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ETH > SEC Filings for ETH > Form 10-K on 15-Aug-2014All Recent SEC Filings

Show all filings for ETHAN ALLEN INTERIORS INC

Form 10-K for ETHAN ALLEN INTERIORS INC


15-Aug-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation

The following discussion of financial condition and results of operations is based upon, and should be read in conjunction with, our Consolidated Financial Statements (including the notes thereto) included under Item 8 of this Annual Report.

Forward-Looking Statements

Management's discussion and analysis of financial condition and results of operations and other sections of this Annual 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 potential effects of natural disasters affecting our suppliers 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; the effects of terrorist attacks or conflicts or wars involving the United States or its allies or trading partners; those matters discussed in Items 1A and 7A of this Annual Report 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

Our consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles that require, in some cases, that certain estimates and assumptions be made that affect the amounts and disclosures reported in those financial statements and the related accompanying notes. Estimates are based on currently known facts and circumstances, prior experience and other assumptions believed to be reasonable. We use our best judgment in valuing these estimates and may, as warranted, solicit external advice. Actual results could differ from these estimates, assumptions and judgments, and these differences could be material. The following critical accounting policies, some of which are impacted significantly by estimates, assumptions and judgments, affect our consolidated financial statements.

Inventories - Inventories (finished goods, work in process and raw materials) are stated at the lower of cost, determined on a first-in, first-out basis, or market. Cost is determined based solely on those charges incurred in the acquisition and production of the related inventory (i.e. material, labor and manufacturing overhead costs). We estimate an inventory reserve for excess quantities and obsolete items based on specific identification and historical write-downs, taking into account future demand and market conditions. If actual demand or market conditions in the future are less favorable than those estimated, additional inventory write-downs may be required.

Revenue Recognition - Revenue is recognized when all of the following have occurred: persuasive evidence of a sales arrangement exists (e.g. a wholesale purchase order or retail sales invoice); the sales arrangement specifies a fixed or determinable sales price; title and risk of ownership has passed to the customer; no specific performance obligations remain; product is shipped or services are provided to the customer or a fixed schedule of delivery is agreed upon and in place; collectability is reasonably assured. As such, revenue recognition generally occurs upon the shipment of goods to independent retailers or, in the case of Ethan Allen operated retail design centers, upon delivery to the customer. If shipping is billed to customers, this is included in revenue. Recorded sales provide for estimated returns and allowances. We permit our customers to return defective products and incorrect shipments, and terms we offer are standard for the industry.


Allowance for Doubtful Accounts - We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on a review of specifically identified accounts in addition to an overall aging analysis. Judgments are made with respect to the collectability of accounts receivable based on historical experience and current economic trends. Actual losses could differ from those estimates.

Retail Design Center Acquisitions - We account for the acquisition of retail design centers and related assets with the purchase method. Accounting for these transactions as purchase business combinations requires the allocation of purchase price paid to the assets acquired and liabilities assumed based on their fair values as of the date of the acquisition. The amount paid in excess of the fair value of net assets acquired is accounted for as goodwill.

Impairment of Long-Lived Assets and Goodwill - 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. When testing goodwill for impairment, we may assess qualitative factors for some or all of our reporting units to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. Alternatively, we may bypass this qualitative assessment for some or all of our reporting units and determine whether the carrying value exceeds the fair value using a quantitative assessment as described below.

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.

To evaluate goodwill using a quantitative assessment, 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 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.


In the fourth quarter of fiscal years 2014 and 2013, the Company performed qualitative assessments of the fair value of the wholesale reporting unit and concluded that the fair value of its goodwill exceeded its carrying value. In fiscal year 2011 the Company performed a quantitative assessment and determined the fair value of its wholesale reporting unit exceeded its carrying value by a substantial margin. The fair value of the trade name exceeded its carrying value by a substantial margin in fiscal years 2014, 2013 and 2012. To calculate fair value of these assets, management relies on estimates and assumptions which by their nature have varying degrees of uncertainty. Wherever possible, management therefore looks for third party transactions 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.

Income Taxes - Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Additional factors that we consider when making judgments about the deferred tax valuation include tax law changes, a recent history of cumulative losses, and variances in future projected profitability.

The Company evaluates, on a quarterly basis, uncertain tax positions taken or expected to be taken on tax returns for recognition, measurement, presentation, and disclosure in its financial statements. If an income tax position exceeds a 50% probability of success upon tax audit, based solely on the technical merits of the position, the Company recognizes an income tax benefit in its financial statements. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The liability associated with an unrecognized tax benefit is classified as a long-term liability except for the amount for which a cash payment is expected to be made or tax positions settled within one year. We recognize interest and penalties related to income tax matters as a component of income tax expense.

