Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of financial condition and results of operations should be read in conjunction with (i) our Consolidated Financial Statements, and notes thereto, included in Item 1 of Part I of this Quarterly Report on Form 10-Q and (ii) our Annual Report on Form 10-K for the year ended June 30, 2018.
Forward-Looking Statements
Management's discussion and analysis of financial condition and results of operations and other sections of this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which represent our management’s beliefs and assumptions concerning future events based on information currently available to us relating to our future results. Such forward-looking statements are identified in this Quarterly Report on Form 10-Q and in documents incorporated herein by reference by use of forward-looking words such as "anticipate", "believe", "plan", "estimate", "expect", "intend", “will”, “may”, “continue”, “project”, ”target”, “outlook”, “forecast”, “guidance”, and similar expressions and the negatives of such forward-looking words. These forward-looking statements are subject to management decisions and various assumptions about future events, and are not guarantees of future performance. Actual results could differ materially from those anticipated in the forward-looking statements due to a number of risks and uncertainties including, but not limited to: competition from overseas manufacturers and domestic retailers; our anticipating or responding to changes in consumer tastes and trends in a timely manner; our ability to maintain and enhance our brand, marketing and advertising efforts and pricing strategies; changes in global and local economic conditions that may adversely affect consumer demand and spending, our manufacturing operations or sources of merchandise and international operations; changes in U.S. policy related to imported merchandise; an economic downturn; potentially negative or unexpected tax consequences of changes to fiscal and tax policies; our limited number of manufacturing and logistics sites; fluctuations in the price, availability and quality of raw materials; environmental, health and safety requirements; product safety concerns; disruptions to our technology infrastructure (including cyber attacks); increasing labor costs, competitive labor markets and our continued ability to retain high-quality personnel and risks of work stoppages; loss of key personnel; our ability to obtain sufficient external funding to finance our operations and growth; access to consumer credit; the effect of operating losses on our ability to pay cash dividends; additional impairment charges that could reduce our profitability; 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; the results of operations for any quarter are not necessarily indicative of our results of operations for a full year; possible failure to protect our intellectual property; and those matters discussed in “Item 1A – Risk Factors” of our Annual Report on Form 10-K for the year ended June 30, 2018, and elsewhere in this Quarterly Report on Form 10-Q and our SEC filings. Accordingly, actual circumstances and results could differ materially from those contemplated by the forward-looking statements.
Given the risks and uncertainties surrounding forward-looking statements, you should not place undue reliance on these statements. Many of these factors are beyond our ability to control or predict. Our forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. Other than as required by law, we undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
Critical Accounting Policies
The Company’s consolidated financial statements are based on the accounting policies used. Certain accounting polices require that estimates and assumptions be made by management for use in the preparation of the financial statements. Critical accounting policies are those that are central to the presentation of the Company’s financial condition and results and that require subjective or complex estimates by management. We implemented Accounting Standard Update No. 2014-09, Revenue from Contracts with Customers (Accounting Standards Codification Topic 606, “ASC 606”), in the first quarter of fiscal 2019. There have been no other changes with respect to the Company’s critical accounting policies from those disclosed in its 2018 Annual Report on Form 10-K filed with the SEC on August 2, 2018. Also see Note 12, Recently Adopted Accounting Pronouncements, and Note 13, Revenue Recognition.
Overview
We are a leading interior design company and manufacturer and retailer of quality home furnishings. Founded over 85 years ago, today we are a leading international home fashion brand doing business in North America, Europe, Asia and the Middle East. We are vertically integrated from design through delivery, affording our clientele a value proposition of style, quality and price. We offer complementary interior design service to our clients and sell a full range of furniture products and decorative accents through ethanallen.com and a network of approximately 300 design centers in the United States and abroad. The design centers represent a mix of independent licensees and our own Company operated retail segment. We own and operate nine manufacturing facilities including six manufacturing plants and one sawmill in the United States and one manufacturing plant each in Mexico and Honduras.
