UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 1998 ------------------------------------------------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------------------------------------------- Commission File Number: 1-11692 --------------------------------------------------------- Ethan Allen Interiors Inc.; Ethan Allen Inc.; Ethan Allen Finance Corporation; Ethan Allen Manufacturing Corporation; Andover Wood Products Inc. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 06-1275288 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer ID No.) incorporation or organization) Ethan Allen Drive, Danbury, Connecticut 06811 - -------------------------------------------------------------------------------- (Address of principal executive offices) (203) 743-8000 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. [ ] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 27,233,006 at December 31, 1998 ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY INDEX PAGE ---- Part I. Financial Information: Item 1. Consolidated Financial Statements as of December 31 and June 30, 1998 and for the three and six months ended December 31, 1998 and 1997 (unaudited): Consolidated Balance Sheets 2 Consolidated Statements of Income 3 Consolidated Statements of Cash Flows 4 Consolidated Statement of Shareholders' Equity 5 Notes to Consolidated Financial Statements 6 Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosure about Market Risk 13 Part II. Other Information: 14 Item 1. Legal Proceedings Item 2. Changes in Securities Item 6. Exhibits and reports on Form 8-K Signatures ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Consolidated Balance Sheets (Dollars in thousands)
December 31, 1998 June 30, (unaudited) 1998 ----------- ------------ Current assets: Cash and cash equivalents $ 10,941 $ 19,380 Accounts receivable, less allowances of $2,016 and $2,022 at December 31 and June 30, 1998, respectively 31,220 35,640 Notes receivable, current portion, less allowances of $113 and $27 at December 31 and June 30, 1998, respectively 658 686 Inventories (note 3) 133,377 114,364 Prepaid expenses and other current assets 14,413 10,735 Deferred income taxes 8,112 7,094 --------- --------- Total current assets 198,721 187,899 --------- --------- Property, plant and equipment, net 203,117 188,171 Property held for sale (note 4) 484 1,129 Notes receivable, net of current portion, less allowance of $117 and $259 at December 31 and June 30, 1998, respectively 1,387 1,790 Intangibles, net of amortization of $15,904 and $15,060 at December 31 and June 30, 1998, respectively 52,141 50,773 Deferred financing costs, net of amortization of $2,395 and $2,280 at December 31 and June 30, 1998, respectively 517 632 Other assets 3,082 2,729 --------- --------- Total assets $ 459,449 $ 433,123 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt and capital lease obligations $ 1,053 $ 879 Accounts payable 56,765 51,135 Accrued expenses 9,136 5,863 Accrued compensation and benefits 15,339 15,735 --------- --------- Total current liabilities 82,293 73,612 --------- --------- Long-term debt, less current maturities 35,648 11,480 Obligations under capital leases, less current maturities 483 1,016 Other long-term liabilities, principally long-term compensation and environmental 791 812 Deferred income taxes 31,998 31,883 --------- --------- Total liabilities 151,213 118,803 --------- --------- Commitments and Contingencies (note 5) Shareholders' equity: Class A common stock, par value $.01, 70,000,000 shares authorized, 29,716,573 and 29,669,470 shares issued at December 31 and June 30, 1998, respectively 296 296 Preferred stock, par value $.01, 1,055,000 shares authorized, no shares issued and outstanding at December 31 and June 30, 1998, respectively -- -- Additional paid-in capital 265,655 262,462 --------- --------- 265,951 262,758 Less: Treasury stock (at cost) 2,483,567 and 1,216,096 shares at December 31 and June 30, 1998, respectively (78,242) (33,750) --------- --------- 187,709 229,008 Retained Earnings 120,527 85,312 --------- --------- Total shareholders' equity 308,236 314,320 --------- --------- Total liabilities and shareholders' equity $ 459,449 $ 433,123 ========= ========= See accompanying notes to consolidated financial statements.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Consolidated Statements of Income (Unaudited) (In thousands, except per share data)