Business Insurance Reserves - We have insurance programs in place to cover workers' compensation and property/casualty claims. The insurance programs, which are funded through self-insured retention, are subject to various stop-loss limitations. We accrue estimated losses using actuarial models and assumptions based on historical loss experience. Although we believe that the insurance reserves are adequate, the reserve estimates are based on historical experience, which may not be indicative of current and future losses. In addition, the actuarial calculations used to estimate insurance reserves are based on numerous assumptions, some of which are subjective. We adjust insurance reserves, as needed, in the event that future loss experience differs from historical loss patterns.

Other Loss Reserves - We have a number of other potential loss exposures incurred in the ordinary course of business such as environmental claims, product liability, litigation, tax liabilities, restructuring charges, and the recoverability of deferred income tax benefits. Establishing loss reserves for these matters requires the use of estimates and judgment with regard to maximum risk exposure and ultimate liability or realization. As a result, these estimates are often developed with our counsel, or other appropriate advisors, and are based on our current understanding of the underlying facts and circumstances. Because of uncertainties related to the ultimate outcome of these issues or the possibilities of changes in the underlying facts and circumstances, additional charges related to these issues could be required in the future.


Basis of Presentation

As of June 30, 2014, Ethan Allen Interiors Inc. has no material assets other than its ownership of the capital stock of Ethan Allen Global, Inc. and conducts all significant transactions through Ethan Allen Global, Inc.; therefore, substantially all of the financial information presented herein is that of Ethan Allen Global, Inc.

Results of Operations

For the year ended June 30, 2014, our net sales of $746.7 million increased 2.4% compared to fiscal 2013, operating income increased 15.2% over the prior fiscal year, and earnings of $1.47 per diluted share was 32.4% above the year ended June 30, 2013. Net cash provided by operating activities was $59.9 million, a 2.3% decrease over the prior fiscal year of $61.3 million. Our retail division's operating income was up $2.5 million or 31.2% from the prior fiscal year, while the wholesale division operating income grew $7.0 million or 13.7%. Our liquidity continues to be strong, enabling us to pay $11.3 million in dividends during the fiscal year, and increase our inventories by $9.0 million from June 30 2013, while increasing our total cash and securities balance at June 30, 2014 by $32.3 million over the prior fiscal year end to $135.8 million.

Net sales for both our wholesale and retail business segments improved over the prior fiscal year, closing the year with a strong fourth quarter for both segments, following a third quarter that was somewhat hampered by severe winter weather in many parts of the country. Our full year retail segment sales in fiscal 2014 compared to fiscal 2013 grew 0.4%, with a fourth quarter sales increase of 7.1% compared to the fourth quarter of fiscal 2013. Wholesale net sales for the fiscal 2014 year increased 4.4% compared to fiscal 2013, and fourth quarter fiscal 2014 sales increased 8.8% over the fourth quarter of fiscal 2013. Total orders booked by our retail segment increased 1.0% for fiscal 2014 compared to fiscal 2013, while comparable design center orders increased 3.0%. Total orders booked by our retail segment in the fourth quarter were impacted by our decision to close our year-end sale on July 7, 2014 instead of June 30. This change took advantage of the timing of the July 4 holiday period and the July 8 scheduled price increase, though it resulted in some sales and orders which would ordinarily occur in June falling into the next fiscal year.

We continue to make investments to strengthen the level of service, professionalism, interior design competence, efficiency, and effectiveness of the retail network design center personnel. We believe that over time, we will continue to benefit from (i) continuous repositioning and opening of new design centers in our retail network, (ii) frequent new product introductions, (iii) new and innovative marketing promotions and effective use of targeted advertising media, and (iv) continued use of the latest technology coupled with personal service from our interior design professionals. We believe our network of professionally trained interior design professionals differentiates us significantly from others in our industry.

Our manufacturing and logistics operations also gained efficiency by adding capacity in Honduras and adding new technology to our operations. We estimate our manufacturing facilities are currently operating at approximately 74% of capacity based on their current shifts and staffing. We believe we have sufficient scalable capacity that can support strong sales growth while maintaining control over cost, quality and service to our customers.


Business Results:

Our revenues are comprised of (i) wholesale sales to independently operated and Company operated retail design centers and (ii) retail sales of Company operated design centers. See Note 15 to our Consolidated Financial Statements for the year ended June 30, 2014 included under Item 8 of this Annual Report.

