ETHAN ALLEN INTERIORS INC - Quarter Report: 2019 December (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended December 31, 2019

 

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)

 

Delaware		06-1275288
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

 

25 Lake Avenue Ext., Danbury, Connecticut		06811-5286
(Address of principal executive offices)		(Zip Code)

 

(203) 743-8000

(Registrant's telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock $0.01 par value per share		New York Stock Exchange		ETH
(Title of each class)		(Name of each exchange on which registered)		(Trading symbol)

 

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.     ☒ 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   ☒ 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.

 

Large accelerated filer   ☐	Accelerated filer                  ☒
Non-accelerated filer    ☐	Smaller reporting company  ☐
Emerging growth company   ☐

 

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  ☒ No

 

The number of shares outstanding of the registrant’s common stock, $0.01 par value, as of January 23, 2020 was 25,929,436.

 

 

 

Table of Contents

 

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements	2
Consolidated Balance Sheets (Unaudited)	2
Consolidated Statements of Comprehensive Income (Unaudited)	3
Consolidated Statements of Cash Flows (Unaudited)	4
Consolidated Statements of Shareholders’ Equity (Unaudited)	5
Notes to Consolidated Financial Statements (Unaudited)	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3. Quantitative and Qualitative Disclosures About Market Risk	30
Item 4. Controls and Procedures	31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings	32
Item 1A. Risk Factors	32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3. Defaults Upon Senior Securities	33
Item 4. Mine Safety Disclosures	33
Item 5. Other Information	33
Item 6. Exhibits	33
SIGNATURES	34

 

 

 

		December 31, 2019				June 30, 2019
ASSETS
Current assets:
Cash and cash equivalents		$	28,306			$	20,824
Accounts receivable, net			13,139				14,247
Inventories, net			138,997				162,389
Prepaid expenses and other current assets			18,998				18,830
Total current assets			199,440				216,290
Property, plant and equipment, net			245,271				245,246
Goodwill			25,388				25,388
Intangible assets			19,740				19,740
Operating lease right-of-use assets			128,525				-
Deferred income taxes			2,082				2,108
Other assets			1,481				1,579
Total assets		$	621,927			$	510,351
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses		$	27,256			$	35,485
Customer deposits and deferred revenue			47,506				56,714
Accrued compensation and benefits			19,184				21,327
Short-term debt			-				550
Current operating lease liabilities			32,809				-
Other current liabilities			10,687				8,750
Total current liabilities			137,442				122,826
Long-term debt			-				516
Operating lease liabilities, long-term			117,857				-
Deferred income taxes			648				1,069
Other long-term liabilities			3,155				22,011
Total liabilities		$	259,102			$	146,422
Commitments and contingencies (see Note 14)
Shareholders' equity:
Preferred stock, $0.01 par value; 1,055 shares authorized; none issued		$	-			$	-
Common stock, $0.01 par value, 150,000 shares authorized, 49,054 and 49,049 shares issued; 26,046 and 26,587 shares outstanding at December 31, 2019 and June 30, 2019, respectively			491				491
Additional paid-in capital			378,089				377,913
Treasury stock, at cost: 23,008 and 22,462 shares at December 31, 2019 and June 30, 2019, respectively			(666,626	)			(656,597	)
Retained earnings			656,211				647,710
Accumulated other comprehensive loss			(5,377	)			(5,651	)
Total Ethan Allen Interiors Inc. shareholders' equity			362,788				363,866
Noncontrolling interests			37				63
Total shareholders' equity			362,825				363,929
Total liabilities and shareholders' equity		$	621,927			$	510,351

 

		Three months ended								Six months ended
		December 31,								December 31,
		2019				2018				2019				2018
Net sales		$	174,574			$	197,152			$	348,495			$	384,937
Cost of sales			77,053				88,292				157,180				174,627
Gross profit			97,521				108,860				191,315				210,310
Selling, general and administrative expenses			88,495				92,732				174,505				182,383
Restructuring and impairment charges (gains)			(178	)			-				(11,035	)			-
Operating income			9,204				16,128				27,845				27,927
Interest income, net of interest (expense)			63				152				82				125
Income before income taxes			9,267				16,280				27,927				28,052
Provision for income taxes			2,181				4,090				6,735				7,022
Net income		$	7,086			$	12,190			$	21,192			$	21,030
Per share data
Basic earnings per common share:
Net income per basic share		$	0.27			$	0.46			$	0.80			$	0.79
Basic weighted average common shares			26,580				26,574				26,646				26,556
Diluted earnings per common share:
Net income per diluted share		$	0.27			$	0.45			$	0.79			$	0.78
Diluted weighted average common shares			26,612				26,923				26,681				26,932
Comprehensive income
Net income		$	7,086			$	12,190			$	21,192			$	21,030
Other comprehensive income (loss), net of tax
Foreign currency translation adjustments			773				(1,195	)			274				52
Other			(19	)			(19	)			(26	)			(45	)
Other comprehensive income (loss), net of tax			754				(1,214	)			248				7
Comprehensive income		$	7,840			$	10,976			$	21,440			$	21,037

