Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - ETHAN ALLEN INTERIORS INCex_184243.htm
EX-32.1 - EXHIBIT 32.1 - ETHAN ALLEN INTERIORS INCex_184242.htm
EX-31.2 - EXHIBIT 31.2 - ETHAN ALLEN INTERIORS INCex_184241.htm
EX-31.1 - EXHIBIT 31.1 - ETHAN ALLEN INTERIORS INCex_184240.htm
 

 

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 March 31, 2020

 

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 May 8, 2020 was 25,053,082.

 

 

 

 

Ethan Allen Interiors Inc.

Form 10-Q Third Quarter of Fiscal 2020

 

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

    20  
         

Item 3. Quantitative and Qualitative Disclosures About Market Risk

    34  
         

Item 4. Controls and Procedures

    35  
         

PART II - OTHER INFORMATION

       
         

Item 1. Legal Proceedings

    36  
         

Item 1A. Risk Factors

    36  
         

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

    38  
         

Item 3. Defaults Upon Senior Securities

    38  
         

Item 4. Mine Safety Disclosures

    38  
         

Item 5. Other Information

    38  
         

Item 6. Exhibits

    39  
         

SIGNATURES

    39  

 

1

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets (Unaudited)

(In thousands, except par value)

 

   

March 31, 2020

   

June 30, 2019

 

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 116,868     $ 20,824  

Accounts receivable, net

    10,482       14,247  

Inventories, net

    138,774       162,389  

Prepaid expenses and other current assets

    21,204       18,830  

Total current assets

    287,328       216,290  

Property, plant and equipment, net

    242,490       245,246  

Goodwill

    25,388       25,388  

Intangible assets

    19,740       19,740  

Operating lease right-of-use assets

    124,636       -  

Deferred income taxes

    2,044       2,108  

Other assets

    1,478       1,579  

Total ASSETS

  $ 703,104     $ 510,351  

LIABILITIES AND SHAREHOLDERS' EQUITY

               

Current liabilities:

               

Accounts payable and accrued expenses

  $ 30,997     $ 34,166  

Customer deposits and deferred revenue

    52,410       56,714  

Accrued compensation and benefits

    20,065       22,646  

Short-term debt

    -       550  

Current operating lease liabilities

    34,005       -  

Other current liabilities

    9,386       8,750  

Total current liabilities

    146,863       122,826  

Long-term debt

    100,000       516  

Operating lease liabilities, long-term

    112,515       -  

Deferred income taxes

    1,534       1,069  

Other long-term liabilities

    2,946       22,011  

Total LIABILITIES

  $ 363,858     $ 146,422  

Commitments and contingencies (see Note 15)

               

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; 25,053 and 26,587 shares outstanding at March 31, 2020 and June 30, 2019, respectively

    491       491  

Additional paid-in capital

    378,166       377,913  

Treasury stock, at cost: 24,001 and 22,462 shares at March 31, 2020 and June 30, 2019, respectively

    (680,916 )     (656,597 )

Retained earnings

    650,701       647,710  

Accumulated other comprehensive loss

    (9,218 )     (5,651 )

Total Ethan Allen Interiors Inc. shareholders' equity

    339,224       363,866  

Noncontrolling interests

    22       63  

Total shareholders' equity

    339,246       363,929  

Total LIABILITIES AND SHAREHOLDERS' EQUITY

  $ 703,104     $ 510,351  

 

See accompanying notes to consolidated financial statements.

 

2

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income (Unaudited)

(In thousands, except per share data)

 

   

Three months ended

   

Nine months ended

 
   

March 31,

   

March 31,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales

  $ 149,774     $ 177,829     $ 498,269     $ 562,766  

Cost of sales

    65,825       79,435       223,005       254,062  

Gross profit

    83,949       98,394       275,264       308,704  
                                 

Selling, general and administrative expenses

    83,841       87,504       258,346       269,824  

Restructuring and other impairment charges, net of gains (note 10)

    862       221       (10,173 )     284  

Operating income (loss)

    (754 )     10,669       27,091       38,596  

Interest income, net of interest (expense)

    213       (62 )     295       63  

Income (loss) before income taxes

    (541 )     10,607       27,386       38,659  

Income tax expense (benefit)

    (318 )     2,629       6,417       9,651  

Net income (loss)

  $ (223 )   $ 7,978     $ 20,969     $ 29,008  
                                 

Per share data

                               

Basic earnings per common share:

                               

Net income (loss) per basic share

  $ (0.01 )   $ 0.30     $ 0.80     $ 1.09  

Basic weighted average common shares

    25,703       26,705       26,332       26,690  

Diluted earnings per common share:

                               

Net income (loss) per diluted share

  $ (0.01 )   $ 0.30     $ 0.80     $ 1.08  

Diluted weighted average common shares

    25,703       26,751       26,362       26,749  
                                 

Comprehensive income (loss)

                               

Net income (loss)

  $ (223 )   $ 7,978     $ 20,969     $ 29,008  

Other comprehensive income (loss), net of tax

                               

Foreign currency translation adjustments

    (3,841 )     303       (3,567 )     355  

Other

    (15 )     (20 )     (41 )     (65 )

Other comprehensive income (loss), net of tax

    (3,856 )     283       (3,608 )     290  

Comprehensive income (loss)

  $ (4,079 )   $ 8,261     $ 17,361     $ 29,298  

 

See accompanying notes to consolidated financial statements.