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

                                              Fiscal Year Ended June 30,
                                            2014          2013         2012
Revenue:
Wholesale segment                         $   453.6     $  434.4     $  456.9
Retail segment                                580.7        578.3        559.4
Elimination of inter-segment sales           (287.6 )     (283.6 )     (286.9 )
Consolidated revenue                      $   746.7     $  729.1     $  729.4

Operating income (loss):
Wholesale segment                         $    57.8     $   50.8     $   64.4
Retail segment                                 10.5          8.0        (11.5 )
Adjustment for inter-company profit (1)         1.3          1.6         (3.2 )
Consolidated operating income             $    69.6     $   60.4     $   49.7

(1) Represents the change in wholesale profit contained in Ethan Allen operated design center inventory existing at the end of the period.

Fiscal 2014 Compared to Fiscal 2013

Consolidated revenue for the fiscal year ended June 30, 2014 was $746.7 million compared to $729.1 million in fiscal 2013. There was year-over-year sales growth in both the wholesale and retail segments. The increase in the wholesale segment was partly due to higher international shipments in the current year and increased shipments to the retail segment.

Wholesale revenue for fiscal 2014 increased by $19.2 million, or 4.4%, to $453.6 million from $434.4 million in the prior fiscal year. The year-over-year increase was attributable to increased sales to both our Company operated design centers and independent retailers worldwide. Orders similarly increased 4.3% during the same period. The number of total design centers globally as of June 30, 2014 was 295, which was unchanged from June 30, 2013. The independently operated retail network increased by four net design centers to 152 at June 30, 2014 including a net increase of 2 locations to 70 in China. The count of Ethan Allen operated design centers was 143 at June 30, 2014 and 147 at June 30, 2013, and we opened nine design centers (six of which were relocations), and closed seven design centers. Our international net sales to independent retailers were 6.5% of our consolidated net sales for the year ended June 30, 2014 compared with 5.1% the previous year.

Retail revenue from Ethan Allen operated design centers for the twelve months ended June 30, 2014 increased by $2.5 million, or 0.4%, to $580.7 million from $578.3 million for the twelve months ended June 30, 2013. Year-over-year, written orders for the Company operated design centers increased 1.0% and comparable design centers written business increased 3.0%.

Gross profit for fiscal 2014 increased to $406.5 million from $398.3 million in fiscal 2013. The $8.1 million increase in gross profit was primarily attributable to the increase in wholesale net sales of 4.4% or $19.2 million. Our consolidated gross margin decreased to 54.4% for fiscal 2014 from 54.6% in fiscal 2013 as a result, primarily, of the lower mix of retail net sales to consolidated net sales in the current year (77.8%) compared to the prior fiscal year (79.3%).


Operating expenses decreased $1.1 million or 0.3% to $336.9 million or 45.1% of net sales in fiscal 2014 from $337.9 million or 46.3% of net sales in fiscal 2013. The decrease in current year expenses is primarily due to operating efficiencies, partly offset by higher variable costs on increased sales.

Operating income for the year ended June 30, 2014 totaled $69.6 million, or 9.3% of net sales, compared to $60.4 million, or 8.3% of net sales, in the prior year. Wholesale operating income for fiscal 2014 totaled $57.8 million, or 12.7% of net sales, as compared to $50.8 million, or 11.7% of net sales, in the prior year. Retail operating income was $10.5 million, or 1.8% of sales, for fiscal 2014, compared to $8.0 million, or 1.4% of sales, for fiscal 2013, an improvement of $2.5 million. The improvement in consolidated operating income was primarily attributable to an increase in sales volume for both the retail and wholesale segments and the improved gross profit in the wholesale segment leveraged against tightly controlled operating expenses.

Interest and other income, net was $0.3 million in fiscal 2014 compared to an expense of $1.5 million in fiscal 2013. The $1.8 million increase was primarily due to the loss incurred on the repurchase of $24 million of the Senior Notes during the fourth quarter of the prior fiscal year.

Interest and other related financing costs decreased $1.3 million to $7.5 million from $8.8 million in the prior year. The decrease is primarily due to less interest expense throughout fiscal 2014, from lower debt due to the Senior Note repurchases during fiscal 2013.