 

		Six months ended
		December 31,
		2019				2018
Cash Flows from Operating Activities
Net income		$	21,192			$	21,030
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			8,430				9,925
Shared-based compensation expense			123				807
Non-cash operating lease cost			16,191				-
Deferred income taxes			153				(79	)
Restructuring and impairment charges (gains)			(6,503	)			-
Restructuring payments			(5,021	)			-
Loss on disposal of property, plant and equipment			163				43
Other			136				(16	)
Change in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable, net			973				3,130
Inventories, net			21,303				3,838
Prepaid expenses and other current assets			226				719
Customer deposits and deferred revenue			(9,746	)			(7,006	)
Accounts payable and accrued expenses			(8,342	)			(3,420	)
Accrued compensation and benefits			(475	)			2,312
Operating lease liabilities			(16,037	)			-
Other assets and liabilities			622				192
Net cash provided by operating activities			23,388				31,475
Cash Flows from Investing Activities
Proceeds from disposal of property, plant and equipment			12,423				1
Capital expenditures			(7,987	)			(4,954	)
Acquisitions, net of cash acquired			(1,281	)			-
Other investing activities			20				94
Net cash provided by (used in) investing activities			3,175				(4,859	)
Cash Flows from Financing Activities
Payments on debt and finance lease liabilities			(278	)			(310	)
Payment of cash dividends			(10,685	)			(10,137	)
Repurchases of common stock			(8,163	)			-
Other financing activities			53				274
Net cash used in financing activities			(19,073	)			(10,173	)
Effect of exchange rate changes on cash and cash equivalents			(8	)			(43	)
Net increase in cash and cash equivalents			7,482				16,400
Cash and cash equivalents at beginning of period			20,824				22,363
Cash and cash equivalents at end of period		$	28,306			$	38,763

 

																						Accumulated
										Additional												Other								Non-
		Common Stock								Paid-in				Treasury Stock								Comprehensive				Retained				Controlling				Total
		Shares				Par Value				Capital				Shares				Amount				Loss				Earnings				Interests				Equity
Balance at June 30, 2019			49,049			$	491			$	377,913				22,462			$	(656,597	)		$	(5,651	)		$	647,710			$	63			$	363,929
Net income			-				-				-				-				-				-				14,106				-				14,106
Common stock issued on share-based awards			1				-				18				-				-				-				-				-				18
Share-based compensation expense			-				-				151				-				-				-				-				-				151
Impact of ASU 2016-02 adoption, net of tax			-				-				-				-				-				-				(1,585	)			-				(1,585	)
Cash dividends declared			-				-				-				-				-				-				(5,610	)			-				(5,610	)
Other comprehensive income (loss)			-				-				-				-				-				(499	)			-				(7	)			(506	)
Balance at September 30, 2019			49,050			$	491			$	378,082				22,462			$	(656,597	)		$	(6,150	)		$	654,621			$	56			$	370,503
Net income			-				-				-				-				-				-				7,086				-				7,086
Common stock issued on share-based awards			4				-				35				-				-				-				-				-				35
Share-based compensation expense			-				-				(28	)			-				-				-				-				-				(28	)
Cash dividends declared			-				-				-				-				-				-				(5,496	)			-				(5,496	)
Repurchase of common stock			-				-				-				546				(10,029	)			-				-				-				(10,029	)
Other comprehensive income (loss)			-				-				-				-				-				773				-				(19	)			754
Balance at December 31, 2019			49,054			$	491			$	378,089				23,008			$	(666,626	)		$	(5,377	)		$	656,211			$	37			$	362,825

																						Accumulated
										Additional												Other								Non-
		Common Stock								Paid-in				Treasury Stock								Comprehensive				Retained				Controlling				Total
		Shares				Par Value				Capital				Shares				Amount				Loss				Earnings				Interests				Equity
Balance at June 30, 2018			48,989			$	490			$	376,950				22,460			$	(656,551	)		$	(6,171	)		$	669,013			$	139			$	383,870
Net income			-				-				-				-				-				-				8,840				-				8,840
Common stock issued on share-based awards			40				-				637				-				-				-				-				-				637
Share-based compensation expense			-				-				491				-				-				-				-				-				491
Cash dividends declared			-				-				-				-				-				-				(5,072	)			-				(5,072	)
Other comprehensive income (loss)			-				-				-				-				1,247				-				-				(26	)			1,221
Balance at September 30, 2018			49,029			$	490			$	378,078				22,460			$	(656,551	)		$	(4,924	)		$	672,781			$	113			$	389,987
Net income			-				-				-				-				-				-				12,190				-				12,190
Common stock issued on share-based awards			9				-				164				-				-				-				-				-				164
Share-based compensation expense			-				-				316				-				-				-				-				-				316
Cash dividends declared			-				-				-				-				-				-				(31,778	)			-				(31,778	)
Other comprehensive income (loss)			-				-				-				-				-				(1,195	)			-				(19	)			(1,214	)
Balance at December 31, 2018			49,038			$	490			$	378,558				22,460			$	(656,551	)		$	(6,119	)		$	653,193			$	94			$	369,665

