UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
or
[ ] TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________________ to ________________________
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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
At December 31, 2004, there were 35,497,507 sharesof Class A Common Stock, par value $.01, outstanding.
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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIESConsolidated Balance Sheets (In thousands, except share data)
See accompanying notes to consolidated financial statements.
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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIESConsolidated Statements of Operations (In thousands, except per share data)
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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIESConsolidated Statements of Cash Flows(In thousands)
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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIESConsolidated Statements of Shareholders' EquitySix Months Ended December 31, 2004(In thousands, except share data)
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The following discussion of financial condition and results of operations should be read in conjunction with (i) the Consolidated Financial Statements of the Company, and notes thereto, as set forth in this Form 10-Q and (ii) the Company’s Annual Report on Form 10-K for the year ended June 30, 2004.
Management’s discussion and analysis of financial condition and results of operations and other sections of this Quarterly Report contain forward-looking statements relating to future results of the Company. Such forward-looking statements are identified by use of forward-looking words such as “anticipates”, “believes”, “plans”, “estimates”, “expects”, and “intends” or words or phrases of similar expression. These forward-looking statements are subject to management decisions and various assumptions, risks and uncertainties, including, but not limited to: changes in political and economic conditions; changes in demand for the Company’s products; acceptance of new products; changes in conditions in the various geographic markets where the Company does business; technology developments affecting the Company’s products; changes in laws and regulations; and those matters discussed in the Company’s filings with the Securities and Exchange Commission (“SEC”). Accordingly, actual circumstances and results could differ materially from those contemplated by the forward-looking statements.
The Company’s consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America which require, in some cases, that certain estimates and assumptions be made that affect the amounts and disclosures reported in those financial statements and the related accompanying notes. Estimates are based on currently known facts and circumstances, prior experience and other assumptions believed to be reasonable. Management uses its best judgment in valuing these estimates and may, as warranted, solicit external advice. Actual results could differ from these estimates, assumptions and judgments and these differences could be material. The following critical accounting policies, some of which are impacted significantly by estimates, assumptions and judgments, affect the Company’s consolidated financial statements.
Inventories– Inventories (finished goods, work in process and raw materials) are stated at the lower of cost, determined on a first-in, first-out basis, or market. Cost is determined based solely on those charges incurred in the acquisition and production of the related inventory (i.e. material, labor and manufacturing overhead costs). The Company estimates an inventory reserve for excess quantities and obsolete items based on specific identification and historical write-offs, taking into account future demand and market conditions. If actual demand or market conditions in the future are less favorable than those estimated, additional inventory write-downs may be required.
Revenue Recognition – Revenue is recognized when all of the following have occurred: persuasive evidence of a sales arrangement exists (e.g. a wholesale purchase order or retail sales invoice); the sales arrangement specifies a fixed or determinable sales price; product is shipped or services are provided to the customer; and collectibility is reasonably assured. This occurs upon the shipment of goods to independent retailers or, in the case of Ethan Allen-owned retail stores, upon delivery to the customer. Recorded sales provide for estimated returns and allowances. The Company permits retail customers to return defective products and incorrect shipments, and terms offered by the Company are standard for the industry.
Allowance for Doubtful Accounts – The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowance for doubtful accounts is based on a review of specifically identified accounts in addition to an overall aging analysis. Judgments are made with respect to the collectibility of accounts receivable based on historical experience and current economic trends. Actual losses could differ from those estimates.
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Retail Store Acquisitions — The Company accounts for the acquisition of retail stores and related assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, which requires application of the purchase method for all business combinations initiated after June 30, 2001. Accounting for these transactions as purchase business combinations requires the allocation of purchase price paid to the assets acquired and liabilities assumed based on their fair values as of the date of the acquisition. The amount paid in excess of the fair value of net assets acquired is accounted for as goodwill.
Impairment of Long-Lived Assets and Goodwill — The Company periodically evaluates whether events or circumstances have occurred that indicate that long-lived assets may not be recoverable or that the remaining useful life may warrant revision. When such events or circumstances are present, the Company assesses the recoverability of long-lived assets by determining whether the carrying value will be recovered through the expected undiscounted future cash flows resulting from the use of the asset. In the event the sum of the expected undiscounted future cash flows is less than the carrying value of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded. The long-term nature of these assets requires the estimation of its cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of the impairment test.