Our business model is to maintain continued focus on (i) communicating our messages with strong advertising and marketing campaigns, (ii) capitalizing on the strength of our interior design professionals and management in our retail design centers, (iii) utilizing ethanallen.com as a key marketing tool to drive traffic to a network of 200 North American design centers located near our demographic base, (iv) investing in new technologies across key aspects of our vertically integrated business, and (v) leveraging the benefits of our vertical integration by maintaining our manufacturing capacity in North America where we manufacture approximately 75% of our products.
Our competitive advantages arise from:
|
●
|
providing fashionable high quality products of the finest craftsmanship;
|
|
●
|
offering complimentary design service through an estimated 2,000 motivated interior design professionals network-wide, which we believe makes us the world’s leading interior design network;
|
|
●
|
offering a wide array of custom products across our upholstery, case goods, and accent product categories;
|
|
●
|
enhancing our technology in all aspects of the business; and
|
|
●
|
leveraging our vertically integrated structure.
|
We have completed a major transformation of our product offerings, having refreshed over 70% of our entire product line over the past three years. Our GSA business continues to grow, and the GSA is now one of our ten largest customers. Our internet sales, while still a minor portion of our sales, are growing at a rate that continues to out-pace our brick and mortar design centers. In the spring and summer of 2018, we launched our new Uptown collection, featuring a modern perspective on classic designs.
We are in the midst of a major brand-building marketing program utilizing multiple mediums including direct mail, television, print, digital and social marketing. This program targets a broad demographic base beyond our core customer. We expect that as we continue to market to this broader base, our brand awareness will increase and ultimately drive increased revenues over time. Consequently, our first quarter fiscal 2018 advertising expense increased by 12.8% over the same prior year period.
While we implement major product introductions, such as the introductions described above, our wholesale segment experiences some disruptions in manufacturing as we change tooling and manufacturing methods, build prototypes and then ramp up production. In our retail segment, some disruption also occurs in our design centers as we update floor displays, and sell the remainder of our older products on clearance to make space for the new product. These disruptions may affect sales and expenses.
Sales increases of 5.8% for wholesale and 2.6% for retail combined to increase gross profit by $1.1 million. Gross margin was below the prior year, primarily due to increased raw material costs, which reduced gross profit by $0.8 million and the retail sales mix in relation to total sales, which was 77.3% in the current quarter compared to 78.1% in the comparable prior year period. Operating expenses increased in total due to increases in advertising and distribution expenses, and decreased as a percentage of sales. Income taxes were reduced due to the changes resulting from the U.S. Tax Cuts and Jobs Act enacted in December 2017, with an effective tax rate of 24.9% in the current quarter compared to 35.1% in the prior year. The net result was an increase in earnings per diluted share of $0.06.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
Results of Operations
A summary of our consolidated operations is presented in the following tables. In this Item 2 of this quarterly report, unless otherwise noted, all comparisons in the discussion following are from the three month period ended September 30, 2018 to the comparable prior year fiscal three month period ($ in millions except per share amounts).
|
|
Three months ended September 30,
|
|
|
|
2018
|
|
|
%
|
|
|
2017
|
|
|
%
|
|
Net sales
|
|
$
|
187.8
|
|
|
|
100.0
|
%
|
|
$
|
181.3
|
|
|
|
100.0
|
%
|
Gross profit
|
|
|
101.5
|
|
|
|
54.0
|
%
|
|
|
100.3
|
|
|
|
55.3
|
%
|
Selling, general and administrative expenses
|
|
|
89.7
|
|
|
|
47.7
|
%
|
|
|
88.8
|
|
|
|
49.0
|
%
|
Operating income
|
|
|
11.8
|
|
|
|
6.3
|
%
|
|
|
11.5
|
|
|
|
6.4
|
%
|
Net income
|
|
|
8.8
|
|
|
|
4.7
|
%
|
|
|
7.4
|
|
|
|
4.1
|
%
|
Earnings per diluted share
|
|
$
|
0.33
|
|
|
|
|
|
|
$
|
0.27
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
24.4
|
|
|
|
|
|
|
$
|
17.6
|
|
|
|
|
|
A summary of changes from the preceding fiscal year are presented in the following table.