 

(1)	Organization and Nature of Business

 

Founded in 1932 and incorporated in Delaware in 1989, Ethan Allen Interiors Inc., through its wholly-owned subsidiary, Ethan Allen Global, Inc., and Ethan Allen Global, Inc.’s subsidiaries (collectively, “we,” “us,” “our,” “Ethan Allen” or the “Company”), is a leading interior design company, manufacturer and retailer in the home furnishings marketplace. Today we are a global luxury international home fashion brand that is vertically integrated from design through delivery, which affords our customers a value proposition of style, quality and price. We provide complimentary interior design service to our customers and sell a full range of furniture products and decorative accents through a retail network of approximately 300 design centers in the United States and abroad as well as online at ethanallen.com. The design centers represent a mix of independent licensees and Company-owned and operated locations. Our Company operates retail design centers located in the United States and Canada. The independently operated design centers are located in the United States, Asia, the Middle East and Europe. We also own and operate nine manufacturing facilities including six manufacturing plants in the United States, two manufacturing plants in Mexico and one manufacturing plant in Honduras.

 

(2)	Interim Basis of Presentation

 

Use of Estimates. We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”), 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 net sales 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, goodwill and indefinite-lived intangible asset impairment analyses, useful lives for property, plant and equipment, inventory obsolescence, business insurance retention reserves, tax valuation allowances, the evaluation of uncertain tax positions and other loss reserves.

 

Principles of Consolidation. We conduct business globally and have strategically aligned our business into two reportable segments: Wholesale and Retail. These two segments represent strategic business areas of our vertically integrated enterprise that operate separately and provide their own distinctive services. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany activity and balances have been eliminated from 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 and six months ended December 31, 2019 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 fiscal 2019 Annual Report on Form 10-K (the “2019 Annual Report on Form 10-K”).

 

Reclassifications. Certain reclassifications have been made to the amounts in prior periods in order to conform to the current period’s presentation. These changes were made for disclosure purposes only and did not have any impact on previously reported results.

 

(3)	Recent Accounting Pronouncements

 

New Accounting Standards or Updates Recently Adopted

 

Leases – In February 2016, the FASB issued accounting standards update (“ASU”) 2016-02, Leases (Topic 842), an update related to accounting for leases. This standard requires an entity to recognize lease liabilities and a right-of-use asset for all leases on the balance sheet and to disclose key information about the entity's leasing arrangements. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, with earlier adoption permitted. In July 2018, the FASB approved an amendment to the new guidance that allows companies the option of using the effective date of the new standard as the initial application (at the beginning of the period in which it is adopted, rather than at the beginning of the earliest comparative period) and to recognize the effects of applying the new ASU as a cumulative effect adjustment to the opening balance sheet or retained earnings.

 

We adopted ASU 2016-02 as of July 1, 2019 using the modified retrospective method and have not restated comparative periods. We elected the package of practical expedients upon adoption, which permits us (i) to not reassess whether any expired or existing contracts are or contain leases, (ii) to not reassess lease classification for any expired or existing leases, and (iii) to not reassess treatment of initial direct costs, if any, for any expired or existing leases. In addition, we elected not to separate lease and non-lease components when determining the ROU asset and lease liability for our design center real estate leases and did not elect the hindsight practical expedient, which would have allowed us to use hindsight when determining the remaining lease term as of the adoption date on July 1, 2019. Lastly, we elected the short-term lease exception policy for all leases, permitting us to exclude the recognition requirements of this standard from leases with initial terms of 12 months or less.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Upon adoption we recognized operating lease assets of $129.7 million and operating lease liabilities of $149.7 million on our consolidated balance sheet. In addition, $20.0 million of deferred rent and various lease incentives, which were reflected as other long-term liabilities as of June 30, 2019, were reclassified as a component of the right-of-use assets upon adoption. The Company also recognized a cumulative adjustment as of July 1, 2019, which decreased opening retained earnings by $1.6 million due to the impairment of certain right-of-use assets. The adoption of the new standard did not have a material impact on our consolidated statements of operations or cash flows. See Note 6 for further details on new disclosures required under ASU 2016-02.

 

Recent Accounting Standards or Updates Not Yet Effective

 

Credit Losses of Financial Instruments – In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, an update that requires measurement and recognition of expected credit losses for financial assets held based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This accounting standards update will be effective for us beginning in the first quarter of fiscal 2021 and we do not expect the adoption to have a material impact on our consolidated financial statements.

