ETHAN ALLEN INTERIORS INC - Quarter Report: 2013 September (Form 10-Q)

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, 2013

OR

[  ]     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     [  ] 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).     [X] Yes       [  ] 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).     [  ] 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 25, 2013, there were 28,914,601 shares of Class A Common Stock,

 par value $.01, outstanding.

Table of Contents

PART I - FINANCIAL INFORMATION

 PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands)

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited

(In thousands, except per share data)

ETHAN ALLEN INTERIORS INC.

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

 Three Months Ended September 30, 2013

(Unaudited)

(In thousands)

See accompanying notes to consolidated financial statements.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1)   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. 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.

Our consolidated financial statements include the accounts of an entity in which we are a majority shareholder and have the power to direct the activities that most significantly impact the entity’s performance. Noncontrolling interest amounts in the entity are immaterial and included in the Consolidated Statement of Comprehensive Income within interest and other miscellaneous income, net.

For the three months ended September 30, 2013 and 2012, the Company has combined selling, general and administrative expenses in a single line item on the Consolidated Statements of Comprehensive Income to remove information that we do not believe is meaningful and to improve comparability with peer companies. Selling expenses, general and administrative expenses, and restructuring and impairment charges had previously been presented separately.

(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 months ended September 30, 2013 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 for the year ended June 30, 2013.

(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; impacts from tax law changes; or change in judgment as to the realizability of deferred tax assets. The Company identifies items which are not normal and are non-recurring 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.

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 domestic and foreign jurisdictions. As of September 30, 2013, the Company and certain subsidiaries are currently under audit from 2006 through 2011 in the U.S. 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. It is reasonably possible that some of these audits may be completed during the next twelve months. It is reasonable to expect that various issues relating to uncertain tax benefits will be resolved within the next twelve months as exams are completed or as statutes expire and will impact the effective tax rate.

The Company’s consolidated effective tax rate was 36.2% for the three months ended September 30, 2013, and 36.4% for the three months ended September 30, 2012. The current quarter effective tax rate primarily includes tax expense on the current quarter’s net income, interest expense on uncertain tax positions, and the impact of maintaining valuation allowances on certain deferred tax assets, partly offset by the reversal and recognition of some uncertain tax positions. The prior period effective tax rate primarily includes the tax expense on that quarter’s net income, interest expense on uncertain tax positions, and the impact of maintaining valuation allowances on deferred tax assets in the retail segment.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(4)   Restricted Cash and Investments

At September 30, 2013 and June 30, 2013, we held $14.9 million and $15.4 million respectively, of restricted cash and investments in lieu of providing letters of credit for the benefit of the provider of our workmen’s compensation and other insurance and for the benefit of the issuer of our private label credit card. These funds can be invested in high quality money market mutual funds, U.S. Treasuries and U.S. Government agency fixed income instruments, and cannot be withdrawn without the prior written consent of the secured party. These assets are carried at cost, which approximates market value and are classified as long-term assets because they are not expected to be used within one year to fund operations. See also Note 12, “Fair Value Measurements".

(5)   Marketable Securities

At September 30, 2013 and June 30, 2013, the Company held marketable securities of $13.4 million and $15.5 million respectively, classified as current assets, consisting of U.S. municipal and corporate bonds with maturities ranging from less than one year to less than two years, which were rated A/A2 or better by the rating services Standard & Poors (“S&P”) and Moodys Investors Service (“Moodys”) respectively. There have been no material realized or unrealized gains or losses for the three months ended September 30, 2013 and September 30, 2012. We do not believe there are any impairments considered to be other than temporary at September 30, 2013. See also Note 12, “Fair Value Measurements"

(6)   Inventories

Inventories at September 30, 2013 and June 30, 2013 are summarized as follows (in thousands):

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(7)   Borrowings

Total debt obligations at September 30, 2013 and June 30, 2013 consist of the following (in thousands):

In September 2005, we issued $200.0 million in ten-year senior unsecured notes due 2015 (the "Senior Notes"). The Senior Notes were issued by Global, bearing an annual coupon rate of 5.375% with interest payable semi-annually in arrears on April 1 and October 1. We have used the net proceeds of $198.4 million to improve our retail network, invest in our manufacturing and logistics operations, and for other general corporate purposes. In fiscal years 2011 through 2013, the Company repurchased an aggregate $70.6 million of the Senior Notes in several unsolicited transactions.