 

3

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

 

   

Nine months ended

 
   

March 31,

 

 

 

2020

   

2019

 
Cash Flows from Operating Activities                

Net income

  $ 20,969     $ 29,008  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    12,845       14,742  

Share-based compensation expense

    200       986  

Non-cash operating lease cost

    24,369       -  

Deferred income taxes

    1,077       (390 )

Restructuring and other impairment charges, net of gains

    (5,647 )     284  

Restructuring payments

    (5,574 )     (177 )

Loss on disposal of property, plant and equipment

    191       134  

Other

    (13 )     (16 )

Change in operating assets and liabilities, net of effects of acquisitions:

               

Accounts receivable, net

    3,630       (3,474 )

Inventories, net

    21,567       (1,613 )

Prepaid expenses and other current assets

    (1,980 )     (1,290 )

Customer deposits and deferred revenue

    (4,914 )     1,145  

Accounts payable and accrued expenses

    (3,428 )     (510 )

Accrued compensation and benefits

    429       4,414  

Operating lease liabilities

    (24,411 )     -  

Other assets and liabilities

    (626 )     1,064  

Net cash provided by operating activities

    38,684       44,307  
                 

Cash Flows from Investing Activities

               

Proceeds from disposal of property, plant and equipment

    12,423       1  

Capital expenditures

    (12,457 )     (6,990 )

Acquisitions, net of cash acquired

    (1,350 )     -  

Other investing activities

    20       124  

Net cash used in investing activities

    (1,364 )     (6,865 )
                 

Cash Flows from Financing Activities

               

Borrowings on revolving credit facility

    100,000       16,000  

Payments on borrowings

    -       (8,000 )

Payment of cash dividends

    (16,181 )     (41,916 )

Repurchases of common stock

    (24,319 )     -  

Other financing activities

    (369 )     (190 )

Net cash provided by (used in) financing activities

    59,131       (34,106 )
                 

Effect of exchange rate changes on cash and cash equivalents

    (407 )     43  
                 

Net increase in cash and cash equivalents

    96,044       3,379  

Cash and cash equivalents at beginning of period

    20,824       22,363  

Cash and cash equivalents at end of period

  $ 116,868     $ 25,742  

 

See accompanying notes to consolidated financial statements.

 

4

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

Consolidated Statements of Shareholders’ Equity (Unaudited)

 (In thousands)

 

Fiscal 2020

                                           

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)

    -                                                                  

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)

    -                                                                  

Balance at December 31, 2019

    49,054     $ 491     $ 378,089       23,008     $ (666,626 )   $ (5,377 )   $ 656,211     $ 37     $ 362,825  

Net loss

    -       -       -       -       -       -       (223 )     -       (223 )

Share-based compensation expense

    -       -       77       -       -       -       -       -       77  

Cash dividends declared

    -       -       -       -       -       -       (5,287 )     -       (5,287 )

Repurchase of common stock

    -       -       -       993       (14,290 )     -       -       -       (14,290 )

Other comprehensive income (loss)

    -       -       -       -       -       (3,841 )     -       (15 )     (3,856 )

Balance at March 31, 2020

    49,054     $ 491     $ 378,166       24,001     $ (680,916 )   $ (9,218 )   $ 650,701     $ 22     $ 339,246  

 

Fiscal 2019

                                           

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)

    -                                                                  

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)

    -                                                                  

Balance at December 31, 2018

    49,038     $ 490     $ 378,558       22,460     $ (656,551 )   $ (6,119 )   $ 653,193     $ 94     $ 369,665  

Net income

    -       -       -       -       -       -       7,978       -       7,978  

Common stock issued on share-based awards

    2       -       19       -       -       -       -       -       19  

Share-based compensation expense

    -       -       179       -       -       -       -       -       179  

Cash dividends declared

    -       -       -       -       -       -       (5,075 )     -       (5,075 )

Other comprehensive income (loss)

    -       -       -       -       -       303       -       (20 )     283  

Balance at March 31, 2019

    49,039     $ 490     $ 378,756       22,460     $ (656,551 )   $ (5,816 )   $ 656,096     $ 74     $ 373,049  

 

See accompanying notes to consolidated financial statements.

 

5

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements (Unaudited)

 

 

 

(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 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 nine months ended March 31, 2020 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.

 

6

 

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 7 for further details on new disclosures required under ASU 2016-02.

 

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. The Company early adopted ASU 2017-04 during fiscal 2020.

 

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.

 

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. 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.

 

Reference Rate Reform on Financial Reporting In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, an update that provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. This accounting standards update is intended to ease the process of migrating away from LIBOR to new reference rates and will be effective for us beginning in the first quarter of fiscal 2021. 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 March 31, 2020 have had or are expected to have an impact on our consolidated financial statements.

 

7

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

 

(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.