Three Months Six Months Ended December 31, Ended December 31, 1998 1997 1998 1997 -------- -------- -------- -------- Net sales $193,674 $172,743 $359,900 $325,237 Cost of sales 103,918 92,030 193,140 173,758 -------- -------- -------- -------- Gross profit 89,756 80,713 166,760 151,479 Operating expenses: Selling 30,640 26,567 58,464 52,894 General and administrative 24,287 22,033 46,879 42,512 -------- -------- -------- -------- Operating income 34,829 32,113 61,417 56,073 -------- -------- -------- -------- Interest and other miscellaneous income, net 348 1,014 818 1,802 Interest and related expense: Interest expense 594 1,390 890 2,794 Amortization of deferred financing costs 57 102 115 211 -------- -------- -------- -------- 651 1,492 1,005 3,005 -------- -------- -------- -------- Income before income taxes 34,526 31,635 61,230 54,870 Income tax expense 13,340 12,544 23,835 21,745 -------- -------- -------- -------- Net income $ 21,186 $ 19,091 $ 37,395 $ 33,125 ======== ======== ======== ======== Per share data (note 7): Net Income per basic share $ 0.77 $ 0.66 $ 1.35 $ 1.15 ======== ======== ======== ======== Basic weighted average common shares outstanding 27,476 28,713 27,741 28,727 Net Income per diluted share $ 0.75 $ 0.65 $ 1.32 $ 1.13 ======== ======== ======== ======== Diluted weighted average common shares outstanding 28,061 29,380 28,362 29,338 Dividend declared per common share $ 0.04 $ 0.03 $ 0.08 $ 0.06 ======== ======== ======== ========
See accompanying notes to consolidated financial statements. ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Consolidated Statements of Cash Flows (Unaudited) (Dollars in thousands)
Six Months Ended December 31, 1998 1997 -------- --------- Operating activities: Net income $ 37,395 $ 33,125 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,903 8,115 Provision for deferred income taxes (903) (896) Other non-cash charges 344 82 Change in: Accounts receivable 4,363 3,997 Inventories (15,757) (1,277) Prepaid and other current assets (3,678) (4,127) Other assets (850) (1,122) Accounts payable 8,039 8,470 Accrued expenses 2,938 (525) Other long-term liabilities (21) (27) -------- -------- Net cash provided by operating activities 39,773 45,815 -------- -------- Investing activities: Proceeds from the disposal of property, plant and equipment -- 780 Capital expenditures (21,091) (13,446) Payments received on long-term notes receivable 486 1,182 Disbursements made for long-term notes receivable -- (77) Acquisition of business - Inventory (3,256) -- Excess of Purchase price over cost (2,212) -- Redemptions of short term securities -- 10,476 Investments in short term securities -- (12,295) -------- -------- Net cash used in investing activities (26,073) (13,380) -------- -------- Financing activities: Payments to acquire treasury stock (44,492) (4,842) Payments on revolving credit facility (30,000) -- Borrowings on revolving credit facility 54,500 -- Other long-term borrowings -- 111 Redemption of Senior Notes -- (139) Payments on long-term debt, including current maturities (76) (76) Payments under capital leases (614) (821) Issuance of capital stock 784 1,015 Payment of dividends (2,241) (1,726) -------- -------- Net cash used in financing activities (22,139) (6,478) -------- -------- Net increase in cash and cash equivalents (8,439) 25,957 Cash and cash equivalents at beginning of period 19,380 21,866 -------- -------- Cash and cash equivalents at end of period $ 10,941 $ 47,823 ======== ======== See accompanying notes to consolidated financial statements.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Consolidated Statements of Shareholders' Equity Six Months Ended December 31, 1998 (Unaudited) (Dollars in thousands)
Additional Common Paid-In Treasury Retained Stock Capital Stock Earnings Total ------ ---------- ----------- --------- ---------- Balance at June 30, 1998 $ 296 $ 262,462 $ (33,750) $ 85,312 $ 314,320 Issuance of common stock - 784 -- -- 784 Purchase of 1,267,471 shares treasury stock - -- (44,492) -- (44,492) Tax benefit associated with the exercise of employee options and warrants - 2,409 -- -- 2,409 Dividends declared - -- -- (2,180) (2,180) Net income - -- -- 37,395 37,395 ------- ---------- ----------- --------- ---------- Balance at December 31, 1998 $ 296 $ 265,655 $ (78,242) $ 120,527 $ 308,236 ======= ========== =========== ========= ========== See accompanying notes to consolidated financial statements.
ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (Unaudited) (1) Basis of Presentation Ethan Allen Interiors Inc. (the "Company") is a Delaware corporation incorporated on May 25, 1989. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary Ethan Allen Inc. ("Ethan Allen") and Ethan Allen's subsidiaries. All of Ethan Allen's capital stock is owned by the Company. The Company has no other assets or operating results other than those associated with its investment in Ethan Allen. (2) Interim Financial Presentation All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. In the opinion of the Company, all adjustments, consisting only of normal recurring accruals necessary for fair presentation, have been included in the financial statements. The results of operations for the three and six months ended December 31, 1998 are not necessarily indicative of results for the fiscal year. (3) Inventories Inventories at December 31 and June 30, 1998 are summarized as follows (dollars in thousands): December 31, June 30, 1998 1998 ------------ ---------- Retail merchandise $ 46,234 $ 38,329 Finished products 34,817 28,931 Work in process 16,464 15,707 Raw materials 35,862 31,397 -------- -------- $133,377 $114,364 ======== ======== (4) Property Held for Sale Property held for sale is recorded at lower of cost or net realizable values. (5) Contingencies The Company has been named as a potentially responsible party ("PRP") for the cleanup of four sites currently listed or proposed for inclusion on the National Priorities List ("NPL") under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"). Numerous other parties have been identified as PRP's at these sites. Liability under CERCLA may be joint and several. The Company has total reserves of $500,000 applicable to these sites, which the Company believes is sufficient to cover any resulting liability. With respect to all of these sites, the Company believes that it is not a major contributor based on the very small volume of waste generated by the Company in relation to total volume at the site. The Company has concluded its involvement with one site and has settled as a de-minimis party. For two of the sites, the remedial investigation is ongoing. A volume based allocation of responsibility among the parties has been prepared. With respect to the fourth site, a consent decree to finally resolve the matter with the EPA has been signed and the Company has entered upon a program to design and construct a landfill cap of the Parker Landfill site. The cap will be funded by a number of parties including the Federal Government, the State of Vermont and other companies who contributed hazardous materials to the site. Another company is responsible for the ground water remediation and still another is responsible for operation and maintenance. (6) Wholly-Owned Subsidiary The Company owns all of the outstanding stock of Ethan Allen, has no material assets other than its ownership of Ethan Allen stock, and conducts all significant operating transactions through Ethan Allen. The Company has guaranteed Ethan Allen's obligations under the Credit Agreement and has pledged all the outstanding capital stock of Ethan Allen to secure its guarantee under its Credit Agreement. ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (Unaudited) The condensed balance sheets of Ethan Allen as of December 31 and June 30, 1998 are as follows (dollars in thousands): December 31, June 30, 1998 1998 ------------ ---------- Assets - ------ Current assets $198,705 $187,677 Non-current assets 344,797 282,874 -------- -------- Total assets $543,502 $470,551 ======== ======== Liabilities - ----------- Current liabilities $ 81,096 $ 72,380 Non-current liabilities 68,920 45,191 -------- -------- Total liabilities $150,016 $117,571 ======== ======== A summary of Ethan Allen's operating activity for the three and six months ended December 31, 1998 and 1997, is as follows (dollars in thousands): Three Months Six Months Ended December 31, Ended December 31, 1998 1997 1998 1997 -------- -------- -------- --------- Net sales $193,674 $172,743 $359,900 $325,237 Gross profit 89,756 80,713 166,760 151,479 Operating income 34,865 32,134 61,488 56,114 Interest expense 594 1,390 890 2,794 Amortization of deferred financing costs 57 102 115 211 Income before income tax expense 34,562 31,656 61,301 54,911 Net income 21,222 19,112 37,466 33,166 7) Earnings per Share Basic and diluted earnings per share are calculated based upon the provisions of SFAS 128, using the following share data (in thousands): Three Months Six Months Ended December 31, Ended December 31, 1998 1997 1998 1997 -------- --------- -------- ------- Weighted average common shares outstanding for basic calculation 27,476 28,713 27,741 28,727 Add: Effect of stock options and warrants 585 667 621 611 Weighted average common shares outstanding - adjusted for diluted calculation 28,061 29,380 28,362 29,338 8) Segment Information The Company's operations are classified into two business segments: wholesale and retail home furnishings. The wholesale home furnishings segment is principally involved in the manufacture, sale and distribution of home furnishings products to a network of independently-owned