Table of Contents

 

 

 

**UNITEDSTATES**

**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 thequarterly period ended March 31, 2009**

** **

**OR**

 
| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                 to                **

 

**Commission File Number:  1-11692**

 

**Ethan Allen Interiors Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **06-1275288**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **Ethan  Allen Drive, Danbury, Connecticut**                    | ** ** | **06811**                             |
| (Address of  principal executive offices)                       |       | (Zip Code)                            |

 

**(203) 743-8000**

(Registrant’stelephone number, including area code)

 

**N/A**

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   x Yes   o No

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or such shorter period that theregistrant was required to submit and post such files);   o Yes  o No

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act

 

| Large  accelerated filer  x |   | Accelerated  filer  o         |
|----------------------------------|--------|------------------------------------|
|                             |   |                               |
| Non-accelerated  filer  o   |   | Smaller  reporting company  o |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  o Yes x No

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

At March 31,2009, there were 28,953,929 shares of Class A Common Stock, par value$.01, outstanding.

 

 

 

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Table of Contents

 

TABLE OF CONTENTS

** **
| **Item**                                     | ** **                                                                                                                                                           | **Page**   |
|----------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Part I — Financial Information** |
| ** **                                   | ** **                                                                                                                                                           | ** ** |
| 1.                                           | Financial  Statements as of March 31, 2009 (unaudited) and June 30, 2008 and  for the three and nine months ended March 31, 2009 and 2008 (unaudited) |       |
|                                         |                                                                                                                                                                 |       |
|                                         | Consolidated Balance Sheets                                                                                                                                          | 2          |
|                                         |                                                                                                                                                                 |       |
|                                         | Consolidated Statements of Operations                                                                                                                                | 3          |
|                                         |                                                                                                                                                                 |       |
|                                         | Consolidated Statements of Cash Flows                                                                                                                                | 4          |
|                                         |                                                                                                                                                                 |       |
|                                         | Consolidated Statements of Shareholders’ Equity                                                                                                                 | 5          |
|                                         |                                                                                                                                                                 |       |
|                                         | Notes to Consolidated Financial Statements                                                                                                                           | 6          |
|                                         |                                                                                                                                                                 |       |
| 2.                                           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                          | 24         |
|                                         |                                                                                                                                                                 |       |
| 3.                                           | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                          | 35         |
|                                         |                                                                                                                                                                 |       |
| 4.                                           | Controls and  Procedures                                                                                                                                             | 36         |
|                                         |                                                                                                                                                                 |       |
| **Part II  - Other Information**        |
| ** **                                   | ** **                                                                                                                                                           | ** ** |
| 1.                                           | Legal Proceedings                                                                                                                                                    | 36         |
|                                         |                                                                                                                                                                 |       |
| 1A.                                          | Risk Factors                                                                                                                                                         | 36         |
|                                         |                                                                                                                                                                 |       |
| 2.                                           | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                         | 37         |
|                                         |                                                                                                                                                                 |       |
| 3.                                           | Defaults  Upon Senior Securities                                                                                                                                     | 37         |
|                                         |                                                                                                                                                                 |       |
| 4.                                           | Submission  of Matters to a Vote of Security Holders                                                                                                                 | 38         |
|                                         |                                                                                                                                                                 |       |
| 5.                                           | Other Information                                                                                                                                                    | 38         |
| ** **                                   | ** **                                                                                                                                                           | ** ** |
| 6.                                           | Exhibits                                                                                                                                                             | 38         |
|                                         |                                                                                                                                                                 |       |
|                                         | Signatures                                                                                                                                                           | 39         |

 

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**PART I - FINANCIAL INFORMATION**

**Item 1.Financial Statements**

**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

(In thousands, except share data)

 
| ** **                                                                                                                                                                      | ** ** | **March 31, 2009** | ** ** | **June 30, 2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                      |       |                    |       |                   |       |
| Current assets:                                                                                                                                                                 |       |                    |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                      |       | $                       | 51,159     |                   | $          | 74,376 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,589 at March 31,  2009 and $2,535 at June 30, 2008                                                   |       | 10,434                  |       | 12,672                 |       |
| Inventories  (note 4)                                                                                                                                                           |       | 174,310                 |       | 186,265                |       |
| Prepaid expenses  and other current assets                                                                                                                                      |       | 28,425                  |       | 32,860                 |       |
| Deferred income  taxes                                                                                                                                                          |       | 4,865                   |       | 4,005                  |       |
| Total current  assets                                                                                                                                                           |       | 269,193                 |       | 310,178                |       |
|                                                                                                                                                                            |       |                    |       |                   |       |
| Property, plant  and equipment, net                                                                                                                                             |       | 347,744                 |       | 350,432                |       |
| Goodwill and  other intangible assets (notes 6 and 7)                                                                                                                           |       | 45,156                  |       | 96,823                 |       |
| Other assets                                                                                                                                                                    |       | 3,945                   |       | 4,540                  |       |
| Total assets                                                                                                                                                                    |       | $                       | 666,038    |                   | $          | 761,973 |   |
|                                                                                                                                                                            |       |                    |       |                   |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                  |       |                    |       |                   |       |
| Current  liabilities:                                                                                                                                                           |       |                    |       |                   |       |
| Current  maturities of long-term debt (note 8)                                                                                                                                  |       | $                       | 42         |                   | $          | 41 |   |
| Customer  deposits                                                                                                                                                              |       | 31,200                  |       | 47,297                 |       |
| Accounts payable                                                                                                                                                                |       | 19,621                  |       | 26,444                 |       |
| Accrued  compensation and benefits                                                                                                                                              |       | 33,358                  |       | 32,568                 |       |
| Accrued expenses  and other current liabilities (note 5)                                                                                                                        |       | 26,949                  |       | 29,152                 |       |
| Total current  liabilities                                                                                                                                                      |       | 111,170                 |       | 135,502                |       |
|                                                                                                                                                                            |       |                    |       |                   |       |
| Long-term debt  (note 8)                                                                                                                                                        |       | 203,077                 |       | 202,988                |       |
| Other long-term  liabilities                                                                                                                                                    |       | 21,059                  |       | 20,383                 |       |
| Deferred income  taxes                                                                                                                                                          |       | 6,579                   |       | 27,327                 |       |
| Total  liabilities                                                                                                                                                              |       | 341,885                 |       | 386,200                |       |
|                                                                                                                                                                            |       |                    |       |                   |       |
| Shareholders’  equity:                                                                                                                                                     |       |                    |       |                   |       |
| Class A  common stock, par value $.01, 150,000,000 shares authorized; 48,334,870  shares issued at March 31, 2009 and 48,251,780 shares issued at  June 30, 2008 |       | 483                     |       | 482                    |       |
| Class B  common stock, par value $.01, 600,000 shares authorized; no shares issued and  outstanding at March 31, 2009 and June 30, 2008                          |       | —                  |       | —                 |       |
| Preferred stock,  par value $.01, 1,055,000 shares authorized; no shares issued and outstanding  at March 31, 2009 and June 30, 2008                                  |       | —                  |       | —                 |       |
| Additional  paid-in capital                                                                                                                                                     |       | 356,084                 |       | 354,725                |       |
|                                                                                                                                                                            |       | 356,567                 |       | 355,207                |       |
| Less: Treasury  stock (at cost), 19,380,941 shares at March 31, 2009 and 19,565,901  shares at June 30, 2008                                                          |       | (583,220                | )          | (588,783               | )          |
| Retained  earnings                                                                                                                                                              |       | 550,123                 |       | 606,648                |       |
| Accumulated  other comprehensive income (note 12)                                                                                                                               |       | 683                     |       | 2,701                  |       |
| Total  shareholders’ equity                                                                                                                                                |       | 324,153                 |       | 375,773                |       |
| Total liabilities  and shareholders’ equity                                                                                                                                |       | $                       | 666,038    |                   | $          | 761,973 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

**Consolidated Statements of Operations (Unaudited)**

**(In thousands, except per share data)**

** **
| ** **                                           | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                                            |       | $                                      | 140,221    |                                  | $          | 235,901 |   | $ | 535,620 |   | $ | 744,138 |   |
| Cost of sales                                        |       | 74,171                                 |       | 110,714                               |       | 255,828 |   | 346,041 |   |
| Gross profit                                         |       | 66,050                                 |       | 125,187                               |       | 279,742 |   | 398,097 |   |
|                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Operating  expenses:                                 |       |                                   |       |                                  |       |   |   |   |   |
| Selling                                              |       | 42,251                                 |       | 56,112                                |       | 146,274 |   | 171,290 |   |
| General and  administrative                          |       | 42,781                                 |       | 49,502                                |       | 131,806 |   | 145,940 |   |
| Goodwill  impairment (note 7)                        |       | 48,400                                 |       | —                                |       | 48,400 |   | — |   |
| Restructuring  and impairment charge net (note 5)    |       | 7,325                                  |       | 3,993                                 |       | 5,721 |   | 3,993 |   |
| Total operating  expenses                            |       | 140,757                                |       | 109,607                               |       | 332,801 |   | 321,223 |   |
|                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Operating income  (loss)                             |       | (74,707                                | )          | 15,580                                |       | (52,409 | ) | 76,874 |   |
| Interest and  other miscellaneous income, net        |       | 806                                    |       | 1,375                                 |       | 3,019 |   | 6,478 |   |
| Interest and  other related financing costs (note 8) |       | 2,985                                  |       | 2,914                                 |       | 8,818 |   | 8,793 |   |
|                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Income (loss)  before income taxes                   |       | (76,886                                | )          | 14,041                                |       | (58,208 | ) | 74,559 |   |
|                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Income tax  expense (benefit) (note 3)               |       | (28,212                                | )          | 5,195                                 |       | (22,444 | ) | 27,587 |   |
|                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Net income  (loss)                                   |       | $                                      | (48,674    | )                                     | $          | 8,846 |   | $ | (35,764 | ) | $ | 46,972 |   |
|                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Per share data  (note 11):                           |       |                                   |       |                                  |       |   |   |   |   |
| Basic earnings  per common share:                    |       |                                   |       |                                  |       |   |   |   |   |
| Net income  (loss) per basic share                   |       | $                                      | (1.69      | )                                     | $          | 0.31 |   | $ | (1.24 | ) | $ | 1.59 |   |
| Basic weighted  average common shares                |       | 28,861                                 |       | 28,909                                |       | 28,768 |   | 29,461 |   |
| Diluted earnings  per common share:                  |       |                                   |       |                                  |       |   |   |   |   |
| Net income  (loss) per diluted share                 |       | $                                      | (1.69      | )                                     | $          | 0.30 |   | $ | (1.24 | ) | $ | 1.58 |   |
| Diluted weighted  average common shares              |       | 28,861                                 |       | 29,049                                |       | 28,768 |   | 29,685 |   |

 

See accompanying notes to consolidated financial statements.

 

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** **

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**ConsolidatedStatements of Cash Flows (Unaudited)**

(In thousands)

 
| ** **                                                                         | ** ** | **Nine Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Operating  activities:                                                             |       |                                  |       |   |   |
| Net income  (loss)                                                                 |       | $                                     | (35,764    | ) | $ | 46,972 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation and  amortization                                                     |       | 19,285                                |       | 18,077 |   |
| Compensation  expense related to share-based awards                                |       | 1,357                                 |       | 913 |   |
| Provision  (benefit) for deferred income taxes                                     |       | (18,865                               | )          | 54 |   |
| Excess tax  benefits from share-based payment arrangements                         |       | —                                |       | (2,093 | ) |
| Goodwill  impairment                                                               |       | 48,400                                |       | — |   |
| Restructuring  and impairment charge (benefit), net                                |       | (1,124                                | )          | 2,579 |   |
| (Gain) loss on  disposal of property, plant and equipment                          |       | 758                                   |       | (280 | ) |
| Other                                                                              |       | 168                                   |       | 175 |   |
| Change in assets  and liabilities, net of the effects of acquired businesses:      |       |                                  |       |   |   |
| Accounts  receivable                                                               |       | 1,974                                 |       | 1,644 |   |
| Inventories                                                                        |       | 12,784                                |       | (1,683 | ) |
| Prepaid and  other current assets                                                  |       | 1,945                                 |       | (4,443 | ) |
| Other assets                                                                       |       | 764                                   |       | 395 |   |
| Customer  deposits                                                                 |       | (16,457                               | )          | (6,799 | ) |
| Accounts payable                                                                   |       | (6,413                                | )          | (280 | ) |
| Accrued expenses  and other current liabilities                                    |       | 4,021                                 |       | 3,445 |   |
| Other long-term  liabilities                                                       |       | 960                                   |       | 8,584 |   |
| Net cash  provided by operating activities                                         |       | 13,793                                |       | 67,260 |   |
|                                                                               |       |                                  |       |   |   |
| Investing  activities:                                                             |       |                                  |       |   |   |
| Proceeds from  the disposal of property, plant & equipment                |       | 6,283                                 |       | 6,936 |   |
| Capital  expenditures                                                              |       | (20,466                               | )          | (46,297 | ) |
| Acquisitions                                                                       |       | (741                                  | )          | (6,762 | ) |
| Other                                                                              |       | (147                                  | )          | 25 |   |
| Net cash used in  investing activities                                             |       | (15,071                               | )          | (46,098 | ) |
|                                                                               |       |                                  |       |   |   |
| Financing  activities:                                                             |       |                                  |       |   |   |
| Payments on  long-term debt                                                        |       | (31                                   | )          | (30 | ) |
| Proceeds from  issuance of common stock                                            |       | 2                                     |       | 472 |   |
| Excess tax  benefits from share-based payment arrangements                         |       | —                                |       | 2,093 |   |
| Payment of  deferred financing costs                                               |       | (447                                  | )          | — |   |
| Payment of cash  dividends                                                         |       | (20,720                               | )          | (19,164 | ) |
| Purchases and  other retirements of company stock                                  |       | —                                |       | (75,577 | ) |
| Net cash used in  financing activities                                             |       | (21,196                               | )          | (92,206 | ) |
| Effect of  exchange rate changes on cash                                           |       | (743                                  | )          | 176 |   |
| Net decrease in  cash & cash equivalents                                  |       | (23,217                               | )          | (70,868 | ) |
| Cash &  cash equivalents - beginning of period                            |       | 74,376                                |       | 147,879 |   |
| Cash &  cash equivalents - end of period                                  |       | $                                     | 51,159     |   | $ | 77,011 |   |

 

See accompanying notes to consolidated financial statements.

