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| ETH > SEC Filings for ETH > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-2009
Quarterly Report
The following discussion of financial condition and results of operations should be read in conjunction with (i) our Consolidated Financial Statements, and notes thereto, as set forth in this Quarterly Report on Form 10-Q and (ii) our Annual Report on Form 10-K/A for the year ended June 30, 2009.
Forward-Looking Statements
Management's discussion and analysis of financial condition and results of
operations and other sections of this Quarterly Report contain forward-looking
statements relating to our future results. Such forward-looking statements are
identified by use of forward-looking words such as "anticipates", "believes",
"plans", "estimates", "expects", and "intends" or words or phrases of similar
expression. These forward-looking statements are subject to management decisions
and various assumptions, risks and uncertainties, including, but not limited to:
the effects of terrorist attacks or conflicts or wars involving the United
States or its allies or trading partners; the effects of labor strikes; weather
conditions that may affect sales; volatility in fuel, utility, transportation
and security costs; changes in global or regional political or economic
conditions, including changes in governmental and central bank policies; changes
in business conditions in the furniture industry, including changes in consumer
spending patterns and demand for home furnishings; effects of our brand
awareness and marketing programs, including changes in demand for our existing
and new products; our ability to locate new design center sites and/or negotiate
favorable lease terms for additional design centers or for the expansion of
existing design centers; competitive factors, including changes in products or
marketing efforts of others; pricing pressures; fluctuations in interest rates
and the cost, availability and quality of raw materials; those matters discussed
in Items 1A and 7A of our Annual Report on Form 10-K/A for the year ended
June 30, 2009 and in our SEC filings; and our future decisions. Accordingly,
actual circumstances and results could differ materially from those contemplated
by the forward-looking statements.
Critical Accounting Policies
The Company's consolidated financial statements are based on the accounting policies used. Certain accounting polices require that estimates and assumptions be made by management for use in the preparation of the financial statements. Critical accounting policies are those that are central to the presentation of the Company's financial condition and results and that require subjective or complex estimates by management. The Company updated its disclosure regarding Impairment of Long-Lived Assets and Goodwill. For further information regarding the Company's other critical accounting policies, see the Company's 2009 Annual Report on Form 10-K/A filed with the SEC on August 27, 2009
Impairment of Long-Lived Assets and Goodwill - We periodically evaluate whether events or circumstances have occurred that indicate that long-lived and indefinite-lived assets may not be recoverable or that the remaining useful life may warrant revision. When such events or circumstances are present, the Company determines whether the carrying value exceeds the fair value as described below.
In accordance with ASC Topic 360, "Property, Plant and Equipment" (SFAS No. 144), the recoverability of long-lived assets are evaluated for impairment 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 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 ASC Topic 350, "Intangibles-Goodwill and Other" (SFAS No. 142), goodwill and other indefinite-lived intangible assets are evaluated for impairment on an annual basis 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. We conduct our required annual impairment test of goodwill and other intangible assets during the fourth quarter of each fiscal year.
To evaluate goodwill, the Company determines the current fair value of the Reporting Units using a combination of "Market" and "Income" approaches. In the Market approach, the "Guideline Company" method is used, which focuses on comparing the Company's risk profile and growth prospects to reasonably similar publicly traded companies. Key assumptions used for the Guideline Company method are total invested capital ("TIC") multiples for revenues and operating cash flows, as well as consideration of control premiums. The TIC multiples are determined based on public furniture companies within our peer group, and if appropriate, recent comparable transactions are also considered. Control premiums are determined using recent comparable transactions in the open market. Under the Income approach, a discounted cash flow method is used, which includes a terminal value, and is based on external analyst financial projection estimates, as well as internal financial projection estimates prepared by management. The long-term terminal growth rate assumptions reflect our current long-term view of the market in which we compete. Discount rates use the weighted average cost of capital for companies within our peer group, adjusted for specific company risk premium factors.
