ETHAN ALLEN INTERIORS INC - Quarter Report: 2018 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 2018

OR

For the transition period from __________ to __________

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit such files).     [X] Yes      [  ] No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” "accelerated filer", "smaller reporting company", and “emerging growth company” in Rule 12b-2 of the Exchange Act

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 January 16, 2019, there were 26,579,544 shares of Common Stock, par value $.01, outstanding.

Table of Contents 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands)

See accompanying notes to consolidated financial statements.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(In thousands, except per share data)

See accompanying notes to consolidated financial statements. 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

See accompanying notes to consolidated financial statements.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Six Months Ended December 31, 2018

(Unaudited)

(In thousands)

See accompanying notes to consolidated financial statements.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

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, 2018.

Forward-Looking Statements

Management's discussion and analysis of financial condition and results of operations and other sections of this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which represent our management’s beliefs and assumptions concerning future events based on information currently available to us relating to our future results. Such forward-looking statements are identified in this Quarterly Report on Form 10-Q and in documents incorporated herein by reference by use of forward-looking words such as "anticipate", "believe", "plan", "estimate", "expect", "intend", “will”, “may”, “continue”, “project”, ”target”, “outlook”, “forecast”, “guidance”, and similar expressions and the negatives of such forward-looking words. These forward-looking statements are subject to management decisions and various assumptions about future events, and are not guarantees of future performance. Actual results could differ materially from those anticipated in the forward-looking statements due to a number of risks and uncertainties including, but not limited to: competition from overseas manufacturers and domestic retailers; our anticipating or responding to changes in consumer tastes and trends in a timely manner; our ability to maintain and enhance our brand, marketing and advertising efforts and pricing strategies; changes in global and local economic conditions that may adversely affect consumer demand and spending, our manufacturing operations or sources of merchandise and international operations; changes in U.S. policy related to imported merchandise; an economic downturn; potentially negative or unexpected tax consequences of changes to fiscal and tax policies; our limited number of manufacturing and logistics sites; fluctuations in the price, availability and quality of raw materials; environmental, health and safety requirements; product safety concerns; disruptions to our technology infrastructure (including cyber attacks); increasing labor costs, competitive labor markets and our continued ability to retain high-quality personnel and risks of work stoppages; loss of key personnel; our ability to obtain sufficient external funding to finance our operations and growth; access to consumer credit; the effect of operating losses on our ability to pay cash dividends; additional impairment charges that could reduce our profitability; 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; the results of operations for any quarter are not necessarily indicative of our results of operations for a full year; possible failure to protect our intellectual property; and those matters discussed in “Item 1A – Risk Factors” of our Annual Report on Form 10-K for the year ended June 30, 2018, and elsewhere in this Quarterly Report on Form 10-Q and our SEC filings. Accordingly, actual circumstances and results could differ materially from those contemplated by the forward-looking statements.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Given the risks and uncertainties surrounding forward-looking statements, you should not place undue reliance on these statements. Many of these factors are beyond our ability to control or predict. Our forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. Other than as required by law, we undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.

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. We implemented Accounting Standard Update No. 2014-09, Revenue from Contracts with Customers (Accounting Standards Codification Topic 606, “ASC 606”), in the first quarter of fiscal 2019. There have been no other changes with respect to the Company’s critical accounting policies from those disclosed in its 2018 Annual Report on Form 10-K filed with the SEC on August 2, 2018. Also see Note 12, Recently Adopted Accounting Pronouncements, and Note 13, Revenue Recognition.

Overview

We are a leading interior design company and manufacturer and retailer of quality home furnishings. Founded over 85 years ago, today we are a leading international home fashion brand doing business in North America, Europe, Asia and the Middle East. We are vertically integrated from design through delivery, affording our clientele a value proposition of style, quality and price. We offer complementary interior design service to our clients and sell a full range of furniture products and decorative accents through ethanallen.com and a network of approximately 300 design centers in the United States and abroad. The design centers represent a mix of independent licensees and our own Company operated retail segment. We own and operate nine manufacturing facilities including six manufacturing plants and one sawmill in the United States and one manufacturing plant each in Mexico and Honduras.