 

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**ETHAN ALLEN INTERIORS INC.AND SUBSIDIARIES**

**ConsolidatedStatements of Shareholders’ Equity**

**Nine Months Ended March 31,2009**

**(Unaudited)**

**(In thousands, except sharedata)**

 
| ** **                                                    | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In****Capital** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|-------------------|------------|------------------------------------|------------|---------------------|------------|-----------------------------------------------|------------|------------------------|------------|-----------|------------|
| Balance at  June 30, 2008                                |       | $                 | 482        |                               | $          | 354,725             |       | $                                             | (588,783   | )                      | $          | 2,701     |       | $ | 606,648 |   | $ | 375,773 |   |
|                                                          |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Share-based  compensation expense (note 10)                   |       | —            |       | 1,357                              |       | —              |       | —                                        |       | —                 |       | 1,357     |       |
|                                                          |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Issuance of  common stock upon exercise of share-based awards |       | 1                 |       | 2                                  |       | —              |       | —                                        |       | —                 |       | 3         |       |
|                                                          |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Issuance of  treasury shares for 401k company match           |       | —            |       | —                             |       | 5,563               |       | —                                        |       | (3,431                 | )          | 2,132     |       |
|                                                          |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Dividends  declared on common stock                           |       | —            |       | —                             |       | —              |       | —                                        |       | (17,330                | )          | (17,330   | )          |
|                                                          |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Other  comprehensive income (note 12):                        |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Currency  translation adjustments                             |       | —            |       | —                             |       | —              |       | (2,054                                        | )          | —                 |       | (2,054    | )          |
| Hedge  amortization, net of tax and other                     |       | —            |       | —                             |       | —              |       | 36                                            |       | —                 |       | 36        |       |
| Net income  (loss)                                            |       | —            |       | —                             |       | —              |       | —                                        |       | (35,764                | )          | (35,764   | )          |
| Total  comprehensive income (loss)                            |       |              |       |                               |       |                |       |                                          |       |                   |       | (37,782   | )          |
|                                                          |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Balance at  March 31, 2009                               |       | $                 | 483        |                               | $          | 356,084             |       | $                                             | (583,220   | )                      | $          | 683       |       | $ | 550,123 |   | $ | 324,153 |   |

 

See accompanying notes to consolidated financial statements.

 

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** **

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

**(1)      Basisof Presentation and Recent Accounting Pronouncements**

 

***Basisof Presentation***

 

Ethan AllenInteriors Inc. (“Interiors”) is a Delaware corporation incorporated on May 25,1989. The consolidated financial statements include the accounts of Interiors,its wholly owned subsidiary Ethan Allen Global, Inc. (“Global”), andGlobal’s subsidiaries (collectively “We”, “Us”, “Our”, “Ethan Allen”, or the “Company”).  All intercompany accounts and transactionshave been eliminated in the consolidated financial statements.  All of Global’s capital stock is owned byInteriors, which has no assets or operating results other than those associatedwith its investment in Global.

 

We prepare ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States, which requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Due to the inherent uncertainty involved in making those estimates,actual results could differ from those estimates.  Areas in which significant estimates havebeen made include, but are not limited to, revenue recognition, the allowancefor doubtful accounts receivable, inventory obsolescence, tax valuationallowances, useful lives for property, plant and equipment and definite livedintangible assets, goodwill and indefinite lived intangible asset impairmentanalyses, the evaluation of uncertain tax positions and the fair value ofassets acquired and liabilities assumed in business combinations.

 

***RecentlyAdopted Accounting Pronouncements***

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “*Fair Value Measurements*” (“SFAS No. 157”) which definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements, yet does not require any new fair value measurements.  In February 2008, the FASB issued FASBStaff Position No. 157-2 (“FSP No. 157-2”), which delayed theeffective date of SFAS No. 157 as it relates to non-financial assets andnon-financial liabilities until July 1, 2009 for the Company, except foritems that are recognized or disclosed at fair value by the Company on arecurring basis.  Effective July 1,2008, the Company adopted the provisions of SFAS No. 157, except as itrelates to those non-financial assets and non-financial liabilities excludedunder FSP No. 157-2.  Those excludeditems for which the Company has not applied the fair value provisions of SFAS No. 157include goodwill and other intangible assets (note 7), assets held for sale(note 5), liabilities for exit or disposal activities (note 5), and businessacquisitions (note 6).  The Company iscurrently evaluating the impact of this statement on the Company’s financialposition, results of operations and cash flows as it relates to non-financialassets and non-financial liabilities. For the impact of adoption of this statement on financial assets,financial liabilities, and non-financial assets recognized at fair value on arecurring basis, see note 13.

 

Statement ofFinancial Accounting Standard No. 159, “*The FairValue Option for Financial Assets and Financial Liabilities — Including anamendment of FASB Statement No. 115”* (“SFAS No. 159”)*,* became effective for us on July 1, 2008.  SFAS No. 159 gives us the option toelect fair value for the initial and subsequent measurement for certainfinancial assets and liabilities, with the difference between the carryingvalue before election and the fair value recorded upon election as anadjustment to beginning retained earnings. The fair value option may be elected on an instrument by instrumentbasis and is irrevocable, unless a new election date occurs.  The Company did not apply the fair valueoption to any of its outstanding instruments, and therefore, SFAS No. 159did not have an impact on the Company’s consolidated financial statements.

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**(2)      Interim Financial Presentation**

 

All intercompanyaccounts and transactions have been eliminated in the consolidated financialstatements.  In our opinion, alladjustments, consisting only of normal recurring adjustments necessary for fairpresentation, have been included in the consolidated financial statements. Theresults of operations for the nine months ended March 31, 2009 are notnecessarily indicative of results that may be expected for the entire fiscalyear. The interim consolidated financial statements should be read inconjunction with the consolidated financial statements and accompanying notesincluded in our Annual Report on Form 10-K for the year ended June 30,2008.

 

**(3)****                  ****Income Taxes**

 

The Companyreviews its expected annual effective income tax rates and makes changes on aquarterly basis as necessary based on certain factors such as changes inforecasted annual operating income; changes to actual or forecasted permanentbook to tax differences; impacts from future tax audits with state, federal orforeign tax authorities; or impacts from tax law changes.  The Company identifies items which are notnormal and are nonrecurring in nature and treats these as discrete events. Thetax effect of discrete items is recorded in the quarter in which the discreteevents occur. Due to the volatility of these factors, the Company’sconsolidated effective income tax rate can change significantly on a quarterlybasis.

 

In accordance withFASB Interpretation No. 48, “A*ccounting for Uncertaintyin Income Taxes — an interpretation of FASB Statement No. 109,*”(“FIN 48”) we recognize the tax benefit from an uncertain tax positiononly if it is more likely than not that the tax position will be sustained onexamination by the taxing authorities, based on the technical merits of theposition. We adopted the provisions set forth by FIN 48 effective July 1,2007.

 

Essentially all ofthe unrecognized tax benefits, if recognized, would be recorded as a benefit toincome tax expense. Our continuing practice is to recognize interest andpenalties related to income tax matters as a component of income tax expense.

 

The Company’sconsolidated effective income tax rate was 38.6% and 37.0% for the nine monthsended March 31, 2009 and 2008, respectively. The current effective taxrate is higher due primarily to the impact of the deduction for domesticproduction activities.

 

The Companyconducts business globally and, as a result, the Company or one or more of itssubsidiaries files income tax returns in the U.S., various state, and foreignjurisdictions. In the normal course of business, the Company is subject toexamination by the taxing authorities in such major jurisdictions as Canada,Mexico and the U.S. As of March 31, 2009, certain subsidiaries of theCompany are currently under audit from 2001 through 2007 in the U.S. It isreasonably possible that some of these audits may be completed during the nexttwelve months. While the amount of uncertain tax benefits with respect to theentities and years under audit may change within the next twelve months, it isnot anticipated that any of the changes will be significant.

 

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** **

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

** **

**(4)****                  ****Inventories**

 

Inventories at March 31, 2009 and June 30,2008 are summarized as follows (in thousands):

 
| ** **      | ** ** | **March 31,  2009** | ** ** | **June 30,  2008** | ** ** |
|-----------------|------------|--------------------------|------------|-------------------------|------------|
|            |       |                     |       |                    |       |
| Finished goods  |       | $                        | 145,292    |                    | $          | 153,981 |   |
| Work in process |       | 7,411                    |       | 5,985                   |       |
| Raw materials   |       | 21,607                   |       | 26,299                  |       |
|            |       | $                        | 174,310    |                    | $          | 186,265 |   |

 

Inventories arepresented net of a related valuation allowance of $2.2 million at March 31,2009 and $2.3 million at June 30, 2008.

 

**(5)****                  ****Restructuring and ImpairmentCharges**

 

In recent years,we have developed, announced and executed plans to consolidate our operationsas part of an overall strategy to maximize production efficiencies and maintainour competitive advantage.

 

On January 6, 2009, the Companyannounced a plan to consolidate the operations of its Eldred, Pennsylvaniaupholstery manufacturing plant and several of its retail service centers.Business previously serviced by the Eldred Pennsylvania facility has beentransferred to the Company’s facilities in North Carolina and California, andthe Company is expanding the production in those facilities.  Business currently served by the retailservice centers is being transferred to other Company locations serving thesame general market areas.  The Companyexpects pre-tax restructuring, impairment, and other related charges will totalapproximately $9 million, with approximately $4 million in employee severanceand other payroll and benefit costs, $3 million in write down of long-livedassets, and $2 million in other associated costs, after which time we expectthe actions to be complete.  By segment,we expect $6 million in costs for the wholesale segment and $3 million for theretail segment.  The majority of chargeswill be non-cash in nature representing an approximate after-tax impact of $5.7million or $0.20 per diluted share.  Thetotal costs incurred in the current period, and the cumulative amount incurredto date are shown in the following table (in thousands).

 
| ** **                                              | ** ** | **Three  months ended March 31, 2009** | ** **  |
|---------------------------------------------------------|------------|---------------------------------------------|-------------|
| ** **                                              | ** ** | **New  charges  (credits)**                 | ** **  | **Utilized** | ** ** | **Balance  at  March 31,  2009** | ** ** |
| Employee severance and  other payroll and benefit costs |       | $                                           | 3,936       |   | $ | 3,137 |   | $ | 799 |   |
| Write down of  long-lived assets                        |       | 2,721                                       |        | 2,721 |   | — |   |
| Other associated costs                                  |       | 394                                         |        | (15 | ) | 409 |   |
|                                                    |       | $                                           |  7,051 |   | $ | 5,843 |   | $ | 1,208 |   |

 

On January 10, 2008, we announced aplan to consolidate the operations of certain company owned retail designcenters and retail service centers. In connection with this initiative, wepermanently ceased operations at eleven design centers and six retail servicecenters which, for the most part, were consolidated into other existingoperations.  We also implemented ourdesign team concept across the Retail division at the end of fiscal 2008.  These decisions resulted in a reduction inheadcount of approximately 400 employees, with the reduction in headcountoccurring mostly during the third and fourth quarters of fiscal 2008.  Additionally, other actions taken duringfiscal 2008 were not included in the restructuring plan. Altogether, there weremore than 500 fewer associates in our Retail business by the end of June 2008.In fiscal 2009, a $1.8 million restructuring and impairment net gain wasrecorded.  Of this amount, 

 

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**Notes to Consolidated Financial Statements(Unaudited)**

 

$4.2 million was a realized gain on thesale of property classified as held for sale and was partially offset by $2.4million in lease termination costs and adjustments for expected charges onleased properties no longer being used. Since the plan was announced, we have recorded pre-tax restructuring andimpairment charges totaling $5.2 million, including $0.9 million in employeeseverance and other payroll and benefit costs, $5.6 million in leasetermination and other exit costs, and a benefit of $1.4 million on long-livedassets.  The estimated present value offuture lease payments with terms ranging from less than one to seven years, andone ground lease with 25 years remaining are included in the balance at March 31,2009 and contain estimates that will likely require adjustment in thefuture.  In addition to the retail charges,$0.4 million was recorded in the first fiscal quarter of 2009 to update thefair value of a wholesale plant site held for sale.  These charges are reported together in thefollowing table (in thousands).

 
| ** **                                              | ** ** | ** **                                 | ** ** | **Three  months ended March 31, 2009** | ** ** | ** **   | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------|------------|--------------|------------|
| ** **                                              | ** ** | **Balance  at  December 31,****2008** | ** ** | **New  charges  (credits)**                 | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance  at  March 31,****2009** | ** ** |
| Employee severance and  other payroll and benefit costs |       | $                                          | —     |                                        | $          |         |       | $ | — |   | $ | — |   | $ | — |   |
| Other associated costs                                  |       | 3,494                                      |       | —                                      |       | (472         | )          | 249 |   | 3,271 |   |
| Write down of long-lived  assets                        |       | —                                     |       | —                                      |       | (24          | )          | 24 |   | — |   |
|                                                    |       | $                                          | 3,494      |                                        | $          | —       |       | $ | (496 | ) | $ | 273 |   | $ | 3,271 |   |
|                                                         |            |                                            |            |                                             |            |              |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                              | ** ** | ** **                             | ** **  | **Nine  months ended March 31, 2009** | ** ** | ** **   | ** ** |
|---------------------------------------------------------|------------|----------------------------------------|-------------|--------------------------------------------|------------|--------------|------------|
| ** **                                              | ** ** | **Balance  at  June 30,****2008** | ** **  | **New  charges  (credits)**                | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance  at  March 31,****2009** | ** ** |
| Employee severance and  other payroll and benefit costs |       | $                                      | —      |                                       | $          | 64           |       | $ | (64 | ) | $ | — |   | $ | — |   |
| Other associated costs                                  |       | 3,358                                  |        | 1,677                                      |       | (2,358       | )          | 594 |   | 3,271 |   |
| Write down of  long-lived assets                        |       | —                                 |        | (4,080                                     | )          | 3,665        |       | 415 |   | — |   |
|                                                    |       | $                                      |  3,358 |                                       | $          | (2,339       | )          | $ | 1,243 |   | $ | 1,009 |   | $ | 3,271 |   |

 

**(6)****                  ****Business Acquisitions**

 

In October 2008, we acquired, in a singletransaction, one Ethan Allen retail design center from an independent retailerfor consideration of approximately $0.3 million of cash and forgiveness ofreceivables.  As a result of thisacquisition, we recorded additional inventory of $0.2 million and goodwill of$0.1 million.

 

In August 2008, weacquired in two transactions, two Ethan Allen retail design centers fromindependent retailers for consideration of approximately $0.6 million of cashand forgiveness of receivables, assumed customer deposits of $0.7 million andother liabilities of $0.2 million.  As aresult of this acquisition, we recorded additional inventory of $0.7 millionand goodwill of $0.7 million.

 

In October 2007, weacquired in a single transaction, two Ethan Allen retail design centers from anindependent retailer for consideration of approximately $2.1 million of cashand forgiveness of receivables, assumed customer deposits of $1.1 million andother liabilities of $0.1 million.  As aresult of this acquisition, we recorded additional inventory of $1.9 million,other assets of $0.4 million, and goodwill of $1.0 million.

 

Also in October 2007,we acquired a cut and sew upholstery facility from Americraft Leather for totalconsideration of approximately $4.4 million. The facility, which contains 40,000 square feet of manufacturing spaceand employs about 180 people, is located in Silao, in the state of Guanajuato,Mexico.  As a result of this acquisition,our initial 

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

purchase price allocationresulted in additional property, plant and equipment of $2.7 million, inventoryof $1.1 million, and goodwill of $0.6 million.

 

The ConsolidatedStatements of Cash Flows for the nine months ended March 31, 2008 reflect$0.6 million of consideration paid during the period in connection with theacquisition of a retail design center with an effective (closing) date of June 30,2007 and for which funding did not occur until July 2, 2007.

 

All acquisitions aresubject to a contractual holdback or reconciliation period, during which theparties to the transaction may agree to certain normal and customary purchaseaccounting adjustments.

 

Goodwill associated withour acquisitions represents the premium paid to the seller related to theacquired business (i.e. market presence) and other fair value adjustments tothe assets acquired and liabilities assumed. Further discussion of our goodwill and other intangible assets can befound in Note 7.

