Ethan Allen Interiors Inc. — Form 10-Q
Reporting period: Three months ended September 30, 2019 (first quarter of fiscal 2020), compared with the three months ended September 30, 2018. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context
Ethan Allen is a vertically integrated home furnishings designer, manufacturer and retailer, operating Wholesale and Retail segments. It sells through company-operated and independently operated design centers and online, and operates manufacturing facilities in North America. At quarter-end, it had 145 company-operated and 156 independent design centers.
Financial performance and liquidity
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $173.9 | $187.8 | (7.4%) |
| Gross profit / margin | $93.8 / 53.9% | $101.5 / 54.0% | Profit (7.5%) |
| Adjusted gross margin | 56.3% | 54.0% | +2.3 percentage points |
| Operating income / margin | $18.6 / 10.7% | $11.8 / 6.3% | +58.0% |
| Adjusted operating income / margin | $12.2 / 7.0% | $11.8 / 6.3% | +3.5% |
| Net income | $14.1 | $8.8 | +59.6% |
| Diluted EPS | $0.53 | $0.33 | +60.6% |
| Adjusted diluted EPS | $0.35 | $0.33 | +6.1% |
| Cash from operating activities | $23.4 | $24.4 | (4.3%) |
Adjusted measures are non-GAAP. Adjusted gross profit excludes $4.1 million of inventory write-downs and manufacturing overhead costs. Adjusted operating income excludes the Passaic property gain and other restructuring-related items; see the filing’s reconciliation for details.
Wholesale sales fell 14.2% to $101.3 million; Retail sales fell 5.5% to $137.3 million before intersegment eliminations. Wholesale operating income was $16.9 million versus $14.3 million, but adjusted wholesale operating income declined 27.7% to $10.4 million. Retail operating income improved to $1.6 million from a $1.6 million loss.
Cash and cash equivalents were $45.9 million at September 30, up from $20.8 million at June 30. Operating cash flow was $23.4 million; investing activities provided $6.9 million, including $11.6 million of net proceeds from the Passaic property sale, partly offset by $3.4 million of capital expenditures and $1.3 million for design-center acquisitions. Financing activities used $5.2 million, including $5.1 million of dividends. The company reported no debt borrowings and $148.4 million of availability under its $165 million revolving facility; it was in compliance with covenants.
Adoption of lease accounting on July 1, 2019 added operating lease right-of-use assets and liabilities to the balance sheet. At September 30, operating lease liabilities were $149.9 million on a present-value basis. The company also reported $370.5 million of shareholders’ equity and total assets of $653.9 million.
Material changes versus the prior comparable period
- Sales decreased 7.4%, principally reflecting lower China sales and softer retail demand. China net sales declined 49.4%; wholesale orders from China fell 37.6%, which management attributed mainly to tariffs imposed by China and trade-related uncertainty. Wholesale orders overall declined 1.5%, while orders excluding China rose 0.7%.
- Contract sales grew, including growth associated with the GSA contract; contract orders increased 62.4% year over year. Management said contract sales increased $4.5 million.
- Reported operating income and EPS benefited materially from an $11.5 million pre-tax gain on the Passaic property sale. Management estimated the gain, net of other fiscal 2020 restructuring activities and corporate actions, increased diluted EPS by $0.18; adjusted diluted EPS was $0.35.
- Retail mix increased to 78.9% of consolidated sales from 77.3%. Adjusted gross margin improved, while adjusted operating expenses declined 4.4% but rose as a percentage of sales because revenue fell.
- Operating cash flow was down $1.0 million, with restructuring payments of $4.1 million a principal offset to higher net income and non-cash items.
Outlook, risks and unusual items
Management described its outlook as “cautiously optimistic,” without providing specific financial guidance. It plans to continue investing in product, marketing, technology, design centers and North American manufacturing; it expects to maintain a balanced sourcing approach, manufacturing approximately 75% of products in North America. In October 2019, it introduced a $100 annual-fee membership program offering 20% everyday savings and free in-home delivery.
Restructuring continued following the closure of the Passaic facility and the transfer of most Old Fort case-goods manufacturing. First-quarter actions included $1.7 million of restructuring and exit charges, $1.1 million of manufacturing variances, and a $3.1 million non-cash inventory write-down. The Passaic sale generated a reported $11.5 million pre-tax gain. The company had previously terminated approximately 380 associates in connection with the optimization.
Risks highlighted include volatile consumer demand and economic conditions, international trade disputes and tariffs, competition and pricing pressure, supply-chain disruption, raw-material costs, changing consumer preferences, and information-technology and cybersecurity risks. The company reported ongoing U.S. tax audits for fiscal 2016 but did not expect related changes to be significant. It stated that unresolved legal matters were not expected to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
The quarterly dividend was increased to $0.21 per share from $0.19; the $5.6 million payment was made October 25, 2019. Future dividends remain subject to Board approval and business and liquidity conditions.
Important facts for investors to verify
- How sales, orders and margins develop in China and other international markets, and the effects of trade disputes and tariffs.
- Whether adjusted margin improvements and retail profitability persist as sales remain below the prior-year level; distinguish recurring performance from the Passaic gain and other adjustments.
- Progress and costs of manufacturing and logistics optimization, including remaining severance and exit obligations and the effects of inventory write-downs.
- Cash generation, working-capital trends, lease commitments and credit-facility availability, particularly as dividends and capital expenditures continue.
- Dividend sustainability and the performance of the new membership program; management provided no quantified forward guidance.