Income tax was an expense of $19.5 million for fiscal 2014 as compared to an expense of $17.7 million for fiscal 2013. Our effective tax rate for fiscal 2014 was 31.2% compared to 35.3% in fiscal 2013. The current fiscal year effective tax rate includes tax expense on income, the benefit from the reversal of valuation allowances against certain deferred tax assets in the retail segment, and the recognition of certain previously unrecognized tax benefits, partly offset by recording additional uncertain tax positions and interest expense on uncertain tax positions. The prior period effective tax rate includes tax expense on income, interest expense on uncertain tax positions, and the recording of additional uncertain tax positions partially offset by the recognition of previously unrecognized tax benefits and the impact of maintaining certain valuation allowances.

Net income for fiscal 2014 was $42.9 million as compared to $32.5 million in fiscal 2013. Net income per diluted share totaled $1.47 in the current year compared to $1.11 per diluted share in the prior year.

Fiscal 2013 Compared to Fiscal 2012

Consolidated revenue for the fiscal year ended June 30, 2013 was $729.1 million compared to $729.4 million in fiscal 2012. There was year-over-year growth in the retail segment in both net sales and written orders, which were offset by declines in our wholesale segment. The decreases in the wholesale segment were partly due to lower international shipments and higher display product sales in fiscal 2012.

Wholesale revenue for fiscal 2013 decreased by $22.5 million, or 4.9%, to $434.4 million from $456.9 million in fiscal 2012. The year-over-year decrease was primarily attributable to a reduction in the incoming order rate for the second and third quarters of fiscal 2013. Orders in the fourth quarter of fiscal 2013 increased over the same previous year period. We believe this decrease in year-over-year sales and orders is due primarily to (i) lower shipments of prototype products, (ii) lower international shipments, and (iii) a slight decrease in the number of total design centers globally, in fiscal 2013. The number of total design centers globally decreased to 295 at June 30, 2013 from 298 at June 30, 2012. The independently operated retail network decreased by three net design centers to 148 at June 30, 2013 including a net decrease of 2 locations to 68 in China. While the count of Ethan Allen operated design centers was 147 at both June 30 of 2013 and 2012, we opened seven design centers (three of which were relocations), acquired two from independent retailers, closed four design centers, and sold two to an independent retailer.


Retail revenue from the Company operated design centers for the twelve months ended June 30, 2013 increased by $18.9 million, or 3.4%, to $578.3 million from $559.4 million for the twelve months ended June 30, 2012. We believe the increase in retail sales by Ethan Allen operated design centers is due to (i) our new product introductions, promotional marketing campaigns, and the design solutions approach of our interior design professionals, (ii) continued use of both our national television and direct mail media campaigns, (iii) our digital communications to prospective clients, and (iv) the positive effects of continuously repositioning our retail network. These factors were partly offset by a decrease in clearance sale revenue by our US retail division. We ended both fiscal years 2013 and 2012 with 147 Ethan Allen operated design centers. Year-over-year, written business of Ethan Allen operated design centers increased 1.1% and comparable design centers written business increased 1.0%.

Gross profit for fiscal 2013 increased to $398.3 million from $390.3 million in fiscal 2012. The $8.1 million increase in gross profit was primarily attributable to (i) the increase in retail net sales of 3.4% or $18.9 million
(ii) a stronger sell through of retail inventory, releasing profit contained in the retail segment inventory, and (iii) the higher mix of retail net sales to consolidated net sales in fiscal 2013 (79.3%) compared to fiscal 2012 (76.7%). These positive factors were partly offset by a decline in wholesale gross profit driven primarily by 4.9% or $22.5 million lower wholesale net sales. Our consolidated gross margin increased to 54.6% for fiscal 2013 from 53.5% in fiscal 2012 as a result, primarily, of the factors noted above.

Operating expenses decreased $2.7 million or 0.8% to $337.9 million or 46.3% of net sales in fiscal 2013 from $340.6 million or 46.7% of net sales in fiscal 2012. The decrease in fiscal 2013 expenses is primarily due to operating efficiencies in our retail segment and general cost controls partly offset by
(i) losses on the sale of vacant real estate, (ii) certain costs associated with increasing capacities of our plants in Mexico and Honduras, and (iii) costs of international expansion into Montreal and Belgium during fiscal 2013.

Operating income for the year ended June 30, 2013 totaled $60.4 million, or 8.3% of net sales, compared to $49.7 million, or 6.8% of net sales, in fiscal 2012. Wholesale operating income for fiscal 2013 totaled $50.8 million, or 11.7% of net sales, as compared to $64.4 million, or 14.1% of net sales, in the previous year. Retail operating income was $8.0 million, or 1.4% of sales, for fiscal . . .

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