 

A summary of ourallocation of purchase price accounting for acquisitions during the three andnine months ended March 31, 2009 and 2008 is provided below (inthousands).

 
| ** **                                              | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                              | ** ** | **2009**                              | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Business segment**                                    | ** ** | **Retail**                            | ** ** | **Retail**                           | ** ** | **Retail** | ** ** | **Wholesale** | ** ** | **Retail** | ** ** |
| Total  consideration                                    |       | $                                     | 94         |                                 | $          | 15 |   | $ | 1,005 |   | $ | 4,298 |   | $ | 2,262 |   |
| Fair value of  assets acquired and liabilities assumed: |       |                                  |       |                                 |       |   |   |   |   |   |   |
| Inventory                                               |       | 3                                     |       | (43                                  | )          | 829 |   | 1,054 |   | 1,841 |   |
| PP&E and  other assets                              |       | (5                                    | )          | (51                                  | )          | 55 |   | 2,707 |   | 340 |   |
| Customer  deposits                                      |       | 5                                     |       | 43                                   |       | (556 | ) | — |   | (1,090 | ) |
| A/P and other  liabilities                              |       | 100                                   |       | 74                                   |       | (86 | ) | (100 | ) | 134 |   |
| Goodwill                                                |       | $                                     | (9         | )                                    | $          | (8 | ) | $ | 763 |   | $ | 637 |   | $ | 1,037 |   |

 

**(7)****                  ****Goodwill, Other Intangible Assetsand Goodwill Impairment**

 

In accordance withSFAS No. 142, Goodwill and Other Intangible Assets, we do not amortizegoodwill or other indefinite-lived intangible assets but, rather, evaluate suchassets for impairment on an annual basis and between annual tests wheneverevents or circumstances indicate that the carrying value of the goodwill orother intangible asset may exceed its fair value. We conduct our requiredannual impairment test during the fourth quarter of each fiscal year.

 

The Companydetermined that it was appropriate to perform an interim impairment test as of March 31,2009 due to the severe adverse changes in the business climate, as evidenced bythe sudden and dramatic decline in macroeconomic indicators including consumerconfidence and in our net sales.  Wedetermined that the carrying value of the goodwill on our retail division’sbooks exceeded its fair value. Therefore, we recorded a non-cash impairmentcharge of $48.4 million.

 

As of March 31,2009, we had remaining goodwill of $25.4 million and other indefinite-livedintangible assets of $19.7 million. Comparable balances as of June 30,2008 were $77.1 million and $19.7 million, respectively.

 

Goodwill in theretail and wholesale segments was $0 and $25.4 million, respectively, at March 31,2009 and $48.9 million and $28.2 million, respectively, at June 30, 2008.Goodwill in the wholesale segment decreased $2.7 million in the first quarterof fiscal 2009 due to the effective settlement of tax positions taken inprevious years.  The wholesale segment,at both dates, includes indefinite-lived intangible assets of $19.7 million forEthan Allen trade names.  If 

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

our stock priceand operating results decline beyond anticipated levels, the Company may againneed to conduct an evaluation of the fair values of these assets, which mightresult in an additional impairment.

 

**(8)****                  ****Borrowings**

 

Total debt obligations atMarch 31, 2009 and June 30, 2008 consist of the following (inthousands):

 
| ** **                    | ** ** | **March 31,  2009** | ** ** | **June 30,  2008** | ** ** |
|-------------------------------|------------|--------------------------|------------|-------------------------|------------|
| 5.375% Senior  Notes due 2015 |       | $                        | 198,958    |                    | $          | 198,837 |   |
| Industrial  revenue bonds     |       | 3,855                    |       | 3,855                   |       |
| Other debt                    |       | 306                      |       | 337                     |       |
| Total debt                    |       | 203,119                  |       | 203,029                 |       |
| Less current maturities       |       | 42                       |       | 41                      |       |
| Total long-term  debt         |       | $                        | 203,077    |                    | $          | 202,988 |   |

 

On September 27, 2005, we completeda private offering of $200.0 million of ten-year senior unsecured notes due2015 (the “Senior Notes”). The Senior Notes were offered by Global and have anannual coupon rate of 5.375% with interest payable semi-annually in arrears on April 1and October 1 of each year. Proceeds received in connection with the issuance of the Senior Notes,net of a related discount of $1.6 million, totaled $198.4 million. We used thenet proceeds from the offering to expand our retail network, invest in ourmanufacturing and logistics operations, and for other general corporatepurposes.  As of March 31, 2009,outstanding borrowings related to this transaction have been included in theConsolidated Balance Sheets within long-term debt. The discount on the SeniorNotes is being amortized to interest expense over the life of the related debtas is debt issuance costs of $2.0 million primarily for banking, legal,accounting, rating agency, and printing services and $0.8 million of losses onsettled forward contracts entered in conjunction with this debt issuance.

 

**(9)****                  ****Litigation and EnvironmentalMatters**

 

We and our subsidiaries are subject tovarious environmental laws and regulations. Under these laws, we and/or oursubsidiaries are, or may be, required to remove or mitigate the effects on theenvironment of the disposal or release of certain hazardous materials.

 

During the quarter ended December 31,2008, we resolved our liability as a potentially responsible party (“PRP”) withrespect to the remediation of the one remaining active site listed, or proposedfor inclusion, on the National Priorities List (“NPL”) under the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”).The site is located in High Point, North Carolina.  We were able to resolve our liability as partof a de minimis settlement.

 

In addition, in July 2000, we werenotified by the State of New York (the “State”) that we may be named a PRP in aseparate, unrelated matter with respect to a site located in Carroll, New York.To date, no further notice has been received from the State and the State hasnot yet conducted an initial environmental study at this site.

 

As of March 31, 2009, we believethat established reserves related to these environmental contingencies areadequate to cover probable and reasonably estimable costs associated with theremediation and restoration of these sites. We believe our currently anticipated capital expenditures forenvironmental control facility matters are not material.

 

We are subject to other federal, stateand local environmental protection laws and regulations and are involved, fromtime to time, in investigations and proceedings regarding environmentalmatters.  Such investigations and 

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

proceedings typically concern airemissions, water discharges, and/or management of solid and hazardous wastes.We believe that our facilities are in material compliance with all suchapplicable laws and regulations.

 

Regulations issued under the Clean AirAct Amendments of 1990 required the industry to reformulate certain furniturefinishes or institute process changes to reduce emissions of volatile organiccompounds. Compliance with many of these requirements has been facilitatedthrough the introduction of high solids coating technology and alternativeformulations. In addition, we have instituted a variety of technical andprocedural controls, including reformulation of finishing materials to reducetoxicity, implementation of high velocity low pressure spray systems,development of storm water protection plans and controls, and furtherdevelopment of related inspection/audit teams, all of which have served toreduce emissions per unit of production. We remain committed to implementingnew waste minimization programs and/or enhancing existing programs with theobjective of (i) reducing the total volume of waste, (ii) limitingthe liability associated with waste disposal, and (iii) continuouslyimproving environmental and job safety programs on the factory floor whichserve to minimize emissions and safety risks for employees. We will continue toevaluate the most appropriate, cost effective control technologies forfinishing operations and design production methods to reduce the use ofhazardous materials in the manufacturing process.

 

**(10)****           ****Share-Based Compensation**

 

On November 11,2008, M. Farooq Kathwari, our President and Chief Executive Officer, wasawarded options to purchase 50,000 shares of the Company’s common stock at theclosing stock price on the grant date. The grant was issued at an exercise price of $15.93, and vests in fourequal annual installments on the anniversary date of the grant.  Also on November 11, 2008, Mr. Kathwarireceived an award of 0 to 60,000 restricted shares, with vesting based onspecific financial performance over the final three quarters of fiscal 2009.

 

On November 5,2008, the Company awarded options to purchase 148,060 shares of our commonstock to a large group of associates at the closing stock price on the grantdate of $17.60. These grants vest in four equal annual installments on theanniversary date of the grant.

 

On October 10,2007, the Company’s Board of Directors and Mr. Kathwari agreed to theterms of a new employment agreement expiring on June 30, 2012 (the “Agreement”).  Pursuant to the terms of the Agreement, Mr. Kathwariwas awarded options to purchase 150,000 shares of our common stock on October 10,2007, and options to purchase an additional 90,000 shares on July 1, 2008,in each case at the closing stock price on the grant date.  The 2007 grant was issued at an exerciseprice of $34.03, and vests in three equal installments on each June 30 of2008, 2009 and 2010.  The 2008 grant wasissued at an exercise price of $24.62, and vests in two equal installments oneach of June 30, 2009 and 2010.  TheAgreement provides for an additional grant of 60,000 options on July 1,2009, with an exercise price equal to the closing price of a share of ourcommon stock on the New York Stock Exchange on that date.  The 2009 grant will vest on June 30,2010.  All options awarded under theAgreement have a contractual term of 10 years.

 

In connection withthe Agreement, Mr. Kathwari received an award of 20,000 restricted shareswith vesting based on continuing service and the performance of the Company’sstock price during the 32 month period subsequent to the award date as comparedto the Standard and Poor’s 500 index.  OnJuly 1, 2008, an additional award of 20,000 restricted shares with thesame vesting conditions (over a 36 month period) was granted.  Mr. Kathwari will also receive, as perthe Agreement, an additional grant of 20,000 restricted shares on July 1,2009 with the same 36 month vesting, continuing service and performanceconditions.

 

Also in connectionwith the Agreement, Mr. Kathwari received on November 13, 2007 anaward of 15,000 restricted shares.  Theseshares are service-based with 3,000 shares vesting on June 30 for each ofthe years 2008 through 2012.

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

**(11)****           ****Earnings Per Share**

 

Basic and dilutedearnings per share are calculated using the following weighted average sharedata (in thousands):

 
| ** **                                                                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                    | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Weighted average  common shares outstanding for basic calculation             |       | 28,861                                 |       | 28,909                                |       | 28,768 |   | 29,461 |   |
| Effect of  dilutive stock options and other share-based awards                |       | —                                 |       | 140                                   |       | — |   | 224 |   |
| Weighted average  common shares outstanding adjusted for dilution calculation |       | 28,861                                 |       | 29,049                                |       | 28,768 |   | 29,685 |   |

 

As of March 31,2009 and 2008, stock options to purchase 2,276,345 and 1,705,547 common shares,respectively, were excluded from the respective diluted earnings per sharecalculation because their impact was anti-dilutive.

 

**(12)****           ****Comprehensive Income**

 

Total comprehensive income represents the sum of netincome and items of “other comprehensive income or loss” that are reporteddirectly in equity.  Such items, whichare generally presented on a net of tax basis, may include foreign currencytranslation adjustments, minimum pension liability adjustments (i.e. gains andlosses) on certain derivative instruments, and unrealized gains and losses oncertain investments in debt and equity securities.  We have reported our total comprehensiveincome in the Consolidated Statements of Shareholders’ Equity.

 

Our accumulated othercomprehensive income, which is comprised of losses on certain derivativeinstruments and accumulated foreign currency translation adjustments, totaled$0.7 million at March 31, 2009 and $2.7 million at June 30,2008.  Losses on derivative instrumentsare the result of cash flow hedging contracts entered into in connection withthe issuance of the Senior Notes (see Note 8). Foreign currency translation adjustments are the result of changes inforeign currency exchange rates related to our operation of five Ethan Allenowned retail design centers located in Canada and our cut and sew plant locatedin Mexico.  Foreign currency translationadjustments exclude income tax expense (benefit) given that the earnings ofnon-U.S. subsidiaries are deemed to be reinvested for an indefinite period oftime.

 

**(13)****           ****Financial Instruments**

 

We adopted SFAS No. 157on July 1, 2008 for all financial assets and liabilities and non-financialassets and liabilities that are recognized or disclosed at fair value in thefinancial statements on a recurring basis (at least annually). SFAS No. 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements.

 

SFAS No. 157 definesfair value as the price that would be received upon sale of an asset or paidupon transfer of a liability in an orderly transaction between marketparticipants at the measurement date and in the principal or most advantageousmarket for that asset or liability. The fair value should be calculated basedon assumptions that market participants would use in pricing the asset orliability, not on assumptions specific to the entity. In addition, the fairvalue of liabilities should include consideration of non-performance riskincluding our own credit risk.

 

In addition to definingfair value, SFAS No. 157 expands the disclosure requirements around fairvalue and establishes a fair value hierarchy for valuation inputs. Thehierarchy prioritizes the inputs into three levels based on the extent to whichinputs used in measuring fair value are observable in the market. Eachfair value measurement is

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

reported in one of thethree levels which is determined by the lowest level input that is significantto the fair value measurement in its entirety. These levels are:

 

·                  Level 1 – inputs are based uponunadjusted quoted prices for identical instruments traded in active markets.

 

·                  Level 2 – inputs are based upon quotedprices for similar instruments in active markets, quoted prices for identicalor similar instruments in markets that are not active, and model-basedvaluation techniques for which all significant assumptions are observable inthe market or can be corroborated by observable market data for substantiallythe full term of the assets or liabilities.

 

·                  Level 3 – inputs are generallyunobservable and typically reflect management’s estimates of assumptions thatmarket participants would use in pricing the asset or liability. The fairvalues are therefore determined using model-based techniques that includeoption pricing models, discounted cash flow models, and similar techniques.

 

The following sectiondescribes the valuation methodologies we use to measure different financialassets and liabilities at fair value.

 

**Cash Equivalents**

** **

Cash equivalents consistof money market accounts and mutual funds in U.S. government and agencysecurities.  We use quoted prices inactive markets for identical assets or liabilities to determine fairvalue.  This pricing methodology appliesto our Level 1 cash equivalents.  We donot hold any Level 2 or Level 3 investments in our cash equivalents.

 

**Assets and Liabilities Measuredat Fair Value on a Recurring Basis**

** **

At March 31, 2009,the Company’s assets and liabilities measured at fair value on a recurringbasis consist of $40.7 million in cash equivalents, which were valued usingLevel 1 inputs.

 

**Assets and Liabilities Measuredat Fair Value on a Nonrecurring Basis**

** **

We measure certainassets, including our cost and equity method investments, at fair value on anonrecurring basis. These assets are recognized at fair value when they aredeemed to be other-than-temporarily impaired. During the three months ended March 31,2009, we determined that the goodwill for the Retail segment was impaired, anda goodwill impairment charge of $48.4 million was recorded (see note 7).

 

**(14)****           ****Segment Information**

 

Our operations areclassified into two operating segments: wholesale and retail.  These operating segments represent strategicbusiness areas which, although they operate separately and provide their owndistinctive services, enable us to more effectively offer our complete line ofhome furnishings and accessories.

 

The wholesalesegment is principally involved in the development of the Ethan Allen brand,which encompasses the design, manufacture, domestic and offshore sourcing, saleand distribution of a full range of home furnishings and accessories to anetwork of independently owned and Ethan Allen owned design centers as well asrelated marketing and brand awareness efforts. Wholesale revenue is generated upon the wholesale sale and shipment ofour product to all retail design centers, including those owned by EthanAllen.  Wholesale profitability includes (i) thewholesale gross margin, which represents the difference between the wholesale salesprice and the cost associated with manufacturing and/or sourcing the relatedproduct, and (ii) other operating costs associated with wholesale segmentactivities.