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and other intangible assets are to be evaluated for impairment at the reporting unit level on an annual basis and between annual tests whenever events or circumstances indicate that the carrying value of a reporting unit may exceed its fair value. The Company conducts its required annual impairment test during the fourth quarter of each fiscal year. The impairment test uses a discounted cash flow model to estimate the fair value of a reporting unit. This model requires the use of long-term planning forecasts and assumptions regarding industry-specific economic conditions that are outside the control of the Company.
Business Insurance Reserves – The Company has insurance programs in place to cover workers’ compensation and property/casualty claims. The insurance programs, which are funded through self-insured retention, are subject to various stop-loss limitations. The Company accrues estimated losses using actuarial models and assumptions based on historical loss experience. Although management believes that the insurance reserves are adequate, the reserve estimates are based on historical experience, which may not be indicative of current and future losses. In addition, the actuarial calculations used to estimate insurance reserves are based on numerous assumptions, some of which are subjective. The Company adjusts insurance reserves, as needed, in the event that future loss experience differs from historical loss patterns.
Other Loss Reserves – The Company has a number of other potential loss exposures incurred in the ordinary course of business such as environmental claims, product liability, litigation, tax liabilities, restructuring charges, and the recoverability of deferred income tax benefits. Establishing loss reserves for these matters requires management’s estimate and judgment with regard to maximum risk exposure and ultimate liability or realization. As a result, these estimates are often developed with the Company’s counsel, or other appropriate advisors, and are based on management’s current understanding of the underlying facts and circumstances. Because of uncertainties related to the ultimate outcome of these issues or the possibilities of changes in the underlying facts and circumstances, additional charges (or credits) related to these matters could be required in the future.
Ethan Allen’s revenues are comprised of (i) wholesale sales to independently-owned and Company-owned retail stores and (ii) retail sales of Company-owned stores. See Note 11 to the Company’s Consolidated Financial Statements for the three and six months ended December 31, 2004 and 2003.
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The components of consolidated revenue and operating income were as follows (in millions):
Consolidated revenue for the three months ended December 31, 2004 increased by $4.0 million, or 1.7%, to $245.2 million, from $241.2 million for the three months ended December 31, 2003. Net sales for the period reflect the delivery of product associated with booked orders and related backlog existing as of the end of the preceding quarter. The increase in net sales for the period was due, primarily, to the continued expansion and strategic re-positioning of the Company’s retail segment and the success of recent product introductions. These increases were partially offset by a decrease in wholesale sales volume as a result of the decline in the related incoming order rate noted during the first quarter of fiscal 2005.
Total wholesale revenue for the second quarter of fiscal 2005 decreased by $2.4 million, or 1.4%, to $161.3 million from $163.7 million in the second quarter of fiscal 2004. The decrease was attributable to the decline in the incoming order rate noted during the prior quarter, particularly within the Company’s case goods operations, as compared to the same period in the prior year. This decrease was partially offset by increased revenue attributable to increased throughput within the Company’s upholstery operations and improved service position, resulting in shorter delivery cycle times, within certain imported product lines.
Total retail revenue from Ethan Allen-owned stores for the three months ended December 31, 2004 increased by $6.2 million, or 4.2%, to $155.8 million from $149.6 million for the three months ended December 31, 2003. The increase in retail sales by Ethan Allen-owned stores was attributable to an increase in sales generated by newly opened (including relocated) or acquired stores of $6.0 million, and an increase in comparable store delivered sales of $2.5 million, or 1.8%, partially offset by a decrease resulting from sold and closed stores, which generated $2.3 million fewer sales in the second quarter of fiscal 2005 as compared to the same period in fiscal 2004. The number of Ethan Allen-owned stores increased to 124 as of December 31, 2004 as compared to 121 as of December 31, 2003. During the twelve months ended December 31, 2004, the Company acquired 5 stores from, and sold 3 stores to, independent retailers, closed 3 stores, and opened 1 store. The Company-owned store count at December 31, 2004 also reflects the net addition of 3 stores stemming from Ethan Allen’s acquisition of the 25% minority interest in a joint venture previously established in 1998 between the Company and an independent retailer. While the operations of these stores have been reflected in the Company’s consolidated financial statements since inception of the joint venture as a result of the Company’s 75% majority ownership, the stores were not previously included in the Company’s store count due to the fact that they were independently managed.
