Ethan Allen Interiors Inc. — Q2 FY2017 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2016; comparisons are with the corresponding 2015 periods. Amounts are in U.S. dollars unless noted. Ethan Allen operates wholesale and retail home-furnishings businesses, with a vertically integrated manufacturing and design-center network.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $194.7 million | $207.5 million | $388.0 million | $397.9 million |
| Gross profit / margin | $108.1 million / 55.5% | $116.1 million / 55.9% | $216.6 million / 55.8% | $220.7 million / 55.5% |
| SG&A | $91.0 million / 46.8% of sales | $89.6 million / 43.1% | $181.2 million / 46.7% | $173.3 million / 43.6% |
| Operating income / margin | $17.1 million / 8.8% | $26.5 million / 12.8% | $35.4 million / 9.1% | $47.4 million / 11.9% |
| Net income | $10.7 million | $16.5 million | $22.2 million | $29.7 million |
| Diluted EPS | $0.38 | $0.58 | $0.79 | $1.04 |
| Operating cash flow | Quarterly value not clearly provided | Quarterly value not clearly provided | $27.5 million | $21.0 million |
- Q2 sales declined 6.2% year over year; operating income fell 35.5%, net income 35.3%, and diluted EPS 34.5%.
- For the six-month period, sales declined 2.5%, operating income 25.3%, net income 25.1%, and diluted EPS 24.0%.
- Q2 retail sales decreased 5.1%; comparable retail sales fell 5.4%, total written business declined 3.6%, and comparable design-center written business decreased 4.5%. Wholesale sales fell 10.1%.
- Six-month retail sales were down 0.7% and wholesale sales down 7.5%. Retail operating income was $3.2 million versus $8.3 million; wholesale operating income was $30.7 million versus $40.3 million.
Liquidity, debt, and capital allocation
- At December 31, 2016, cash and cash equivalents were $57.1 million, restricted cash and investments were $7.3 million, and working capital was $136.6 million. The current ratio was 2.22, versus 2.01 at June 30, 2016.
- Total debt obligations were $41.1 million, including $25.0 million drawn on the revolving facility, a $15.0 million term loan, and $1.1 million in capital leases. Debt net of issuance costs was $40.3 million. Facility availability was $89.9 million; the facility matures October 21, 2019.
- The company reported compliance with facility covenants and was exempt from the fixed-charge coverage covenant under the stated conditions. Debt is floating-rate; the company reported no interest-rate hedging and said a 10% rate change would not materially affect results or financial condition.
- Six-month cash flow: operating activities provided $27.5 million; investing activities used $9.4 million, including $11.3 million of capital expenditures; financing activities used $13.5 million. Cash increased $4.5 million to $57.1 million.
- Financing included $9.5 million of dividends and $3.4 million spent to repurchase 107,700 shares. The quarterly dividend was $0.17 per share in each of the first two fiscal quarters. Management expects to continue dividends as economic conditions and liquidity permit; 1,650,160 shares remained authorized for repurchase.
Material changes and management commentary
- Management attributed weaker sales, particularly retail, to consumer pullback around the election cycle and a more promotional environment. Lower sales and product mix reduced Q2 gross profit and wholesale margin.
- SG&A increased year over year. Q2 comparisons included a $1.3 million prior-year real-estate sale gain; current-period costs included the Ethan Allen | Disney launch and more recently opened design centers. Six-month expenses also reflected a current-period real-estate disposition loss versus a prior-year gain, higher product-launch advertising, costs from a net increase of four design centers, and Disney-launch expenses.
- Six-month gross margin improved to 55.8% from 55.5%, helped by a greater retail share of sales, higher average sales per unit, and less clearance activity; the improvement did not offset higher operating expenses and lower revenue.
- The company said its product transformation, which refreshed over 70% of products, was completed in November 2016. It remains “cautiously optimistic,” citing existing programs and planned introductions, while expecting intense industry competition and pricing pressure. No quantified earnings or revenue guidance was provided.
- Management expects cash from operations to fund anticipated capital expenditures. The planned doubling of the upholstery facility in Mexico was expected to be completed by the end of calendar 2017. Current capital spending included upholstery-capacity expansion, new design centers, and improvements related to the Disney launch.
Risks, contingencies, and unusual items
- Risks identified include consumer spending and demand, competition and pricing pressure, raw-material and transportation costs, interest rates and access to financing, weather, labor disruptions, and supplier or geopolitical events.
- The company was under U.S. tax audit for 2009–2014. It said changes in uncertain tax benefits within the next year were not expected to be significant, though resolutions could affect the effective tax rate.
- Routine litigation and environmental matters were described; management believed existing matters were unlikely to have a material adverse effect. Environmental capital expenditures currently anticipated were not material.
- The consumer-credit program is administered by a third party on a non-recourse basis for customer receivables. Ethan Allen has certain obligations if a participating independent retailer defaults; the maximum potential payment is indeterminable, but recourse against the retailer exists. No collateral was required at period-end.
- Product warranty liability was $1.2 million. No material subsequent events were reported. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether retail orders and comparable sales stabilize after the reported declines and promotional selling environment.
- Whether margins recover as product-launch costs, design-center expenses, and the completed product transformation affect results.
- Progress, spending, and expected completion timing for the Mexico upholstery-capacity expansion and other capital projects.
- Debt-facility availability, floating-rate exposure, covenant status, and the sustainability of dividends and share repurchases if operating performance weakens.
- Updates on the 2009–2014 tax audits, consumer-credit-program exposure, and any litigation or warranty matters that become probable and estimable.