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

The retail segmentsells home furnishings and accessories to consumers through a network of Companyowned design centers.  Retail revenue isgenerated upon the retail sale and delivery of our product to ourcustomers.  Retail profitability includes(i) the retail gross margin, which represents the difference between theretail sales price and the cost of goods purchased from the wholesale segment,and (ii) other operating costs associated with retail segment activities.

 

Inter-segmenteliminations result, primarily, from the wholesale sale of inventory to theretail segment, including the related profit margin.

 

We evaluateperformance of the respective segments based upon revenues and operatingincome. While the manner in which our home furnishings and accessories aremarketed and sold is consistent, the nature of the underlying recorded sales(i.e. wholesale versus retail) and the specific services that each operatingsegment provides (i.e. wholesale manufacturing, sourcing, and distributionversus retail selling) are different. Within the wholesale segment, we maintain revenue information accordingto each respective product line (i.e. case goods, upholstery, or homeaccessories and other).

 

A breakdown ofwholesale sales by these product lines for the three and nine months ended March 31,2009 and 2008 is provided as follows:

 
| ** **                  | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                  | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Case Goods                  |       | 42                                     | %          | 41                                    | %          | 41 | % | 44 | % |
| Upholstered  Products       |       | 40                                     |       | 41                                    |       | 41 |   | 39 |   |
| Home Accessories  and Other |       | 18                                     |       | 18                                    |       | 18 |   | 17 |   |
|                        |       | 100                                    | %          | 100                                   | %          | 100 | % | 100 | % |

 

Revenueinformation by product line is not as easily determined within the retailsegment. However, because wholesale production and sales are matched, for themost part, to incoming orders, we believe that the allocation of retail salesby product line would be similar to that of the wholesale segment.

 

15

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Table ofContents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

 

Segmentinformation for the three and nine months ended March 31, 2009 and 2008 isset forth as follows:

 
| ** **                              | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Net  sales:**                         |       |                                   |       |                                  |       |   |   |   |   |
| Wholesale  segment                      |       | $                                      | 88,072     |                                  | $          | 156,269 |   | $ | 318,215 |   | $ | 468,522 |   |
| Retail segment                          |       | 103,305                                |       | 172,779                               |       | 406,358 |   | 548,112 |   |
| Elimination of  inter-company sales     |       | (51,156                                | )          | (93,147                               | )          | (188,953 | ) | (272,496 | ) |
| Consolidated  Total                     |       | $                                      | 140,221    |                                  | $          | 235,901 |   | $ | 535,620 |   | $ | 744,138 |   |
|                                    |       |                                   |       |                                  |       |   |   |   |   |
| **Operating  income (loss):**           |       |                                   |       |                                  |       |   |   |   |   |
| Wholesale  segment (1)(2)               |       | $                                      | (6,068     | )                                     | $          | 26,676 |   | $ | 14,396 |   | $ | 79,832 |   |
| Retail segment  (3)(4)                  |       | (71,920                                | )          | (8,544                                | )          | (78,156 | ) | (1,294 | ) |
| Adjustment of  inter-company profit (5) |       | 3,281                                  |       | (2,552                                | )          | 11,351 |   | (1,664 | ) |
| Consolidated  Total                     |       | $                                      | (74,707    | )                                     | $          | 15,580 |   | $ | (52,409 | ) | $ | 76,874 |   |
|                                    |       |                                   |       |                                  |       |   |   |   |   |
| **Capital  expenditures:**              |       |                                   |       |                                  |       |   |   |   |   |
| Wholesale  segment                      |       | $                                      | 350        |                                  | $          | 1,098 |   | $ | 2,664 |   | $ | 5,458 |   |
| Retail segment                          |       | 3,970                                  |       | 14,886                                |       | 17,802 |   | 40,839 |   |
| Acquisitions  (6)(7)(8)                 |       | 94                                     |       | 15                                    |       | 741 |   | 6,153 |   |
| Consolidated  Total                     |       | $                                      | 4,414      |                                  | $          | 15,999 |   | $ | 21,207 |   | $ | 52,450 |   |

 
| **Total assets**                  | ** ** | **March 31,  2009** | ** ** | **June 30,  2008** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-------------------------|------------|
| Wholesale  segment                |       | $                        | 315,442    |                    | $          | 342,960 |   |
| Retail segment                    |       | 379,543                  |       | 459,842                 |       |
| Inventory profit  elimination (9) |       | (28,947                  | )          | (40,829                 | )          |
| Consolidated  Total               |       | $                        | 666,038    |                    | $          | 761,973 |   |

 

----

| (1) | Operating income (loss)  for the wholesale segment for 2009 includes a pre-tax restructuring and  impairment charge of $5.5 million for the three months ended March 31,  2009.                                                  |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Operating income (loss)  for the wholesale segment for 2009 includes a pre-tax restructuring and  impairment charge of $5.9 million for the nine months ended March 31,  2009.                                                   |
| (3) | Operating income (loss)  for the retail segment for 2009 includes a goodwill impairment charge of  $48.4 million and a pre-tax restructuring and impairment charge of $1.9  million for the three months ended March 31, 2009.   |
| (4) | Operating income (loss)  for the retail segment for 2009 includes a goodwill impairment charge of  $48.4 million and a pre-tax restructuring and impairment credit of $0.2  million for the nine months ended March 31, 2009.    |
| (5) | Represents the change  in the inventory profit elimination necessary to adjust for the embedded  wholesale profit contained in Ethan Allen-owned design center inventory  existing at the end of the period.                          |
| (6) | Acquisitions for the  nine months ended March 31, 2009 include the purchase of three retail  design centers.                                                                                                                     |
| (7) | Acquisitions for 2008  exclude the purchase (for consideration totaling $0.6 million) of a retail  design center with an effective (closing) date of June 30, 2007 and for  which funding did not occur until July 2, 2007. |
| (8) | Acquisitions for the  nine months ended March 31, 2008 include the purchase of two retail  design centers and the purchase of a cut and sew plant in Mexico.                                                                     |
| (9) | Represents the  wholesale profit contained in Ethan Allen-owned design center inventory that  has not yet been realized. These profits are realized when the related  inventory is sold.                                              |

 

There were 42independent retail design centers located outside the United States at March 31,2009. Approximately 3% to 4% of our net sales were derived from sales to theseretail design centers.

 

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** **

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements(Unaudited)**

** **

**(15)****           ****Subsequent Events**

** **

Revolver Termination

 

The Companyterminated its $100 million cash flow based revolving credit facility effectiveMay 4, 2009.  Although we have noplans to use any revolving credit facility in the near term, we are innegotiations to establish an asset based revolving credit facility of up to $60million.  At March 31, 2009, we had$12.5 million in trade and standby letters of credit outstanding under the revolvingcredit facility. These letters of credit continue to be supported by a separatefacility with JP Morgan.  We believe wewill continue to have adequate liquidity to meet our current needs.

 

Ethan Allendeclares quarterly cash dividend

 

Ethan Allen’sBoard of Directors has declared a quarterly cash dividend of $0.05 per share,which will be payable to shareholders of record as of July 10, 2009 andpaid on July 24, 2009.

 

**(16)****           ****Recent Accounting Pronouncements**

** **

In December 2007, the FASB issued SFAS No. 141(revised 2007), *Business Combinations* (SFAS No. 141(R)),which replaces SFAS No. 141. SFAS No. 141(R) establishesprinciples and requirements for how an acquirer in a business combinationrecognizes and measures the identifiable assets acquired, the liabilitiesassumed, and any controlling interest; recognizes and measures the goodwillacquired in the business combination or a gain from a bargain purchase; anddetermines what information to disclose to enable users of the financialstatements to evaluate the nature and financial effects of the businesscombination. SFAS No. 141(R) is to be applied prospectively tobusiness combinations for which the acquisition date is on or after an entity’sfiscal year that begins after December 15, 2008 (July 1, 2009 for theCompany). The impact of this statement on the Company’s financial position,results of operations and cash flows will be dependent upon the terms,conditions and details of such acquisitions.

 

In February 2008, the FASB issued FASB StaffPosition 157-2, “*Effective Date of FASB Statement No. 157”*,which delays the effective date of SFAS No. 157 to July 1, 2009 forus, for all non-financial assets and non-financial liabilities, except foritems that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually).  The Company is currently evaluating theimpact of this statement on the Company’s financial position, results ofoperations and cash flows as it relates to non-financial assets and non-financialliabilities.

 

**(17)****           ****Financial Information About theParent, the Issuer and the Guarantors**

** **

On September 27,2005, Global (the “Issuer”) issued $200 million aggregate principal amount ofSenior Notes which have been guaranteed on a senior basis by Interiors (the “Parent”),and other wholly owned domestic subsidiaries of the Issuer and the Parent,including Ethan Allen Retail, Inc., Ethan Allen Operations, Inc.,Ethan Allen Realty, LLC, Lake Avenue Associates, Inc. and Manor House, Inc.The subsidiary guarantors (other than the Parent) are collectively called the “Guarantors”.  The guarantees of the Guarantors areunsecured.  All of the guarantees arefull, unconditional and joint and several and the Issuer and each of theGuarantors are 100% owned by the Parent. Ethan Allen (UK) Ltd., KEAInternational Inc. (which was legally dissolved in January 2007),Northeast Consolidated, Inc. (which was legally dissolved in June 2007),Riverside Water Works, Inc. (which was legally dissolved in June 2007),and our other subsidiaries which are not guarantors are called the “Non-Guarantors”.During the quarter ended December 31, 2008, we determined that ourinternational subsidiaries in Canada and Mexico are non-guarantors. The Companyhas reclassified, for all prior periods presented, the financial results ofthese international subsidiaries to reflect their non-guarantor status.

 

The following tables setforth the condensed consolidating balance sheets as of March 31, 2009 and June 30,2008, the condensed consolidating statements of operations for the three andnine months ended March 31, 2009 and 2008, and the condensed consolidatingstatements of cash flows for the nine months ended March 31, 2009 and 2008of the Parent, the Issuer, the Guarantors and the Non-Guarantors.

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

(In thousands)

**March 31,2009**

 
| ** **                                       | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current assets:                                  |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash  equivalents                       |       | $          | —     |       | $          | 47,999         |       | $                  | 2,200      |             | $          | 960              |       | $ | — |   | $ | 51,159 |   |
| Accounts  receivable, net                        |       | —     |       | 9,723      |       | 408            |       | 303                |       | —           |       | 10,434           |       |
| Inventories                                      |       | —     |       | —     |       | 199,089        |       | 4,168              |       | (28,947          | )          | 174,310          |       |
| Prepaid expenses  and other current assets       |       | —     |       | 26,089     |       | 6,689          |       | 512                |       | —           |       | 33,290           |       |
| Intercompany                                     |       | —     |       | 777,623    |       | 220,324        |       | (3,173             | )          | (994,774         | )          | —           |       |
| Total current  assets                            |       | —     |       | 861,434    |       | 428,710        |       | 2,770              |       | (1,023,721       | )          | 269,193          |       |
|                                             |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Property, plant  and equipment, net              |       | —     |       | 12,450     |       | 330,501        |       | 4,793              |       | —           |       | 347,744          |       |
| Goodwill and  other intangible assets            |       | —     |       | 37,905     |       | 7,251          |       | —             |       | —           |       | 45,156           |       |
| Other assets                                     |       | —     |       | 3,062      |       | 878            |       | 5                  |       | —           |       | 3,945            |       |
| Investment in  affiliated companies              |       | 629,127    |       | 9,213      |       | —         |       | —             |       | (638,340         | )          | —           |       |
| Total assets                                     |       | $          | 629,127    |       | $          | 924,064        |       | $                  | 767,340    |             | $          | 7,568            |       | $ | (1,662,061 | ) | $ | 666,038 |   |
|                                             |       |       |       |       |       |           |       |               |       |             |       |             |       |
| **Liabilities  and Shareholders’ Equity**   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current  liabilities:                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current  maturities of long-term debt            |       | $          | —     |       | $          | —         |       | $                  | 42         |             | $          | —           |       | $ | — |   | $ | 42 |   |
| Customer  deposits                               |       | —     |       | —     |       | 30,076         |       | 1,124              |       | —           |       | 31,200           |       |
| Accounts payable                                 |       | —     |       | 9,788      |       | 9,719          |       | 114                |       | —           |       | 19,621           |       |
| Accrued expenses  and other current liabilities  |       | 3,028      |       | 43,153     |       | 13,899         |       | 227                |       | —           |       | 60,307           |       |
| Intercompany                                     |       | 301,946    |       | 597        |       | 686,869        |       | 5,362              |       | (994,774         | )          | —           |       |
| Total current  liabilities                       |       | 304,974    |       | 53,538     |       | 740,605        |       | 6,827              |       | (994,774         | )          | 111,170          |       |
|                                             |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Long-term debt                                   |       | —     |       | 198,958    |       | 4,119          |       | —             |       | —           |       | 203,077          |       |
| Other long-term  liabilities                     |       | —     |       | 7,352      |       | 13,574         |       | 133                |       | —           |       | 21,059           |       |
| Deferred income  taxes                           |       | —     |       | 6,579      |       | —         |       | —             |       | —           |       | 6,579            |       |
| Total  liabilities                               |       | 304,974    |       | 266,427    |       | 758,298        |       | 6,960              |       | (994,774         | )          | 341,885          |       |
|                                             |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Shareholders’  equity                       |       | 324,153    |       | 657,637    |       | 9,042          |       | 608                |       | (667,287         | )          | 324,153          |       |
| Total  liabilities and shareholders’ equity |       | $          | 629,127    |       | $          | 924,064        |       | $                  | 767,340    |             | $          | 7,568            |       | $ | (1,662,061 | ) | $ | 666,038 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

(In thousands)