Comparable stores are those which have been operating for at least 15 months. Minimal net sales, derived from the delivery of customer ordered product, are generated
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during the first three months of operations of newly opened stores. Stores acquired from retailers by Ethan Allen are included in comparable store sales in their 13th full month of Ethan Allen-owned operations.
Total booked orders, which include wholesale orders and written business of Ethan Allen-owned retail stores, increased 4.7% from the prior year quarter. Quarter-over-quarter, wholesale orders increased 3.5% while Ethan Allen-owned store written business increased 8.2% and comparable store written business increased 5.7%. The increase in retail written sales during the current quarter was likely attributable to improvements in consumer confidence noted since completion of the November election, the continued expansion and re-positioning of the Company’s retail segment, and increased distribution of the “Furnishing Solutions by Ethan Allen” direct mail magazine. During the quarter, the Company distributed over 11 million copies of the magazine, representing a 33% increase over historical levels for the period.
Gross profit increased during the quarter to $119.5 million from $116.3 million in the prior year comparable quarter. The $3.2 million, or 2.7%, increase in gross profit was primarily attributable to (i) an increase in total sales volume, including a higher proportionate share of retail sales to total sales (64% in the current quarter compared to 62% in the prior year quarter), and (ii) a reduction in costs associated with excess capacity at the Company’s manufacturing facilities. These favorable variances were partially offset by (i) ordinary inefficiencies experienced within the Company’s case goods operations associated with the production of first cuts for new collections, and (ii) the increased cost of selected raw materials, namely lumber, foam, plywood, and steel. Consolidated gross margin increased to 48.7% in the second quarter of fiscal 2005 from 48.2% in the prior year quarter as a result, primarily, of the factors identified previously.
Operating expenses increased $5.5 million, or 7.1%, to $82.7 million, or 33.7% of net sales, in the current year quarter from $77.2 million, or 32.0% of net sales, in the prior year quarter. This increase was primarily attributable to the continued growth of the retail segment and the higher proportionate share of retail sales to total sales in the current quarter as compared to the prior year quarter. This expansion has resulted in higher costs associated with designer salaries and commissions, credit card fees, occupancy, delivery and warehousing, other managerial salaries and benefits, and advertising. In addition, advertising costs within the wholesale segment increased during the quarter, primarily related to the increased distribution of the Company’s direct mail magazine. These increases were partially offset by cost savings attributable to the closure of selected plant locations in recent periods.
Operating income for the three months ended December 31, 2004 was $36.8 million, or 15.0% of net sales, compared to $39.1 million, or 16.2% of net sales, for the three months ended December 31, 2003. This represents a decrease of $2.3 million, and was primarily attributable to the higher operating expenses referred to previously, partially offset by the overall increase in gross profit noted during the period.
Total wholesale operating income for the second quarter of fiscal 2005 was $26.8 million, or 16.6% of net sales, as compared to $30.2 million, or 18.5% of net sales, in the comparable prior year quarter. The decrease of $3.4 million, or 11.4%, was primarily attributable to (i) ordinary inefficiencies experienced within the Company’s case goods operations associated with the production of first cuts for new collections, (ii) the increased cost of selected raw materials, namely lumber, foam, plywood, and steel, (iii) an increase in selling expenses, primarily related to the increased distribution of the Company’s direct mail magazine, and (iv) the decrease in wholesale sales volume. These decreases were partially offset by a reduction in costs associated with excess capacity at the Company’s manufacturing facilities, and cost savings attributable to the closure of selected plant locations in recent periods.
Operating income for the retail segment increased $0.2 million to $6.2 million for the second quarter of fiscal 2005, as compared to $6.0 million in the prior year period. Operating income amounted to 4.0% of net sales in both periods. The increase in retail operating income generated by Ethan Allen-owned stores was primarily attributable to an
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increase in sales volume and the gain associated with the sale of three Company-owned stores to independent Ethan Allen retailers, partially offset by higher operating expenses related to the continued expansion of the retail network.
Interest and other miscellaneous income, net for the current quarter increased $0.6 million, to $1.3 million, from $0.7 million in the prior year quarter. The increase was the result of additional income recorded in the current year in connection with the sale of real estate, partially offset by a decrease in interest income associated with the lower cash balances maintained during the current period.