The fair value of our trade name, which is the Company's only indefinite lived intangible asset other than goodwill, is valued using the relief-from-royalty method. Significant factors used in trade name valuation are rates for royalties, future growth, and a discount factor. Royalty rates are determined using an average of recent comparable values. Future growth rates are based on the Company's perception of the long term values in the market in which we compete, and the discount rate is determined using the weighted average cost of capital for companies within our peer group, adjusted for specific company risk premium factors. The fair value of the trade name substantially exceeded the carrying value in fiscal 2009.
As a result of the economic downturn that began in the fall of 2008, the Company's revenues and operating margins were negatively impacted. In response, the Company reduced headcount, consolidated its manufacturing, retail, and logistics footprint and repositioned its marketing approach. As a result of these changes, the Company's cash flow forecasts were continually updated to reflect the rapid changes in the business and the industry. During fiscal 2009, the Company determined that $48.4 million of goodwill in the Retail segment was considered impaired and fully written off. The cash flow projections used in its fair value evaluations are the best estimates of the Company and require significant management judgment.
In the fiscal quarter ended June 30, 2009, the Company performed its annual impairment test and no impairment of goodwill was appropriate as the fair value of the wholesale reporting unit net assets exceeded the book value by approximately 10%. During the quarter ending September 30, 2009, the business performance was consistent with the previous quarter, revenues and operating costs were on plan, the Company's average quarterly stock price increased 13% (from $12.11 for the quarter ended June 30, 2009, to $13.69 for the quarter ended September 30, 2009), and cash reserves increased to $72.5 million at September 30, 2009 from $53.0 million at June 30, 2009. The Company considered these and other factors and concluded that an interim impairment test was not required. There can be no assurance that the outcome of future reviews will not result in substantial impairment charges.
To calculate fair value of the assets described above, management relies on estimates and assumptions which by their nature have varying degrees of uncertainty. Wherever possible, management therefore looks for third party transactions as described above to provide the best possible support for the assumptions incorporated. Management considers several factors to be significant when estimating fair value including expected financial outlook of the business, changes in the Company's stock price, the impact of changing market conditions on financial performance and expected future cash flows, and other factors. Deterioration in any of these factors may result in a lower fair value assessment which could lead to impairment of the long-lived assets and goodwill of the Company.
Results of Operations
Our Company has been severely impacted by the economic factors in the United States and abroad which we began to feel in earnest during our second quarter of fiscal 2009. Weakness in the U.S. economy from continued high unemployment, volatile capital markets, depressed housing prices and tight consumer spending have all put negative stress on the economy which continues to have a negative impact on our business. As we work through these difficult times, we have taken dramatic actions to significantly reduce our infrastructure in all facets of our business including closing and realigning manufacturing plants, consolidating logistics operations, and closing under-performing retail design centers. We have also launched initiatives to increase sales, such as special savings product promotions, our designer affiliate program and converting our case goods business to custom.
In fiscal 2009, the Company made several announcements on changes to our operations. In January 2009, the Company announced a plan to consolidate the operations of its Eldred, Pennsylvania upholstery manufacturing plant and several of its retail service centers. In June 2009, the Company announced the consolidation of its Chino, California operations into its Maiden, North Carolina facility and the consolidation of its Andover, Maine sawmill and dimension mill to its Beecher Falls, Vermont sawmill and dimension mill operations which will continue to operate while the other manufacturing operations from Beecher Falls were moved to our plant in Orleans, Vermont. In large part, these efforts to realign our manufacturing operations were concluded in this first quarter of fiscal 2009. The Company estimates pre-tax restructuring, impairment, accelerated depreciation and other related charges for all of the fiscal 2009 actions will ultimately approximate $31 million, consisting of an $18 million impact from long-lived assets, $8 million in employee severance and other payroll and benefit costs, and $5 million in other associated costs. By segment, we expect $24 million in costs for the wholesale segment and $7 million for the retail segment. Total costs for these 2009 actions in the current fiscal year by segment are $0.2 million of restructuring charges and $6.6 million in accelerated depreciation for Wholesale, and $0.4 million of restructuring charges for Retail. Cumulative charges to date for these actions totaling $20.2 million have been classified in the Statement of Operations as restructuring and impairment charges and $6.6 million of accelerated depreciation recorded in cost of sales. Approximately 800 employee positions and 140 contract worker positions have been or will be eliminated due to these actions.