|
|
Three months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Net sales
|
|
|
3.6
|
%
|
|
|
(6.2
|
%)
|
Operating income
|
|
|
2.2
|
%
|
|
|
(37.0
|
%)
|
Net income
|
|
|
19.2
|
%
|
|
|
(35.7
|
%)
|
Earnings per diluted share
|
|
|
22.2
|
%
|
|
|
(34.1
|
%)
|
Net cash provided by operating activities
|
|
|
38.6
|
%
|
|
|
(35.9
|
%)
|
The components of consolidated revenues and operating income (loss) by business segment are as follows (in millions):
|
|
Three months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Revenue:
|
|
|
|
|
|
|
|
|
Wholesale segment
|
|
$
|
118.1
|
|
|
$
|
111.6
|
|
Retail segment
|
|
|
145.2
|
|
|
|
141.6
|
|
Elimination of inter-segment sales
|
|
|
(75.5
|
)
|
|
|
(71.9
|
)
|
Consolidated revenue
|
|
$
|
187.8
|
|
|
$
|
181.3
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss):
|
|
|
|
|
|
|
|
|
Wholesale segment
|
|
$
|
14.3
|
|
|
$
|
13.5
|
|
Retail segment
|
|
|
(1.6
|
)
|
|
|
(2.8
|
)
|
Adjustment for inter-company profit (1)
|
|
|
(0.9
|
)
|
|
|
0.8
|
|
Consolidated operating income
|
|
$
|
11.8
|
|
|
$
|
11.5
|
|
|
(1)
|
Represents the change in wholesale profit contained in Ethan Allen operated design center inventory existing at the end of the period.
|
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
A summary by business segment of annual percentage changes from the preceding fiscal year are presented in the following tables:
|
|
Three months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Wholesale segment
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
5.8
|
%
|
|
|
(2.6
|
%)
|
Operating Income
|
|
|
6.3
|
%
|
|
|
(18.4
|
%)
|
Backlog
|
|
|
(21.6
|
%)
|
|
|
50.7
|
%
|
|
|
Three months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Retail segment
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
2.6
|
%
|
|
|
(7.0
|
%)
|
Comparable design center revenue
|
|
|
0.8
|
%
|
|
|
(8.8
|
%)
|
Total written orders
|
|
|
(0.2
|
%)
|
|
|
1.7
|
%
|
Comparable design center written orders
|
|
|
(2.1
|
%)
|
|
|
0.5
|
%
|
Operating Income
|
|
|
43.8
|
%
|
|
|
(371.1
|
%)
|
Backlog
|
|
|
(4.7
|
%)
|
|
|
10.4
|
%
|
We measure the performance of our design centers based on net sales and written orders booked on a comparable period basis. Comparable design centers are those which have been operating for at least 15 months, including relocated design centers provided the original and relocated design center location had been operating for at least 15 months on a combined basis. During the first three months of operations of newly opened design centers, written orders are booked but minimal net sales are achieved through the delivery of products. Design centers we acquire from independent retailers are included in comparable design center sales in their 13th full month of Ethan Allen-owned operations. The frequency of our promotional events as well as the timing of the end of those events can also affect the comparability of orders booked during a given period. Our international net sales are composed of our wholesale segment sales to independent retailers and our retail segment sales to consumers through the Company operated international design centers. International net sales as a percent of our consolidated net sales were 7.9% in the current year quarter and 11.0% in the prior year quarter. The following tables show selected design center location information.