Our business model is to maintain continued focus on (i) communicating our messages with strong advertising and marketing campaigns, (ii) capitalizing on the strength of our interior design professionals and management in our retail design centers, (iii) utilizing ethanallen.com as a key marketing tool to drive traffic to a network of 200 North American design centers located near our demographic base, (iv) investing in new technologies across key aspects of our vertically integrated business, and (v) leveraging the benefits of our vertical integration by maintaining our manufacturing capacity in North America where we manufacture approximately 75% of our products.

Our competitive advantages arise from:

We have completed a major transformation of our product offerings, having refreshed over 70% of our entire product line over the past three years. In the spring and summer of 2018, we further strengthened our offerings with new products featuring a modern perspective on classic designs. Our contract business, including GSA, hospitality and commercial sales, continues to grow and the GSA is now one of our ten largest customers. Our internet sales, while still a minor portion of our sales, are growing at a rate that continues to out-pace our brick and mortar design centers.

We measure the performance of our design centers based on net sales and written orders booked on a comparable period basis. Comparable design centers are those which have been operating for at least 15 months, including relocated design centers provided the original and relocated design center location had been operating for at least 15 months on a combined basis. During the first three months of operations of newly opened design centers, written orders are booked but minimal net sales are achieved through the delivery of products. Design centers we acquire 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 also affect the comparability of orders booked during a given period. Our international net sales are composed of our wholesale segment sales to independent retailers and our retail segment sales to consumers through the Company operated international design centers.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Results of Operations

A summary of our consolidated operations is presented in the following tables. In this Item 2 of this quarterly report, unless otherwise noted, all comparisons in the discussion following are from the three or six month period ended December 31, 2018 to the comparable prior year fiscal three or six month period ($ in millions except per share amounts).

A summary of changes from the preceding fiscal year are presented in the following table.

The components of consolidated revenues and operating income (loss) by business segment are as follows (in millions):

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

A summary by business segment of annual percentage changes from the preceding fiscal year are presented in the following tables:

We are in the midst of a major brand-building marketing program utilizing multiple mediums including direct mail, television, print, digital and social marketing. This program targets a broad demographic base beyond our core customer. We expect that as we continue to market to this broader base, our brand awareness will increase and ultimately drive increased revenues over time. We accelerated our advertising expense in our first quarter of fiscal 2019, increasing by 12.8% over the same prior year period. During this second quarter of fiscal 2019, we moderated our advertising, which decreased 12.4% over the same prior year period. On a year-to-date basis our advertising expense is 0.8% less than the prior year.

A sales decrease for the second quarter of 8.7% for wholesale was partly offset by a 3.6% increase for retail. The increase in retail sales contributed in reducing inventory resulting in a release of intercompany profit previously held in inventory. These factors combined to increase gross profit by $1.1 million. International net sales decreased 29.4% primarily due to China and Canada, and as a percent of our consolidated net sales were 7.1% in the current year quarter and 10.0% in the prior year quarter. Gross margin was above the prior year, primarily due to improved retail gross margin, and the retail sales mix in relation to total sales, which was 80.4% in the current quarter compared to 77.1% in the comparable prior year period, and in an increase of intercompany profit in inventory. Operating expenses increased in total due to increases in logistics expenses and increased retail expenses due to the change in retail sales mix mentioned previously, partially offset by reduced advertising expenses. Income taxes were affected by the changes resulting from the Tax Act enacted in December 2017, with an effective tax rate of 25.1% in the current quarter compared to 16.0% in the prior year. The net result was a decrease in earnings per diluted share of $0.09.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

The following tables show selected design center location information.

Second Quarter Ended December 31, 2018 Compared to Second Quarter Ended December 31, 2017

Consolidated net sales for the quarter of $197.2 million compared to $198.5 million for the same period in the prior year, a decrease of 0.7%. Sales decreased for our wholesale segment, which were partly offset by an increase in our retail segment. There was a decrease in international sales in our retail and wholesale segments. We believe this decrease is related to the economic uncertainty surrounding current international trade disputes.