 

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 March 31, 2020 and June 30, 2019, these amounts were immaterial.

 

We capitalize commission fees paid to our associates as contract assets within Prepaid expenses and other current assets on our consolidated balance sheets. These prepaid commissions are subsequently recognized as a selling expense upon delivery (when we have transferred control of our product to our customer). At March 31, 2020, we had prepaid commissions of $7.1 million, which we expect to recognize to selling expense in the next six months. Prepaid commissions totaled $8.0 million at June 30, 2019.

 

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 $1.1 million and $54.7 million, respectively, as net sales upon delivery to the customer during the three and nine months ended March 31, 2020. Customer deposits totaled $50.2 million at March 31, 2020.

 

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 March 31, 2020 (in thousands):

 

   

Wholesale

   

Retail

   

Total

 

Upholstery(1)

  $ 47,214     $ 54,791     $ 102,005  

Case goods(2)

    30,096       31,822       61,918  

Accents(3)

    16,942       25,849       42,791  

Other(4)

    (1,113 )     3,236       2,123  

Total before intercompany eliminations

  $ 93,139     $ 115,698       208,837  

Intercompany eliminations(5)

                    (59,063 )

Consolidated net sales

                  $ 149,774  

 

8

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

The following table disaggregates net sales by product category by segment for the nine months ended March 31, 2020 (in thousands):

 

   

Wholesale

   

Retail

   

Total

 

Upholstery(1)

  $ 141,563     $ 181,723     $ 323,286  

Case goods(2)

    95,922       110,465       206,387  

Accents(3)

    51,109       86,078       137,187  

Other(4)

    (2,237 )     13,799       11,562  

Total before intercompany eliminations

  $ 286,357     $ 392,065       678,422  

Intercompany eliminations(5)

                    (180,153 )

Consolidated net sales

                  $ 498,269  

 

 

(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.

 

 

(5)

Inventories

 

Inventories are stated at the lower of cost (on a 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 March 31, 2020 and June 30, 2019 are summarized as follows (in thousands):

 

   

March 31,

   

June 30,

 
   

2020

   

2019

 

Finished goods

  $ 105,678     $ 128,047  

Work in process

    10,467       9,185  

Raw materials

    24,237       26,661  

Inventory reserves

    (1,608 )     (1,504 )

Inventories, net

  $ 138,774     $ 162,389  

 

 

 

(6)

Goodwill and Other Intangible Assets

 

Our goodwill and intangible assets are comprised of goodwill, which represents the excess of cost over the fair value of net assets acquired, and our Ethan Allen trade name and related trademarks. Both goodwill and indefinite-lived intangible assets are not amortized as they are estimated to have an indefinite life.

 

We are required to test goodwill and indefinite-lived intangibles at the reporting level for potential impairment annually, or more frequently if impairment indicators occur. Goodwill and other indefinite-lived intangible assets are evaluated for impairment on an annual basis during the fourth quarter of each fiscal year, and between annual tests whenever events or circumstances indicate that the carrying value of the goodwill or other intangible asset may exceed its fair value.

 

In the fiscal third quarter ended March 31, 2020, wholesale net sales declined 14.1% and there was a meaningful decline (46.4%) in our stock price from the fiscal second quarter to the third quarter (from $19.06 to $10.22). This decline coupled with the significant adverse changes in the business climate from the COVID-19 health crisis, led us to determine that an impairment triggering event occurred, which required an interim quantitative impairment assessment of goodwill and intangible assets. Based on the Company’s interim quantitative assessment performed as of March 31, 2020, the fair value of the wholesale reporting unit exceeded its related carrying value by approximately 25%, thus no impairment of goodwill as of March 31, 2020.

 

9

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

The fair value of our trade name, which is the Company’s only indefinite-lived intangible asset other than goodwill, was also reviewed as of March 31, 2020 for impairment. We performed the interim trade name impairment test and concluded that its fair value substantially exceeded the carrying value as of March 31, 2020, thus no impairment.

 

As of March 31, 2020, the goodwill balance was $25.4 million, while other indefinite-lived intangible assets totaled $19.7 million. If the market valuation of our common shares or operating results within the wholesale reporting unit significantly decline beyond current levels, we may again need to conduct an evaluation of the fair value of our goodwill and trade name, which may result in an impairment charge.  

 

 

 

(7)

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 relate to how the Company determines the discount rate to discount the unpaid lease payments to present value and the lease term.

 

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.

 

10

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

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

 

   

March 31, 2020

 

Weighted-average remaining lease term (in years)

       

Operating leases

    6.7  

Financing leases

    1.7  

Weighted-average discount rate

       

Operating leases

    3.8

%

Financing leases

    4.4

%

 

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

 

   

Statement of Comprehensive Income Location

 

Three months ended

March 31, 2020

   

Nine months ended

March 31, 2020

 

Operating lease cost

 

Selling, general and administrative (“SG&A”)

  $ 8,178     $ 24,369  

Financing lease cost:

                   

Depreciation of property

 

SG&A

    152       445  

Interest on lease liabilities

 

Interest income, net of interest (expense)

    8       25  

Short-term lease cost

 

SG&A

    280       1,022  

Variable lease cost(1)

 

SG&A

    2,333       7,169  

Less: Sublease income

 

SG&A

    (486 )     (1,588 )

Total lease expense

  $ 10,465     $ 31,442  

 

 

(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 March 31, 2019, as reported within SG&A, was $8.2 million, net of sublease rental income of $0.5 million. For the nine months ended March 31, 2019, operating lease rent expense was $24.2 million, net of sublease rental income of $1.5 million.

