30,
Total assets		2009			2009
Wholesale segment		$	281,075		$	276,250
Retail segment		385,279			397,877
Inventory profit elimination (5)		(27,789		)	(27,642		)
Consolidated Total		$	638,565		$	646,485

 

(1)          Operating income (loss) for the wholesale segment for the three months ended September 30, 2009 and 2008 includes pre-tax restructuring and impairment charges of $0.2 million and $0.4 million, respectively.

(2)          Operating income (loss) for the retail segment for the three months ended September 30, 2009 and 2008 includes pre-tax restructuring and impairment charges of $0.7 million and a net recovery of $2.0 million, respectively.

(3)          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.

(4)          Acquisitions for the three months ended September 30, 2008 include the purchase of two retail design centers.

(5)          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 49 independent retail design centers located outside the United States at September 30, 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 October 9, 2009 and paid on October 26, 2009.

 

Ethan Allen expands revolving credit facility

 

On October 23, 2009, the Company amended its three-year revolving credit facility by increasing the credit financing by $20 million, with total borrowing under the agreement (subject to borrowing base availability) of up to $60

 

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million. The Amended Facility is secured by all assets owned, leased or operated by the Company in the United States including intellectual property, and excludes any real estate owned by the Company.

 

Standard & Poor’s lowers credit rating

 

On November 2, 2009, Standard & Poor’s Rating Services lowered its corporate credit and senior unsecured debt ratings to ‘B+’ from ‘BB’ and indicated the outlook was negative. The rating agency cited very weak operating performance due to lower consumer spending and a tough retail environment in its rating action. The Company believes this change does not materially affect its ability to operate and further believes it has adequate liquidity and cash flow to meet current business needs.

 

(16)    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 September 30, 2009 and June 30, 2009, the condensed consolidating statements of operations for the three months ended September 30, 2009 and 2008, and the condensed consolidating statements of cash flows for the three months ended September 30, 2009 and 2008 of the Parent, the Issuer, the Guarantors and the Non-Guarantors.

 

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CONDENSED CONSOLIDATING BALANCE SHEET

(In thousands)

September 30, 2009

 

		Parent			Issuer			Guarantors			Non-Guarantors			Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents		$	—		$	68,296		$	2,888		$	1,268		$	—		$	72,452
Accounts receivable, net		—			12,269			540			244			—			13,053
Inventories		—			—			169,742			4,708			(27,789		)	146,661
Prepaid expenses and other current assets		—			12,736			6,469			620			—			19,825
Intercompany		—			767,471			229,281			(3,294		)	(993,458		)	—
Total current assets		—			860,772			408,920			3,546			(1,021,247		)	251,991
Property, plant and equipment, net		—			11,201			304,005			4,978			—			320,184
Goodwill and other intangible assets		—			37,905			7,223			—			—			45,128
Other assets		—			20,454			802			6			—			21,262
Investment in affiliated companies		599,745			(39,991		)	—			—			(559,754		)	—
Total assets		$	599,745		$	890,341		$	720,950		$	8,530		$	(1,581,001	)	$	638,565
Liabilities and Shareholders’ Equity
Current liabilities:
Current maturities of long-term debt		$	—		$	—		$	42		$	—		$	—		$	42
Customer deposits		—			—			37,175			1,710			—			38,885
Accounts payable		—			6,278			14,559			240			—			21,077
Accrued expenses and other current liabilities		1,559			39,363			16,968			302			—			58,192
Intercompany		306,402			8,123			673,183			5,750			(993,458		)	—
Total current liabilities		307,961			53,764			741,927			8,002			(993,458		)	118,196
Long-term debt		—			199,038			4,098			—			—			203,136
Other long-term liabilities		—			10,571			14,737			141			—			25,449
Deferred income taxes		—			—			—			—			—			—
Total liabilities		307,961			263,373			760,762			8,143			(993,458		)	346,781
Shareholders’ equity		291,784			626,968			(39,812		)	387			(587,543		)	291,784
Total liabilities and shareholders’ equity		$	599,745		$	890,341		$	720,950		$	8,530		$	(1,581,001	)	$	638,565

 

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CONDENSED CONSOLIDATING BALANCE SHEET

(In thousands)

June 30, 2009

 

		Parent			Issuer			Guarantors			Non-Guarantors			Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents		$	—		$	47,712		$	3,592		$	1,656		$	—		$	52,960
Accounts receivable, net		—			12,049			783			254			—			13,086
Inventories		—			—			179,705			4,456			(27,642		)	156,519
Prepaid expenses and other current assets		—			20,509			8,084			544			—			29,137
Intercompany receivables		—			782,736			227,453			(3,010		)	(1,007,179		)	—
Total current assets		—			863,006			419,617			3,900			(1,034,821		)	251,702
Property, plant and equipment, net		—			11,748			317,144			4,707			—			333,599
Goodwill and other intangible assets		—			37,905			7,223			—			—			45,128
Other assets		—			15,323			727			6			—			16,056
Investment in affiliated companies		612,391			(20,616		)	—			—			(591,775		)	—
Total assets		612,391			907,366			744,711			8,613			(1,626,596		)	646,485
Liabilities and Shareholders’ Equity
Current liabilities:
Current maturities of long-term debt		—			—			42			—			—			42
Customer deposits		—			—			30,412			1,279			—			31,691
Accounts payable		—			8,851			13,106			242			—			22,199
Accrued expenses and other current liabilities		1,552			41,004			15,707			268			—			58,531
Intercompany payables		304,917			8,123			687,826			6,313			(1,007,179		)	—
Total current liabilities		306,469			57,978			747,093			8,102			(1,007,179		)	112,463
Long-term debt		—			198,998			4,108			—			—			203,106
Other long-term liabilities		—			10,565			14,290			138			—			24,993
Deferred income taxes		—			—			—			—			—			—
Total liabilities		306,469			267,541			765,491			8,240			(1,007,179		)	340,562
Shareholders’ equity		305,922			639,825			(20,780		)	373			(619,417		)	305,923
Total liabilities and shareholders’ equity		$	612,391		$	907,366		$	744,711		$	8,613		$	(1,626,596	)	$	646,485

 

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