Retail net sales for the quarter of $158.5 million compared to $153.0 million for the prior year period, an increase of 3.6%. Comparative retail net sales increased 2.7%. There were 146 Company-operated design centers during the quarter, down from 148 in the prior year quarter. There was a 4.7% increase in sales in the U.S., while sales from the Canadian design centers decreased 20.2%. Total written business (new orders booked) decreased 3.4%, with decreases in both the U.S. and Canada. Comparable design center written business in the quarter decreased 4.2% in total.

Wholesale net sales for the quarter of $107.7 million compared to $118.0 million for the prior year period, a decrease of 8.7%. During the previous year, wholesale segment sales were at elevated levels as the shipping delays and the high backlogs from the first quarter were mostly caught up in the second quarter. This year the wholesale segment backlog levels in the first quarter were at normal levels as our manufacturing is running more efficiently this year with no shipping delays. Lower international sales, especially to China, partially offset by increased contract sales, also contributed to the sales decrease.

Gross profit for the quarter of $108.9 million compared to $107.8 million for the prior year period, an increase of 1.0%, with an increase in our retail segment and a decrease in our wholesale segment primarily related to lower sales volume. Consolidated gross margin for the quarter was 55.2% compared to 54.3%. Retail sales as a percent of total consolidated sales was 80.4% for the quarter compared to 77.1% in the prior year quarter, increasing our consolidated gross margin due to this increased percentage.

Operating expenses for the quarter of $92.7 million, or 47.0% of net sales, increased $2.5 million compared to $90.3 million, or 45.5% of net sales, for the prior year period. The 2.7% increase to prior year was primarily due to increased wholesale distribution costs of $1.0 million and higher variable costs in retail due to higher retail sales, partly offset by a decrease in advertising of $1.1 million.

Operating income and profit margin for the quarter of $16.1 million, or 8.2% of net sales, compared to $17.5 million, or 8.8% of net sales, for the prior year period. The primary causes for the 8.0% decrease in operating income were the decreased sales in wholesale partly offset by retail sales increases, increased variable costs of logistics partly associated with increased sales, as discussed previously.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Retail operating income for the quarter of $3.1 million, or 2.1% of sales, compared to a loss of $0.6 million, or -0.4% of sales, for the prior year period. The higher operating income and improved margin in the current quarter was driven primarily by the improved sales and gross margin in the current year period.

Wholesale operating income for the quarter of $8.8 million, or 8.2% of sales, compared to $15.5 million, or 13.2% of sales, for the prior year period. The decrease was largely due to the decrease in current period net sales, as discussed above.

Income tax expense for the quarter totaled $4.1 million compared to $2.8 million. Our effective tax rate was 25.1% in the quarter compared to 16.0%. The effective tax rate for the second quarter of fiscal 2019 primarily includes tax expense on that quarter’s net income, tax and interest expense on uncertain tax positions and tax expense on cancelation and exercise of stock options. The prior period’s effective tax rate primarily includes tax expense on the taxable year’s net income, the tax benefit lost on the cancelation of stock options, and also includes tax and interest expense on uncertain tax positions partially offset by the tax benefit from the re-measurement of deferred tax assets and liabilities and the vesting of restricted stock units.

Net income for the quarter of $12.2 million compared to $14.9 million for the prior year period a decrease of 18.0%. This resulted in net income per diluted share for the quarter of $0.45 compared to $0.54, a decrease of 16.7%.

Six Months Ended December 31, 2018 Compared to Six Months Ended December 31, 2017

Consolidated net sales year-to-date of $384.9 million compared to $379.8 million for the same period in the prior year, an increase of 1.4%. Domestic sales increased for both wholesale and retail, and international sales decreased in both segments. We believe this decrease in international sales is related to the economic uncertainty surrounding current international trade disputes.

Retail net sales year-to-date of $303.7 million compared to $294.6 million for the prior year period, an increase of 3.1%. Comparative retail net sales increased 1.8%. There were 146 Company-operated design centers during the period, down from 148 in the prior year. There was a 4.4% increase in sales in the U.S., while sales from the Canadian design centers decreased 24.2%. Total written business (new orders booked) decreased 1.7%, with a decrease in both Canada and the U.S. Comparable design center written business year-to-date decreased 3.1% in total.