We also maintain a $50 million senior secured, asset-based revolving credit facility (the “Facility”). We have not had any revolving loans under the Facility at any time. At both September 30, 2013 and June 30, 2013, there were $0.6 million of standby letters of credit outstanding under the Facility. The Facility is subject to borrowing base availability and includes a right for the Company to increase the total facility to $100 million subject to certain conditions. 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 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. Remaining availability under the Facility totaled $49.4 million at September 30, 2013 and at June 30, 2013 and as a result, covenants and other restricted payment limitations did not apply. The Facility expires March 25, 2016, or June 26, 2015 if the Senior Notes have not been refinanced prior to that date.

At both September 30, 2013 and June 30, 2013, we were in compliance with all covenants of the Senior Notes and the Facility.

(8)   Litigation

We are routinely involved in various investigations or as a defendant in litigation, in the ordinary course of business. We are also subject to various 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. 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.  

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. We believe that our facilities are in material compliance with all such applicable laws and regulations. Our currently anticipated capital expenditures for environmental control facility matters are not material.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Although the outcome of the various claims and proceedings against us cannot be predicted with certainty, management believes that the likelihood is remote that any existing claims or proceedings will have a material adverse effect on our financial position, results of operations or cash flows.

(9)   Share-Based Compensation

During the three months ended September 30, 2013, the Company awarded options to purchase 23,499 shares of our common stock with a weighted average exercise price equal to the grant date closing market price of $29.79 per share, a weighted average grant date fair value of $14.34 and vesting over two years. During the three months ended September 30, 2013, options covering 415,550 shares of common stock were cancelled, primarily due to the expiration of their 10 year term. At September 30, 2013, there are 1,459,458 shares of common stock available for future issuance pursuant to the 1992 Stock Option Plan.

(10)   Earnings Per Share

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

As of September 30, 2013 and 2012, stock options to purchase 489,549 and 1,089,382 common shares, respectively, were excluded from the respective diluted earnings per share calculation because their impact was anti-dilutive.

(11)   Accumulated Other Comprehensive Income

The following table sets forth the activity in accumulated other comprehensive income for the period ended September 30, 2013 (in thousands):

Foreign currency translation adjustments are the result of changes in foreign currency exchange rates related to our operations in Canada, Belgium, Honduras, and Mexico, and exclude income taxes given that the earnings of non-U.S. subsidiaries are deemed to be reinvested for an indefinite period of time. The derivative instruments are reclassified to interest expense in our consolidated statements of operations.

(12)   Fair Value Measurements

We determine 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 is calculated based on assumptions that market participants use in pricing the asset or liability, and not on assumptions specific to the Company. In addition, the fair value of liabilities includes consideration of non-performance risk including our own credit risk. Each fair value measurement is reported in one of three levels, 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.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents our assets and liabilities measured at fair value on a recurring basis at September 30, 2013 and June 30, 2013 (in thousands):

Cash equivalents consist of money market accounts and mutual funds in U.S. government and agency fixed income securities. We use quoted prices in active markets for identical assets or liabilities to determine fair value. There were no transfers between level 1 and level 2 during the first three months of fiscal 2014 or fiscal 2013. At September 30, 2013 and June 30, 2013, $14.9 million and $15.4 million respectively, of the cash equivalents were restricted, and classified as long-term assets.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

At September 30, 2013, available-for-sale securities consist of $12.2 million in U.S. municipal bonds and $1.2 million of corporate bonds, and at June 30, 2013, available-for-sale securities consisted of $14.0 million in U.S. municipal bonds and $1.5 million of corporate bonds, all with maturities of less than two years. The bonds are rated A/A2 or better by S&P/Moodys respectively. As of September 30, 2013 and June 30, 2013, there were no material gross unrealized gains or losses on available-for-sale securities.

As of September 30, 2013 and June 30, 2013, the contractual maturities of our available-for-sale securities were as follows:

No investments have been in a continuous loss position for more than one year, and no other-than-temporary impairments were recognized. See also Note 4, "Restricted Cash and Investments" and Note 5, "Marketable Securities".

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

We measure certain assets at fair value on a non-recurring basis. These assets are recognized at fair value when they are deemed to be impaired. During the three month periods ended September 30, 2013 and 2012, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.