Income tax expense for the three months ended December 31, 2004 was $14.7 million as compared to $15.3 million for the three months ended December 31, 2003. The Company’s effective tax rate for the current quarter was 38.7%, up from 38.5% in the prior year quarter. The slightly higher effective tax rate is the result of recently-enacted changes within certain state tax legislation, and increased state income tax liability arising in connection with the operation of a greater number of Company-owned stores, some of which are located in new jurisdictions.
The Company recorded net income of $23.3 million for the quarter ended December 31, 2004, as compared to $24.4 million in the prior year quarter. Net income per diluted share totaled $0.64 for both periods.
Consolidated revenue for the six months ended December 31, 2004 increased by $11.7 million, or 2.5%, to $475.6 million, from $463.9 million for the six months ended December 31, 2003. Net sales for the period reflect the delivery of product associated with booked orders and related backlog existing as of the beginning of the period. The increase in net sales for the period was due, primarily, to the continued expansion and strategic re-positioning of the Company’s retail segment and the success of recent product introductions, partially offset, to some degree, by full implementation of the Company’s “everyday value” pricing strategy.
Total wholesale revenue for the first six months of fiscal 2005 remained relatively unchanged at $322.7 million when compared to the prior year comparable period. The flat year-over-year results were attributable to a decline in case goods sales volume, offset by increased throughput within the Company’s upholstery operations, and improved service position, resulting in shorter delivery cycle times, within certain imported product lines.
Total retail revenue from Ethan Allen-owned stores for the six months ended December 31, 2004 increased by $15.2 million, or 5.4%, to $297.5 million from $282.3 million for the six months ended December 31, 2003. The increase in retail sales by Ethan Allen-owned stores was attributable to an increase in sales generated by newly opened (including relocated) or acquired stores of $11.0 million, and an increase in comparable store delivered sales of $8.7 million, or 3.3%, partially offset by a decrease resulting from sold and closed stores, which generated $4.4 million fewer sales during the first six months of fiscal 2005 as compared to the same period in fiscal 2004.
Total booked orders for the first six months of the current fiscal year, which include wholesale orders and written business of Ethan Allen-owned retail stores, decreased 2.1% from the prior year period. Year-over-year, wholesale orders decreased 4.1% while Ethan Allen-owned store written business increased 3.8% and comparable store written business increased 1.8%. The increase in retail written sales was likely attributable to improvements in consumer confidence, the continued expansion and re-positioning of the Company’s retail segment, and increased distribution of the “Furnishing Solutions by Ethan Allen” direct mail magazine.
Gross profit increased during the six month period ended December 31, 2004 to $229.8 million from $224.7 million in the prior year comparable period. The $5.1 million, or 2.3%, increase in gross profit was primarily attributable to (i) an increase in total sales volume, including a higher proportionate share of retail sales to total sales (63%
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in the current period compared to 61% in the prior year period), and (ii) a reduction in costs associated with excess capacity at the Company’s manufacturing facilities. These favorable variances were partially offset by (i) ordinary inefficiencies experienced within the Company’s case goods operations associated with the production of first cuts for new collections, (ii) the increased cost of selected raw materials, namely lumber, foam, plywood, and steel, and (iii) full implementation of the Company’s “everyday pricing” program. Consolidated gross margin decreased slightly to 48.3% in the first six months of fiscal 2005 from 48.4% in the prior year comparable period as a result, primarily, of the factors identified previously.
Operating expenses increased $4.8 million, or 3.0%, to $161.8 million, or 34.0% of net sales, in the current year period from $157.0 million, or 33.8% of net sales, in the prior year period. This increase was primarily attributable to the continued growth of the retail segment and the higher proportionate share of retail sales to total sales in the current period as compared to the prior year period. This expansion has resulted in higher costs associated with designer salaries and commissions, credit card fees, occupancy, delivery and warehousing, and other managerial salaries and benefits. In addition, advertising costs within the wholesale segment increased during the period, primarily related to the increased distribution of the Company’s direct mail magazine. These increases were partially offset by lower expenditures related to national television advertising, and cost savings attributable to the closure of selected plant locations in recent periods.
Operating income for the six months ended December 31, 2004 was $68.0 million, or 14.3% of net sales, compared to $67.7 million, or 14.6% of net sales, for the six months ended December 31, 2003. This represents an increase of $0.3 million, and was primarily attributable to the overall increase in gross profit noted during the period, partially offset by the higher operating expenses referred to previously.