Wholesale net sales year-to-date of $225.7 million compared to $229.6 million for the prior year period, a decrease of 1.7%. During the previous year, wholesale segment sales were at elevated levels as the shipping delays and the high backlogs from the first quarter were mostly caught up in the second quarter. This year the wholesale segment backlog levels in the first quarter were at normal levels as our manufacturing is running more efficiently this year with no shipping delays. Lower international sales, especially to China, partially offset by increased contract sales, also contributed to the sales decrease.

Gross profit year-to-date of $210.3 million compared to $208.1 million for the prior year period, an increase of 1.1%, with an increase in our retail segment and a decrease in our wholesale segment. Gross profit for wholesale decreased due to lower sales volume. Consolidated gross margin year-to-date was 54.6% compared to 54.8%. Retail sales as a percent of total consolidated sales was 78.9% year-to-date compared to 77.6% in the prior year period, increasing our consolidated gross margin due to this increased percentage.

Operating expenses year-to-date of $182.4 million, or 47.4% of net sales, increased $3.4 million compared to $179.0 million, or 47.1% of net sales, for the prior year period. The 1.9% increase to prior year was primarily due to increased logistics costs of $2.2 million.

Operating income and profit margin year-to-date of $27.9 million, or 7.3% of net sales, compared to $29.1 million, or 7.7% of net sales, for the prior year period. The primary causes for the 4.0% decrease in operating income were the reduced sales in wholesale and increased variable costs of freight, distribution and warehouse costs, partly offset by increased domestic retail sales as discussed previously.

Retail operating income year-to-date of $1.8 million, or 0.6% of sales, compared to a loss of $3.4 million, or -1.2% of sales, for the prior year period. The improved operating income in the current period was driven primarily by the improved domestic sales in the current year period.

Wholesale operating income year-to-date of $23.1 million, or 10.2% of sales, compared to $29.0 million, or 12.6% of sales, for the prior year period. The decrease was largely due to the decrease in second quarter net sales coupled with an increase in distribution costs.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Income tax expense year-to-date totaled $7.0 million compared to $6.8 million. Our effective tax rate was 25.0% in the period compared to 23.5%. The effective tax rate for the current year-to-date period of fiscal 2019 primarily includes tax expense on that fiscal year’s net income, tax and interest expense on uncertain tax positions and tax expense on cancelation and exercises of stock options. The prior period’s effective tax rate primarily includes tax expense on the taxable year’s net income, the tax benefit lost on the cancelation of stock options, and also includes tax and interest expense on uncertain tax positions partially offset by the tax benefit from the re-measurement of deferred tax assets and liabilities and the vesting of restricted stock units.

Net income year-to-date of $21.0 million compared to $22.3 million for the prior year period a decrease of 5.6%. This resulted in net income per diluted share year-to-date of $0.78 compared to $0.80, a decrease of 2.5%.

Liquidity and Capital Resources

At December 31, 2018, we held cash and cash equivalents of $38.8 million. At June 30, 2018, we held cash and cash equivalents of $22.4 million. Our principal sources of liquidity include cash and cash equivalents, cash flow from operations, amounts available under the Facility, and other borrowings.

During the quarter ended December 31, 2018 the Company entered into a five-year, $165 million senior secured revolving credit facility, which amended and restated the previously existing facility. For a detailed discussion of our debt obligations and timing of our related cash payments see Note 6 to the Consolidated Financial Statements included under Item 1 of this Quarterly Report.

A summary of net cash provided by (used in) operating, investing, and financing activities for the six months ended December 31, 2018 and 2017 is provided below (in millions):

Cash Provided by (Used in) Operating Activities

Year-to-date, cash of $31.5 million was provided by operating activities, an increase of $17.3 million. This was largely due to changes in the ordinary course of business for working capital items, primarily an inventory increase during fiscal 2018 to support the order backlog. Working capital items consist of current assets (accounts receivable, inventories, prepaid and other current assets) less current liabilities (customer deposits, payables, and accrued expenses and other current liabilities).