 

Goodwill Impairment Test – In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which removes the requirement for companies to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This accounting standards update will be effective for us beginning in the first quarter of fiscal 2021 and we do not expect the adoption to have a material impact on our consolidated financial statements.

 

Implementation Costs in a Cloud Computing Arrangement – In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, an update related to a client’s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. This guidance aligns the requirements for capitalizing implementation costs in a cloud computing service contract with the guidance for capitalizing implementation costs to develop or obtain internal-use software. Capitalized implementation costs related to a hosting arrangement that is a service contract will be amortized over the term of the hosting arrangement, beginning when the module or component of the hosting arrangement is ready for its intended use. This accounting standards update will be effective for us beginning in the first quarter of fiscal 2021, with early adoption permitted. We are currently evaluating the impact of this accounting standards update, but do not expect the adoption to have a material impact on our consolidated financial statements.

 

Simplifying the Accounting for Income Taxes – In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, an update intended to simplify various aspects related to accounting for income taxes. This guidance removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This accounting standards update will be effective for us beginning in the first quarter of fiscal 2022, with early adoption permitted. We are currently evaluating the impact of this accounting standards update, but do not expect the adoption to have a material impact on our consolidated financial statements.

 

No other new accounting pronouncements issued or effective as of December 31, 2019 have had or are expected to have an impact on our consolidated financial statements.

 

(4)	Revenue Recognition

 

Our reported revenue (net sales) consist substantially of product sales. We report product sales net of discounts and recognize them at the point in time when control transfers to the customer. For sales to our customers in our wholesale segment, control typically transfers when the product is shipped. For sales in our retail segment, control generally transfers upon delivery to the customer. We recognize shipping and handling expense as fulfillment activities (rather than as a promised good or service) when the activities are performed even if those activities are performed after the control of the good has been transferred. Accordingly, we record the expenses for shipping and handling activities at the same time we recognize net sales. We exclude from the measurement of the transaction price all taxes imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer, including sales, use, excise, value-added, and franchise taxes (collectively referred to as sales taxes). We do not adjust net sales for the effects of financing components as we believe that we will receive payment from the customer within one year of when we transfer control of the related goods.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Estimated refunds for sales returns and allowances are based on our historical return patterns. We record these estimated refunds on a gross basis rather than on a net basis and have recorded an asset for product we expect to receive back from customers in Prepaid expenses and other current assets and a corresponding refund liability in Other current liabilities on our consolidated balance sheets. At December 31, 2019 and June 30, 2019, these amounts were immaterial.

 

In many cases we receive deposits from customers before we have transferred control of our product to our customers, resulting in contract liabilities. These customer deposits are reported as a current liability in Customer deposits and deferred revenue on our consolidated balance sheets. At June 30, 2019 we had customer deposits of $56.7 million, of which we recognized $7.0 million and $53.6 million, respectively, as net sales upon delivery to the customer during the three and six months ended December 31, 2019. Customer deposits totaled $45.9 million at December 31, 2019.

 

During October 2019 we introduced the Ethan Allen Member Program, which for a $100 annual fee, offers special members-only pricing, free shipping and white glove in-home delivery, and in our United States design centers, access to preferred financing plans. New membership fees are recorded as deferred revenue when collected from customers and recognized as revenue on a straight-line basis over the membership period of one year. These non-refundable fees are initially reported as a current liability in Customer deposits and deferred revenue on our consolidated balance sheet while recognized revenue is reported within Net sales on our consolidated statement of comprehensive income. Revenue recognized from annual membership fees is reported as a part of other revenue in the disaggregated revenue tables below.

 

The following table disaggregates net sales by product category by segment for the three months ended December 31, 2019 (in thousands):

 

 

The following table disaggregates net sales by product category by segment for the six months ended December 31, 2019 (in thousands):

 

 

(1)

Upholstery furniture includes fabric-covered items such as sleepers, recliners and other motion furniture, chairs, ottomans, custom pillows, sofas, loveseats, cut fabrics and leather.

 

(2)

Case goods furniture includes items such as beds, dressers, armoires, tables, chairs, buffets, entertainment units, home office furniture, and wooden accents.

 

(3)

Accents includes items such as window treatments and drapery hardware, wall décor, florals, lighting, clocks, mattresses, bedspreads, throws, pillows, decorative accents, area rugs, wall coverings and home and garden furnishings.

 

(4)

Other includes membership revenue, product delivery sales, the Ethan Allen Hotel room rentals and banquets, sales of third-party furniture protection plans and other miscellaneous product sales less prompt payment discounts, sales allowances and other incentives.

 

(5)

Represents the elimination of all intercompany wholesale segment sales to the retail segment during the period presented.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

 

(5)	Inventories

 

Inventories are stated at the lower of cost (on first-in, first-out basis) or net realizable value. Cost is determined based solely on those charges incurred in the acquisition and production of the related inventory.