|
|
Fiscal 2019
|
|
|
Fiscal 2018
|
|
|
|
Independent
|
|
|
Company-
|
|
|
|
|
|
|
Independent
|
|
|
Company-
|
|
|
|
|
|
|
|
retailers
|
|
|
operated
|
|
|
Total
|
|
|
retailers
|
|
|
operated
|
|
|
Total
|
|
Retail Design Center location activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
|
148
|
|
|
|
148
|
|
|
|
296
|
|
|
|
155
|
|
|
|
148
|
|
|
|
303
|
|
New locations
|
|
|
6
|
|
|
|
-
|
|
|
|
6
|
|
|
|
3
|
|
|
|
2
|
|
|
|
5
|
|
Closures
|
|
|
(1
|
)
|
|
|
(1
|
)
|
|
|
(2
|
)
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
(2
|
)
|
Transfers
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance at end of period
|
|
|
153
|
|
|
|
147
|
|
|
|
300
|
|
|
|
156
|
|
|
|
150
|
|
|
|
306
|
|
Relocations (in new and closures)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail Design Center geographic locations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
43
|
|
|
|
141
|
|
|
|
184
|
|
|
|
48
|
|
|
|
144
|
|
|
|
192
|
|
Canada
|
|
|
-
|
|
|
|
6
|
|
|
|
6
|
|
|
|
-
|
|
|
|
6
|
|
|
|
6
|
|
China
|
|
|
92
|
|
|
|
-
|
|
|
|
92
|
|
|
|
83
|
|
|
|
-
|
|
|
|
83
|
|
Other Asia
|
|
|
10
|
|
|
|
-
|
|
|
|
10
|
|
|
|
12
|
|
|
|
-
|
|
|
|
12
|
|
Europe
|
|
|
1
|
|
|
|
-
|
|
|
|
1
|
|
|
|
6
|
|
|
|
-
|
|
|
|
6
|
|
Middle East
|
|
|
7
|
|
|
|
-
|
|
|
|
7
|
|
|
|
7
|
|
|
|
-
|
|
|
|
7
|
|
Total
|
|
|
153
|
|
|
|
147
|
|
|
|
300
|
|
|
|
156
|
|
|
|
150
|
|
|
|
306
|
|
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
First Quarter Ended September 30, 2018 Compared to First Quarter Ended September 30, 2017
Consolidated net sales
for the quarter of $187.8 million compared to $181.3 million for the same period in the prior year, an increase of 3.6%. Wholesale segment sales increased largely due to increased GSA contract orders. Manufacturing production levels were strong during the quarter, without the previous year disruptions from first production runs that had caused shipping delays, which helped drive stronger shipments to the retail segment and contributed to increased retail segment sales.
Retail net sales
for the quarter of $145.2 million compared to $141.6 million for the prior year period, an increase of 2.6%. Comparative retail net sales increased 0.8%. There were 147 Company-operated design centers during the quarter, down from 150 in the prior year quarter. There was a 4.1% increase in sales in the U.S., while sales from the Canadian design centers decreased 28.0%. We believe this decrease in Canadian design center sales is related to the economic uncertainty surrounding current international trade disputes. Total written business (new orders booked) decreased 0.2%, with a decrease in Canada partly offset by an increase in the U.S. written business. Comparable design center written business in the quarter decreased 2.1% in total, primarily attributable to a decrease in Canada.
Wholesale net sales
for the quarter of $118.1 million compared to $111.6 million for the prior year period, an increase of 5.8%. The increase in sales is due to increases to our GSA contract business, partially offset by decreases to our international retailers.
Gross profit
for the quarter of $101.5 million compared to $100.3 million for the prior year period, an increase of 1.1%, with an increase in both our retail and wholesale segments. Gross profit for wholesale increased due to higher sales volume, partly offset by an increase in raw materials costs of $0.8 million. Consolidated gross margin for the quarter was 54.0% compared to 55.3%. Retail sales as a percent of total consolidated sales was 77.3% for the quarter compared to 78.1% in the prior year quarter, decreasing our consolidated gross margin due to this reduced percentage.
Operating expenses
for the quarter of $89.7 million, or 47.7% of net sales, increased $0.9 million compared to $88.8 million, or 49.0% of net sales, for the prior year period. The 1.0% increase to prior year was primarily due to increased freight, distribution and warehouse costs of $1.5 million due to increased sales, and an increase in advertising of $0.9 million, partly offset by prior year organizational changes and other exit costs of $0.8 that did not recur this year.
Operating income and profit margin
for the quarter of $11.8 million, or 6.3% of net sales, compared to $11.5 million, or 6.4% of net sales, for the prior year period. The primary causes for the 2.2% increase in operating income were the increased sales in wholesale and retail and prior year organizational changes that did not recur, partly offset by increased variable costs of freight , distribution and warehouse costs associated with increased sales, and increased raw material costs, as discussed previously.
Retail operating income
for the quarter of a loss of $1.6 million, or -1.1% of sales, compared to a loss of $2.8 million, or -2.0% of sales, for the prior year period. The lower operating loss and improved margin in the current quarter was driven primarily by the improved sales in the current year period.
