Ethan Allen Interiors Inc. — Q2 FY2020 Form 10-Q
Reporting period: Three and six months ended December 31, 2019. Dollar amounts are in millions unless stated otherwise. Ethan Allen is a vertically integrated home furnishings designer, manufacturer and retailer, reporting Wholesale and Retail segments.
Financial performance and position
| Metric | Q2 FY2020 | Q2 FY2019 | First half FY2020 | First half FY2019 |
|---|---|---|---|---|
| Net sales | $174.6 | $197.2 | $348.5 | $384.9 |
| Gross profit / margin | $97.5 / 55.9% | $108.9 / 55.2% | $191.3 / 54.9% | $210.3 / 54.6% |
| Operating income / margin | $9.2 / 5.3% | $16.1 / 8.2% | $27.8 / 8.0% | $27.9 / 7.3% |
| Net income | $7.1 | $12.2 | $21.2 | $21.0 |
| Diluted EPS | $0.27 | $0.45 | $0.79 | $0.78 |
| Operating cash flow | Not clearly stated for quarter | Not clearly stated for quarter | $23.4 | $31.5 |
- Q2 sales fell 11.5%; Wholesale sales declined 14.6% and Retail sales declined 12.2%. First-half sales fell 9.5%.
- Q2 SG&A was $88.5 million, down from $92.7 million, but increased to 50.6% of sales from 47.0% as revenue declined. First-half reported operating income included a $11.5 million gain on the sale of the Passaic property.
- For the first half, adjusted operating income was $21.7 million, down 23.1%, and adjusted diluted EPS was $0.62, down 21.5%, per company-defined non-GAAP measures.
- Cash and cash equivalents were $28.3 million at December 31, up from $20.8 million at June 30, 2019. Current assets were $199.4 million and current liabilities $137.4 million.
- No borrowings were outstanding under the $165 million revolving credit facility. Borrowing-base availability was $126.4 million; standby letters of credit were $5.8 million. The company reported compliance with facility covenants.
- Total debt was nil at period-end; lease liabilities were $150.7 million, including $32.8 million current and $117.9 million long-term operating lease liabilities. These lease obligations are distinct from debt.
- First-half investing cash flow was positive $3.2 million, including $12.4 million of proceeds from property and equipment disposals, partly offset by $8.0 million of capital expenditures and $1.3 million of design-center acquisitions. Financing used $19.1 million, including $10.7 million in dividends and $8.2 million in share repurchases.
Material changes and unusual items
- The company introduced its $100 annual Ethan Allen Member Program in October 2019, shifting away from event-driven promotions. Management said the transition was weighing on sales and operating income during the initial year; the longer selling cycle, lower delivery-fee revenue and timing of membership-fee recognition were expected to contribute to the impact.
- Q2 wholesale orders booked fell 21.8% year over year; management reported sequential monthly improvement, with December orders increasing year over year. First-half orders were down 10.5%.
- International sales were weaker, particularly in China. China wholesale orders fell 69.3% in Q2 and 53.8% for the first half; management cited economic uncertainty and trade disputes. Contract sales, including the U.S. government GSA contract, grew.
- Gross margin improved year over year, attributed to retail price optimization and manufacturing efficiencies. However, lower sales volumes and the quarter’s sales mix reduced gross profit dollars.
- In September 2019, the company sold its Passaic, New Jersey property and recorded an $11.5 million pretax gain. First-half costs also included a $3.2 million noncash inventory write-down and manufacturing/logistics restructuring and exit charges. The filing reports $4.5 million of first-half adjustments to gross profit and $5.0 million of restructuring charges used in management’s adjusted operating-income discussion.
- The company adopted the new lease accounting standard on July 1, 2019, recognizing operating lease assets and liabilities and recording a $1.6 million reduction to opening retained earnings for impairment of certain right-of-use assets. Comparative periods were not restated.
Outlook, commentary and risks
- Management described its outlook as “cautiously optimistic,” with no specific financial guidance provided. It expects the membership program to gain momentum and planned a January 2020 direct-mail campaign to 2.5 million households, alongside other marketing.
- Management expects to continue investing in design centers, technology, and manufacturing and logistics capabilities. About 75% of products are manufactured in North America, according to the filing.
- The company said operating cash flow, cash and credit availability should be sufficient for working capital, capital expenditures, acquisitions, dividends and other cash needs. Regular dividends remain subject to economic conditions, liquidity and Board approval.
- Principal disclosed risks include weak or volatile consumer demand, the uncertain reception and financial effects of the membership transition, international economic and trade conditions, supply-chain disruption, competition, raw-material cost or availability, and operational, cybersecurity and product-safety risks.
- Routine legal matters include employment, commercial, intellectual-property and environmental matters. Management did not expect unresolved matters, individually or together, to materially adversely affect financial position, results or cash flows. U.S. tax audits cover fiscal 2015–2018; management did not expect significant changes from those audits within the next twelve months.
- On January 13, 2020, the Board increased the aggregate share-repurchase authorization to 3.0 million shares. Future purchases may be suspended or discontinued at any time.
Important facts for investors to verify
- Whether the membership model stabilizes orders and sales, and whether management’s reported monthly order improvement continues.
- How much of first-half reported earnings and operating income depended on the Passaic property gain, and the nature and recurrence of excluded restructuring and inventory charges.
- Whether retail profitability recovers: the Retail segment recorded a Q2 operating loss of $0.1 million versus $3.3 million of operating income a year earlier.
- The impact of continued weakness in China and Canada, trade conditions, and consumer discretionary spending on sales and orders.
- Lease commitments, capital spending, dividends and repurchases relative to operating cash generation; first-half operating cash flow declined to $23.4 million from $31.5 million.
- Reconcile the filing’s differing Q2 diluted-EPS presentation: the financial statements report $0.27, while the MD&A key-metrics table lists $0.26 for GAAP diluted EPS.