Total wholesale operating income for the first six months of fiscal 2005 was $55.1 million, or 17.1% of net sales, as compared to $57.2 million, or 17.7% of net sales, in the comparable prior year period. The decrease of $2.1 million, or 3.7%, was primarily attributable to (i) ordinary inefficiencies experienced within the Company’s case goods operations associated with the production of first cuts for new collections, (ii) the increased cost of selected raw materials, namely lumber, foam, plywood, and steel, (iii) an increase in selling expenses, primarily related to the increased distribution of the Company’s direct mail magazine, and (iv) full implementation of the Company’s “everyday pricing” program. These factors were partially offset by lower expenditures related to national television advertising, a reduction in excess capacity at the Company’s manufacturing facilities, and cost savings attributable to the closure of selected plant locations in recent periods.
Operating income for the retail segment increased $3.1 million to $9.3 million, or 3.1% of net sales, for the first six months of fiscal 2005, as compared to $6.2 million, or 2.2% of net sales, in the prior year period. The increase in retail operating income generated by Ethan Allen-owned stores was primarily attributable to increased sales volume, partially offset by higher operating expenses related to the continued expansion of the retail network.
Interest and other miscellaneous income, net for the current six month period decreased $1.7 million, to $1.2 million, from $2.9 million in the prior year period. The decrease was the result of (i) the favorable settlement of an outstanding legal matter recorded during the prior year period, (ii) a decrease in interest income associated with the lower cash balances maintained during the current period, and (iii) an increase in the Company’s share of losses incurred in connection with its United Kingdom joint venture with MFI Furniture Group Plc.
Income tax expense for the six months ended December 31, 2004 was $26.8 million as compared to $27.0 million for the six months ended December 31, 2003. The Company’s effective tax rate for the current quarter was 38.8%, up from 38.4% in the prior year quarter. The higher effective tax rate is the result of recently-enacted changes within certain state tax legislation, and increased state income tax liability arising in
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connection with the operation of a greater number of Company-owned stores, some of which are located in new jurisdictions.
The Company recorded net income of $42.2 million for the first six months of fiscal 2005 as compared to $43.3 million in the prior year comparable period. Net income per diluted share totaled $1.15 for the current period and $1.13 per diluted share in the prior year period.
The Company’s principal sources of liquidity include cash and cash equivalents, cash flow from operations and borrowing capacity under a $100.0 million revolving credit facility. In addition to the $100.0 million revolving credit component, the facility includes an accordion feature which provides for an additional $50.0 million of liquidity if needed, as well as sub-facilities for trade and standby letters of credit of $50.0 million and swing-line loans of $3.0 million.
As of December 31, 2004, the Company maintained cash and short-term investments totaling $33.0 million and outstanding debt and capital lease obligations totaling $4.6 million. The current and long-term portions of the Company’s outstanding debt and capital lease obligations totaled $0.1 million and $4.5 million, respectively, at that date. The Company had no revolving loans outstanding under the credit facility as of December 31, 2004, and trade and standby letters of credit outstanding under the facility at that date totaled $15.7 million. Remaining available borrowing capacity under the facility was $84.3 million at December 31, 2004.
Net cash provided by operating activities totaled $66.8 million for the first six months of fiscal 2005 as compared to $76.5 million for the first six months of fiscal 2004. The current period decrease of $9.7 million was principally the result of (i) changes in accounts payable ($4.8 million effect), resulting from the ordinary timing of related cash disbursements, including estimated quarterly income tax payments and treasury stock repurchases, (ii) changes in prepaid expenses and other current assets ($4.5 million effect), (iii) changes in customer deposits ($3.0 million effect), (iv) a decrease in net income ($1.1 million effect), and (v) changes in other assets ($1.1 million effect). These unfavorable variances were partially offset by (i) changes in accrued expenses ($2.0 million effect), (ii) additional cash collections related to outstanding accounts receivable ($1.8 million effect), and (iii) changes in inventories ($1.5 million effect).
The decrease in inventory levels since June 2004 was the result, primarily, of a decline in finished goods and work-in-process inventories. The decrease in finished goods inventories was related, in part, to reductions within certain imported product lines, and is consistent with the increased sales volume noted for the six month period. The decline in work-in-process inventories is attributable to the consolidation of two manufacturing facilities, announced in April 2004, and the related phase-out of those plants’ production during the current period. These decreases were partially offset by an increase in raw material inventories resulting from the purchase of lumber, fabric, and purchased frames in anticipation of future production needs.