Wholesale operating income
for the quarter of $14.3 million, or 12.1% of sales, compared to $13.5 million, or 12.1% of sales, for the prior year period. The increase was largely due to the increase in current period net sales, partly offset by raw material cost increases as discussed above.
Income tax expense
for the quarter totaled $2.9 million compared to $4.0 million. Our effective tax rate was 24.9% in the quarter compared to 35.1%. The effective tax rate for the quarter was lower due to the changes introduced by the U.S. Tax Cuts and Jobs Act enacted in December 2017. The effective tax rate for the first quarter of fiscal 2019 primarily includes tax expense on that quarter’s net income, tax expense on cancelation of stock options, and tax and interest expense on uncertain tax positions. The effective tax rate for the first quarter of fiscal 2018 primarily includes tax expense on that quarter’s net income, and tax and interest expense on uncertain tax positions, partially offset by the tax benefit on the vesting of restricted stock units. See Note 3, Income Taxes, for further information.
Net income
for the quarter of $8.8 million compared to $7.4 million for the prior year period an increase of 19.2%. This resulted in net income per diluted share for the quarter of $0.33 compared to $0.27, an increase of 22.2%.
Liquidity and Capital Resources
At September 30, 2018, we held cash and cash equivalents of $39.6 million. At June 30, 2018, we held cash and cash equivalents of $22.4 million. Our principal sources of liquidity include cash and cash equivalents, cash flow from operations, amounts available under the Facility, and other borrowings.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
For a detailed discussion of our debt obligations and timing of our related cash payments see Note 6 to the Consolidated Financial Statements included under Item 1 of this Quarterly Report.
A summary of net cash provided by (used in) operating, investing, and financing activities for the three months ended September 30, 2018 and 2017 is provided below (in millions):
|
|
Three months ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Cash provided by (used in) operating activities
|
|
|
|
|
|
|
|
|
Net income plus depreciation and amortization
|
|
$
|
13.8
|
|
|
$
|
12.5
|
|
Working capital items
|
|
|
10.2
|
|
|
|
3.7
|
|
Other operating activities
|
|
|
0.4
|
|
|
|
1.4
|
|
Total provided by operating activities
|
|
$
|
24.4
|
|
|
$
|
17.6
|
|
|
|
|
|
|
|
|
|
|
Cash provided by (used in) investing activities
|
|
|
|
|
|
|
|
|
Capital expenditures and acquisitions
|
|
$
|
(2.8
|
)
|
|
$
|
(2.7
|
)
|
Other investing activities
|
|
|
0.1
|
|
|
|
0.1
|
|
Total provided by (used in) investing activities
|
|
$
|
(2.7
|
)
|
|
$
|
(2.6
|
)
|
|
|
|
|
|
|
|
|
|
Cash provided by (used in) financing activities
|
|
|
|
|
|
|
|
|
Payments on long-term debt and capital lease obligations
|
|
$
|
(0.2
|
)
|
|
$
|
(14.1
|
)
|
Payment of cash dividends
|
|
|
(5.1
|
)
|
|
|
(5.2
|
)
|
Purchase/retirement of company stock
|
|
|
-
|
|
|
|
(1.1
|
)
|
Other financing activities
|
|
|
0.7
|
|
|
|
-
|
|
Total provided by (used in) financing activities
|
|
$
|
(4.6
|
)
|
|
$
|
(20.4
|
)
|
Cash Provided by (Used in) Operating Activities
Year-to-date, cash of $24.4 million was provided by operating activities, an increase of $6.8 million. This was largely due to changes in the ordinary course of business for working capital items, primarily an inventory increase to support the order backlog. Working capital items consist of current assets (accounts receivable, inventories, prepaid and other current assets) less current liabilities (customer deposits, payables, and accrued expenses and other current liabilities).
Cash Provided by (Used in) Investing Activities
Year-to-date, $2.7 million of cash was used in investing activities, an increase of $0.1 million. Capital expenditures remained consistent with the prior year. Current year capital expenditures primarily related to retail design center improvements. We anticipate that cash from operations will be sufficient to fund future capital expenditures. Effective July 1, 2018, the company considers restricted cash as a component of cash and cash equivalents as presented on the statement of cash flows. Previously the net change in restricted cash was considered an investing activity. Prior periods have been reclassified to conform to current year presentation. See also notes 4 and 12.