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Cash Provided by (Used in) Investing Activities

Year-to-date, $4.9 million of cash was used in investing activities, an increase of $0.3 million. Capital expenditures remained consistent with the prior year and primarily related to retail design center improvements. We anticipate that cash from operations will be sufficient to fund future capital expenditures. Effective July 1, 2018, the company considers restricted cash as a component of cash and cash equivalents as presented on the statement of cash flows. Previously the net change in restricted cash was considered an investing activity. Prior periods have been reclassified to conform to current year presentation. See also notes 4 and 12.

Cash Provided by (Used in) Financing Activities

Year-to-date, $10.2 million was used in financing activities, which is $15.4 million less cash used than the $25.6 million of cash used during the first six months of fiscal 2018. This was primarily due to a $13.2 million pre-payment on the term loan in the prior fiscal year. During the current fiscal year to date period we paid dividends of $10.1 million compared to $10.5 million in the prior year to date period, paying $0.38 per share in both year to date periods. In November 2018, we declared a $1.00 per share special cash dividend, payable to our shareholders in January 2019, and a regular quarterly dividend of $0.19 per share, also payable to our shareholders in January 2019. The Company has continuously paid dividends for every quarter since 1996 and we expect to continue to do so as economic conditions and liquidity permit.

We believe that our cash flow from operations, together with our other available sources of liquidity including the Facility and refinancing alternatives, will be adequate to make all required debt payments, to permit anticipated capital expenditures, and to fund working capital and other cash requirements. As of December 31, 2018, we had working capital of $82.9 million compared to $93.2 million at June 30, 2018, a decrease of $10.3 million, or 11.1%. The Company had a current ratio of 1.59 to 1 at December 31, 2018 and 1.77 to 1 at June 30, 2018.

In addition to using available cash to fund changes in working capital, necessary capital expenditures, acquisition activity, the repayment of debt and the payment of dividends, the Company has been authorized by our board of directors to repurchase our common stock from time to time, either directly or through agents, in the open market at prices and on terms satisfactory to us. During the six months ending December 31, 2018 there were no share repurchases.

At December 31, 2018, we had a remaining Board authorization to repurchase 2,518,046 shares of our common stock pursuant to our previously announced share repurchase program.

Contractual Obligations

We amended our credit facility in December 2018, as more fully described in this form 10-Q in Part I, Financial Statements, under Note 6, Borrowings. There has been no other material change to the amount or timing of cash payments related to our outstanding contractual obligations as set forth in Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended June 30, 2018 as filed with the SEC on August 2, 2018.

Off-Balance Sheet Arrangements and Other Commitments, Contingencies and Contractual Obligations

Except as indicated below, we do not utilize or employ any off-balance sheet arrangements, including special-purpose entities, in operating our business. As such, we do not maintain any (i) retained or contingent interests, (ii) derivative instruments (other than as specified below), or (iii) variable interests which could serve as a source of potential risk to our future liquidity, capital resources and results of operations.

We may, from time to time in the ordinary course of business, provide guarantees on behalf of selected affiliated entities or become contractually obligated to perform in accordance with the terms and conditions of certain business agreements. The nature and extent of these guarantees and obligations may vary based on our underlying relationship with the benefiting party and the business purpose for which the guarantee or obligation is being provided. The only such program in place at both December 31, 2018 and June 30, 2018 was for our consumer credit program described below.