 

The following table discloses the operating and financing lease assets and liabilities recognized within our consolidated balance sheet as of March 31, 2020 (in thousands):

 

 

Consolidated Balance Sheet Location

 

March 31, 2020

 

Assets

         

Operating leases

Operating lease right-of-use assets (non-current)

  $ 124,636  

Financing leases

Property, plant and equipment, net

    741  

Total lease assets

    $ 125,377  
           

Liabilities

         

Current:

         

Operating leases

Current operating lease liabilities

  $ 34,005  

Financing leases

Other current liabilities

    604  

Noncurrent:

         

Operating leases

Operating lease liabilities, long-term

    112,515  

Financing leases

Other long-term liabilities

    127  

Total lease liabilities

    $ 147,251  

 

11

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

The ROU assets by segment are as follows as of March 31, 2020 (in thousands):

 

Retail

  $ 124,694  

Wholesale

    683  

Total ROU assets

  $ 125,377  

 

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 March 31, 2020 (in thousands):

 

Fiscal Year

 

Operating Leases

   

Financing Leases

 

2020 (remaining three months)

  $ 8,910     $ 151  

2021

    33,424       459  

2022

    29,082       78  

2023

    22,936       39  

2024

    17,875       19  

Thereafter

    55,783       8  

Total undiscounted future minimum lease payments

    168,010       754  

Less: imputed interest

    (21,490 )     (23 )

Total present value of lease obligations

  $ 146,520     $ 731  

 

As of March 31, 2020, we have entered into one additional operating lease for a design center relocation, which has not yet commenced and is therefore not part of the table above nor included in the lease right-of-use assets and liabilities. The lease will commence when we obtain possession of the underlying leased asset which is expected to be during the first half of fiscal 2021. The lease is for a period of ten years and has aggregate undiscounted future rent payments of $3.2 million.

 

At March 31, 2020, we did not have any financing leases that had not commenced.

 

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

   

Nine months ended

March 31, 2020

 

Cash paid for amounts included in the measurement of lease liabilities:

       

Operating cash flows from operating leases

  $ 24,411  

Operating cash flows from financing leases

  $ 422  

Operating lease assets obtained in exchange for new operating lease liabilities

  $ 16,333  

 

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):

 

Fiscal Year

 

Operating Leases

   

Financing Leases (1)

2020

  $ 33,761     $ 550  

2021

    30,534       437  

2022

    26,443       60  

2023

    20,276       19  

2024

    15,345       -  

Thereafter

    43,500       -  

Total

  $ 169,859     $ 1,066  

 

(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.

 

12

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES 

 

 

 

(8)

Income Taxes

 

We review our 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. We identify 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, our consolidated effective income tax rate can change significantly quarter over quarter.

 

We conduct business globally and, as a result, we file income tax returns in the United States and in various state and foreign jurisdictions. In the normal course of business, we are subject to periodic examination in such domestic and foreign jurisdictions by tax authorities. We are currently under audit in the United States for fiscal 2016 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.

 

Our consolidated effective tax rate was 58.8% and 23.4% respectively, for the three and nine months ended March 31, 2020 compared with 24.8% and 25.0% in the prior year periods. Our effective tax rate varies from the 21% federal statutory rate due to state taxes and other nonrecurring events that may not be predictable.

 

 

(9)

Debt

 

Total debt obligations at March 31, 2020 and June 30, 2019 consist of the following (in thousands):

 

   

March 31,

   

June 30,

 
   

2020

   

2019

 
                 

Borrowings under revolving credit facility

  $ 100,000     $ -  

Capital leases (1)

    -       1,066  

Total debt

    100,000       1,066  

Less current maturities

    -       550  

Total long-term debt

  $ 100,000     $ 516  

 

 

 

(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 7 for further details regarding capital lease obligations.

 

Credit Agreement

 

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 “Credit Agreement”) with JPMorgan Chase Bank, N.A. as administrative agent and syndication agent and Capital One, National Association, as documentation agent. The Credit Agreement provides for a $165 million revolving credit facility (the “Facility”), subject to borrowing base availability, with the maturity date of December 21, 2023. We incurred financing costs of $0.6 million, 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.

 

13

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Borrowings under the Facility

 

On March 23, 2020, we provided notice to the administrative agent under the Credit Agreement to borrow a principal amount of $80 million under the Facility. Subsequently, on March 30, 2020, we borrowed an additional $20 million, bringing our aggregate borrowings to $100 million under the Facility as of March 31, 2020. Prior to such notice, there were no borrowings outstanding under the Facility. The borrowings bear a weighted average interest rate equal to the one-month LIBOR rate of 0.95% plus a spread using a debt leverage pricing grid, currently at 1.50%. Interest on the borrowings outstanding is payable monthly in arrears and the principal balance is payable on the maturity date of December 21, 2023. We elected to draw down on the Facility to increase our cash position as a precautionary measure and to preserve financial flexibility in consideration of the disruption and uncertainty surrounding the ongoing COVID-19 pandemic.