In fiscal 2008, we announced a plan to consolidate the operations of certain Company-operated retail design centers and retail service centers. In connection with this initiative, we have permanently ceased operations at ten design centers and six retail service centers which, for the most part, were consolidated into other existing operations. We also implemented our design team concept across the Retail division at the end of fiscal 2008. Costs for the January 2008 actions in the current fiscal year totaled $0.2 million, all of which was for the Retail segment, mostly due to net losses on the sale of real estate. Cumulative charges to date for these actions total $5.8 million, all of which have been classified in the Statement of Operations as restructuring and impairment charges of the Retail segment.
Our revenues are comprised of (i) wholesale sales to independently owned and Company-owned retail design centers and (ii) retail sales of Company-owned design centers. See Note 14 to our Consolidated Financial Statements for the three months ended September 30, 2009 and 2008 for the components of consolidated revenue and operating income, capital expenditures, and total assets by segment.
Quarter Ended September 30, 2009 Compared to Quarter Ended September 30, 2008
Consolidated revenuefor the three months ended September 30, 2009 decreased 33.8% to $136.2 million, from $205.8 million for the three months ended September 30, 2008. During the quarter, sales continue to be affected by the negative economic stresses mentioned earlier, as well as the use of highly-promotional pricing strategies by the Company's competitors. These factors were partially offset by (i) several new marketing initiatives including
our rewards program and special savings pricing, and our new interactive web site ethanalleninc.com, (ii) the continued use of national television media, where we emphasize to clients our interior design services and the full line of our quality product offerings, and (iii) the positive effects of efforts to reposition the retail network.
Wholesale revenue for the first quarter of fiscal 2009 decreased 33.0% to $81.3 million from $121.3 million in the prior year comparable period. The quarter-over-quarter decrease was primarily attributable to a decline in the incoming order rate due to a continued soft retail environment for home furnishings noted throughout the current period. These decreases were partially offset by our rewards program and celebration pricing during the quarter. In addition, there were two more independent retail design centers at September 30, 2009, which increased to 134 from 132, including two locations transferred into the company's Retail division during the year. There were the same number of shipping days in the quarter both this year and last year.
Retail revenue from Ethan Allen-owned design centers for the three months ended September 30, 2009 decreased 33.8% to $103.2 million from $155.9 million for the three months ended September 30, 2008. We believe the decrease in retail sales by Ethan Allen-operated design centers is due to the same soft market conditions experienced by the wholesale segment, as evidenced by a 35.3% decrease in comparable store sales, a net $2.1 million decrease in new/closed store sales, and a net decrease in the number of Ethan Allen-operated design centers to 155 as of September 30, 2009 as compared to 160 as of September 30, 2008. These decreases were partially offset by our rewards program and celebration pricing during the quarter. During the quarter, we opened two (including one relocation) and closed five design centers.
Comparable design centers are those which have been operating for at least 15 months. Minimal net sales, derived from the delivery of customer ordered product, are generated during the first three months of operations of newly opened (including relocated) design centers. Design centers acquired by us from independent retailers are included in comparable design centers sales in their 13th full month of Ethan Allen-owned operations.
Quarter-over-quarter, written business of Ethan Allen-owned design centers decreased 19.5% while comparable design centers written business decreased 20.0%. Over that same period, wholesale orders decreased 21.4%. Both retail and wholesale written business reflect the softer retail environment for home furnishings noted throughout the period as a result of continued negative economic stresses previously discussed.
We have made considerable investment within the retail network to strengthen the
level of service, professionalism, interior design competence, efficiency, and
effectiveness of the retail design center personnel. We believe that
implementation of the "team" concept has helped us continue to improve the
customer service experience. We also believe that over time, we will benefit
from (i) our repositioning of the retail network, (ii) new product
introductions, (iii) new marketing initiatives such as our rewards program,
special savings pricing, and our new interior design affiliate (IDA) program,
(iv) continued use of technology including our state-of-the-art website coupled
with personal service from our design professionals, and (iv) ongoing use of
national television and shelter magazines as advertising media.