Cash Provided by (Used in) Financing Activities
Year-to-date, $4.6 million was used in financing activities, which is $15.8 million less cash used than the $20.4 million of cash used during the first three months of fiscal 2018. This was primarily due to a $13.2 million pre-payment on the term loan in the prior fiscal year. During the current fiscal year to date period we paid dividends of $5.1 million compared to $5.2 million in the prior year to date period, paying $0.19 per share in both periods. The Company has continuously paid dividends for every quarter since 1996 and we expect to continue to do so as economic conditions and liquidity permit.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
We believe that our cash flow from operations, together with our other available sources of liquidity including the Facility and refinancing alternatives, will be adequate to make all required payments of principal and interest on our debt, to permit anticipated capital expenditures, and to fund working capital and other cash requirements. As of September 30, 2018, we had working capital of $100.2 million compared to $93.2 million at June 30, 2018, an increase of $7.0 million, or 7.5%. The Company had a current ratio of 1.74 to 1 at September 30, 2018 and 1.77 to 1 at June 30, 2018.
In addition to using available cash to fund changes in working capital, necessary capital expenditures, acquisition activity, the repayment of debt and the payment of dividends, the Company has been authorized by our board of directors to repurchase our common stock from time to time, either directly or through agents, in the open market at prices and on terms satisfactory to us. During the three months ending September 30, 2018 there were no share repurchases.
At September 30, 2018, we had a remaining Board authorization to repurchase 2,518,046 shares of our common stock pursuant to our previously announced share repurchase program.
Contractual Obligations
There has been no material change to the amount or timing of cash payments related to our outstanding contractual obligations as set forth in Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended June 30, 2018 as filed with the SEC on August 2, 2018.
Off-Balance Sheet Arrangements and Other Commitments, Contingencies and Contractual Obligations
Except as indicated below, we do not utilize or employ any off-balance sheet arrangements, including special-purpose entities, in operating our business. As such, we do not maintain any (i) retained or contingent interests, (ii) derivative instruments (other than as specified below), or (iii) variable interests which could serve as a source of potential risk to our future liquidity, capital resources and results of operations.
We may, from time to time in the ordinary course of business, provide guarantees on behalf of selected affiliated entities or become contractually obligated to perform in accordance with the terms and conditions of certain business agreements. The nature and extent of these guarantees and obligations may vary based on our underlying relationship with the benefiting party and the business purpose for which the guarantee or obligation is being provided. The only such program in place at both September 30, 2018 and June 30, 2018 was for our consumer credit program described below.
Ethan Allen Consumer Credit Program
The terms and conditions of our consumer credit program, which is financed and administered by a third-party financial institution on a non-recourse basis to Ethan Allen, are set forth in an agreement between the Company and that financial service provider (the “Program Agreement”) which was last amended effective January 2014. Any independent retailer choosing to participate in the consumer credit program is required to enter into a separate agreement with that same third-party financial institution which sets forth the terms and conditions under which the retailer is to perform in connection with its offering of consumer credit to its customers (the “Retailer Agreement”). We have obligated ourselves on behalf of any independent retailer choosing to participate in our consumer credit program by agreeing, in the event of default, breach, or failure of the independent retailer to perform under such Retailer Agreement, to take on certain responsibilities of the independent retailer, including, but not limited to, delivery of goods and reimbursement of customer deposits. Customer receivables originated by independent retailers remain non-recourse to Ethan Allen. The Program Agreement will terminate on July 31, 2019, but includes a provision for automatic one-year renewals unless either party gives notice of termination. While the maximum potential amount of future payments (undiscounted) that we could be required to make under this obligation is indeterminable, recourse provisions exist that would enable us to recover, from the independent retailer, any amount paid or incurred by us related to our performance. Based on the underlying creditworthiness of our independent retailers, including their historical ability to perform satisfactorily in connection with the terms of our consumer credit program, we believe this obligation will expire without requiring funding by us. To ensure funding for delivery of products sold, the terms of the Program Agreement also contain a right for the financial services provider to demand from the Company collateral at a variable rate based on the volume of program sales if the Company does not meet a covenant regarding minimum working capital or tangible net worth. At both September 30, 2018 and June 30, 2018, we were in compliance with such covenant.