 

The outstanding borrowings of $100 million are reported as Long-term debt within the consolidated balance sheet at March 31, 2020. For the nine months ended March 31, 2020 and 2019, we recorded interest expense of $0.2 million and $0.3 million, respectively, on our outstanding debt.

 

The fair value of our long-term debt was $100 million as of March 31, 2020, which we believe approximates the carrying amount as the terms and interest rate approximate market rates given its floating interest rate basis.

 

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 March 31, 2020 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 $23.9 million at March 31, 2020 and $158.9 million at June 30, 2019. At both March 31, 2020 and June 30, 2019, we were in compliance with all the covenants under the Facility.

 

 

(10)

Restructuring and Other Impairment Activities

 

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

 

Restructuring, impairment and other related costs incurred during the three and nine months ended March 31, 2020 were as follows (in thousands):

 

   

Three months ended

   

Nine months ended

   
   

March 31, 2020

   

March 31, 2020

   

Optimization of manufacturing and logistics

  $ 368     $ 829    

Gain on sale of Passaic property

    -       (11,497 )  

Impairment of long-lived assets (retail)

    389       389    

Other charges

    105       106    

Total Restructuring and other impairment charges, net of gains

  $ 862     $ (10,173 )  

Manufacturing overhead costs

    (5 )     1,318    (1)

Inventory write-downs

    -       3,208    (1)

Total

  $ 857     $ (5,647 )  

 

(1)

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

 

14

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Restructuring and Other Related Charges Rollforward

 

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

 

   

Balance

   

Fiscal 2020 Activity

   

Balance

 

Optimization of Manufacturing and Logistics

 

June 30, 2019

   

New Charges (Income)

   

Non-Cash

   

(Payments) Receipts

   

March 31, 2020

 

Employee severance, other payroll and benefit costs

  $ 1,714     $ 777     $ 23     $ (2,468 )   $ -  

Manufacturing overhead costs

    -       1,318       -       (1,318 )     -  

Sale of Passaic property

    -       (11,497 )     245       11,742       -  

Sale of other property, plant and equipment

    -       (675 )     -       675       -  

Other exit costs

    -       727       (523 )     (1,250 )     -  

Sub-total

  $ 1,714     $ (9,350 )   $ (255 )   $ 7,381     $ -  
                                         

Other Restructuring and Impairment Charges

                                       

Inventory write-downs

  $ -     $ 3,208     $ 3,208     $ -     $ -  

Impairment of long-lived assets (retail)

    -       389       389       -       -  

Lease exit costs (remaining lease rentals)

    3,145       -       2,878       (267 )     -

 (1)

Other charges (income)

    224       106       -       (271 )     59

 (2)

Sub-total

  $ 3,369     $ 3,703     $ 6,475     $ (538 )   $ 59  
                                         

Total Restructuring, Impairments and other exit costs

  $ 5,083     $ (5,647 )   $ 6,220     $ 6,843     $ 59  

 

(1)

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.

 

(2)

The remaining balance from the other charges (income) as of March 31, 2020 is recorded within Accounts payable and accrued expenses.

 

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.

 

We completed this optimization project in fiscal 2020 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 these initiatives, we recorded pre-tax restructuring and other exit charges totaling $2.1 million, consisting of $1.3 million in abnormal manufacturing variances associated with the Passaic and Old Fort facilities, $0.8 million in employee severance and other payroll and benefit costs and $0.7 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 other impairment charges, net of 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 other impairment charges, net of 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.

 

15

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES 

 

 

 

(11)

Share-Based Compensation

 

During the nine months ended March 31, 2020 and 2019, we recognized total share-based compensation expense of $0.2 million and $1.0 million, respectively. These amounts have been included in the consolidated statements of comprehensive income within selling, general and administrative expenses. As of March 31, 2020, $1.2 million of total unrecognized compensation expense related to non-vested equity awards is expected to be recognized over a weighted average period of 2.8 years. There was no share-based compensation capitalized for the nine months ended March 31, 2020 and 2019, respectively.

 

At March 31, 2020, there were 1,394,808 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.

 

Stock Option Activity

 

A summary of stock option activity during the nine months ended March 31, 2020 is presented below.

 

           

Weighted

 
           

Average

 
   

Options

   

Exercise Price

 

Outstanding at June 30, 2019

    378,911     $ 21.95  

Granted

    59,188     $ 17.27  

Exercised

    (4,500 )   $ 11.74  

Canceled (forfeited/expired)

    (23,495 )   $ 23.30  

Outstanding at March 31, 2020

    410,104     $ 21.31  

Exercisable at March 31, 2020

    314,151     $ 21.56  

 

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

 

   

FY 2020

 

Volatility

    30.8 %

Risk-free rate of return

    1.62 %

Dividend yield

    4.42 %

Expected average life (years)

    5.9  

 

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.