**June 30,2008**

 
| ** **                                       | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current assets:                                  |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash  equivalents                       |       | $          | —     |       | $          | 71,117         |       | $                  | 1,307      |             | $          | 1,952            |       | $ | — |   | $ | 74,376 |   |
| Accounts  receivable, net                        |       | —     |       | 11,937     |       | 431            |       | 304                |       | —           |       | 12,672           |       |
| Inventories                                      |       | —     |       | —     |       | 222,130        |       | 4,964              |       | (40,829          | )          | 186,265          |       |
| Prepaid expenses  and other current assets       |       | —     |       | 15,355     |       | 21,020         |       | 490                |       | —           |       | 36,865           |       |
| Intercompany  receivables                        |       | —     |       | 712,981    |       | 209,471        |       | —             |       | (922,452         | )          | 0                |       |
| Total current  assets                            |       | —     |       | 811,390    |       | 454,359        |       | 7,710              |       | (963,281         | )          | 310,178          |       |
|                                             |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Property, plant  and equipment, net              |       | —     |       | 13,186     |       | 331,581        |       | 5,665              |       | —           |       | 350,432          |       |
| Goodwill and  other intangible assets            |       | —     |       | 37,905     |       | 55,189         |       | 3,729              |       | —           |       | 96,823           |       |
| Other assets                                     |       | —     |       | 3,604      |       | 929            |       | 7                  |       | —           |       | 4,540            |       |
| Investment in  affiliated companies              |       | 665,427    |       | 118,371    |       | —         |       | —             |       | (783,798         | )          | —           |       |
| Total assets                                     |       | $          | 665,427    |       | $          | 984,456        |       | $                  | 842,058    |             | $          | 17,111           |       | $ | (1,747,079 | ) | $ | 761,973 |   |
|                                             |       |       |       |       |       |           |       |               |       |             |       |             |       |
| **Liabilities  and Shareholders’ Equity**   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current  liabilities:                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current  maturities of long-term debt            |       | —     |       | —     |       | 41             |       | —             |       | —           |       | 41               |       |
| Customer  deposits                               |       | —     |       | —     |       | 45,486         |       | 1,811              |       | —           |       | 47,297           |       |
| Accounts payable                                 |       | —     |       | 9,785      |       | 15,936         |       | 723                |       | —           |       | 26,444           |       |
| Accrued expenses  and other current liabilities  |       | 6,438      |       | 36,885     |       | 18,022         |       | 375                |       | —           |       | 61,720           |       |
| Intercompany  payables                           |       | 283,216    |       | 597        |       | 628,925        |       | 9,714              |       | (922,452         | )          | —           |       |
| Total current  liabilities                       |       | 289,654    |       | 47,267     |       | 708,410        |       | 12,623             |       | (922,452         | )          | 135,502          |       |
| Long-term debt                                   |       | —     |       | 198,837    |       | 4,151          |       | —             |       | —           |       | 202,988          |       |
| Other long-term  liabilities                     |       | —     |       | 7,819      |       | 12,380         |       | 184                |       | —           |       | 20,383           |       |
| Deferred income  taxes                           |       | —     |       | 27,327     |       | —         |       | —             |       | —           |       | 27,327           |       |
| Total  liabilities                               |       | 289,654    |       | 281,250    |       | 724,941        |       | 12,807             |       | (922,452         | )          | 386,200          |       |
| Shareholders’  equity                       |       | 375,773    |       | 703,206    |       | 117,117        |       | 4,304              |       | (824,627         | )          | 375,773          |       |
| Total  liabilities and shareholders’ equity |       | $          | 665,427    |       | $          | 984,456        |       | $                  | 842,058    |             | $          | 17,111           |       | $ | (1,747,079 | ) | $ | 761,973 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

(In thousands)

**Three Months Ended March 31, 2009**

** **
| ** **                                         | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                          |       | $          | —     |       | $          | 88,573         |       | $                  | 139,264    |             | $          | 3,993            |       | $ | (91,609 | ) | $ | 140,221 |   |
| Cost of sales                                      |       | —     |       | 67,571     |       | 99,103         |       | 2,646              |       | (95,149          | )          | 74,171           |       |
| Gross profit                                       |       | —     |       | 21,002     |       | 40,161         |       | 1,347              |       | 3,540            |       | 66,050           |       |
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general  and administrative expenses      |       | 41         |       | 12,611     |       | 70,020         |       | 2,360              |       | —           |       | 85,032           |       |
| Restructuring  and impairment charge, (credit) net |       | —     |       | —     |       | 55,725         |       | —             |       | —           |       | 55,725           |       |
| Total operating  expenses                          |       | 41         |       | 12,611     |       | 125,745        |       | 2,360              |       | —           |       | 140,757          |       |
| Operating income  (loss)                           |       | (41        | )          | 8,391      |       | (85,584        | )          | (1,013             | )          | 3,540            |       | (74,707          | )          |
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and  other miscellaneous income, net      |       | (48,633    | )          | (85,859    | )          | 5              |       | 5                  |       | 135,288          |       | 806              |       |
| Interest and  other related financing costs        |       | —     |       | 2,908      |       | 77             |       | —             |       | —           |       | 2,985            |       |
| Income (loss)  before income tax expense           |       | (48,674    | )          | (80,376    | )          | (85,656        | )          | (1,008             | )          | 138,828          |       | (76,886          | )          |
| Income tax  expense                                |       | —     |       | (28,212    | )          | —         |       | —             |       | —           |       | (28,212          | )          |
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income  (loss)                                 |       | $          | (48,674    | )          | $          | (52,164        | )          | $                  | (85,656    | )                | $          | (1,008           | )          | $ | 138,828 |   | $ | (48,674 | ) |

 

**Three Months Ended March 31, 2008**

** **
| ** **                                         | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                          |       | $          | —     |       | $          | 157,138        |       | $                  | 239,316    |             | $          | 6,800            |       | $ | (167,353 | ) | $ | 235,901 |   |
| Cost of sales                                      |       | —     |       | 110,602    |       | 160,661        |       | 3,926              |       | (164,475         | )          | 110,714          |       |
| Gross profit                                       |       | —     |       | 46,536     |       | 78,655         |       | 2,874              |       | (2,878           | )          | 125,187          |       |
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general  and administrative expenses      |       | 42         |       | 12,893     |       | 89,316         |       | 3,363              |       | —           |       | 105,614          |       |
| Restructuring  and impairment charge, (credit) net |       | —     |       | —     |       | 3,993          |       | —             |       | —           |       | 3,993            |       |
| Total operating  expenses                          |       | 42         |       | 12,893     |       | 93,309         |       | 3,363              |       | —           |       | 109,607          |       |
| Operating income  (loss)                           |       | (42        | )          | 33,643     |       | (14,654        | )          | (489               | )          | (2,878           | )          | 15,580           |       |
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and  other miscellaneous income, net      |       | 8,888      |       | (13,299    | )          | 8              |       | 44                 |       | 5,734            |       | 1,375            |       |
| Interest and  other related financing costs        |       | —     |       | 2,838      |       | 76             |       | —             |       | —           |       | 2,914            |       |
| Income (loss)  before income tax expense           |       | 8,846      |       | 17,506     |       | (14,722        | )          | (445               | )          | 2,856            |       | 14,041           |       |
| Income tax  expense                                |       | —     |       | 5,195      |       | —         |       | —             |       | —           |       | 5,195            |       |
|                                               |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income  (loss)                                 |       | $          | 8,846      |       | $          | 12,311         |       | $                  | (14,722    | )                | $          | (445             | )          | $ | 2,856 |   | $ | 8,846 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

(In thousands)

**Nine Months Ended March 31, 2009**

 
| ** **                                    | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                     |       | $          | —     |       | $          | 319,295        |       | $                  | 542,712    |             | $          | 16,054           |       | $ | (342,441 | ) | $ | 535,620 |   |
| Cost of sales                                 |       | —     |       | 236,974    |       | 363,840        |       | 9,387              |       | (354,373         | )          | 255,828          |       |
| Gross profit                                  |       | —     |       | 82,321     |       | 178,872        |       | 6,667              |       | 11,932           |       | 279,792          |       |
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general  and administrative expenses |       | 124        |       | 37,546     |       | 232,400        |       | 8,010              |       | —           |       | 278,080          |       |
| Restructuring  and impairment charge, net     |       | —     |       | —     |       | 54,121         |       | —             |       | —           |       | 54,121           |       |
| Total operating  expenses                     |       | 124        |       | 37,546     |       | 286,521        |       | 8,010              |       | —           |       | 332,201          |       |
| Operating income  (loss)                      |       | (124       | )          | 44,775     |       | (107,649       | )          | (1,343             | )          | 11,932           |       | (52,409          | )          |
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and  other miscellaneous income, net |       | (35,640    | )          | (106,152   | )          | 13             |       | 9                  |       | 144,789          |       | 3,019            |       |
| Interest and  other related financing costs   |       | —     |       | 8,589      |       | 229            |       | —             |       | —           |       | 8,818            |       |
| Income (loss)  before income tax expense      |       | (35,764    | )          | (69,966    | )          | (107,865       | )          | (1,334             | )          | 156,721          |       | (58,208          | )          |
| Income tax  expense                           |       | —     |       | (22,444    | )          | —         |       | —             |       | —           |       | (22,444          | )          |
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income  (loss)                            |       | $          | (35,764    | )          | $          | (47,522        | )          | $                  | (107,865   | )                | $          | (1,334           | )          | $ | 156,721 |   | $ | (35,764 | ) |

 

**Nine Months Ended March 31, 2008**

** **
| ** **                                    | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                     |       | $          | —     |       | $          | 469,918        |       | $                  | 742,072    |             | $          | 20,680           |       | $ | (488,532 | ) | $ | 744,138 |   |
| Cost of sales                                 |       | —     |       | 330,924    |       | 491,147        |       | 10,641             |       | (486,671         | )          | 346,041          |       |
| Gross profit                                  |       | —     |       | 138,994    |       | 250,925        |       | 10,039             |       | (1,861           | )          | 398,097          |       |
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general  and administrative expenses |       | 125        |       | 36,158     |       | 271,262        |       | 9,685              |       | —           |       | 317,230          |       |
| Restructuring  and impairment charge, net     |       | —     |       | —     |       | 3,993          |       | —             |       | —           |       | 3,993            |       |
| Total operating  expenses                     |       | 125        |       | 36,158     |       | 275,255        |       | 9,685              |       | —           |       | 321,223          |       |
| Operating income  (loss)                      |       | (125       | )          | 102,836    |       | (24,330        | )          | 354                |       | (1,861           | )          | 76,874           |       |
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and  other miscellaneous income, net |       | 47,097     |       | (17,668    | )          | 591            |       | 76                 |       | (23,618          | )          | 6,478            |       |
| Interest and  other related financing costs   |       | —     |       | 8,564      |       | 229            |       | —             |       | —           |       | 8,793            |       |
| Income (loss)  before income tax expense      |       | 46,972     |       | 76,604     |       | (23,968        | )          | 430                |       | (25,479          | )          | 74,559           |       |
| Income tax  expense                           |       | —     |       | 27,587     |       | —         |       | —             |       | —           |       | 27,587           |       |
|                                          |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income  (loss)                            |       | $          | 46,972     |       | $          | 49,017         |       | $                  | (23,968    | )                | $          | 430              |       | $ | (25,479 | ) | $ | 46,972 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

(In thousands)

**Nine Months Ended March 31, 2009**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net cash  provided by (used in) operating activities         |       | $          | 20,718     |       | $          | (21,503        | )          | $                  | 14,724     |             | $          | (146             | )          | $ | — |   | $ | 13,793 |   |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from  investing activities:                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Capital  expenditures                                        |       | —     |       | (1,257     | )          | (19,106        | )          | (103               | )          | —           |       | (20,466          | )          |
| Acquisitions                                                 |       | —     |       | —     |       | (741           | )          | —             |       | —           |       | (741             | )          |
| Proceeds from  the disposal of property, plant and equipment |       | —     |       | 19         |       | 6,264          |       | —             |       | —           |       | 6,283            |       |
| Other                                                        |       | —     |       | 70         |       | (217           | )          | —             |       | —           |       | (147             | )          |
| Net cash used in  investing activities                       |       | —     |       | (1,168     | )          | (13,800        | )          | (103               | )          | —           |       | (15,071          | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from  financing activities:                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Payments on  long-term debt                                  |       | —     |       | —     |       | (31            | )          | —             |       | —           |       | (31              | )          |
| Purchases and  other retirements of company stock            |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Proceeds from  issuance of common stock                      |       | 2          |       | —     |       | —         |       | —             |       | —           |       | 2                |       |
| Payment of  deferred financing costs                         |       | —     |       | (447       | )          | —         |       | —             |       | —           |       | (447             | )          |
| Dividends paid                                               |       | (20,720    | )          | —     |       | —         |       | —             |       | —           |       | (20,720          | )          |
| Net cash  provided by (used in) financing activities         |       | (20,718    | )          | (447       | )          | (31            | )          | —             |       | —           |       | (21,196          | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Effect of  exchange rate changes on cash                     |       | —     |       | —     |       | —         |       | (743               | )          | —           |       | (743             | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net increase  (decrease) in cash and cash equivalents        |       | —     |       | (23,118    | )          | 893            |       | (992               | )          | —           |       | (23,217          | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash  equivalents – beginning of period        |       | —     |       | 71,117     |       | 1,307          |       | 1,952              |       | —           |       | 74,376           |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash  equivalents – end of period              |       | $          | —     |       | $          | 47,999         |       | $                  | 2,200      |             | $          | 960              |       | $ | — |   | $ | 51,159 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

(In thousands)

**Nine Months Ended March 31, 2008**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net cash  provided by (used in) operating activities         |       | $          | 94,269     |       | $          | (67,614        | )          | $                  | 39,951     |             | $          | 654              |       | $ | — |   | $ | 67,260 |   |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from  investing activities:                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Capital  expenditures                                        |       | —     |       | (3,895     | )          | (42,381        | )          | (21                | )          | —           |       | (46,297          | )          |
| Acquisitions                                                 |       | —     |       | —     |       | (6,762         | )          | —             |       | —           |       | (6,762           | )          |
| Proceeds from  the disposal of property, plant and equipment |       | —     |       | —     |       | 6,936          |       | —             |       | —           |       | 6,936            |       |
| Other                                                        |       | —     |       | 25         |       | —         |       | —             |       | —           |       | 25               |       |
| Net cash used in  investing activities                       |       | —     |       | (3,870     | )          | (42,207        | )          | (21                | )          | —           |       | (46,098          | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from  financing activities:                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Payments on  long-term debt                                  |       | —     |       | —     |       | (30            | )          | —             |       | —           |       | (30              | )          |
| Purchases and  other retirements of company stock            |       | (75,577    | )          | —     |       | —         |       | —             |       | —           |       | (75,577          | )          |
| Proceeds from  issuance of common stock                      |       | 472        |       | —     |       | —         |       | —             |       | —           |       | 472              |       |
| Excess tax  benefits from share-based payment arrangements   |       | —     |       | 2,093      |       | —         |       | —             |       | —           |       | 2,093            |       |
| Dividends paid                                               |       | (19,164    | )          | —     |       | —         |       | —             |       | —           |       | (19,164          | )          |
| Net cash  provided by (used in) financing activities         |       | (94,269    | )          | 2,093      |       | (30            | )          | —             |       | —           |       | (92,206          | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Effect of  exchange rate changes on cash                     |       | —     |       | —     |       | —         |       | 176                |       | —           |       | 176              |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net increase  (decrease) in cash and cash equivalents        |       | —     |       | (69,391    | )          | (2,286         | )          | 809                |       | —           |       | (70,868          | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash  equivalents – beginning of period        |       | —     |       | 142,253    |       | 4,953          |       | 673                |       | —           |       | 147,879          |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash  equivalents – end of period              |       | $          | —     |       | $          | 72,862         |       | $                  | 2,667      |             | $          | 1,482            |       | $ | — |   | $ | 77,011 |   |

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

 

**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

The followingdiscussion of financial condition and results of operations should be read inconjunction with (i) our Consolidated Financial Statements, and notesthereto, as set forth in this Quarterly Report on Form 10-Q and (ii) ourAnnual Report on Form 10-K for the year ended June 30, 2008.

 

**Forward-LookingStatements**

 

Management’sdiscussion and analysis of financial condition and results of operations andother sections of this Quarterly Report contain forward-looking statementsrelating to our future results. Such forward-looking statements are identifiedby use of forward-looking words such as “anticipates”, “believes”, “plans”, “estimates”,“expects”, and “intends” or words or phrases of similar expression. Theseforward-looking statements are subject to management decisions and variousassumptions, risks and uncertainties, including, but not limited to: theeffects of terrorist attacks or conflicts or wars involving the United Statesor its allies or trading partners; the effects of labor strikes; weatherconditions that may affect sales; volatility in fuel, utility, transportationand security costs; changes in global or regional political or economicconditions, including changes in governmental and central bank policies;changes in business conditions in the furniture industry, including changes inconsumer spending patterns and demand for home furnishings; effects of ourbrand awareness and marketing programs, including changes in demand for ourexisting and new products; our ability to locate new design center sites and/ornegotiate favorable lease terms for additional design centers or for theexpansion of existing design centers; competitive factors, including changes inproducts or marketing efforts of others; pricing pressures; fluctuations ininterest rates and the cost, availability and quality of raw materials; thosematters discussed in Items 1A and 7A of our Annual Report on Form 10-K forthe year ended June 30, 2008 and in our SEC filings; and our futuredecisions. Accordingly, actual circumstances and results could differmaterially from those contemplated by the forward-looking statements.

 

**CriticalAccounting Policies**

 

There have been nomaterial changes with respect to the Company’s critical accounting policiesfrom those disclosed in its 2008 Annual Report on Form 10-K filed with theSEC on August 22, 2008.

 

**Resultsof Operations**

 

Our Company has been severely impacted bythe ongoing recession in the United States and abroad.  Continued weakness in the U.S. economy, highunemployment, volatile capital markets, depressed housing prices and tightconsumer lending practices have driven consumer confidence down to, or near,historical lows and resulted in considerable negative pressure on spending byindividual consumers, our primary customer base.  The Company is continuing to adjust ourinfrastructure to match our sales volumes as we work through these difficulttimes.

 

Management performed testing for theimpairment of goodwill as of March 31, 2009 due to the acceleration ofsevere adverse changes in the business climate, as evidenced by the sudden anddramatic adverse changes in macroeconomic indicators like unemployment, capitalmarket prices, housing prices and consumer lending practices, coupled with adecline in our net sales.  The fair valueof goodwill was measured by first determining the fair value of the Wholesaleand Retail segment, using both a market approach and an income approach, and then reconciling to thetotal market capitalization of the Company (“step 1”).  For the Retail segment, a separate estimationof the fair value of all identifiable assets and liabilities was required (“step2”).  The estimated fair value determinedfrom step 2 was greater than the value of the Retail segment determined in step1.  Consequently all goodwill on the Retailsegment was considered impaired and a non-cash charge of $48.4 million wasrecorded against income.

 

On January 6, 2009, the Companyannounced a plan to consolidate the operations of its Eldred, Pennsylvaniaupholstery manufacturing plant and several of its retail service centers.Business previously serviced by the 

 

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Eldred Pennsylvania facility has been transferredto the Company’s facilities in North Carolina and California, and the Companyis expanding the production in those facilities.  Business currently served by the retailservice centers is being transferred to other Company locations serving the samegeneral market areas.  The Companyexpects pre-tax restructuring, impairment, and other related charges will totalapproximately $9 million, with approximately $4 million in employee severanceand other payroll and benefit costs, $3 million in write down of long-livedassets, and $2 million in other associated costs, after which time we expectthe actions to be complete.  By segment,we expect $6 million in costs for the wholesale segment and $3 million for theretail segment.  The majority of chargeswill be non-cash in nature representing an approximate after-tax impact of $5.7million or $0.20 per diluted share.

 

On January 10, 2008, we announced aplan to consolidate the operations of certain company owned retail designcenters and retail service centers. In connection with this initiative, wepermanently ceased operations at eleven design centers and six retail servicecenters which, for the most part, were consolidated into other existingoperations.  We also implemented ourdesign team concept across the Retail division at the end of fiscal 2008.  These decisions resulted in a reduction inheadcount of approximately 400 employees, with the reduction in headcountoccurring mostly during the third and fourth quarters of fiscal 2008.  Additionally, other actions taken duringfiscal 2008 were not included in the restructuring plan. Altogether, there weremore than 500 fewer associates in our Retail business by the end of June 2008.In fiscal 2009, a $1.8 million restructuring and impairment net gain was recorded.  Of this amount, $4.2 million was a realizedgain on the sale of property classified as held for sale and was partiallyoffset by $2.4 million in lease termination costs and adjustments for expectedcharges on leased properties no longer being used.  Since the plan was announced, we haverecorded pre-tax restructuring and impairment charges totaling $5.2 million,including $0.9 million in employee severance and other payroll and benefitcosts, $5.6 million in lease termination and other exit costs, and a benefit of$1.4 million on long-lived assets.  Theestimated present value of future lease payments with terms ranging from lessthan one to seven years, and one ground lease with 25 years remaining are includedin the balance at March 31, 2009 and contain estimates that will likelyrequire adjustment in the future.  Inaddition to the retail charges, $0.4 million was recorded in the first fiscalquarter of 2009 to update the fair value of a wholesale plant site held forsale.

 

Our revenues arecomprised of (i) wholesale sales to independently owned and Company-ownedretail design centers and (ii) retail sales of Company-owned designcenters.  See Note 14 to our ConsolidatedFinancial Statements for the three and nine months ended March 31, 2009and 2008.

 

The components ofconsolidated revenue and operating income were as follows (in millions):

 
| ** **                          | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                          | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Revenue:**                        |       |                                   |       |                                  |       |   |   |   |   |
| Wholesale  segment                  |       | $                                      | 88.1       |                                  | $          | 156.3 |   | $ | 318.2 |   | $ | 468.5 |   |
| Retail segment                      |       | 103.3                                  |       | 172.8                                 |       | 406.4 |   | 548.1 |   |
| Elimination of  inter-company sales |       | (51.2                                  | )          | (93.1                                 | )          | (189.0 | ) | (272.5 | ) |
| Consolidated  revenue               |       | $                                      | 140.2      |                                  | $          | 235.9 |   | $ | 535.6 |   | $ | 744.1 |   |

 
| ** **                              | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Operating  income (loss):**           |       |                                   |       |                                  |       |   |   |   |   |
| Wholesale  segment (1)(2)               |       | $                                      | (6.1       | )                                     | $          | 26.7 |   | $ | 14.4 |   | $ | 79.8 |   |
| Retail segment  (3)(4)                  |       | (71.9                                  | )          | (8.6                                  | )          | (78.2 | ) | (1.3 | ) |
| Adjustment of  inter-company profit (5) |       | 3.3                                    |       | (2.6                                  | )          | 11.4 |   | (1.7 | ) |
| Consolidated  operating income (loss)   |       | $                                      | (74.7      | )                                     | $          | 15.6 |   | $ | (52.4 | ) | $ | 76.9 |   |

 

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| (1) | Operating income (loss)  for the wholesale segment for 2009 includes a pre-tax restructuring and  impairment charge of $5.5 million for the three months ended March 31,  2009.                                                |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Operating income (loss)  for the wholesale segment for 2009 includes a pre-tax restructuring and  impairment charge of $5.9 million for the nine months ended March 31,  2009.                                                 |
| (3) | Operating income (loss)  for the retail segment for 2009 includes a goodwill impairment charge of  $48.4 million and a pre-tax restructuring and impairment charge of $1.9  million for the three months ended March 31, 2009. |
| (4) | Operating income (loss)  for the retail segment for 2009 includes a goodwill impairment charge of  $48.4 million and a pre-tax restructuring and impairment credit of $0.2  million for the nine months ended March 31, 2009.  |
| (5) | Represents the change  in the inventory profit elimination necessary to adjust for the wholesale  profit contained in Ethan Allen-owned design center inventory existing at the  end of the period.                                 |

 

***QuarterEnded March 31, 2009 Compared to Quarter Ended March 31, 2008***

 

**Consolidated revenue** for the three months ended March 31,2009 decreased 40.6% to $140.2 million, from $235.9 million for the threemonths ended March 31, 2008.  Duringthe quarter, sales were negatively affected by a number of factors including,but not limited to, the continued weakness in the U.S. economy, highunemployment, volatile capital markets, depressed housing prices and tightconsumer lending practices. Although the granting of new credit through ourthird party consumer credit program saw a return to stability, default ratescontinue to rise.  We believe the factorscited above have caused consumer confidence levels to drop to, or near,historic lows.  We believe these factors werepartially offset by (i) our ongoing efforts to reposition the retail network,(ii) new product introductions, (iii) improved use of technologyincluding our state-of-the-art website coupled with personal service from ourdesign professionals and (iv) the continued use of national television andshelter magazines as advertising medium. Net sales for the period largelyreflect the delivery of product associated with booked orders and backlogexisting as of the end of the preceding quarter.  The Company’s sales decrease is primarily theresult of lower volume, not lower prices.

 

**Wholesalerevenue** for thethird quarter of fiscal 2009 decreased 43.6% to $88.1 million from $156.3million in the prior year comparable period. The quarter-over-quarter decrease wasprimarily attributable to a decline in the incoming order rate due to a continuedsoft retail environment for home furnishings noted throughout the currentperiod.  In addition, there were 8 fewerindependent retail design centers at March 31, 2009, which decreased to131 from 139, including seven locations transferred in to the company’s Retaildivision during the year.   There were the same number of shipping daysin the quarter both this year and last year.

 

**Retail revenue** from Ethan Allen-owned design centersfor the three months ended March 31, 2009 decreased 40.2% to $103.3million from $172.8 million for the three months ended March 31,2008.  We believe the decrease in retailsales by Ethan Allen-owned design centers is due to the same soft marketconditions experienced by the wholesale segment, as evidenced by a 41.8% decreasein comparable store sales. Partially offsetting this was a net $5.2 milliondecrease in new/closed store sales, and a net increase in the number of EthanAllen-owned design centers to 159 as of March 31, 2009 as compared to 153as of March 31, 2008.  During thattwelve month period, we acquired seven design centers from independentretailers and opened eleven design centers (four of which were relocationswhere the original site was also closed), and closed eight design centers.

 

Comparable designcenters are those which have been operating for at least 15 months.  Minimal net sales, derived from the deliveryof customer ordered product, are generated during the first three months ofoperations of newly opened (including relocated) design centers. Design centersacquired by us from independent retailers are included in comparable designcenters sales in their 13th full month of Ethan Allen-owned operations.

 

Quarter-over-quarter,written business of Ethan Allen-owned design centers decreased 38.5% whilecomparable design centers written business decreased 40.4%.  Over that same period, wholesale ordersdecreased 42.6%.  Both retail andwholesale written business reflect the softer retail environment for homefurnishings noted throughout the period as a result of continued weakness inthe U.S. economy, high unemployment, volatile capital markets, depressedhousing prices and tight consumer lending practices, and general uncertaintyabout the economy in the U.S. and abroad.

 

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We have madeconsiderable investment within the retail network to strengthen the level ofservice, professionalism, interior design competence, efficiency, andeffectiveness of the retail design center personnel.  The implementation of the “team” concept hasresulted in the development of over 280 interior design teams.  We believe that this team structure will helpus continue to improve the customer service experience.  We also believe that over time, we willbenefit from (i) our repositioning of the retail network, (ii) regularnew product introductions, (iii) improved use of technology including ourstate-of-the-art website coupled with personal service from our designprofessionals, and (iv) the continued use of national television andshelter magazines as advertising media.

 

**Grossprofit** decreasedduring the quarter to $66.1 million from $125.2 million in the prior yearcomparable quarter.  The 47.2%, decreasein gross profit was primarily attributable to (i) the reduction in netsales of 40.6%, with an overall decrease in shipments in both market segments, (ii) lowermargin percentages within the wholesale segment due to under absorbing of plantoverhead costs on the lower production volume, as well as disruptions and costsdue to restructuring activities, and (iii) slightly lower margins withinthe retail segment, due to sales of discontinued product and floor samples tomake room for the new American Artisan product introduction, and design centerconsolidations and repositioning.  Thesefactors were partially offset by a favorable shift in sales mix with retailsales representing a higher proportionate share of total sales in the currentquarter (74%) compared to the prior year period (73%). Consolidated grossmargin decreased to 47.1% from 53.1% in the prior year as a result, primarily,of the factors set forth above.

 

**Operatingprofit**, theelements of which are discussed in greater detail below, was impacted by thefollowing items during the three months ended March 31, 2009 and 2008:

 

**Operatingexpenses**increased 28.4% to $140.8 million, and increased to 100.4% of sales, in thecurrent quarter from $109.6 million, or 46.5% of sales, in the prior yearquarter.  Selling expenses were down inabsolute terms due to lower sales volume. Salary related costs decreased due to the reduced number of employeesand other cost cutting efforts taken by the Company that impacted bonus andbenefits.  Advertising expenses were down$4.7 million.

 

**Consolidatedoperating income (loss)** for the three month period ended March 31, 2009 was a loss of$74.7 million, or 53.3% of sales, as compared to income of $15.6 million, or6.6% of sales, for the three months ended March 31, 2008.  This decrease of $90.3 million is due to adecrease in gross profit mostly due to reduced sales, partly offset by adecrease in period over period operating expenses, both of which were discussedpreviously.

 

**Wholesaleoperating income (loss)** for the three months ended March 31, 2009 totaled a loss of $6.1million, or 6.9% of sales, as compared to income of $26.7 million, or 17.1% ofsales, in the prior year comparable quarter. The decrease of $32.7 million wasprimarily attributable to a decrease in sales volume, and higher unabsorbedcosts in our manufacturing plants due to lower production volumes.

 

**Retailoperating income (loss)** decreased $63.4 million to a loss of $71.9 million, or -69.6% ofsales, for the third quarter of fiscal 2009 from a loss of $8.5 million, or-4.9% of sales, for the third quarter of fiscal 2008.  The decrease in retail operating incomegenerated by Ethan Allen-owned design centers was primarily due to reducedsales attributed to the weak retail environment for home furnishings.

 

**Interest and other miscellaneousincome, net**decreased $0.6 million from the prior year comparable quarter.  The decrease was due, primarily to a decreasein investment income resulting from lower cash and cash equivalent balances andlower rates of interest during the current period.

 

**Interest and other relatedfinancing costs**amounted to just under $3.0 million in both the current and prior yearperiods.  This amount consists,primarily, of interest expense incurred in connection with our issuance ofsenior unsecured debt in September 2005.

 

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**Income tax expense** for the three months ended March 31,2009 totaled a benefit of $28.2 million as compared to an expense of $5.2million for the three months ended March 31, 2008.  Our effective tax rate for the currentquarter was 36.7% compared to 37.0% in the prior year quarter.

 

**Netincome (loss)** forthe three months ended March 31, 2009, was a loss of $48.7 million ascompared to net income of $8.8 million in the prior year comparableperiod.  There was a net loss per dilutedshare of $1.69 in the current quarter and net income per diluted share of $0.30in the prior year quarter.

 

***NineMonths Ended March 31, 2009 Compared to Nine Months Ended March 31,2008***

 

**Consolidatedrevenue** for thenine months ended March 31, 2009 decreased by 28.0%, to $535.6 million,from $744.1 million for the nine months ended March 31, 2008.  During the period, sales were negativelyaffected by a weak retail environment for home furnishings which we believe isdue to a number of factors including but not limited to continued weakness inthe U.S. economy, high unemployment, volatile capital markets, depressedhousing prices and tight consumer lending practices.  Net sales for the period largely reflect thedelivery of product associated with booked orders and backlog existing as ofthe end of the preceding quarter.  TheCompany’s sales decrease is primarily the result of lower volume, not lowerprices.

 

**Wholesalerevenue** for thefirst nine months of fiscal 2009 decreased 32.1%, to $318.2 million from $468.5million in the prior year comparable period. The period-over-period decrease wasprimarily attributable to a decline in the incoming order rate due to acontinued soft retail environment for home furnishings noted throughout thecurrent period.  In addition, there were8 fewer independent retail design centers, which decreased to 131 from 139,including seven locations transferred in to the company’s Retail divisionduring the year. There was one more shipping day during the current nine month period.

 

**Retail revenue** from Ethan Allen-owned design centersfor the nine months ended March 31, 2009 decreased by 25.9%, to $406.4million from $548.1 million for the nine months ended March 31, 2008.  We believe the decrease in retail sales byEthan Allen-owned design centers is due to the same soft market conditionsexperienced by the wholesale segment, as evidenced by a 28.9% decrease incomparable store sales. Partially offsetting this was a net $0.1 milliondecrease in new/closed store sales, and a net increase in the number of EthanAllen-owned design centers to 159 as of March 31, 2009 as compared to 153as of March 31, 2008.  During thattwelve month period, we acquired seven design centers from independentretailers and opened eleven design centers (four of which were relocations),and closed eight design centers.

 

Period-over-period,written business of Ethan Allen-owned design centers decreased 30.8% whilecomparable design centers written business decreased 33.6%.  Over that same period, wholesale ordersdecreased 33.8%.  Both retail andwholesale written business reflects the softer retail environment for homefurnishings noted throughout the period and discussed in the analysis of thequarter results.

 

**Grossprofit** decreasedduring the nine months to $279.8 million from $398.1 million in the prior yearcomparable period.  The 29.7%, decreasein gross profit was primarily attributable to the reduction in net sales of28.0%, with an overall decrease in shipments in both market segments, and lowermargin percentages within the wholesale segment due to under absorbing of plantoverhead costs on the lower production volume. These factors were partially offset by (i) an improved marginpercentage in our retail segment and (ii) a favorable shift in sales mixwith retail sales representing a higher proportionate share of total sales in thecurrent nine months (76%) compared to the prior year period (74%) and fromlower elimination of profit in consolidations due primarily to lower Retailinventory.

 

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Consolidated grossmargin decreased to 52.2% for the first nine months of fiscal 2009 from 53.5%in the prior year period as a result, primarily, of the factors set forthabove.

 

**Operatingprofit**, the elementsof which are discussed in greater detail below, was impacted by the followingitems during the nine months ended March 31, 2009 and 2008:

 

**Operatingexpenses**increased $11.0 million, or 3.4%, to $332.2 million, and increased to 62.0% ofsales, in the current period from $321.2 million, or 43.2% of sales, in theprior nine month period.  Decreases insalary related costs were experienced due to the reduced number of employeesand other cost cutting efforts taken by the Company that impacted bonuses andbenefits.  Advertising expenses were down$9.2 million while enhancing our national TV and shelter magazinepresence.  These reductions were partlyoffset by an incremental charge of $7.0 million due to the implementation ofthe team concept in the retail division whereby design associates are paid abase salary with an opportunity to earn a bonus.  This caused a temporary overlap of expenseswhich is now concluded.

 

**Consolidatedoperating income (loss)** for the nine month period ended March 31, 2009 totaled a loss of$52.4 million, or 9.8% of sales, as compared to income of $76.9 million, or10.3% of sales, for the nine months ended March 31, 2008.  This decrease of $129.3 million is due to adecrease in gross profit mostly due to reduced sales, partly offset by adecrease in period over period operating expenses, both of which were discussedpreviously.

 

**Wholesaleoperating income (loss)** for the nine months ended March 31, 2009 totaled $14.4 million,or 4.5% of sales, as compared to $79.8 million, or 17.0% of sales, in the prioryear comparable period. The decrease of $65.4 million was primarilyattributable to a decrease in sales volume and higher unabsorbed costs in ourmanufacturing plants due to lower production volumes.

 

**Retailoperating income (loss)** increased $76.9 million to a loss of $78.2 million, or -19.2% ofsales, for the first nine months of fiscal 2009 from a loss of $1.3 million, or-0.2% of sales, for the same period of fiscal 2008.  The decrease in retail operating incomegenerated by Ethan Allen-owned design centers was primarily due to reducedsales attributed to the weak retail environment for home furnishings.

 

**Interest and other miscellaneousincome, net**decreased $3.5 million from the prior year comparable quarter.  The decrease was due, primarily to a decreasein investment income resulting from lower cash and cash equivalent balances andlower rates of interest during the current period, and by gains recorded inconnection with the sale of selected real estate assets in the prior year.

 

**Interest and other relatedfinancing costs**amounted to approximately $8.8 million in both the current and prior yearperiods.  This amount consists primarilyof interest expense incurred in connection with our issuance of seniorunsecured debt in September 2005.

 

**Incometax expense** forthe nine months ended March 31, 2009 totaled a benefit of $22.4 million ascompared to expense of $27.6 million for the nine months ended March 31,2008.  Our effective tax rate for thecurrent period was 38.6% compared to 37.0% in the prior year period.  The current effective tax rate is higher dueprimarily to the impact of the deduction for domestic production activities.

 

**Netincome (loss)** forthe nine months ended March 31, 2009, was a loss of $35.8 million ascompared to income of $47.0 million in the prior year comparable period.  Net income (loss) per diluted share totaled($1.24) in the current period and $1.58 in the prior year.

 

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**Liquidityand Capital Resources**

 

At March 31,2009, we held cash and cash equivalents of $51.2 million.  Our principal sources of liquidity includecash and cash equivalents, cash flow from operations, and borrowings.

 

Global capitalmarkets continue to be disrupted and volatile. The cost and availability of funding has been and may continue to beadversely affected by illiquid credit markets. Some lenders have reduced or, in some cases, ceased to provide fundingto borrowers.  However, our lenders havenot indicated to us that they would not continue to provide funding to us ornot honor or be able to fully perform their obligations under the credit facility.  Our access to the credit facility could alsobe negatively affected if operating results fall below prescribed levels.  Continued turbulence in the financial marketscould also adversely affect the cost and availability of financing to us in thefuture.

 

The Company terminatedits $100 million cash flow based revolving credit facility effective May 4,2009.  Although we have no plans to useany revolving credit facility in the near term, we are in negotiations toestablish an asset based revolving credit facility of up to $60 million.  At March 31, 2009, we had $12.5 millionin trade and standby letters of credit outstanding under the revolving creditfacility. These letters of credit continue to be supported by a separatefacility with JP Morgan.  We believe thatwe will continue to have adequate liquidity to meet our current needs.

 

In September 2005,we completed a private offering of $200.0 million in ten-year senior unsecurednotes due 2015 (the “Senior Notes”). The Senior Notes were offered by EthanAllen Global, Inc. (“Global”), a wholly-owned subsidiary of the Company,and have an annual coupon rate of 5.375%. We have used the net proceeds of $198.4 million to expand our retailnetwork, invest in our manufacturing and logistics operations, and for othergeneral corporate purposes.

 

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A summary of netcash provided by (used in) operating, investing, and financing activities forthe nine month periods ended March 31, 2009 and 2008 is provided below (inmillions):

 
| ** **                                                 | ** ** | **Nine Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                 | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Operating  Activities                                      |       |                                  |       |   |   |
| Net income plus  depreciation and amortization             |       | $                                     | (16.5      | ) | $ | 65.0 |   |
| Working capital                                            |       | (2.1                                  | )          | (8.1 | ) |
| Excess tax benefits  from share-based payment arrangements |       | —                                |       | (2.1 | ) |
| Other (non-cash  items, long-term assets and liabilities)  |       | 32.4                                  |       | 12.5 |   |
| Total provided  by operating activities                    |       | $                                     | 13.8       |   | $ | 67.3 |   |
|                                                       |       |                                  |       |   |   |
| Investing  Activities                                      |       |                                  |       |   |   |
| Capital  expenditures                                      |       | $                                     | (20.5      | ) | $ | (46.3 | ) |
| Acquisitions                                               |       | (0.7                                  | )          | (6.7 | ) |
| Asset sales                                                |       | 6.3                                   |       | 6.9 |   |
| Other                                                      |       | (0.2                                  | )          | (0.0 | ) |
| Total provided  by (used in) investing activities          |       | $                                     | (15.1      | ) | $ | (46.1 | ) |
|                                                       |       |                                  |       |   |   |
| Financing  Activities                                      |       |                                  |       |   |   |
| Issuances of  common stock                                 |       | —                                |       | 0.5 |   |
| Purchases of  company stock                                |       | —                                |       | (75.6 | ) |
| Payment of  dividends                                      |       | (20.7                                 | )          | (19.2 | ) |
| Payment of  deferred financing costs                       |       | 0.5                                   |       | — |   |
| Excess tax  benefits from share-based payment arrangements |       | —                                |       | 2.1 |   |
| Total provided  by (used in) financing activities          |       | $                                     | (21.2      | ) | $ | (92.2 | ) |

 

***OperatingActivities***

 

As compared to thesame period in fiscal year 2008, cash provided by operating activitiesdecreased $53.5 million, primarily due to an $82.7 million decrease in netincome, and a lower year to date benefit from changes in working capital(accounts receivable, inventories, prepaid and other current assets, customerdeposits, payables, and accrued expenses and other current liabilities) largelyarising from a decrease in customer deposits liability.  During the quarter we extended our tradereceivable terms with our independent dealers by 15 days.

 

***InvestingActivities***

 

As compared to thesame period in fiscal year 2008, cash used in investing activities decreased$31.1 million during the nine months ended March 31, 2009 due, primarily,to a reduction in cash utilized to fund capital expenditures andacquisitions.  We anticipate that cashfrom operations will be sufficient to fund future capital expenditures.

 

***FinancingActivities***

 

As compared to thesame period in fiscal year 2008, cash used in financing activities decreased$71.0 million during the nine months ended March 31, 2009, primarily as aresult of a decrease in payments for the acquisition of treasury stock.  The Company has continuously paid dividendsevery quarter since 1996.  On November 12,2008, the Board declared a dividend of $0.25 per common share, payable on January 23,2009, to shareholders of record as of January 9, 2009.  However, in an effort to maintain prudentlevels of cash in the current difficult economic conditions, and in light ofour recent decline in revenues, our Board of Directors has recently reduced ourdividend payments.  On January 29,2009, the Board declared a quarterly cash dividend of $0.10 per share, payableto shareholders of record as of April 14, 2009 and payable on April 28,2009. On April 21, 2009, the Board declared a dividend of $0.05 per commonshare, payable on July 24, 2009 to shareholders of record on July 10,2009.  If adverse economic conditionscontinue, the Company may further reduce our quarterly dividends.

 

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As of March 31,2009, our outstanding debt totaled $203.1 million, the current and long-termportions of which amounted to less than $0.1 million and $203.1 million,respectively.  The aggregate scheduledmaturities of long-term debt for each of the next five fiscal years are: lessthan $0.1 million in each of fiscal 2009 and 2010, $3.9 million in fiscal 2011and less than $0.1 million in fiscal 2012. The balance of our long-term debt ($199.1 million) matures in fiscalyears 2013 and thereafter.

 

There has been nomaterial change to the amount or timing of cash payments related to ouroutstanding contractual obligations as set forth in Part II, Item 7 – *Management’s Discussion and Analysis of Financial Condition and Resultsof Operation* of our Annual Report on Form 10-K for the yearended June 30, 2008 as filed with the Securities and Exchange Commissionon August 22, 2008.

 

We believe thatour cash flow from operations, together with our other available sources ofliquidity, will be adequate to make all required payments of principal andinterest on our debt, to permit anticipated capital expenditures, and to fundworking capital and other cash requirements. As of March 31, 2009, we had working capital of $158.0 million anda current ratio of 2.4 to 1.

 

In addition tousing available cash to fund changes in working capital, necessary capitalexpenditures, acquisition activity, the repayment of debt, and the payment ofdividends, we have been authorized by our Board of Directors to repurchase ourcommon stock, from time to time, either directly or through agents, in the openmarket at prices and on terms satisfactory to us. All of our common stockrepurchases and retirements are recorded as treasury stock and result in areduction of shareholders’ equity.

 

During the ninemonths ended March 31, 2009 and 2008, we repurchased and/or retired thefollowing shares of our common stock:

 
| ** **                        | ** ** | **Nine Months Ended  March 31** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2009**                             | ** ** | **2008(1)(2)** | ** ** |
| Common shares  repurchased        |       | —                               |       | 2,259,631 |   |
| Cost to  repurchase common shares |       | —                               |       | $ | 69,745,024 |   |
| Average price  per share          |       | —                               |       | $ | 30.87 |   |

 

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| (1) | Repurchase activity for  the nine months ended March 31, 2008 excludes $3,436,230 in common stock  repurchases with a June 2007 trade date and a July 2007 settlement  date.                                                                                                                                                                               |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | During  August 2007, we also retired 661,688 shares of common stock tendered  upon the exercise of outstanding employee stock options (592,861 to cover  share exercise and 68,827 to cover related employee tax withholding  liabilities). The total value of such shares on the date redeemed was  $23,033,359, representing an average price per share of $34.81. |

 

For each of theperiods presented above, we funded our purchases of treasury stock withexisting cash on hand and cash generated through current periodoperations.  On November 13, 2007,the Board of Directors increased the then remaining share repurchaseauthorization to 2,000,000 shares.  As ofMarch 31, 2009, we had a remaining Board authorization to repurchase1,567,669 shares.

 

**Off-BalanceSheet Arrangements and Other Commitments, Contingencies and ContractualObligations**

 

Except asindicated below, we do not utilize or employ any off-balance sheetarrangements, including special-purpose entities, in operating ourbusiness.  As such, we do not maintainany (i) retained or contingent interests, (ii) derivative instruments(other than as specified below), or (iii) variable interests which couldserve as a source of potential risk to our future liquidity, capital resourcesand results of operations.

 

In connection withthe issuance of the Senior Notes, Global, in July and August 2005,entered into six separate forward contracts to hedge the risk-free interestrate associated with $108.0 million of the related debt in order to mitigatethe negative impact of interest rate fluctuations on earnings, cash flows andequity. The forward contracts 

 

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were entered intowith a major banking institution thereby mitigating the risk of credit loss.Upon issuance of the Senior Notes in September 2005, the related forwardcontracts were settled. At the present time we have no current plans to engagein further hedging activities.

 

We may, from timeto time in the ordinary course of business, provide guarantees on behalf ofselected affiliated entities or become contractually obligated to perform inaccordance with the terms and conditions of certain business agreements. Thenature and extent of these guarantees and obligations may vary based on ourunderlying relationship with the benefiting party and the business purpose forwhich the guarantee or obligation is being provided. Details of thosearrangements for which we act as guarantor or obligor are provided below.

 

***Retailer-RelatedGuarantees***

 

IndependentRetailer Credit Facility

 

On April 9,2009, we have obligated ourselves, on behalf of one of our independentretailers, with respect to a $0.9 million credit facility (the “Credit Facility”)comprised of a $0.6 million revolving line of credit and a $0.3 million termloan. This obligation requires us, in the event of the retailer’s default underthe Credit Facility, to repurchase the retailer’s inventory, applying suchpurchase price to the retailer’s outstanding indebtedness under the CreditFacility. Our obligation remains in effect for the life of the term loan.  The agreement expires in April 2011. Themaximum potential amount of future payments (undiscounted) that we could berequired to make under this obligation is limited to the amount outstandingunder the Credit Facility at the time of default (subject to pre-determinedlending limits based on the value of the underlying inventory) and, as such, isnot an estimate of future cash flows.  Nospecific recourse or collateral provisions exist that would enable recovery ofany portion of amounts paid under this obligation, except to the extent that wemaintain the right to take title to the repurchased inventory. We anticipatethat the repurchased inventory could subsequently be sold through our retaildesign center network.

 

As of March 31,2009, the amount outstanding under the Credit Facility totaled approximately$0.9 million, of which $0.6 million was outstanding under the revolving creditline and $0.3 million under the term loan. Based on the underlying creditworthiness of the respective retailer, webelieve this obligation will expire without requiring funding by us. However,in accordance with the provisions of FASB Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*, a liabilityhas been established to reflect our non-contingent obligation under thisarrangement as a result of modifications made to the Credit Facility subsequentto January 1, 2003.  As of March 31,2009, the carrying amount of such liability is less than $50,000.

 

Ethan Allen Consumer CreditProgram

 

The terms and conditions of our consumer creditprogram, which is financed and administered by a third-party financialinstitution on a non-recourse basis to Ethan Allen, are set forth in anagreement between us and that financial service provider (the “ProgramAgreement”). Any independent retailer choosing to participate in the consumercredit program is required to enter into a separate agreement with that samethird-party financial institution which sets forth the terms and conditionsunder which the retailer is to perform in connection with its offering ofconsumer credit to its customers (the “Retailer Agreement”). We have obligatedourselves on behalf of any independent retailer choosing to participate in ourconsumer credit program by agreeing, in the event of default, breach, orfailure of the independent retailer to perform under such Retailer Agreement,to take on certain responsibilities of the independent retailer, including, butnot limited to, delivery of goods and reimbursement of customer deposits.Customer receivables originated by independent retailers remain non-recourse toEthan Allen. Our obligation remains in effect for the term of the ProgramAgreement which expires in July 2012. While the maximum potential amountof future payments (undiscounted) that we could be required to make under thisobligation is indeterminable, recourse provisions exist that would enable us torecover, from the independent retailer, any amount paid or incurred by usrelated to our performance. Based on the underlying creditworthiness 

 

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of our independent retailers, including theirhistorical ability to satisfactorily perform in connection with the terms ofour consumer credit program, we believe this obligation will expire withoutrequiring funding by us.

 

***ProductWarranties***

 

Our products,including our case goods, upholstery and home accents, generally carry explicitproduct warranties that extend from one to ten years and are provided based onterms that are generally accepted in the industry.  All of our domestic independent retailers arerequired to enter into, and perform in accordance with the terms and conditionsof, a warranty service agreement. We record provisions for estimated warrantyand other related costs at time of sale based on historical warranty lossexperience and make periodic adjustments to those provisions to reflect actualexperience. On rare occasion, certain warranty and other related claims involvematters of dispute that ultimately are resolved by negotiation, arbitration orlitigation.  In certain cases, a materialwarranty 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 to beboth probable and estimable. It is reasonably possible that, from time to time,additional warranty and other related claims could arise from disputes or othermatters beyond the scope of our historical experience. As of March 312009, our product warranty liability totaled $1.2 million.

 

**BusinessOutlook**

 

The United States economyis in a recession which has spread to Europe, Asia and elsewhere.  The current overall weakness in the U.S.economy continues to adversely affected our business and we cannot predict,with any degree of certainty when these difficult economic conditions willbegin to improve.

 

As macro-economicfactors change, it is also possible that our costs associated with production(including raw materials, labor and utilities), distribution (including freightand fuel charges), and retail operations (including compensation, benefits,delivery, warehousing, occupancy, and advertising expenses) may increase.  We cannot reasonably predict when, or to whatextent, such events may occur or what effect, if any, such events may have onour consolidated financial condition or results of operations.

 

The homefurnishings industry remains extremely competitive with respect to both thesourcing of products and the retail sale of those products. Domesticmanufacturers continue to face pricing pressures as a result of themanufacturing capabilities developed during recent years in other countries,specifically within Asia. In response to these pressures, a large number ofU.S. furniture manufacturers and retailers, including the Company, haveincreased their overseas sourcing activities in an attempt to maintain acompetitive advantage and retain market share. At the present time, wedomestically manufacture and/or assemble approximately 65% of our products. Wecontinue to believe that a balanced approach to product sourcing, whichincludes the domestic manufacture of certain product offerings coupled with theimport of other selected products, provides the greatest degree of flexibilityand is the most effective approach to ensuring that acceptable levels ofquality, service and value are attained.

 

We believe that ourexisting business model which includes: (i) an established brand; (ii) acomprehensive complement of home decorating solutions and complimentaryinterior design services and (iii) a vertically-integrated operatingstructure will position us well to take advantage of improved economicconditions when they occur.

 

In addition, webelieve that our retail strategy, which involves (i) a continued focus onproviding a wide array of product solutions and superior customer servicecoupled with state-of-the-art technology in our newly launched website, (ii) theopening of new or relocated design centers in more prominent locations, whileencouraging independent retailers to do the same, and (iii) thedevelopment of a more professional, team based structure within our retailnetwork, provides an opportunity to grow our business when the currentdifficult economic conditions improve.

 

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**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

 

Other than notedbelow, there have been no material changes to the market risks disclosed in ourAnnual Report on Form 10-K for the year ended June 30, 2008 as filedwith the Securities and Exchange Commission on August 22, 2008.

 

**A prolongedeconomic downturn may continue to materially adversely affect our business.**

 

Our business and resultsof operations are affected by international, national and regional economicconditions.  The United States and otherinternational economies have entered a recession and concerns over the durationor depth appear to be increasing. Our primary customer base, direct orindirect, is composed of individual consumers. Continued weakness in the U.S. economy, high unemployment, volatilecapital markets, depressed housing prices and tight consumer lending practiceshave resulted in considerable negative pressure on consumer spending.  We believe these events have impactedconsumers in our markets in ways that have negatively affected ourbusiness.  In the event the currenteconomic downturn continues, or worsens, our current and potential customersmay be inclined to further delay their purchases.  In addition, further tightening of creditmarkets may restrict our customers ability and willingness to make purchases.

 

**Access to consumer credit couldbe interrupted and reduce sales and profitability.**

 

Our ability to continueto access consumer credit for our clients could be negatively affected byconditions outside our control. Given the current turmoil in capital markets,there is a risk that though we have agreements that do not expire until July 2012,our business partner may not be able to fulfill their obligations under thatagreement.

 

**Additionalimpairment charges could reduce our profitability.**

 

We have significantlong-lived tangible and intangible assets recorded on our balance sheets.  If our operating results continue to decline,we may incur additional impairment charges in the future, which could have amaterial impact on our financial results. Although any such impairment charge would be a non-cash expense, itcould materially increase our expenses and reduce our profitability in theperiod recorded. We will continue to evaluate the recoverability of thecarrying amount of our long-lived tangible and intangible assets on an ongoingbasis.  There can be no assurance thatthe outcome of such future reviews will not result in substantial impairmentcharges.  Impairment assessmentinherently involves judgments as to assumptions about expected future cash flowsand the impact of market conditions on those assumptions.  Future events and changing market conditionsmay impact our assumptions as to prices, costs or other factors that may resultin changes in our estimates of future cash flows.  Although we believe the assumptions we use intesting for impairment are reasonable, significant changes in any of ourassumptions could produce a significantly different result.

 

**Failureto establish a revolving credit facility could significantly reduce ourfinancial flexibility.**

 

The Company terminatedits $100 million cash flow based revolving credit facility effective May 4,2009, and we are in negotiations to establish an asset based revolving creditfacility of up to $60 million.  At March 31,2009, we had $12.5 million in trade and standby letters of credit outstandingunder the revolving credit facility. These letters of credit continue to besupported by a separate facility with JP Morgan.  If the Company were unable to establish a newrevolving credit facility, we might need to find a different source to fund ourtrade and standby letters of credit, and our financial flexibility would be significantlyreduced.

 

**Continuedoperating losses could reduce our liquidity and impact our dividend policy.**

 

Historically, we haverelied on our cash from operations to fund our operations and the payment ofcash dividends.  If the Company continuesto experience operating losses we may not be able to fund a shortfall from 

 

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operations and wouldrequire external funding.  Due to recentchanges in the capital markets, some financing instruments used by the Companyin the past are currently not available to the Company. We cannot assure thatadditional sources of financing would be available to the Company oncommercially favorable terms should the Company’s capital requirements exceedcash available from operations and existing cash and cash equivalents.  In such circumstances the Company may furtherreduce its quarterly dividends.

 

**Item 4.Controls and Procedures**

 

**Management’sReport on Disclosure Controls and Procedures**

 

Our management,including the Chairman of the Board and Chief Executive Officer (“CEO”) and theVice President-Finance (“VPF”), conducted an evaluation of the effectiveness ofdisclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) as of the end of the period covered by this report. Based on suchevaluation, the CEO and VPF have concluded that, as of March 31, 2009, ourdisclosure controls and procedures were effective in ensuring that materialinformation relating to us (including our consolidated subsidiaries), which isrequired to be disclosed by us in our periodic reports filed or submitted underthe Exchange Act is (i) recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and (ii) accumulatedand communicated to management, including the CEO and VPF, as appropriate, toallow timely decisions regarding required disclosure.

 

**Changesin Internal Control over Financial Reporting**

 

There have been nochanges in our internal control over financial reporting (as such term isdefined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)during the fiscal quarter ended March 31, 2009 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II- OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

Except as set forth inNote 9 to the Consolidated Financial Statements included in Part I — “*Financial Statements*” of this report, Item 1, which isincorporated by reference herein, there has been no material change to thematters discussed in Part I, Item 3 - *Legal Proceedings*in our Annual Report on Form 10-K for the year ended June 30, 2008 asfiled with the Securities and Exchange Commission on August 22, 2008.

 

**Item 1A.Risk Factors**

 

Other than notedbelow, there have been no material changes to the market risks disclosed in ourAnnual Report on Form 10-K for the year ended June 30, 2008 as filedwith the Securities and Exchange Commission on August 22, 2008.

 

**Aprolonged economic downturn may continue to materially adversely affect ourbusiness.**

 

Our business and resultsof operations are affected by international, national and regional economicconditions.  The United States and otherinternational economies have entered a recession and concerns over the durationor depth appear to be increasing. Our primary customer base, direct orindirect, is composed of individual consumers. Continued weakness in the U.S. economy, high unemployment, volatilecapital markets, depressed housing prices and tight consumer lending practiceshave resulted in considerable negative pressure on consumer spending.  We believe these events have impactedconsumers in our markets in ways that have negatively affected our business.  In the event the current economic downturncontinues, or worsens, our current and potential 

 

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customers may be inclinedto further delay their purchases.  Inaddition, further tightening of credit markets may restrict our customersability and willingness to make purchases.

 

**Access to consumer credit could be interrupted andreduce sales and profitability.**

 

Our ability to continue to access consumer credit forour clients could be negatively affected by conditions outside our control.Given the current turmoil in capital markets, there is a risk that though wehave agreements that do not expire until July 2012, our business partnermay not be able to fulfill their obligations under that agreement.

 

**Additionalimpairment charges could reduce our profitability.**

 

We have significantlong-lived tangible and intangible assets recorded on our balance sheets.  If our operating results continue to decline,we may incur additional impairment charges in the future, which could have amaterial impact on our financial results. Although any such impairment charge would be a non-cash expense, itcould materially increase our expenses and reduce our profitability in theperiod recorded. We will continue to evaluate the recoverability of thecarrying amount of our long-lived tangible and intangible assets on an ongoingbasis.  There can be no assurance thatthe outcome of such future reviews will not result in substantial impairmentcharges.  Impairment assessmentinherently involves judgments as to assumptions about expected future cashflows and the impact of market conditions on those assumptions.  Future events and changing market conditionsmay impact our assumptions as to prices, costs or other factors that may resultin changes in our estimates of future cash flows.  Although we believe the assumptions we use intesting for impairment are reasonable, significant changes in any of ourassumptions could produce a significantly different result.

 

**Failureto establish a revolving credit facility could significantly reduce ourfinancial flexibility.**

 

The Company terminatedits $100 million cash flow based revolving credit facility effective May 4,2009, and we are in negotiations to establish an asset based revolving creditfacility of up to $60 million.  At March 31,2009, we had $12.5 million in trade and standby letters of credit outstandingunder the revolving credit facility. These letters of credit continue to besupported by a separate facility with JP Morgan.  If the Company were unable to establish a newrevolving credit facility, we might need to find a different source to fund ourtrade and standby letters of credit, and our financial flexibility would be significantlyreduced.

 

**Continuedoperating losses could reduce our liquidity and impact our dividend policy.**

 

Historically, we haverelied on our cash from operations to fund our operations and the payment ofcash dividends.  If the Company continuesto experience operating losses we may not be able to fund a shortfall fromoperations and would require external funding. Due to recent changes in the capital markets, some financing instrumentsused by the Company in the past are currently not available to the Company. Wecannot assure that additional sources of financing would be available to theCompany on commercially favorable terms should the Company’s capitalrequirements exceed cash available from operations and existing cash and cashequivalents.  In such circumstances theCompany may further reduce its quarterly dividends.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

 

***IssuerPurchases of Equity Securities***

 

There have been nopurchases made by or on behalf of the Company or any affiliated purchaser (asdefined in Rule 10b-18(a)(3) under the Exchange Act) of our commonstock during the three months ended March 31, 2009.  The maximum number of shares that may yet bepurchased under the plans or program is 1,567,669 shares.

 

**Item 3.Defaults Upon Senior Securities**

 

Not applicable.

 

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**Item 4.Submission of Matters to a Vote of Security Holders**

 

Not applicable.

 

**Item 5.Other Information**

 

Not applicable.

 

**Item 6.Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                   |
|---------------------|------------|-------------------------------------------------------------------|
| 31.1                |       | Rule 13a-14(a) Certification of Principal  Executive Officer |
| 31.2                |       | Rule 13a-14(a) Certification of Principal  Financial Officer |
| 32.1                |       | Section 1350 Certification of Principal  Executive Officer   |
| 32.2                |       | Section 1350 Certification of Principal  Financial Officer   |

 

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SIGNATURES

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

 

 
| ETHAN ALLEN INTERIORS INC.          |
|-------------------------------------|
| (Registrant)                        |
|                                |   |   |
|                                |   |   |
| DATE:  May 11,  2009 |   | BY: | /s/ M. Farooq Kathwari |
|                                |   | Farooq Kathwari |
|                                |   | Chairman, President and  Chief Executive Officer  (Principal Executive Officer) |
|                                |   |   |
|                                |   |   |
| DATE:  May 11,  2009 |   | BY: | /s/ David R. Callen |
|                                |   | David R. Callen |
|                                |   | Vice President,  Finance & Treasurer  (Principal Financial Officer and Principal Accounting Officer) |

 

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EXHIBIT INDEX

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                            |
|---------------------|------------|------------------------------------------------------------------------|
| 31.1                |       | Rule 13a-14(a) Certification  of Principal Executive Officer |
| 31.2                |       | Rule 13a-14(a) Certification  of Principal Financial Officer |
| 32.1                |       | Section 1350  Certification of Principal Executive Officer        |
| 32.2                |       | Section 1350  Certification of Principal Financial Officer        |

 

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