Gross profit decreased during the quarter to $58.3 million from $111.9 million in the prior year comparable quarter. The 47.9% decrease in gross profit was primarily attributable to (i) the reduction in net sales of 33.8%, with an overall decrease in shipments in both market segments, (ii) lower margin percentages within the wholesale segment due to accelerated depreciation from closed manufacturing operations totaling $6.6 million, under absorption of plant overhead costs on the lower production volume, and other plant transition costs related to the restructuring of our manufacturing plants, and (iii) lower margins within the retail segment, due to discounted sales through our rewards program and celebration pricing initiatives and sales of discontinued product and floor samples. The sales mix remained constant with retail sales representing 76% of total sales in both the current and prior year period. Consolidated gross margin decreased to 42.8% from 54.4% in the prior year as a result, primarily, of the factors set forth above.
Operating profit, the elements of which are discussed in greater detail below, was impacted by the following items during the three months ended September 30, 2009 and 2008:
Operating expenses decreased 25.4% to $74.4 million, but increased to 54.6% of sales in the current quarter from $99.7 million, or 48.5% of sales in the prior year quarter. Selling expenses were down in absolute terms due to actions taken and lower sales volume. Salary related costs decreased due to the reduced number of employees and other cost cutting efforts taken by the Company. Advertising expenses were down $2.3 million versus the previous year first fiscal quarter.
Consolidated operating income (loss) for the three month period ended September 30, 2009 was a loss of $16.1 million, or 11.8% of sales, as compared to income of $12.2 million, or 5.9% of sales, for the three months ended September 30, 2008. This decrease of $28.3 million is due to a decrease in gross profit mostly due to reduced sales, and accelerated depreciation charges due to restructuring activities, partly offset by a decrease in period over period operating expenses, both of which were discussed previously.
Wholesale operating income (loss) for the three months ended September 30, 2009 totaled a loss of $4.7 million, or a negative 5.7% of sales, as compared to income of $11.9 million, or 9.8% of sales, in the prior year comparable quarter. The decrease of $16.5 million was primarily attributable to a decrease in sales volume, and the plant transition costs including the $6.6 million of accelerated depreciation noted above relating to the closure of manufacturing plants as discussed previously.
Retail operating loss increased $8.3 million to a loss of $11.3 million, or a negative 11.0% of sales, for the first quarter of fiscal 2010 from a loss of $3.1 million, or a negative 2.0% of sales, for the first quarter of fiscal 2009. The increase in retail operating loss generated by Ethan Allen-operated design centers was primarily due to reduced sales attributed to the weak retail environment for home furnishings offset partially by cost cutting actions taken.
Interest and other miscellaneous income, netdecreased $0.3 million from the prior year comparable quarter. The decrease was due, primarily to a decrease in investment income resulting from lower cash and cash equivalent balances and lower rates of interest during the current period.
Interest and other related financing costsamounted to just under $3.0 million in both the current and prior year periods. This amount consists, primarily, of interest expense incurred in connection with our issuance of senior unsecured debt in September 2005.
Income tax expense for the three months ended September 30, 2009 totaled a benefit of $4.7 million as compared to an expense of $3.0 million for the three months ended September 30, 2008. Our effective tax rate for the current quarter was 25.7% compared to 28.7% in the prior year quarter. The current effective tax rate, resulting in a tax benefit, was adversely affected by valuation allowances against certain state and Canadian deferred tax assets. The prior period tax rate benefitted from a one time adjustment of $0.7 million made in the prior year quarter.
Net income (loss) for the three months ended September 30, 2009, was a loss of $13.6 million as compared to net income of $7.4 million in the prior year comparable period. This resulted in a net loss per diluted share of $0.47 in the current quarter and net income per diluted share of $0.26 in the prior year quarter.
Liquidity and Capital Resources
At September 30, 2009, we held cash and cash equivalents of $72.5 million. Our principal sources of liquidity include cash and cash equivalents, cash flow from operations, the revolving line of credit, and borrowings. The global economy continues to be unsettled, and capital markets continue to be disrupted and volatile. The cost and availability of funding has been and may continue to be adversely affected by illiquid credit markets. Some lenders have reduced or, in some cases, ceased to provide funding to borrowers. However, our lenders have not
indicated to us that they would not continue to provide funding to us or not honor or be able to fully perform their obligations under the credit facility. Our access to the credit facility could also be negatively affected if operating results fall below prescribed levels or if the assets used to determine the borrowing base availability fall below the total available credit under the facility. Continued turbulence in the financial markets could also adversely affect the cost and availability of financing to us in the future.