(13)  Segment Information

Our operations are classified into two operating segments: wholesale and retail. These operating segments represent strategic business areas of our vertically integrated business which, although they operate separately and provide their own distinctive services, enable us to more efficiently control the quality and cost of 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 operated and Ethan Allen operated 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 operated 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 operated 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.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

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). The allocation of retail sales by product line is reasonably similar to that of the wholesale segment. A breakdown of wholesale sales by these product lines for the three months ended September 30, 2013 and 2012 is provided as follows:

Segment information for the three months ended September 30, 2013 and 2012 is provided below (in thousands):

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Our international net sales are comprised of our wholesale segment sales to independent retailers and our retail segment sales to consumers through our Company operated design centers. The number of international design centers, and the related net sales as a percent of our consolidated net sales is shown in the following table. 

(14)  Recently Issued Accounting Pronouncements

There have been no recently issued accounting pronouncements during the three months ended September 30, 2013 or impending accounting changes that are expected to have a material effect on the Company’s financial statements.

(15)  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. Our other subsidiaries which are not guarantors are called the "Non-Guarantors".

The following tables set forth the condensed consolidating balance sheets as of September 30, 2013 and June 30, 2013, the condensed consolidating statements of operations for the three months ended September 30, 2013 and 2012, and the condensed consolidating statements of cash flows for the three months ended September 30, 2013 and 2012 of the Parent, the Issuer, the Guarantors and the Non-Guarantors.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of financial condition and results of operations should be read in conjunction with (i) our Consolidated Financial Statements, and notes thereto, included in Item 1 of Part I of this Quarterly Report on Form 10-Q and (ii) our Annual Report on Form 10-K for the year ended June 30, 2013.

Forward-Looking Statements

Management's discussion and analysis of financial condition and results of operations and other sections of this Quarterly Report contain forward-looking statements relating to our future results. Such forward-looking statements are identified by use of forward-looking words such as "anticipates", "believes", "plans", "estimates", "expects", and "intends" or words or phrases of similar expression. These forward-looking statements are subject to management decisions and various assumptions, risks and uncertainties, including, but not limited to: the potential effects of natural disasters affecting our suppliers or trading partners; the effects of labor strikes; weather conditions that may affect sales; volatility in fuel, utility, transportation and security costs; changes in global or regional political or economic conditions, including changes in governmental and central bank policies; changes in business conditions in the furniture industry, including changes in consumer spending patterns and demand for home furnishings; effects of our brand awareness and marketing programs, including changes in demand for our existing and new products; our ability to locate new design center sites and/or negotiate favorable lease terms for additional design centers or for the expansion of existing design centers; competitive factors, including changes in products or marketing efforts of others; pricing pressures; fluctuations in interest rates and the cost, availability and quality of raw materials; the effects of terrorist attacks or conflicts or wars involving the United States or its allies or trading partners; those matters discussed in Items 1A and 7A of our Annual Report on Form 10-K for the year ended June 30, 2013 and in our SEC filings; and our future decisions. Accordingly, actual circumstances and results could differ materially from those contemplated by the forward-looking statements.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Critical Accounting Policies

The Company’s consolidated financial statements are based on the accounting policies used. Certain accounting polices require that estimates and assumptions be made by management for use in the preparation of the financial statements. Critical accounting policies are those that are central to the presentation of the Company’s financial condition and results and that require subjective or complex estimates by management. There have been no material changes with respect to the Company’s critical accounting policies from those disclosed in its 2013 Annual Report on Form 10-K filed with the SEC on August 16, 2013.

Results of Operations

Written orders booked by our retail division in the first quarter of our 2014 fiscal year ending September 30, 2013, grew 11.4% over the first quarter of fiscal 2013. This included comparable design center written order growth of 13.8%. However, net sales of $141.8 million in the first quarter of fiscal 2014 by our retail division for the quarter were 4.9% lower than the first quarter of the prior fiscal year. This led to an 11.9% increase in our retail backlog at the end of the first fiscal quarter this year.