Product Warranties
Our products, including our case goods, upholstery and home accents, generally carry explicit product warranties that extend up to twelve years and are provided based on terms that are generally accepted in the industry. All our domestic independent retailers are required to enter into and perform in accordance with the terms and conditions of a warranty service agreement. We record provisions for estimated warranty and other related costs at time of sale based on historical warranty loss experience and make periodic adjustments to those provisions to reflect actual experience. On rare occasions, certain warranty and other related claims involve matters of dispute that ultimately are resolved by negotiation, arbitration or litigation. In certain cases, a material warranty issue may arise which is beyond the scope of our historical experience. We provide for such warranty issues as they become known and are deemed both probable and estimable. It is reasonably possible that, from time to time, additional warranty and other related claims could arise from disputes or other matters beyond the scope of our historical experience. At both September 30, 2018 and June 30, 2018 the Company’s product warranty liability totaled $1.5 million.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES
Business Outlook
We continue to strengthen our vertically integrated structure from concept of idea, to engineering, to manufacturing, to retail and logistics. We intend to maintain strong manufacturing capabilities in North America, which we believe is a long-term competitive advantage that will allow us to advance our objectives of maintaining fast order delivery, exceptional quality and improving capacity to ship stocked and custom made-to-order items more quickly, which in turn will allow us to grow our business. Having refreshed over 70% of our products in the last three years, our current product offerings are fresh and relevant.
Our marketing programs continue to be strengthened with messaging focused on our stylish products, quality and service offerings. We expect to continue to expand our advertising during fiscal 2019 as we broaden the reach of our messaging to drive more traffic to our design centers and to ethanallen.com.
Our network of professionally trained interior design professionals differentiate us significantly from our competitors. We continue to strengthen the level of service, professionalism, and interior design competence, as well as to improve the efficiency of our retail operations. We believe that over time, we will continue to benefit from (i) continuous repositioning of 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 combined with personal service from our interior design professionals.
We expect the home furnishings industry to remain extremely competitive with respect to both the sourcing of products and the wholesale and retail sale of those products for the foreseeable future. Domestic manufacturers continue to face pricing pressures because of the lower manufacturing costs on imports, particularly from Asia. While we also utilize overseas sourcing for approximately one quarter of our products, we choose to differentiate ourselves by maintaining a substantial North American manufacturing base, the majority of which is located in the United States. This structure enables us to leverage our vertically integrated structure to our advantage. We continue to believe that a balanced approach to product sourcing, which includes our own North American manufacturing of about 75% of our product offerings coupled with the import of other selected products, provides the greatest degree of flexibility and shorter lead times and is the most effective approach to ensuring that acceptable levels of quality, service and value are attained.
With our vertical enterprise well positioned, we maintain a cautiously optimistic outlook. Our retail strategy will continue with its focus on (i) providing relevant product offerings, a wide array of product solutions, and superior interior design solutions through our large staff of interior design professionals, (ii) continuing strong advertising and marketing campaigns to get our message across and to continue broadening our customer base, (iii) the opening of new or relocated design centers in more prominent locations, and encouraging independent retailers to do the same, (iv) leveraging the use of technology and personal service within our retail network and online through www.ethanallen.com, and (v) further expansion internationally. We believe this strategy provides an opportunity to grow our business.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02,
Leases
, which is intended to improve financial reporting about leasing transactions. The ASU will require lessees that lease assets with lease terms of more than twelve months to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Lessors will remain largely unchanged from current GAAP. In addition, the ASU will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. This pronouncement is effective for the Company on July 1, 2019, and early adoption is permitted. The Company is currently evaluating the impact on our consolidated financial statements.
Where You Can Find Other Information
Our website is
www.ethanallen.com
. Information contained on our website is not part of this Quarterly Report on Form 10-Q. Information that we furnish or file with the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to, or exhibits included in, these reports are available for download, free of charge, on our website soon after such reports are filed with or furnished to the SEC. Our SEC filings, including exhibits filed therewith, are also available on the SEC’s website at www.sec.gov.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES