Ethan Allen Interiors Inc. — FY2018 Form 10-K
Period note: The filing is an annual report for the fiscal year ended June 30, 2018, with comparisons to FY2017. This differs from the request metadata of “2017 Q4.” The filing reports FY2018 fourth-quarter results separately.
Business context
Ethan Allen is a vertically integrated home furnishings designer, manufacturer, wholesaler and retailer, operating through wholesale and company-operated retail segments. At year-end it had 296 design centers: 148 company-operated and 148 independently operated. About 75% of products sold are manufactured or assembled in North America. Retail generated 77% of consolidated sales in FY2018.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $766.8 million | $763.4 million |
| Gross profit / margin | $416.0 million / 54.2% | $419.7 million / 55.0% |
| SG&A | $367.1 million / 47.9% of sales | $361.8 million / 47.4% |
| Operating income / margin | $48.9 million / 6.4% | $58.0 million / 7.6% |
| Net income | $36.4 million | $36.2 million |
| Diluted EPS | $1.32 | $1.29 |
| Operating cash flow | $42.5 million | $78.6 million |
| Capital expenditures and acquisitions | $18.8 million | $18.3 million |
| Cash and cash equivalents at year-end | $22.4 million | $57.7 million |
| Working capital / current ratio | $93.2 million / 1.77 | $116.7 million / 1.92 |
| Total debt, including capital leases | $1.7 million | $14.3 million |
| Effective tax rate | 25.9% | 36.5% |
Wholesale revenue rose 4.9% to $475.7 million, while company-operated retail revenue fell 2.7% to $587.5 million; comparable retail revenue declined 3.2%. Wholesale operating income was $48.5 million, versus $53.5 million; retail posted a $1.7 million operating loss, versus $1.2 million income. Year-end wholesale backlog was $56.5 million, up from $47.4 million, and was expected to be serviced in FY2019 Q1. FY2018 Q4 sales were $205.6 million versus $194.9 million; net income was $11.5 million versus $11.7 million.
Material changes and unusual items
- Consolidated sales increased 0.4%, but gross margin contracted 0.8 percentage points and operating income fell 15.7%. Management cited higher raw-material costs, a lower retail sales mix, increased advertising, and production and shipping disruption.
- Adverse weather affected first-quarter sales, manufacturing and delivery. High-volume GSA contract orders with short lead times, along with first production runs for GSA products and the Passport collection, constrained capacity and delayed shipments to retail customers through the third quarter.
- Operating cash flow declined 46.0%, chiefly reflecting a $13.0 million use of cash from working-capital items, including an $11.9 million inventory increase; FY2017 had benefited from inventory reduction and a $6.4 million inventory write-down.
- The company repurchased 950,484 shares for approximately $22.0 million and paid $29.5 million in dividends, including a special dividend. It repaid the remaining $13.8 million term loan early. Debt at June 30, 2018 consisted of capital leases.
- The Tax Cuts and Jobs Act reduced the reported FY2018 tax rate; a $2.7 million deferred-tax remeasurement benefit was recorded. Management estimated a provisional $125,000 transition-tax obligation.
Outlook, risks and contingencies
Management was “cautiously optimistic,” citing product refreshes, broader advertising, retail repositioning, digital and marketplace sales, and expansion of contract and international business. It expected an FY2019 effective tax rate of approximately 24%–25%, but provided no specific sales or earnings guidance. Management said operating cash flow and other liquidity sources should fund debt service, capital spending and working-capital needs.
A key liquidity issue is that FY2018 share repurchases brought working capital below the minimum required under the consumer-credit program agreement, triggering a Level 1 Collateral Event. The lender may require an eligible letter of credit or substitute collateral—approximately $4 million—within 15 days of written request; no demand had been made as of the filing date. Separately, the company reported $108.8 million of availability under its revolving facility and compliance with its facility covenants at year-end. The facility was scheduled to expire October 21, 2019.
Other risks include competition and discretionary consumer demand, changing tastes, import tariffs and trade-policy changes, raw-material and labor costs, manufacturing or logistics interruptions, cybersecurity and product-safety issues, and environmental obligations. Operating lease commitments totaled approximately $176.0 million, before sublease rentals. The company reported no litigation expected to have a material adverse effect. Management and KPMG reported effective internal control over financial reporting; KPMG issued an unqualified opinion on the financial statements and controls.
For accounting changes, the company expected revenue-standard adoption on July 1, 2018 to have no material ongoing effect, while noting recognition of a returns asset and related liability. It expected the lease standard, effective July 1, 2019, to significantly increase balance-sheet assets and liabilities.
Most important facts for investors to verify
- Whether retail orders and comparable sales recover, and whether the higher wholesale backlog converts to shipments and revenue without further production delays.
- Whether raw-material, advertising and other cost pressures continue to erode margins, particularly in the retail segment.
- Whether the lender requires collateral following the Level 1 Collateral Event, and the company’s working-capital position and revolving-facility availability.
- How cash generation supports dividends, repurchases and capital needs after the sharp year-over-year decline in operating cash flow.
- Whether FY2019 tax-rate expectations hold and what balance-sheet effect results from adoption of the lease standard.