During this first quarter, we undertook a major initiative to prepare our network of design centers for the launch in October 2013 of our “The New Eclecticism” campaign. This launch includes an assortment of new, attractively priced accessory products and is our latest initiative to expand our reach to more consumers by adding fashion, color, and a spirit of mixing things up to our time-honored story of quality, value and style. To make room on our design center floors for these new products, our retail division held significantly more clearance event sales at substantial discounts which resulted in lower gross margins and profitability during the quarter. Our wholesale division net sales during the current fiscal quarter benefitted however, from shipping floor samples of these new products to all of our Company operated design centers and to our independently operated design centers. These shipments led to an increase in wholesale net sales in the first quarter of fiscal 2014 of 1.6% compared to the comparable prior year period. Sales from our wholesale division to our retail division are included in the wholesale net sales but are eliminated from our consolidated net sales. Consolidated net sales were 3.1% lower during the first quarter of fiscal 2014 than the comparable quarter last year, primarily as a result of these lower net sales by our retail division.

We continue to invest significantly in (i) getting our messages across with strong advertising and marketing campaigns, (ii) the strength of our interior design professionals and management in our retail business, (iii) new technologies across key aspects of our vertically integrated business, and (iv) the ramp up of our North American manufacturing capacity where we manufacture approximately 70% of our products. Our competitive advantages arise from:

We continue to make considerable investments to strengthen the level of service, professionalism, and interior design competence, as well as to improve the efficiency of our retail operations. We believe that over time, we will continue to benefit from (i) continuous repositioning of our retail network, (ii) frequent new product introductions, (iii) new and innovative marketing promotions and effective use of targeted advertising media, and (iv) continued use of the latest technology coupled with personal service from our interior design professionals. We believe our network of professionally trained interior design professionals differentiates us significantly from others in our industry.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

During fiscal 2013, the Company’s retail division expanded for the first time into non-English language locations in Montreal, Canada and in Belgium. These international retail locations are initially incurring losses but we expect them to reach breakeven by the end of fiscal 2014.

We measure the performance of our design centers based on net sales and written orders booked on a comparable period to period basis. Comparable design centers are those which have been operating for at least 15 months. Minimal net sales, derived from the delivery of customer ordered product, are generated during the first three months of operations of newly opened (including relocated) design centers. Design centers acquired by us from independent retailers are included in comparable design center sales in their 13th full month of Ethan Allen-owned operations. The frequency of our promotional events as well as the timing of the end of those events can impact the orders booked during a given quarter.

Quarter Ended September 30, 2013 Compared to Quarter Ended September 30, 2012

Consolidated revenue for the three months ended September 30, 2013 decreased 3.1% to $181.7 million, from $187.4 million for the three months ended September 30, 2012. The decrease is primarily due to lower shipments in our retail segment discussed below.

At September 30, 2013, the Company operated 147 of the 297 global network design centers compared with 149 of the 302 at September 30, 2012. Our global network included 70 design centers in China at the end of the current quarter compared to 73 at the end of the first quarter of fiscal 2013. Our international net sales, including those of our Company operated design centers, were approximately 10% of consolidated net sales in both the current and prior year first quarters. The majority of our international sales are to our independent retailer in China.

Wholesale revenue for the first quarter of fiscal 2014 increased 1.6% to $113.2 million from $111.4 million in the prior year comparable period. As noted above, our wholesale net sales benefitted from shipments of floor product samples in support of our launch of “The New Eclecticism” campaign during the quarter partly offset by decreased sales to our independent retailer in China.

Retail revenue from Company operated design centers for the three months ended September 30, 2013 decreased 4.9% to $141.8 million from $149.1 million for the three months ended September 30, 2012. We began the quarter with lower retail backlogs which limited our product deliveries and net sales during the quarter. We sold two design centers in Houston to our independent retailer in the second quarter of fiscal 2013, and had two fewer Company operated design centers as compared to one year ago. We ended the current quarter with 147 Company operated design centers. Company operated design center total written business increased 11.4% while comparable design center written business increased 13.8% during the first quarter of fiscal 2014 compared to the comparable quarter of fiscal 2013.

Gross profit was $98.7 million for the quarter ended September 30, 2013, down 5.3% from the $104.3 million in the prior year comparable quarter. The decrease was driven by 3.1% lower net sales and lower gross margin. Gross margin for the September 30, 2013 quarter was 54.4%, down from 55.6% the prior year quarter, due to (i) a greater volume of clearance sales in the current fiscal quarter as we prepared for our sales initiative beginning in October 2013, (ii) a lower proportion of retail division net sales to our consolidated net sales (78.1% compared to 79.5% the prior year), (iii) a higher proportion of product manufactured in our domestic manufacturing plants as opposed to offshore sourcing, and (iv) a higher proportion of our retail sales with promotional discounts in lieu of full price sales with long term financing costs.