and Ethan Allen-owned stores. The retail home furnishings segment sells home furnishing products through a network of Ethan Allen-owned stores. These products consist of case goods (wood furniture), upholstered products, home accessories and indoor/outdoor furniture. Wholesale profitability includes the wholesale gross margin which is earned on wholesale sales to all retail stores, including Ethan Allen-owned stores. Retail profitability includes the retail margin which is earned based on purchases from the wholesale business. Inter-segment elimination's primarily comprise the wholesale sales and profit on the transfer of inventory between segments. Operating earnings by business segment are defined as sales less operating costs and expenses. Income and expense items, such as corporate operating expenses, are included in the applicable segment. Identifiable assets are those assets used exclusively in the operations of each business segment. Corporate assets principally comprise cash, deferred financing costs, and deferred income taxes. ETHAN ALLEN INTERIORS INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (Unaudited) The following table presents revenue and operating earnings by respective business segment for the three and six months ended December 31, 1998 and 1997 (in thousands): Three Months ended December 31, 1998:
Inter-Segment Wholesale Retail Elimation Consolidated --------- ------ --------- ------------ Net sales $160,193 $ 75,639 $(42,158) $193,674 Operating income 30,972 4,634 (777) 34,829 Interest and other income 292 56 -- 348 Interest expense 451 143 -- 594 Amortization deferred financing costs 39 18 -- 57 Income before income tax expense $ 30,774 $ 4,529 $ (777) $ 34,526 Three Months ended December 31, 1997: Inter-Segment Wholesale Retail Elimation Consolidated --------- ------ --------- ------------ Net sales $144,014 $ 61,150 $(32,421) $172,743 Gross profit 54,007 27,263 (557) 80,713 Operating income 28,011 4,173 (71) 32,113 Interest and other income 959 55 -- 1,014 Interest expense 1,051 339 -- 1,390 Amortization deferred financing costs 73 29 -- 102 Income before income tax expense $ 27,846 $ 3,860 $ (71) $ 31,635 Six Months ended December 31, 1998: Inter-Segment Wholesale Retail Elimation Consolidated --------- ------ --------- ------------ Net sales $301,509 $137,444 $(79,053) $359,900 Gross profit 109,271 60,632 (3,143) 166,760 Operating income 57,074 6,656 (2,313) 61,417 Interest and other income 655 163 -- 818 Interest expense 687 203 -- 890 Amortization deferred financing costs 85 30 -- 115 Income before income tax expense $ 56,957 $ 6,586 $ (2,313) $ 61,230 Six Months ended December 31, 1997: Inter-Segment Wholesale Retail Elimation Consolidated --------- ------ --------- ------------ Net sales $274,238 $113,636 $(62,637) $325,237 Gross profit 103,481 50,586 (2,588) 151,479 Operating income 51,022 6,709 (1,658) 56,073 Interest and other income 1,686 116 -- 1,802 Interest expense 2,109 685 -- 2,794 Amortization deferred financing costs 155 56 -- 211 Income before income tax expense $ 50,444 $ 6,084 $ (1,658) $ 54,870
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussions set forth in this form 10-Q should be read in conjunction with the financial information included herein the Company's Annual Report on Form 10-K for the year ended June 30, 1998. Management's discussion and analysis of financial condition and results of operations and other sections of this report contain forward-looking statements relating to future results of the Company. Such forward-looking statements are identified by use of forward-looking words such as "anticipates", "believes", "plans", "estimates", "expects", and "intends" or words or phrases of similar expression. These forward-looking statements are subject to various assumptions, risk and uncertainties, including but not limited to, changes in political and economic conditions, demand for the Company's products, acceptance of new products, conditions in the various real estate markets where the Company does business, developments affecting the Company's products and to those discussed in the Company's filings with the Securities and Exchange Commission. Accordingly, actual results could differ materially from those contemplated by the forward-looking statements. Results of Operations Ethan Allen's revenues are comprised of wholesale sales to dealer-owned stores and retail sales of Ethan Allen-owned stores as follows (dollars in millions): Three Months Six Months Ended Ended December 31, December 31, 1998 1997 1998 1997 -------- -------- -------- -------- Revenues: Net wholesale sales to dealer-owned stores $ 115.6 $ 106.9 $ 217.5 $ 202.0 Net retail sales of Ethan Allen-owned stores 75.6 61.2 137.4 113.7 Other revenues 2.5 4.6 5.0 9.5 -------- -------- -------- -------- Total $ 193.7 $ 172.7 $ 359.9 $ 325.2 ======== ======== ======== ======== Three Months Ended December 31, 1998 Compared to Three Months Ended December 31, 1997 Sales for the three months ended December 31, 1998 increased by $21.0 million, or 12.1%, over the corresponding period in the prior year to $193.7 million. Net sales by Ethan Allen-owned stores increased $14.4 million or 23.5% to $75.6 million and net sales to dealer-owned stores increased $8.7 million or 8.1% to $115.6 million. Sales growth has resulted from increased sales from relocated and new stores, new product offerings, and expanded national television advertising. At December 31, 1998, there were 315 total stores, of which 243 were dealer-owned, as compared to 306 total stores, of which 241 were dealer-owned at December 31, 1997. The increase in retail sales by Ethan Allen-owned stores is attributable to a 13.7%, or $7.9 million increase in comparable store sales, and an increase in sales generated by newly opened or acquired stores of $7.9 million, partially offset by closed stores, which generated $1.4 million less in sales in the three months ended December 31, 1998 as compared to the three months ended December 31, 1997. Comparable stores are stores that, if newly opened, have been open for at least 15 months. Ethan Allen's retail business is principally special order and minimal net sales are generated during the first three months of operations of newly opened stores. Stores acquired from dealers by Ethan Allen are included in comparable store sales in their thirteenth full month of Ethan Allen-owned operations. Gross profit for the three months ended December 31, 1998 increased by $9.0 million, or 11.2% from the three months ended December 31, 1997 to $89.8 million. This increase is attributable to higher sales volume partially offset by a decrease in gross margin from 46.7% in the three months ended December 31, 1997 to 46.3% in the three months ended December 31, 1998. Gross margins have been negatively impacted by higher employee benefit costs, and price increases in certain lumber species, purchased wood parts and finishing materials. These factors have been partially offset by the leverage benefit of higher sales volumes, a higher proportionate level of retail sales, gains in manufacturing efficiencies, higher production levels and streamlined work processes. A price increase was implemented on selected items for orders received after December 1, 1998. This, however, did not significantly impact second quarter margins. The full effect of the price increase is not expected until the fourth quarter, with some benefit in the third quarter. Selling, general and administrative expenses increased $6.3 million from $48.6 million, or 28.1% of net sales, in the three months ended December 31, 1997 to $54.9 million, or 28.4% of net sales, in the three months ended December 31, 1998. This increase is principally attributable to an increase in the operating expenses of Ethan Allen-owned stores of $5.9 million due to higher sales volumes and the addition of new stores. Operating income for the three months ended December 31, 1998 was $34.8 million or 18.0% of sales, an increase of $2.7 million as compared to the three months ended December 31, 1997. Wholesale operating income was $31.0 million for the three months ended December 31, 1998, reflecting an increase of $3.0 million as compared to the prior year period. This increase is attributable to higher sales volumes partially offset by a slight decline in the wholesale operating margin. Retail operating income was $4.6 million for the three months ended December 31, 1998, an increase of $0.4 million from the prior year. Interest expense, including the amortization of deferred financing costs, for the three months ended December 31, 1998 decreased by $0.8 million to $0.7 million from $1.5 million in the three months ended December 31, 1997, due to lower debt balances outstanding. Income tax expense of $13.3 million was recorded for the three months ended December 31, 1998, as compared to $12.5 million in the prior year quarter. The Company's effective tax rate for the three months ended December 31, 1998 was 38.6% as compared to 39.6% in the three months ended December 31, 1997. The decline in the effective tax rate in the three months ended December 31, 1998 as compared to the corresponding period in the prior year is the result of planning strategies initiated by the Company during the quarter. The Company anticipates that the effective tax rate going forward will be consistent with that of the quarter ended December 31, 1998. For the three months ended December 31, 1998, the Company recorded net income of $21.2 million, compared to net income for the three months ended December 31, 1997 of $19.1 million. Six Months Ended December 31, 1998 Compared to Six Months Ended December 31, 1997 Sales for the six months ended December 31, 1998 increased by $34.7 million, or 10.7%, over the six months ended December 31, 1997 to $359.9 million. Net retail sales by Ethan Allen-owned stores increased by 21.0% to $137.4 million and sales to dealer-owned stores increased by 7.7% to $217.5 million. The increase in sales to dealer-owned stores has resulted from increased sales from relocated and new stores, newer product offerings, and expanded national television advertising. The increase in retail sales by Ethan Allen-owned stores is attributable to a 12.6% or $13.7 million increase in comparable store sales, and an increase in sales generated by newly opened or acquired stores of $12.8 million, partially offset by closed stores which generated $2.8 million less in sales in the six months ended December 31, 1998 as compared to the six months ended December 31, 1997. Gross profit for the six months ended December 31, 1998 increased by $15.3 million from the six months ended December 31, 1997 to $166.8 million. This increase is attributable to higher sales volume partially offset by a decline in gross margin from 46.6% in the six months ended December 31, 1997 to 46.3% in the six months ended December 31, 1998. Gross margins have been negatively impacted by higher employee benefit costs, and price increases in certain lumber species, purchased wood parts and finishing materials. These factors have been partially offset by the leverage benefit of a higher sales volume, higher proportionate level of retail sales, gains in manufacturing efficiencies, higher production levels and streamlined work processes. Selling, general and administrative expenses increased $9.9 million from $95.4 million, or 29.3% of net sales, in the six months ended December 31, 1997 to $105.3 million, or 29.3% of net sales, in the six months ended December 31, 1998. Operating income for the six months ended December 31, 1998 was $61.4 million or 17.1% of sales, an increase of $5.3 million, as compared to the six months ended December 31, 1997. Wholesale operating income was $57.1 million for the six months ended December 31, 1998, an increase of $6.1 million as compared to the six months ended December 31, 1997. This increase is attributable to higher sales volumes partially offset by lower gross margins. Retail operating income was $6.7 million for the six months ended December 31, 1998, which is comparable to the operating margin for the six months ended December 31, 1997. Interest expense, including the amortization of deferred financing costs, for the six months ended December 31, 1998 decreased by $2.0 million to $1.0 million, as compared to the prior year period, due to lower debt balances outstanding. Income tax expense of $23.8 million or an effective tax rate of 38.9%, was recorded for the six months ended December 31, 1998, as compared to $21.7 million or an effective rate of 39.6% in the prior year period. For the six months ended December 31, 1998, the Company recorded net income of $37.4 million, compared to net income for the six months ended December 31, 1997 of $33.1 million. Financial Condition and Liquidity Principal sources of liquidity are cash flow from operations and additional borrowing capacity under the revolving credit facility. Net cash provided by operating activities totaled $39.8 million for the six months ended December 31, 1998, as compared to $45.8 million in the six months ended December 31, 1997. Net income for the six months ended December 31, 1998 was $4.3 million higher than the net income reported for the six months ended December 31, 1997. For the six months ended December 31, 1998, inventories increased $15.8 million as compared to a $1.3 million increase in the prior year period. Additionally, accrued expenses decreased $2.9 million in the six months ended December 31, 1998 as compared to a $0.5 million increase in accrued expenses in the prior year period. At December 31, 1998, the Company had working capital of $116.4 million and a current ratio of 2.41 to 1. During the six months ended December 31, 1998, capital spending totaled $21.1 million as compared to $13.4 million in the six months ended December 31, 1997. Capital expenditures in fiscal 1999 are anticipated to be approximately $50.0 million. The Company anticipates that cash from operations will be sufficient to fund this level of capital expenditures. The current level of anticipated capital spending, which is attributable primarily to manufacturing efficiency improvements and new store openings, is expected to continue for the foreseeable future. Total debt outstanding at December 31, 1998 is $37.2 million. At December 31, 1998, there was $24.5 million in outstanding revolving loans under the Credit Agreement. Trade and standby letters of credit of $15.4 million were outstanding as of December 31, 1998. As of December 31, 1998, aggregate scheduled maturities of long-term debt for each of the next five fiscal years are $0.4 million, $24.7 million, $2.6 million, $0.2 million and $0.1 million, respectively. Management believes that the Company's cash flow from operations, together with its other available sources of liquidity, will be adequate to make all required payments of principal and interest on its debt, to permit anticipated capital expenditures and to fund working capital and other cash requirements. The Company may, from time to time, either directly or through agents, repurchase its common stock in the open market through negotiated purchases or otherwise, at prices and on terms satisfactory to the Company. During the six months ended December 31, 1998, 1,267,471 shares were purchased at an average price of $35.10 per share. Depending on market prices and other conditions relevant to the Company, such purchases may be discontinued at any time. Year 2000 The Company expects to implement the systems and programming changes necessary to address Year 2000 issues and does not believe the cost of such actions will have a material effect on the Company's results of operations or financial condition. However, there is no guarantee that the Company, its suppliers or other third parties will be able to make all of the modifications necessary to address Year 2000 issues on a timely basis. This could have a material adverse effect on the Company's business, financial condition and results of operations. The Company views all of its retail, wholesale and manufacturing applications as mission critical. The Company recently converted its retail, wholesale and a portion of its manufacturing applications onto one single mid range computer, utilizing newly acquired integrated software. The newly implemented software is substantially compliant, with all date fields expanded to four digits. The Company has set up a redundant environment and has rolled the date forward to the year 2000 and is testing all of it business transactions. The testing of these recently implemented applications is expected to be completed by June 30, 1999. Concurrently with the aforementioned project, the Company has been remediating its pre-existing manufacturing systems. This process is complete in the Company's wood manufacturing facilities. Substantial progress has been made in the Company's upholstered and accessory manufacturing systems. These systems are expected to be fully compliant by March 31, 1999. Investments have been made in the Company's peripheral hardware. These investments were necessitated by the retail and wholesale systems conversion. The Company is currently compiling a list of hardware and associated software that has not been recently replaced. The Company expects all hardware to be remediated or replaced by June 30, 1999. The Company's vertical integrated structure might to some degree mitigate the impact of third parties' Year 2000 issues to adversely affect the Company. However, the Company anticipates the possibility that not all of its vendors, retailers and other third parties will have taken the necessary steps to adequately address their respective Year 2000 issues on a timely basis. In order to minimize the impact on the Company, a project team has been formed to monitor the activities of third parties, including sending out inquiries and evaluating responses. Notwithstanding the progress the Company has made thus far in remediating its existing systems and implementing new systems, the Company is finalizing a formal contingency plan. The Company intends to continue monitoring the progress of others in order to determine whether adequate services will be provided to run the Company's operations in the Year 2000. Item 3. Quantitative and Qualitative Disclosure about Market Risk The Company is exposed to interest rate risk primarily through its borrowing activities. The Company's policy has been to utilize United States dollar denominated borrowings to fund its working capital and investment needs. Short term debt, if required, is used to meet working capital requirements and long term debt is generally used to finance long term investments. There is inherent roll-over risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and the Company's future financing requirements. Currently, the Company has outstanding only one debt instrument (principal amount of $4.6 million) which has a variable interest rate. Using a yield to maturity analysis and assuming an increase in the interest rate on this debt of 36 basis points (10% fluctuation in the rate), interest rate variability on this debt would not have a material effect on the Company's financial results. Currently, the Company does not enter into financial instruments transactions for trading or other speculative purposes or to manage interest rate exposure. PART II. OTHER INFORMATION Item 1. - Legal Proceedings There has been no change to matters discussed in Business-Legal Proceedings in the Company's Form 10-K as filed with the Securities and Exchange Commission on September 18, 1998. Item 2. - Changes in Securities There has been no change to matters discussed in Description and Ownership of Capital Stock in the Company's Form 10-K as filed with the Securities and Exchange Commission on September 18, 1998. Item 6. - Exhibits and Reports on Form 8-K Item 4(c)-3. First Amendment to Amended and Restated 1992 Stock Option Plan Item 4(k)-4. First Amendment to Amended and Restated credit Agreement as of August 27, 1997 between Ethan Allen Inc. and the Chase Manhattan Bank Item 4(k)-5. Second Amendment to Amended and Restated credit Agreement as of October 20, 1998 between Ethan Allen Inc. and the Chase Manhattan Bank 27. EDGAR Financial Data Schedule SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ETHAN ALLEN INTERIORS INC. (Registrant) DATE: February 12, 1999 BY: /s/ M. Farooq Kathwari ------------------------------ M. Farooq Kathwari Chairman of the Board President and Chief Executive Officer (Principal Executive Officer) DATE: February 12, 1999 BY: /s/ Gerardo Burdo ------------------------------ Gerardo Burdo Vice President & Treasurer (Principal Financial Officer) DATE: February 12, 1999 BY: /s/ Mary Beth Walsh ------------------------------ Mary Beth Walsh Assistant Corporate Controller (Principal Accounting Officer)