 

Inventories at December 31, 2019 and June 30, 2019 are summarized as follows (in thousands):

 

 

 

(6)

Leases

 

During the first quarter of fiscal 2020, we adopted ASU 2016-02 and all related amendments. The guidance requires lessees to recognize substantially all leases on their balance sheet as a right-of-use (“ROU”) asset and a lease liability.

 

Lease Accounting Policy

 

We have operating leases for many of our design centers that expire at various dates through fiscal 2040. In addition, we also lease certain tangible assets, including computer equipment and vehicles with lease terms ranging from three to five years. We determine if a contract contains a lease at inception based on our right to control the use of an identified asset and our right to obtain substantially all of the economic benefits from the use of that identified asset. Certain operating leases have renewal options and rent escalation clauses as well as various purchase options. We assess these options to determine if we are reasonably certain of exercising these options based on all relevant economic and financial factors. Any options that meet these criteria are included in the lease term at lease commencement.

 

Lease right-of-use assets represent the right to use an underlying asset pursuant to the lease for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. Lease right-of-use assets and lease liabilities are recognized at the commencement of an arrangement where it is determined at inception that a lease exists. These assets and liabilities are initially recognized based on the present value of lease payments over the lease term calculated using our incremental borrowing rate generally applicable to the location of the lease right-of-use asset, unless an implicit rate is readily determinable. We combine lease and certain non-lease components for our design center real estate leases in determining the lease payments subject to the initial present value calculation. Lease right-of-use assets include upfront lease payments and exclude lease incentives, where applicable. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised.

 

Lease expense for operating leases consists of both fixed and variable components. Expense related to fixed lease payments are recognized on a straight-line basis over the lease term. Variable lease payments are generally expensed as incurred, where applicable, and include certain index-based changes in rent, certain non-lease components, such as maintenance and other services provided by the lessor, and other charges included in the lease. Leases with an initial term of twelve months or less are not recorded on the balance sheet. In addition, certain of our equipment lease agreements include variable lease payments, which are based on the usage of the underlying asset. The variable portion of payments are not included in the initial measurement of the asset or lease liability due to uncertainty of the payment amount and are recorded as lease expense in the period incurred.

 

We have elected the short-term lease exemption, whereby leases with initial terms of one year or less are not capitalized and instead expensed on a straight-line basis over the lease term.

 

Key Estimates and Judgments

 

Key estimates and judgments in applying ASU 2016-02 include how the Company determines the discount rate to discount the unpaid lease payments to present value and the lease term.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

ASC 842 requires companies to use the rate implicit in the lease whenever that rate is readily determinable and if the interest rate is not readily determinable, then a lessee may use its incremental borrowing rate. Most of our leases do not have an interest rate implicit in the lease. As a result, for purposes of measuring our ROU asset and lease liability, we determined our incremental borrowing rate by computing the rate of interest that we would have to pay to (i) borrow on a collateralized basis (ii) over a similar term (iii) at an amount equal to the total lease payments and (iv) in a similar economic environment. As we do not have any outstanding public debt, we estimated the incremental borrowing rate based on our estimated credit rating and available market information. We used the incremental borrowing rates we determined as of July 1, 2019 for operating leases that commenced prior to that date. The incremental borrowing rate is subsequently reassessed upon a modification to the lease agreement. In the case an interest rate is implicit in a lease we will use that rate as the discount rate for that lease. The lease term for all of our lease arrangements include the noncancelable period of the lease plus, if applicable, any additional periods covered by an option to extend the lease that is reasonably certain to be exercised by the Company. Our leases generally do not include termination options for either party to the lease or restrictive financial or other covenants. Some of our leases contain variable lease payments based on a Consumer Price Index or percentage of sales, which are excluded from the measurement of the lease liability.

 

The Company's lease terms and discount rates are as follows:

 

 

The following table discloses the location and amount of our operating and financing lease costs within our consolidated statements of comprehensive income (in thousands):

 

 

(1)

Variable lease payments include index-based changes in rent, maintenance, real estate taxes, insurance and other charges included in the lease.

 

Operating lease rent expense during the three months ended December 31, 2018, as reported within SG&A, was $8.0 million, net of sublease rental income of $0.5 million. For the six months ended December 31, 2018, operating lease rent expense was $16.0 million, net of sublease rental income of $1.0 million.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

The following table discloses the operating and financing lease assets and liabilities recognized within our consolidated balance sheet as of December 31, 2019 (in thousands):

 

 

The ROU assets by segment are as follows as of December 31, 2019 (in thousands):

 

 

The table below reconciles the undiscounted future minimum lease payments (displayed by year and in the aggregate) under noncancelable leases with terms of more than one year to the total lease liabilities recognized on the condensed consolidated balance sheets as of December 31, 2019 (in thousands):

 

 

As of December 31, 2019, we have entered into additional operating leases for design center relocations and openings, which have not yet commenced and are therefore not part of the table above nor included in the lease right-of-use assets and liabilities. These leases will commence when we obtain possession of the underlying leased asset which is expected to be during the third quarter of fiscal 2020. These leases are for a period ranging from five to ten years and have aggregated undiscounted future rent payments of $6.3 million.