 

   

FY 2020

   

FY 2019

 

Volatility

    30.8 %     31.3 %

Risk-free rate of return

    1.55 %     2.80 %

Dividend yield

    3.97 %     3.24 %

Expected average life (years)

    5.3       5.0  

 

Restricted Stock Unit Activity

 

A summary of restricted stock unit activity during the nine months ended March 31, 2020 is presented below.

 

           

Weighted

 
   

Restricted
Stock Units

   

Average

Fair Value

 
                 

Outstanding at June 30, 2019

    -     $ -  

Granted

    57,000     $ 9.15  

Vested

    -     $ -  

Canceled (forfeited/expired)

    -     $ -  

Outstanding at March 31, 2020

    57,000     $ 9.15  

 

16

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

During the third quarter of fiscal 2020, we granted 57,000 non-performance based restricted stock units ("RSUs"), with a weighted average grant date fair value of $9.15. The RSUs granted to employees entitle the holder to receive the underlying shares of common stock as the unit vests over the relevant vesting period. The RSUs do not entitle the holder to receive dividends declared on the underlying shares while the RSUs remain unvested. We account for these RSUs as equity-based awards because when they vest, they will be settled in shares of our common stock. The grant date fair value of RSUs is measured by reducing the grant date price of the Company's common stock by the present value of the dividends expected to be paid on the underlying stock during the requisite service period, discounted at the appropriate risk-free interest rate. The RSUs vest 25% annually on the anniversary date of grant and become fully vested after four years. There were no RSUs granted to employees during fiscal 2019.

 

Performance Stock Units

 

A summary of performance units activity during the nine months ended March 31, 2020 is presented below.

 

           

Weighted Average

 
   

Units

   

Grant Date Fair Value

 

Outstanding at June 30, 2019

    313,882     $ 22.80  

Granted

    99,405     $ 12.72  

Vested

    -     $ -  

Canceled (forfeited/expired)

    -     $ -  

Outstanding at March 31, 2020

    413,287     $ 20.37  

 

During the first quarter of fiscal 2020, we granted 99,405 performance-based units. Payout of these units depends on our financial performance (80%) and a market-based condition based on the total return our shareholders receive on their investment in our stock relative to returns earned through investments in other public companies (20%) over a specific performance period of three years. We estimate, as of the date of grant, the fair value of performance 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.

 

   

FY 2020

   

FY 2019

 

Volatility

    30.5 %     32.1 %

Risk-free rate of return

    1.72 %     2.72 %

Dividend yield

    3.97 %     3.24 %

Expected average life (years)

    3.0       3.0  

 

 

(12)

Earnings Per Share

 

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

 

   

Three months ended

   

Nine months ended

 
   

March 31,

   

March 31,

 
   

2020

   

2019

   

2020

   

2019

 

Weighted average shares outstanding for basic calculation

    25,703       26,705       26,332       26,690  

Dilutive effect of stock options and other share-based awards

    -       46       30       59  

Weighted average shares outstanding adjusted for dilution calculation

    25,703       26,751       26,362       26,749  

 

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

 

As of March 31, 2020 and 2019, stock options and restricted stock unit awards of 467,104 and 260,571, respectively, were excluded from the diluted EPS calculations because their inclusion would have been anti-dilutive.

 

As of March 31, 2020 and 2019, the number of performance units excluded from the calculation of diluted EPS was 287,287 and 269,138, respectively. Performance units are excluded from the calculation of diluted EPS unless the performance criteria are probable of being achieved as of the balance sheet date.

 

17

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Share Repurchase Program

 

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. We repurchased 992,636 shares for $14.3 million during the third quarter of fiscal 2020. There were no share repurchases in the year ago third quarter. As of March 31, 2020, 2,007,364 remains available under the current authorization for future share repurchases. 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 was temporarily suspended on April 1, 2020 as part of the Company’s action plan in response to COVID-19.

 

 

(13)

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 March 31, 2020 and 2019 (in thousands).

 

   

2020

   

2019

 

Beginning balance at July 1

  $ (5,651 )   $ (6,171 )

Other comprehensive income (loss), net of tax

    (3,608 )     290  

Less AOCI attributable to noncontrolling interests

    41       65  

Ending balance at March 31

  $ (9,218 )   $ (5,816 )

 

 

(14)

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. 

 

As of March 31, 2020, the Company operated 144 design centers (our retail segment) and our independent retailers operated 159 design centers. Our wholesale segment net sales include sales to our retail segment, which are eliminated in consolidation, and sales to our independent retailers and other third parties. Our retail segment net sales accounted for 79% of our consolidated net sales in the nine months ended March 31, 2020. Our wholesale segment net sales accounted for the remaining 21%.

 

Segment information for the three and nine months ended March 31, 2020 and 2019 is provided below (in thousands):

 

   

Three months ended

   

Nine months ended

 
   

March 31,

   

March 31,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales

                               

Wholesale segment

  $ 93,139     $ 108,367     $ 286,357     $ 334,097  

Retail segment

    115,698       138,947       392,065       442,669  

Elimination of intercompany sales

    (59,063 )     (69,485 )     (180,153 )     (214,000 )

Consolidated Total

  $ 149,774     $ 177,829     $ 498,269     $ 562,766  
                                 

Income (loss) before income taxes

                               

Wholesale segment

  $ 8,936     $ 13,045     $ 31,594     $ 36,181  

Retail segment

    (8,772 )     (1,669 )     (7,343 )     83  

Elimination of intercompany profit (a)

    (918 )     (707 )     2,840       2,332  

Operating income (loss)

    (754 )     10,669       27,091       38,596  

Interest income, net of interest (expense)

    213       (62 )     295       63  

Consolidated Total

  $ (541 )   $ 10,607     $ 27,386     $ 38,659  
                                 

Depreciation and amortization

                               

Wholesale segment

  $ 1,748     $ 1,914     $ 5,388     $ 5,771  

Retail segment

    2,667       2,903       7,457       8,971  

Consolidated Total

  $ 4,415     $ 4,817     $ 12,845     $ 14,742  
                                 

Capital expenditures

                               

Wholesale segment

  $ 3,027     $ 726     $ 5,338     $ 2,407  

Retail segment

    1,512       1,310       7,119       4,583  

Consolidated Total

  $ 4,539     $ 2,036     $ 12,457     $ 6,990  

 

 

(a)

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

 

18

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

   

March 31,

   

June 30,

 

 

 

2020

   

2019

 
Total Assets                

Wholesale segment

  $ 316,974     $ 237,354  

Retail segment

    409,231       299,125  

Inventory profit elimination (a)

    (23,101 )     (26,128 )

Consolidated Total

  $ 703,104     $ 510,351  

 

 

(a)

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.

 

 

(15)      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.

 

The outcome of any matters pending against us is subject to future resolution, including the uncertainties of litigation. Based on information available at March 31, 2020, 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.

 

 

(16)

Subsequent Event

 

COVID-19 Update

 

On March 11, 2020, the World Health Organization declared the current COVID-19 outbreak to be a global pandemic. In response to this declaration and the rapid spread of COVID-19 within the United States, federal, state and local governments throughout the country have imposed varying degrees of restrictions on social and commercial activity to promote social distancing in an effort to slow the spread of the virus. These measures have begun to have a significant adverse impact on many sectors of the economy, including non-essential retail commerce.

 

On April 1, 2020 we announced our action plan in response to the COVID-19 health crisis including, among other things, the continued temporary closure of the Company’s design centers and most of our manufacturing facilities, the furlough of approximately 70% of our global workforce, the decision by the Company’s CEO to temporarily forego his salary through June 30, 2020, a temporary up to 40% reduction in salaries for all senior management and up to 20% for other salaried employees through June 30, 2020, a temporary reduction of 50% in cash compensation of the Company’s directors, the elimination of all non-essential operating expenses, a delay in discretionary capital expenditures and the temporary halt of the share repurchase program. We paid our furloughed associates through April 2, 2020 and impacted employees will continue to receive enrolled benefits for up to two months. Recently, at the quarterly Board of Directors meeting held on April 28, 2020, our Board temporarily suspended the Company’s regular quarterly cash dividend.

 

Customers can schedule appointments with our design consultants and interact with them through Live Chat online at www.ethanallen.com. Design consultants work remotely utilizing technology, including the Ethan Allen inHome augmented reality app, the 3D room planner tool, Skype and FaceTime. We continue to operate our www.ethanallen.com website and distribution centers to deliver products to our customers.

 

We continue to assess the situation on a daily basis; however, as of the date of this filing, we are unable to predict when and how quickly we will be able to resume full retail and manufacturing operations. We began reopening design centers in a number of U.S. states since May 1, 2020 and to increase production in some of our North American manufacturing plants. We look forward to reopening all of our design centers but expect that this situation will have a significant adverse effect on our reported results for fiscal 2020, including our fourth fiscal quarter, and possibly beyond.

 

While we expect the effects of COVID-19 to negatively impact our results of operations, cash flows and financial position, the current level of uncertainty over the economic and operational impacts of COVID-19 means the related financial impact cannot be reasonably estimated at this time. Our consolidated financial statements reflect estimates and assumptions made by management 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 reported amounts of revenue and expenses during the reporting periods presented. Such estimates and assumptions affect, among other things, long-lived asset and indefinite-lived intangible asset valuation; inventory valuation; valuation of deferred income taxes; and income tax contingencies. Events and changes in circumstances arising after March 31, 2020, including those resulting from the impacts of COVID-19, will be reflected in management’s estimates for future periods.

 

19

 

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

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

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results and should be read in conjunction with our 2019 Annual Report on Form 10-K, Current Reports on Form 8-K and other filings with the Securities and Exchange Commission (the “SEC”), and the consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q. Unless otherwise noted, all comparisons in the following discussion are from the three and nine month periods ended March 31, 2020 to the three and nine month periods in the prior year.

 

Our MD&A is presented in the following sections:

 

 

-

Forward-Looking Statements

 

-

Statement Regarding the Impact of COVID-19

 

-

Executive Overview

 

-

Key Operating Metrics

 

-

Results of Operations

 

-

Reconciliation of Non-GAAP Financial Measures

 

-

Liquidity

 

-

Capital Resources

 

-

Share Repurchase Program

 

-

Contractual Obligations

 

-

Dividends

 

-

Off-Balance Sheet Arrangements and Other Commitments and Contingencies

 

-

Foreign Currency

 

-

Significant Accounting Policies

  - Critical Accounting Estimates
 

-

Recent Accounting Pronouncements

 

-

Business Outlook

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q, including this MD&A, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors found in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industry in which we operate and the beliefs and assumptions of our management. Words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “will,” “may,” “continue,” “project,” ”target,” “outlook,” “forecast,” “guidance,” “COVID-19 impact,” variations of such words, and similar expressions and the negatives of such forward-looking words are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business, and other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are subject to management decisions and various assumptions about future events and are not guarantees of future performance. Actual results could differ materially from those anticipated in the forward-looking statements due to a number of risk factors and uncertainties including, but not limited to the following: volatile retail environment and changing economic conditions may further adversely affect consumer demand and spending; global and local economic uncertainty may materially adversely affect our manufacturing operations or sources of merchandise and international operations; disruptions of our supply chain; changes in United States trade and tax policy; competition from overseas manufacturers and domestic retailers; failure to successfully anticipate or respond to changes in consumer tastes and trends in a timely manner; our ability to maintain and enhance our brand; our number of manufacturing and logistics sites may increase our exposure to business disruptions and could result in higher transportation costs; fluctuations in the price, availability and quality of raw materials could result in increased costs or cause production delays; our current and former manufacturing and retail operations and products are subject to increasingly stringent environment, health and safety requirements; the use of emerging technologies as well as unanticipated changes in the pricing and other practices of competitors; reliance on information technology systems to process transactions, summarize results, and manage our business and that of certain independent retailers; disruptions in both our primary and back-up systems; product recalls or product safety concerns; successful cyber-attacks and the ability to maintain adequate cyber-security systems and procedures; loss, corruption and misappropriation of data and information relating to customers; loss of key personnel; additional asset impairment charges that could reduce our profitability; access to consumer credit could be interrupted as a result of conditions outside of our control; our ability to locate new design center sites and/or negotiate favorable lease terms for additional design centers or for the expansion of existing design centers; changes to fiscal and tax policies; our operations present hazards and risks which may not be fully covered by insurance; possible failure to protect our intellectual property; failure to successfully transition from a promotional to a membership model; potential risks and uncertainties relating to the duration, severity and geographic spread of the COVID-19 pandemic and its impact on our business, supplies, customers, employees and supply chains; actions that may be taken by governmental authorities to contain the COVID-19 pandemic or to mitigate its impact; the potential negative impact of COVID-19 on the global economy, consumer demand and the supply chain; the impact of COVID-19 upon our ability to reopen design centers and resume manufacturing operations and the resulting effects upon our financial condition, results of operations and liquidity; and other factors disclosed in Part I, Item 1A. Risk Factors in our 2019 Annual Report on Form 10-K, and elsewhere here in this Quarterly Report on Form 10-Q.

 

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

 

20

 

ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

 

 

Statement Regarding the Impact of COVID-19

 

On March 11, 2020, the World Health Organization declared the current COVID-19 outbreak to be a global pandemic. In response to this declaration and the rapid spread of COVID-19 within the United States, federal, state and local governments throughout the country have imposed varying degrees of restrictions on social and commercial activity to promote social distancing in an effort to slow the spread of the virus. These measures have begun and are expected to continue to have a significant adverse impact upon many sectors of the economy, including non-essential retail commerce, such as our business.

 

In response to these requirements and for the protection of our employees and customers, we implemented certain business continuity plans to ensure the ongoing availability of our services, while taking health and safety measures, including temporarily closures of our design centers and most of our manufacturing plants, implementing enhanced cleaning and hygiene protocols, and implementing remote work policies, where possible. The long-term impact of the COVID-19 pandemic remains uncertain and may continue to adversely impact customer demand, lead to decreased foot traffic to our retail locations as a result of changes in customer behavior patterns, and impact levels of consumer spending, all of which could negatively adversely impact our ongoing and future business and financial condition. We continue to assess the situation on a daily basis; however, while we have begun to reopen design centers in a number of U.S. states since May 1, 2020 and to increase production in some of our North American manufacturing plants, as of the date of this filing, we are unable to predict when and how quickly we will be able to resume full retail and manufacturing operations.

 

On April 1, 2020, the Company implemented its action plan in response to the COVID-19 health crisis. Measures taken included, among other things:

 

 

The furlough of approximately 70% of our global workforce;

 

M. Farooq Kathwari, our Chairman, President and CEO will forego his salary through June 30, 2020;

 

A salary reduction of up to 40% for all senior management and up to 20% for other salaried employees through June 30, 2020;

 

Our Board of Directors reduced their cash compensation by 50% through June 30, 2020;