Operating expenses decreased $3.5 million or 4.1% to $82.8 million from $86.3 million in the prior year quarter due primarily to (i) lower variable costs on the 3.1% decline in net sales, (ii) lower losses on the sale of vacant retail real estate, and (iii) a higher proportion of our retail sales with promotional discounts in lieu of full price sales with long term financing costs. These operating expense declines were partly offset by higher medical and workers compensation costs and international expansion costs.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Operating income and profit margin for the quarter ended September 30, 2013 was $15.9 million, or 8.8% of net sales, a decrease of $2.0 million or 11.2% from the prior year quarter’s $18.0 million, or 9.6% of net sales. Wholesale operating income for the three months ended September 30, 2013 was $16.1 million, or 14.3% of sales, compared to $16.0 million, or 14.4% of sales, in the prior year quarter. Retail operating loss for the first quarter of fiscal 2014 was $0.2 million, or a negative 0.1% of sales, compared to operating income of $1.0 million, or 0.7% of sales the prior year driven primarily by lower retail net sales in the current fiscal quarter.

Interest and other income, net remained consistent with the prior year at $0.1 million.

Interest and other related financing costs amounted to $1.9 million in the current period compared to $2.2 million in the prior year comparable period. The $0.3 million reduction resulted from reductions in debt outstanding. Since September 2012, debt has been reduced by $24.0 million through Senior Note repurchases.

Income tax expense for the three months ended September 30, 2013 totaled $5.1 million compared to $5.8 million for the three months ended September 30, 2012. Our effective tax rate for the current quarter was 36.2% compared to 36.4% in the prior year quarter. The current quarter effective tax rate primarily includes tax expense on the current quarter’s net income, interest expense on uncertain tax positions, and the impact of maintaining valuation allowances on certain deferred tax assets, partly offset by the recognition of some uncertain tax positions. The prior period effective tax rate primarily includes the tax expense on the previous quarter’s net income, interest expense on uncertain tax positions, and the impact of maintaining valuation allowances on deferred tax assets in the retail segment.

Net income for the three months ended September 30, 2013, was $9.0 million compared to $10.1 million in the prior year comparable period. This resulted in net income per diluted share of $0.31 for the quarter ended September 30, 2013 compared to $0.35 per diluted share for the quarter ended September 30, 2012.

Liquidity and Capital Resources

At September 30, 2013, we held unrestricted cash and cash equivalents of $91.2 million, marketable securities of $13.4 million, and restricted cash and investments of $14.9 million. At June 30, 2013, we held unrestricted cash and cash equivalents of $72.6 million, marketable securities of $15.5 million, and restricted cash and investments of $15.4 million. Our principal sources of liquidity include cash and cash equivalents, marketable securities, cash flow from operations, amounts available under our credit facility, and other borrowings.

In September 2005, we issued $200.0 million in ten-year senior unsecured notes due 2015 (the "Senior Notes"). The Senior Notes were issued by Global, bearing an annual coupon rate of 5.375% with interest payable semi-annually in arrears on April 1 and October 1. We used the net proceeds of $198.4 million to improve our retail network, invest in our manufacturing and logistics operations, and for other general corporate purposes. In fiscal years 2011 through 2013, the Company repurchased an aggregate $70.6 million of the Senior Notes in several unsolicited transactions.

We also maintain a $50 million senior secured, asset-based revolving credit facility (the “Facility”). We have not had any revolving loans under the Facility at any time. At both September 30, 2013 and June 30, 2013, there were $0.6 million of standby letters of credit outstanding under the Facility. The Facility is subject to borrowing base availability and includes a right for the Company to increase the total facility to $100 million subject to certain conditions. 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 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. Remaining availability under the Facility totaled $49.4 million at September 30, 2013 and at June 30, 2013 and as a result, covenants and other restricted payment limitations did not apply. The Facility expires March 25, 2016, or June 26, 2015 if the Senior Notes have not been refinanced prior to that date.

At both September 30, 2013 and June 30, 2013, we were in compliance with all covenants of the Senior Notes and the Facility.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

A summary of net cash provided by (used in) operating, investing, and financing activities for the three month periods ended September 30, 2013 and 2012 is provided below (in millions):