 

At December 31, 2019, we did not have any financing leases that had not commenced.

 

Other information for our leases is as follows (in thousands):

 

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

At the beginning of fiscal 2020, we adopted ASU 2016-02, and as required, the following disclosure is provided for periods prior to adoption. As of June 30, 2019, future minimum payments under non-cancelable leases were as follows (in thousands):

 

 

(1)

As of June 30, 2019, our capital lease obligations were $1.1 million of which the current and long-term portions were included within short-term debt and long-term debt, respectively, in the consolidated balance sheet. Monthly minimum lease payments were accounted for as principal and interest payments.

 

 

(7)	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 non-recurring in nature and treats these as discrete events. The tax effect of such items is recorded in the quarter in which the related events occur. Due to the volatility of these factors, the Company's consolidated effective income tax rate can change significantly quarter over quarter.

 

The Company conducts business globally and, as a result, the Company and its subsidiaries files income tax returns in the United States and in various state and foreign jurisdictions. In the normal course of business, the Company is subject to periodic examination in such domestic and foreign jurisdictions by tax authorities. The Company and certain subsidiaries are currently under audit in the United States for fiscal 2015 through fiscal 2018. While the amount of uncertain tax impacts 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 and that various issues relating to uncertain tax impacts 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 is subject to a United States federal statutory tax rate of 21% for fiscal years ending June 30, 2020 and 2019, respectively. The Company’s consolidated effective tax rate was 23.5% and 24.1% respectively, for the three and six months ended December 31, 2019 compared with 25.1% and 25.0% in the prior year periods. The current fiscal year’s effective tax rate primarily includes a provision for income tax on the taxable year’s income and tax and interest expense on uncertain tax positions. The prior quarter’s effective tax rate primarily includes tax expense on the taxable year’s net income, tax expense on cancelations and exercises of stock options and tax and interest expense on uncertain tax positions.

 

(8)

Debt

 

Total debt obligations at December 31, 2019 and June 30, 2019 consist of the following (in thousands):

 

 

(1)

Capital leases were previously reported as debt as of June 30, 2019. Upon the adoption of the new leasing standard, the Company reclassified its capital lease obligations from short and long-term debt to other current liabilities and other long-term liabilities, respectively. Refer to Note 6 for further details regarding capital lease obligations.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Revolving Credit Facility

 

On December 21, 2018, the Company and most of its domestic subsidiaries (the “Loan Parties”) entered into a Second Amended and Restated Credit Agreement (the “Facility”). The Facility amends and restates the existing Amended and Restated Credit Agreement, dated as of October 21, 2014, as amended. The Facility provides a revolving credit line of up to $165 million, subject to borrowing base availability, and extends the maturity of the Facility to December 21, 2023. We incurred financing costs of $0.6 million under the Facility, which are being amortized over the remaining life of the Facility using the effective interest method.

 

At the Company’s option, revolving loans under the Facility bear interest, based on the average availability, at an annual rate of either (a) the London Interbank Offered rate (“LIBOR”) plus 1.5% to 2.0%, or (b) the higher of (i) the prime rate, (ii) the federal funds effective rate plus 0.5%, or (iii) LIBOR plus 1.0% plus in each case 0.5% to 1.0%.

 

The availability of credit at any given time under the Facility will be constrained by the terms and conditions of the Facility, including the amount of collateral available, a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, and other restrictions contained in the Facility. All obligations under the Facility are secured by assets of the Loan Parties, including inventory, receivables and certain types of intellectual property.

 

Borrowings under the Facility

 

As of December 31, 2019, we had no borrowings outstanding under the Facility.

 

Debt Obligations

 

As of December 31, 2019, we have no current outstanding long-term debt obligations. Interest expense incurred during the six months ended December 31, 2019 and 2018 were immaterial.

 

Covenants and Other Ratios

 

The Facility contains various restrictive and affirmative covenants, including required financial reporting, limitations on the ability to grant liens, make loans or other investments, incur additional debt, issue additional equity, merge or consolidate with or into another person, sell assets, pay dividends or make other distributions or enter into transactions with affiliates, along with other restrictions and limitations similar to those frequently found in credit agreements of this type and size. Loans under the Facility may become immediately due and payable upon certain events of default (including failure to comply with covenants, change of control or cross-defaults) as set forth in the Facility.

 

The Facility does not contain any significant financial ratio covenants or coverage ratio covenants other than a fixed charge coverage ratio covenant based on the ratio of (a) EBITDA, plus cash Rentals, minus Unfinanced Capital Expenditures to (b) Fixed Charges, as such terms are defined in the Facility (the “FCCR Covenant”). The FCCR Covenant only applies in certain limited circumstances, including when the unused availability under the Facility falls below $18.5 million. The FCCR Covenant ratio is set at 1.0 and measured on a trailing twelve-month basis.

 

At December 31, 2019 and June 30, 2019, there was $5.8 million and $6.1 million, respectively, of standby letters of credit outstanding under the Facility. Total borrowing base availability under the Facility was $126.4 million at December 31, 2019 and $158.9 million at June 30, 2019. At both December 31, 2019 and June 30, 2019, we were in compliance with all the covenants under the Facility.

 

(9)	Restructuring and Impairment Activities

 

Optimization of Manufacturing and Logistics

 

During the fourth quarter of fiscal 2019, we initiated restructuring plans to consolidate our manufacturing and logistics operations as part of an overall strategy to maximize production efficiencies and maintain our competitive advantage. As of June 30, 2019, we permanently discontinued operations at our Passaic, New Jersey property and ceased using most of our Old Fort, North Carolina case goods manufacturing operations, which we transferred to our other existing case goods operations.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

During the first half of fiscal 2020, we continued with this optimization project as we converted the Old Fort facility into a distribution center and expanded our existing Maiden, North Carolina manufacturing campus while finalizing severance and other exit costs. In connection with the foregoing fiscal 2020 initiatives, we recorded pre-tax restructuring and other exit charges totaling $1.8 million, consisting of $1.3 million in abnormal manufacturing variances associated with the Passaic and Old Fort facilities, $0.7 million in employee severance and other payroll and benefit costs and $0.4 million in other exit costs partially offset by $0.7 million in gains from the sale of property, plant and equipment held at our Old Fort facility. The abnormal manufacturing overhead variances of $1.3 million were recorded within Cost of Sales with the remaining recorded within the line item Restructuring and Impairment Charges (Gains) in the consolidated statements of comprehensive income.

 

As part of our optimization plans, we also completed the sale of our Passaic property in September 2019 to an independent third party and received $12.4 million in cash less certain adjustments, including $0.9 million in selling and other closing costs. As a result of the sale, the Company recognized a pre-tax gain of $11.5 million in the first quarter of fiscal 2020, which was recorded within the line item Restructuring and Impairment Charges (Gains) in the consolidated statements of comprehensive income.

 

Inventory Write-downs

 

During the first half of fiscal 2020 we recorded a non-cash charge of $3.2 million related to the write-down and disposal of certain slow moving and discontinued inventory items, which was due to actual demand and forecasted market conditions for these inventory items being less favorable than originally estimated. Of the total inventory write-down, $2.6 million related to slow moving finished goods with the remaining $0.6 million consisting of raw materials that were disposed. The non-cash inventory write-down was recorded in the consolidated statement of comprehensive income within the line item Cost of Sales.

 

Summary of Restructuring, Impairments and Other related charges (gains)

 

Restructuring, impairment and other related costs incurred during the three and six months ended December 31, 2019 were as follows (in thousands):

 

 

(1)	Manufacturing overhead costs and inventory write-downs are reported within Cost of Sales in the consolidated statements of comprehensive income.

 

Restructuring and Other Related Charges Rollforward

 

The Company’s restructuring activity is summarized in the table below (in thousands):

 

 

(1)	Remaining severance expected to be paid during the third quarter of fiscal 2020. The balance is reported within Accrued compensation and benefits in our consolidated balance sheet as of December 31, 2019.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

(2)

The previously recorded vacant space liability was reclassified from Accounts payable and accrued expenses and Other long-term liabilities to Operating lease right-of-use assets upon the adoption of ASU 2016-02, which requires all right-of-use assets to be measured net of any Topic 420 lease liabilities.

 

(3)	The remaining balance from the other charges (income) as of December 31, 2019 is recorded within Accounts payable and accrued expenses.

 

(10)	Share-Based Compensation

 

During the six months ended December 31, 2019 and 2018, we recognized total share-based compensation expense of $0.1 million and $0.8 million, respectively. These amounts have been included in the consolidated statements of comprehensive income within selling, general and administrative expenses. As of December 31, 2019, $0.8 million of total unrecognized compensation expense related to non-vested equity awards is expected to be recognized over a weighted average period of 2.0 years. There was no share-based compensation capitalized for the six months ended December 31, 2019 or 2018.

 

At December 31, 2019, there were 1,461,475 shares of common stock available for future issuance pursuant to the Ethan Allen Interiors Inc. Stock Incentive Plan. Stock options are granted with an exercise price equal to the market price of our common stock at the date of grant, vest ratably over a specified service period, and have a contractual term of 10 years. Equity awards can also include performance vesting conditions. Company policy further requires an additional one year holding period beyond the service vest date for certain executives. Grants to independent directors have a three-year service vesting condition.

 

A summary of stock option activity during the six months ended December 31, 2019 is presented below.