Net cash used in investing activities totaled $9.6 million for the current six month period compared to $3.9 million in the prior year period. The current period increase of $5.7 million was due, primarily, to (i) a $6.2 million increase in capital spending, exclusive of acquisitions, to $15.4 million from $9.2 million in the prior year period, (ii) a $1.2 million decline in proceeds from the disposal of certain property, plant and equipment, and (iii) a $0.8 million increase in cash utilized to fund acquisition activity (1 retail store was acquired in the current period as compared to no stores acquired in the prior year period). These increases were partially offset by a $2.1 million increase in proceeds related to the sale of three Company-owned stores to independent Ethan Allen retailers. The current level of capital spending is principally attributable to (i) new store development and renovation, (ii) Company-wide technology initiatives, and (iii) improvements within the Company’s remaining manufacturing facilities. The Company anticipates that cash from operations will be sufficient to fund future capital expenditures.
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Net cash used in financing activities totaled $51.9 million for the six months ended December 31, 2004 as compared to $5.9 million in the prior year period. The current period increase of $46.0 million was the result, primarily, of (i) an increase of $39.1 million in payments related to the acquisition of treasury stock, (ii) an increase in cash utilized to repay outstanding debt of $3.8 million, and (iii) a $2.5 million increase in cash utilized in the payment of dividends.
On November 16, 2004, the Company declared a dividend of $0.15 per common share, payable on January 25, 2005, to shareholders of record as of January 10, 2005. The Company expects to continue to declare quarterly dividends for the foreseeable future.
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 its Board of Directors to repurchase its common stock, from time to time, either directly or through agents, in the open market at prices and on terms satisfactory to the Company. The Company also retires shares of unvested restricted stock and, prior to June 30, 2002, repurchased shares of common stock from terminated or retiring employee’s accounts in the Ethan Allen Retirement Savings Plan. All of the Company’s common stock repurchases and retirements are recorded as treasury stock and result in a reduction of shareholders’ equity. During the six months ended December 31, 2004 and 2003, the Company repurchased and/or retired the following shares of its common stock:
For each of the periods presented above, the Company funded its purchases of treasury stock with existing cash on hand and cash generated through current period operations. On November 16, 2004, the Board of Directors increased the share purchase authorization to 2.0 million shares. As of December 31, 2004, the full Board authorization of 2.0 million shares remained.
Subsequent to December 31, 2004 and through February 3, 2005, the Company repurchased, in five separate open market transactions, an additional 188,000 shares of its common stock at a total cost of $6.7 million, representing an average price per share of $35.70. All of the Company’s common stock repurchases and retirements are recorded as treasury stock and result in a reduction of shareholders’ equity.
As of December 31, 2004, aggregate scheduled maturities of long-term debt, including capital lease obligations, for each of the next five fiscal years are: $0.2 million in fiscal 2006; $0.1 million in fiscal 2007; $0.1 million in fiscal 2008; $0.1 million in fiscal 2009; and $0.1 million in fiscal 2010. The balance of the Company’s long-term debt and capital lease obligations ($3.9 million) matures in fiscal years 2011 and thereafter. The Company believes that its cash flow from operations, together with its other available sources of liquidity, will be adequate to make all required payments of principal and interest on its debt, to permit anticipated capital expenditures and to fund working capital and other cash requirements. As of December 31, 2004, the Company had working capital of $154.5 million and a current ratio of 2.19 to 1.
Except as indicated below, the Company does not utilize or employ any off-balance sheet arrangements, including special-purpose entities, in operating its business. As such, the Company does not maintain any (i) retained or contingent interests, (ii)
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derivative instruments, or (iii) variable interests which could serve as a source of potential risk to its future liquidity, capital resources and results of operations.
The Company, or its consolidated subsidiaries, 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 the underlying relationship of the benefiting party to the Company and the business purpose for which the guarantee or obligation is being provided. Details of those arrangements for which the Company, or any of its wholly-owned subsidiaries, act as guarantor or obligor are provided below.
Retailer-Related Guarantees
Ethan Allen Inc. has obligated itself, on behalf of one of its independent retailers, with respect to a $1.5 million credit facility (the “Credit Facility”) comprised of a $1.1 million revolving line of credit and a $0.4 million term loan. This obligation requires the Company, in the event of the retailer’s default under the Credit Facility, to repurchase the retailer’s inventory, applying such purchase price to the retailer’s outstanding indebtedness under the Credit Facility. The Company’s obligation remains in effect for the life of the term loan which expires in April 2008. The maximum potential amount of future payments (undiscounted) that the Company could be required to make under this obligation is limited to the amount outstanding under the Credit Facility at the time of default (subject to pre-determined lending limits based on the value of the underlying inventory) and, as such, is not an estimate of future cash flows. No specific recourse or collateral provisions exist that would enable recovery of any portion of amounts paid under this obligation, except to the extent that the Company maintains the right to take title to the repurchased inventory. Management anticipates that the repurchased inventory could subsequently be sold through the Company’s retail store network. As of December 31, 2004, the amount outstanding under the Credit Facility totaled approximately $0.8 million, of which $0.6 million was outstanding under the revolving credit line. Management expects that, based on the underlying creditworthiness of the respective retailer, this obligation will expire without requiring funding by the Company. However, in accordance with the provisions of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, a liability has been established to reflect the Company’s non-contingent obligation under this arrangement as a result of modifications made to the Credit Facility subsequent to January 1, 2003. As of December 31, 2004, the carrying amount of such liability is less than $50,000.
Indemnification Agreement
In connection with the Company’s joint venture arrangement with United Kingdom-based MFI Furniture Group Plc., Ethan Allen Inc. has entered into a tax cross-indemnification agreement with the joint venture partner. The indemnification agreement stipulates that both parties agree to pay fifty percent of the amount of any tax liability arising as a result of (i) an adverse tax judgment or (ii) the imposition of additional taxes against either partner, and attributable to the operations of the joint venture. The indemnification agreement is effective until such time that the joint venture is terminated. At the present time, management anticipates that the joint venture will continue to operate for the foreseeable future.
The maximum potential amount of future payments (undiscounted) that the Company could be required to make under this indemnification agreement is indeterminable as no such tax liability currently exists. Further, the nature, extent and magnitude of any such tax liability arising in the future as a result of an adverse tax judgment or change in applicable tax law cannot be estimated with any reasonable certainty. It should be further noted that no recourse or collateral provisions exist that would enable recovery of any portion of amounts paid under this indemnification agreement. Management expects, based on its current understanding of the applicable tax laws and the existing legal structure of the joint venture, subject to future changes in applicable laws and
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regulations, this cross-indemnity agreement will expire without requiring funding by the Company. Accordingly, as of December 31, 2004, the carrying amount of the liability related to this indemnification agreement is zero.
Product Warranties
The Company’s products, including its case goods, upholstery and home accents, generally carry explicit product warranties that extend from three to five years and are provided based on terms that are generally accepted in the industry. All of the Company’s domestic independent retailers are required to enter into, and perform in accordance with the terms and conditions of, a warranty service agreement. The Company records provisions for estimated warranty and other related costs at time of sale based on historical warranty loss experience and makes periodic adjustments to those provisions to reflect actual experience. On rare occasion, 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 the Company’s historical experience. The Company provides for such warranty issues as they become known and are deemed to be 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 the Company’s historical experience. As of December 31, 2004, the Company’s product warranty liability totaled $1.5 million.
On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law. The Company is currently reviewing the provisions of the Act in order to determine the impact, if any, on the Company’s consolidated financial condition, results of operations, and cash flows. See Note 13 to the Company’s Consolidated Financial Statements for the three and six months ended December 31, 2004 and 2003.
During the last twelve months, encouraging signs were noted which appeared to indicate that improved levels of consumer confidence and a strengthening of the economy were emerging and were, for the most part, sustainable. More specifically, within the last six months, the U.S. economy appears to have benefited from positive employment trends and an interest rate environment which continues to be favorable. As such, we continue to believe that the business outlook for the Company is promising.
With the uncertainty surrounding the recent Presidential election now resolved, we believe that further economic growth is likely. A combination of the aforementioned factors over the course of the past year appears to have had some degree of positive effect on consumer spending habits, as is reflected in the Company’s incoming order trends noted during much of that time. We anticipate that consumer confidence and discretionary spending will return to the levels noted during the fourth quarter of calendar year 2003 and the first quarter of calendar year 2004. If these apparent signs of economic recovery continue and, again, prove to be sustainable, we believe the longer-term outlook is promising as well.
As the economy strengthens, however, it is also possible that costs associated with production (including raw materials and labor), distribution (including freight and fuel charges), and retail operations (including compensation, delivery and warehousing, occupancy and advertising expenses) may increase. Similarly, continued increases in interest rates and crude oil prices could serve to adversely impact the level of discretionary spending on the part of consumers. We cannot reasonably predict when, or to what extent, such events may occur or what effect, if any, such events may have on the Company’s consolidated financial condition or results of operations.
We continue to believe that there is considerable interest on the part of consumers to invest in their homes. We also believe that this interest has, until recently, been restrained by such factors as high unemployment, sluggish consumer confidence levels and the fact that many home buyers stretched themselves financially to purchase as much home
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as possible, taking advantage of the historically low rate environment. As the economy improves and this interest in home decorating continues to emerge, as we anticipate it will, we believe we will be well positioned to take advantage of the long-awaited increase in demand as a result of (i) our established brand, (ii) our comprehensive complement of home decorating solutions, and (iii) our vertically-integrated business model.
The industry, however, remains extremely competitive with domestic manufacturers now facing increased pricing pressure as a result of the continued development of manufacturing capabilities in other countries, specifically within Asia. In response to these pressures, The American Furniture Manufacturers Committee for Legal Trade (the “Committee”) filed, in July 2003, an anti-dumping petition with the U.S. Department of Commerce (“DOC”) and the International Trade Commission (“ITC”) seeking tariff protection, for U.S. manufacturers, on wooden bedroom furniture imported from China. In December 2004, upon completion of an eighteen month investigation into the matter, the DOC announced its final, amended anti-dumping margins on the subject merchandise. This followed an affirmative vote from the ITC that imports of Chinese wooden bedroom furniture have resulted in material injury to the U.S. furniture manufacturing industry, allowing the DOC to issue an anti-dumping order and instructing U.S. Customs and Border Protection to collect cash deposits on entries of the subject merchandise at the applicable dumping duty rate.
As a result of the DOC final ruling, one of Ethan Allen’s suppliers was assigned a tariff rate of 6.65% while the other was assigned a “de-minimis” rate of 0.83%. Companies assigned a “de-minimis” dumping margin (i.e. any rate <2%) will not have duties applied to their products. The Company currently estimates that less than 5% of wholesale revenues are generated by sales of wooden bedroom furniture produced in China. As such, the Company believes that the tariffs imposed on wooden bedroom furniture imported from China will not have a material adverse effect on its consolidated financial condition or results of operations.
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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
The Company is exposed to interest rate risk primarily through its borrowing activities. The Company’s policy has been to utilize United States dollar denominated borrowings to fund its 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 the Company’s future financing requirements. As of December 31, 2004, the Company has no debt instruments outstanding with variable interest rates.
The Company’s exposure to foreign currency exchange risk is primarily limited to its operation of five Ethan Allen-owned retail stores located in Canada 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 the Company’s consolidated results of operations.
Currently, the Company does not enter into financial instrument transactions for trading or other speculative purposes or to manage interest rate or currency exposure.
Ethan Allen’s management, including the Chairman of the Board and Chief Executive Officer (“CEO”) and the Vice President-Finance (“VPF”), conducted an evaluation of the effectiveness of 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 VPF have concluded that, as of December 31, 2004, the Company’s disclosure controls and procedures are effective in ensuring that material information relating to the Company (including its consolidated subsidiaries), which is required to be included in the Company’s periodic filings under the Exchange Act, has been made known to them in a timely manner.
There have been no changes in the Company’s 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 Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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There has been no material change to the matters discussed in Part I, Item 3 — Legal Proceedings in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on September 10, 2004.
Issuer Purchases of Equity Securities
Certain information regarding purchases made by or on behalf of the Company or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended) of our common stock during the three months ended December 31, 2004 is provided below:
None.
The Annual Meeting of Shareholders of Ethan Allen Interiors Inc. was held on November 16, 2004. Proxies for The Annual Meeting of Shareholders were solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934, as amended; there was no solicitation in opposition to the nominees for the Board of Directors as listed in the proxy statement; and such nominees were elected.
A brief description of each matter voted upon at the Annual Meeting, and the results of the voting, are as follows:
1. Election of Directors to serve for a term expiring in 2007:
2. Election/Ratification of Directors to serve for a term expiring in 2006:
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ETHAN ALLEN INTERIORS INC.(Registrant)
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