On May 29, 2009, the Company entered into a three-year, $40 million senior secured asset-based revolving credit facility ("the "Facility"). The Facility provides revolving credit financing of up to $40 million, subject to borrowing base availability, and includes an accordion feature which, if exercised, would provide up to an additional $20 million of financing. At the Company's option, revolving loans under the Agreement bear interest at an annual rate of either:
(a) London Interbank Offered rate ("LIBOR") plus 3.25% to 4.25%, based on the average availability, or
(b) the higher of (i) a prime rate, (ii) the federal funds effective rate plus 0.50%, or (iii) a LIBOR rate plus 1.00% plus, in each case, an additional 2.25% to 3.25%, based on average availability.
The Facility is secured by all property owned, leased or operated by the Company in the United States excluding any real property owned by the Company and, at September 30, 2009, also excluded any intellectual property owned by the Company unless availability was less than or equal to $17.5 million. The Facility contains customary covenants which may limit the Company's ability to incur debt; engage in mergers and consolidations; make restricted payments (including dividends); sell certain assets; and make investments. The Company may make restricted payments (including dividends) as long as availability equals or exceeds the greater of (i) 25% of the aggregate commitment or (ii) $12 million. If the average monthly availability is less than the greater of (i) 15% of the aggregate commitment and (ii) $9 million, the Company is also required to meet a fixed charge coverage ratio financial covenant which may not be less than 1 to 1 for any period of four consecutive fiscal quarters. The Facility also contains customary borrowing conditions and events of default, the occurrence of which would entitle the lenders to accelerate the maturity of any outstanding borrowings and terminate their commitment to make future loans.
The Company has not drawn any cash advances against the facility, and has no plans to do so. At September 30, 2009, after excluding the $12.5 million we had utilized in letters of credit, remaining availability under the revolver totaled $27.5 million subject to limitations set forth in the agreement noted above. We are in compliance with the terms and conditions of the agreement and as a result, the coverage charge ratio, or other restricted payment limitations did not apply. As of September 30, 2009, we are in compliance with all covenants of our credit facility.
On October 23, 2009, the Company amended the revolving credit facility, increasing the line by $20 million, with total borrowing under the agreement (subject to borrowing base availability and limitations set forth in the agreement noted above) of up to $60 million. The amended facility is secured by all assets owned, leased or operated by the Company in the United States including intellectual property, other than real estate owned by the Company.
In September 2005, we completed a private offering of $200.0 million in ten-year senior unsecured notes due 2015 (the "Senior Notes"). The Senior Notes were offered by Global and have an annual coupon rate of 5.375% with interest payable semi-annually in arrears on April 1 and October 1 of each year. We have used the net proceeds of $198.4 million to expand our retail network, invest in our manufacturing and logistics operations, and for other general corporate purposes.
In June 2009, Moodys Investors Service lowered our corporate and senior unsecured credit ratings to Ba1 from Baa3, and Standard & Poor's ("S&P") lowered our corporate and senior unsecured credit ratings to BB from BBB-. In November 2009 S&P lowered our corporate and senior unsecured credit ratings to B+. Both rating services
pointed to the Company's depressed operating performance due to lower consumer spending and a tough retail environment as reasons for the downgrades. While the change in our credit rating had no impact on our existing credit facilities, the S&P rating, if not improved to investment grade by March 2010, the issuer of our private label credit cards has a right to demand a standby letter of credit of up to $12 million, which would reduce availability under the revolving credit agreement. It does not appear likely that the S&P rating will improve to investment grade prior to March 2010. The Company believes it has sufficient cash and access to credit (including its ability to expand the $40 million credit facility to $60 million) to fund operations and growth plans.
A summary of net cash provided by (used in) operating, investing, and financing activities for the three month periods ended September 30, 2009 and 2008 is provided below (in millions):
. . .
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