 

 

Stock options granted to employees during fiscal 2020 were valued using the Black-Scholes option pricing model with the following assumptions. There were no stock option awards granted to employees during fiscal 2019.

 

 

Non-employee (independent) directors were granted stock options during the first quarter of each fiscal year presented and valued using the Black-Scholes option pricing model with the following assumptions.

 

 

A summary of stock unit awards activity during the six months ended December 31, 2019 is presented below.

 

 

We estimate, as of the date of grant, the fair value of performance stock units with a discounted cash flow model, using as model inputs the risk-free rate of return as the discount rate, dividend yield for dividends not paid during the restriction period, and a discount for lack of marketability for a one-year post-vest holding period. The lack of marketability discount used is the present value of a future put option using the Chaffe model. The weighted average assumptions used for the stock units granted during fiscal 2020 and 2019, respectively, is presented below.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

 

There was no restricted stock award activity during fiscal 2020. As of December 31, 2019, there were no restricted stock awards outstanding.

 

(11)	Earnings Per Share

 

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

 

 

Dilutive potential common shares consist of stock options and performance stock units. 

 

As of December 31, 2019 and 2018, stock options to purchase 280,437 and 157,294 common shares, respectively, were excluded from the diluted EPS calculations because their inclusion would have been anti-dilutive.

 

As of December 31, 2019 and 2018, the number of performance-based equity award grants excluded from the calculation of diluted EPS was 287,287 and 268,752, respectively. Performance-based awards are excluded from the calculation of diluted EPS unless the performance criteria are probable of being achieved as of the balance sheet date.

 

(12)	Accumulated Other Comprehensive Income (Loss)

 

Accumulated other comprehensive income (loss) consists of foreign currency translation adjustments which are the result of changes in foreign currency exchange rates related to our operations outside the United States. Assets and liabilities are translated into U.S. dollars using the current period-end exchange rate and income and expense amounts are translated using the average exchange rate for the period in which the transaction occurred. The following table sets forth the activity in accumulated other comprehensive loss for the fiscal year-to-date period ended December 31, 2019 (in thousands).

 

 

(13)	Segment Information

 

Our operating segments are aligned with how the Company, including its chief operating decision maker, manages the business. As such, our reportable operating segments are the Wholesale segment and the Retail segment. Our wholesale and retail operating segments represent strategic business areas of our vertically integrated enterprise that operate separately and provide their own distinctive services. This vertical structure enables us to offer our complete line of home furnishings and accents more effectively while controlling quality and cost. We evaluate performance of the respective segments based upon revenues and operating income. Inter-segment transactions result, primarily, from the wholesale sale of inventory to the retail segment, including the related profit margin. 

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

As of December 31, 2019, the Company operated 144 design centers (our retail segment) and our independent retailers operated 158 design centers. Our wholesale segment net sales include sales to our retail segment, which are eliminated in consolidation, and sales to our independent retailers. Our retail segment net sales accounted for 79% of our consolidated net sales in the six months ended December 31, 2019. Our wholesale segment net sales accounted for the remaining 21%.

 

Segment information for the three and six months ended December 31, 2019 and 2018 is provided below (in thousands):

 

 

(a)

Represents the change in wholesale profit contained in the retail segment inventory at the end of the period.

 

 

(b)

Represents the wholesale profit contained in the retail segment inventory that has not yet been realized. These profits are realized when the related inventory is sold.

 

(14)	Commitments and Contingencies

 

We accrue non-income tax liabilities for contingencies when management believes that a loss is probable, and the amounts can be reasonably estimated, while contingent gains are recognized only when realized. We are routinely party to various legal proceedings, claims and litigation that have arisen in the ordinary course of business, including employment matters, commercial and intellectual property disputes and environmental items. For more information on how we determine whether to accrue for potential losses resulting from litigation, see Note 20 to our consolidated financial statements included in our 2019 Annual Report on Form 10-K. Environmental items typically involve investigations and proceedings concerning air emissions, hazardous waste discharges, and/or management of solid and hazardous wastes. Under applicable environmental laws and regulations, we and/or our subsidiaries are, or may be, required to remove or mitigate the effects on the environment due to the disposal or release of certain hazardous materials. We believe that our facilities are in material compliance with all such applicable laws and regulations.

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

The outcome of any matters pending against us is subject to future resolution, including the uncertainties of litigation. Based on information available at December 31, 2019, management believes that the ultimate outcome of these unresolved matters against the Company, individually or in the aggregate, will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

 

(15)	Subsequent Event

 

On January 13, 2020, the Company’s Board of Directors authorized an increase in the aggregate share repurchase authorization under the Company’s existing multi-year share repurchase program (the “Share Repurchase Program”) to 3,000,000 shares. The timing and amount of any future share repurchases in the open market and through privately negotiated transactions will be determined by the Company’s officers at their discretion and based on a number of factors, including an evaluation of market and economic conditions. The Share Repurchase Program may be suspended or discontinued at any time without prior notice.