Ethan Allen Consumer Credit Program

The terms and conditions of our consumer credit program, which is financed and administered by a third-party financial institution on a non-recourse basis to Ethan Allen, are set forth in an agreement between the Company and that financial service provider (the “Program Agreement”) which was last amended effective January 2014. Any independent retailer choosing to participate in the consumer credit program is required to enter into a separate agreement with that same third-party financial institution which sets forth the terms and conditions under which the retailer is to perform in connection with its offering of consumer credit to its customers (the “Retailer Agreement”). We have obligated ourselves on behalf of any independent retailer choosing to participate in our consumer credit program by agreeing, in the event of default, breach, or failure of the independent retailer to perform under such Retailer Agreement, to take on certain responsibilities of the independent retailer, including, but not limited to, delivery of goods and reimbursement of customer deposits. Customer receivables originated by independent retailers remain non-recourse to Ethan Allen. The Program Agreement will terminate on July 31, 2019, and the Company will utilize a substitute program upon termination. While the maximum potential amount of future payments (undiscounted) that we could be required to make under this obligation is indeterminable, recourse provisions exist that would enable us to recover, from the independent retailer, any amount paid or incurred by us related to our performance. Based on the underlying creditworthiness of our independent retailers, including their historical ability to perform satisfactorily in connection with the terms of our consumer credit program, we believe this obligation will expire without requiring funding by us. To ensure funding for delivery of products sold, the terms of the Program Agreement also contain a right for the financial services provider to demand from the Company collateral at a variable rate based on the volume of program sales if the Company does not meet a covenant regarding minimum working capital or tangible net worth. At both December 31, 2018 and June 30, 2018, we were in compliance with such covenant.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Product Warranties

Our products, including our case goods, upholstery and home accents, generally carry explicit product warranties that extend up to twelve years and are provided based on terms that are generally accepted in the industry. All our domestic independent retailers are required to enter into and perform in accordance with the terms and conditions of a warranty service agreement. We record provisions for estimated warranty and other related costs at time of sale based on historical warranty loss experience and make periodic adjustments to those provisions to reflect actual experience. On rare occasions, certain warranty and other related claims involve matters of dispute that ultimately are resolved by negotiation, arbitration or litigation. In certain cases, a material warranty issue may arise which is beyond the scope of our historical experience. We provide for such warranty issues as they become known and are deemed both probable and estimable. It is reasonably possible that, from time to time, additional warranty and other related claims could arise from disputes or other matters beyond the scope of our historical experience. At both December 31, 2018 and June 30, 2018 the Company’s product warranty liability totaled $1.5 million.

Business Outlook

We continue to strengthen our vertically integrated structure from concept of idea, to engineering, to manufacturing, to retail and logistics. We intend to maintain strong manufacturing capabilities in North America, which we believe is a long-term competitive advantage that will allow us to advance our objectives of maintaining fast order delivery, exceptional quality and improving capacity to ship stocked and custom made-to-order items more quickly, which in turn will allow us to grow our business. Having refreshed over 70% of our products in the last three years, our current product offerings are fresh and relevant.

Our marketing programs continue to be strengthened with messaging focused on our stylish products, quality and service offerings. We expect to continue to expand our advertising during fiscal 2019 as we broaden the reach of our messaging to drive more traffic to our design centers and to ethanallen.com.

Our network of professionally trained interior design professionals differentiate us significantly from our competitors. We continue 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 combined with personal service from our interior design professionals.

We expect the home furnishings industry to remain extremely competitive with respect to both the sourcing of products and the wholesale and retail sale of those products for the foreseeable future. Domestic manufacturers continue to face pricing pressures because of the lower manufacturing costs on imports, particularly from Asia. While we also utilize overseas sourcing for approximately one quarter of our products, we choose to differentiate ourselves by maintaining a substantial North American manufacturing base, the majority of which is located in the United States. This structure enables us to leverage our vertically integrated structure to our advantage. We continue to believe that a balanced approach to product sourcing, which includes our own North American manufacturing of about 75% of our product offerings coupled with the import of other selected products, provides the greatest degree of flexibility and short lead times and is the most effective approach to ensuring that acceptable levels of quality and service are maintained.

With our vertical enterprise well positioned, we maintain a cautiously optimistic outlook. Our retail strategy will continue with its focus on (i) providing relevant product offerings, a wide array of product solutions, and superior interior design solutions through our large staff of interior design professionals, (ii) continuing strong advertising and marketing campaigns to get our message across and to continue broadening our customer base, (iii) the opening of new or relocated design centers in more prominent locations, and encouraging independent retailers to do the same, (iv) leveraging the use of technology and personal service within our retail network and online through www.ethanallen.com, and (v) further expansion internationally. We believe this strategy provides an opportunity to grow our business.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, Leases, which is intended to improve financial reporting about leasing transactions. The ASU will require lessees that lease assets with lease terms of more than twelve months to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Lessors will remain largely unchanged from current GAAP. In addition, ASU 2016-02 will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. This pronouncement is effective for the Company on July 1, 2019, and early adoption is permitted. The Company is currently evaluating the impact on our consolidated financial statements, but expects that it will have a material impact on our consolidated balance sheet to recognize the right of use assets and related liabilities.

Where You Can Find Other Information

Our website is www.ethanallen.com. Information contained on our website is not part of this Quarterly Report on Form 10-Q. Information that we furnish or file with the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to, or exhibits included in, these reports are available for download, free of charge, on our website soon after such reports are filed with or furnished to the SEC. Our SEC filings, including exhibits filed therewith, are also available on the SEC’s website at www.sec.gov.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risks relating to fluctuations in interest rates and foreign currency exchange rates.

Interest rate risk exists primarily through our borrowing activities. We utilize United States dollar denominated borrowings to fund substantially all our working capital and investment needs. Short-term debt, if required, is used to meet working capital requirements and long-term debt is generally used to finance long-term investments. There is inherent rollover risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and our future financing requirements.

For floating-rate obligations, interest rate changes do not affect the fair value of the underlying financial instrument but would impact future earnings and cash flows, assuming other factors are held constant. Conversely, for fixed-rate obligations, interest rate changes affect the fair value of the underlying financial instrument but would not impact earnings or cash flows. At December 31, 2018, we did not have any floating-rate debt obligations outstanding under our Facility. We currently do not engage in any interest rate hedging activity and we have no intention of doing so in the foreseeable future. Based on the average interest rate of the loans under the Facility during the quarter ended December 31, 2018, and to the extent that borrowings were outstanding, a 10% change in the interest rate would not have a material effect on our consolidated results of operations and financial condition. For information regarding the Company’s other risk factors, see Item 7A – Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the year ended June 30, 2018 as filed with the SEC on August 2, 2018.

Foreign currency exchange risk is primarily limited to our operation of Ethan Allen operated retail design centers located in Canada and our plants in Mexico and Honduras, as substantially all purchases of imported parts and finished goods are denominated in United States dollars. As such, gains or losses resulting from market changes in the value of foreign currencies have not had, nor are they expected to have, a material effect on our consolidated results of operations. A decrease in the value of foreign currencies relative to the United States dollar may affect the profitability of our international vendors and independent international retailers, but as we employ a balanced sourcing strategy, we believe any impact would be moderate.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including the Chairman of the Board and Chief Executive Officer ("CEO") and the Executive Vice President Administration and Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the CEO and CFO have concluded that, as of December 31, 2018, our disclosure controls and procedures were effective in ensuring that material information relating to us (including our consolidated subsidiaries), which is required to be disclosed by us in our periodic reports filed with or submitted to the SEC is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

There have been no material changes to the matters discussed in Part I, Item 3 - Legal Proceedings in our Annual Report on Form 10-K for the year ended June 30, 2018 as filed with the SEC on August 2, 2018. See Note 7 of the Notes to Consolidated Financial Statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of our legal proceedings.

Item 1A. Risk Factors

There have been no material changes to the matters discussed in “Item IA – Risk Factors” in our Annual Report on Form 10-K for the year ended June 30, 2018 as filed with the SEC on August 2, 2018.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

Certain information regarding purchases made by or on behalf of us or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) of our common stock during the three months ended December 31, 2018 on a trade date basis is provided below:

On November 21, 2002, our Board of Directors approved a share repurchase program authorizing us to repurchase up to 2,000,000 shares of our common stock, from time to time, either directly or through agents, in the open market at prices and on terms satisfactory to us. Subsequent to that date, the Board of Directors increased the aggregate authorization under the repurchase program on several separate occasions, the last of which was on April 24, 2018 when the Board of Directors increased the aggregate authorization to approximately 3,000,000 shares. There is no expiration date on the repurchase authorization and the amount and timing of future share repurchases, if any, will be determined as market and business conditions warrant. The maximum number of shares that may yet be purchased under our publicly announced repurchase program is 2,518,046 shares.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Item 6. Exhibits

* - Furnished herewith.

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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