Tableof 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 the quarterly period ended September 30,2009**

 

**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” inRule 12b-2 of the Exchange Act

 

| Large  accelerated filer o |   | Accelerated  filer x         |
|----------------------------|--------|------------------------------|
|                       |   |                         |
| 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 October 30, 2009,there were 28,916,929 shares of Class A Common Stock, par value $.01,outstanding.

 

 

 

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**TABLE OF CONTENTS**

 
| **Item**                                      | ** **                                                                                                                                                          | ** ** | **Page** | ** ** |
|-----------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|                                          |                                                                                                                                                                |       |     |
| **Part I —  Financial Information** |                                                                                                                                                                |       |     |
|                                          |                                                                                                                                                                |       |     |
| 1.                                            | Financial Statements as of  September 30, 2009 (unaudited) and June 30, 2009 and for the three  months ended September 30, 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                                                                                                         |       | 33       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 4.                                            | Controls and  Procedures                                                                                                                                            |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |
| **Part II  - Other Information**         |                                                                                                                                                                |       |     |
|                                          |                                                                                                                                                                |       |     |
| 1.                                            | Legal Proceedings                                                                                                                                                   |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 1A.                                           | Risk Factors                                                                                                                                                        |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 2.                                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                        |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 3.                                            | Defaults  Upon Senior Securities                                                                                                                                    |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 4.                                            | Submission  of Matters to a Vote of Security Holders                                                                                                                |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 5.                                            | Other Information                                                                                                                                                   |       | 34       |       |
|                                          |                                                                                                                                                                |       |     |       |
| 6.                                            | Exhibits                                                                                                                                                            |       | 35       |       |
|                                          |                                                                                                                                                                |       |     |       |
|                                          | Signatures                                                                                                                                                          |       | 36       |       |

 

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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)

 
| ** **                                                                                                                                                                          | ** ** | **September 30,  2009** | ** ** | **June 30,********2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **(unaudited)**              | ** ** | ** **                    | ** ** |
| **ASSETS**                                                                                                                                                                          |       |                         |       |                          |       |
| Current  assets:                                                                                                                                                                    |       |                         |       |                          |       |
| Cash  and cash equivalents                                                                                                                                                          |       | $                            | 72,452     |                          | $          | 52,960 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,243 at  September 30, 2009 and $1,362 at June 30, 2009                                                   |       | 13,053                       |       | 13,086                        |       |
| Inventories  (note 4)                                                                                                                                                               |       | 146,661                      |       | 156,519                       |       |
| Prepaid  expenses and other current assets                                                                                                                                          |       | 12,075                       |       | 21,060                        |       |
| Deferred  income taxes                                                                                                                                                              |       | 7,750                        |       | 8,077                         |       |
| Total  current assets                                                                                                                                                               |       | 251,991                      |       | 251,702                       |       |
|                                                                                                                                                                                |       |                         |       |                          |       |
| Property,  plant and equipment, net                                                                                                                                                 |       | 320,184                      |       | 333,599                       |       |
| Goodwill  and other intangible assets (notes 6 and 7)                                                                                                                               |       | 45,128                       |       | 45,128                        |       |
| Other  assets                                                                                                                                                                       |       | 21,262                       |       | 16,056                        |       |
| Total  assets                                                                                                                                                                       |       | $                            | 638,565    |                          | $          | 646,485 |   |
|                                                                                                                                                                                |       |                         |       |                          |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                       |       |                         |       |                          |       |
| Current  liabilities:                                                                                                                                                               |       |                         |       |                          |       |
| Current  maturities of long-term debt (note 8)                                                                                                                                      |       | $                            | 42         |                          | $          | 42 |   |
| Customer  deposits                                                                                                                                                                  |       | 38,885                       |       | 31,691                        |       |
| Accounts  payable                                                                                                                                                                   |       | 21,077                       |       | 22,199                        |       |
| Accrued  compensation and benefits                                                                                                                                                  |       | 26,989                       |       | 29,533                        |       |
| Accrued  expenses and other current liabilities (note 5)                                                                                                                            |       | 31,203                       |       | 28,998                        |       |
| Total  current liabilities                                                                                                                                                          |       | 118,196                      |       | 112,463                       |       |
|                                                                                                                                                                                |       |                         |       |                          |       |
| Long-term  debt (note 8)                                                                                                                                                            |       | 203,136                      |       | 203,106                       |       |
| Other  long-term liabilities                                                                                                                                                        |       | 25,449                       |       | 24,993                        |       |
| Total  liabilities                                                                                                                                                                  |       | 346,781                      |       | 340,562                       |       |
|                                                                                                                                                                                |       |                         |       |                          |       |
| Shareholders’  equity:                                                                                                                                                         |       |                         |       |                          |       |
| Class A  common stock, par value $.01, 150,000,000 shares authorized; 48,297,870  shares issued at September 30, 2009 and 48,334,870 shares issued at  June 30, 2009 |       | 483                          |       | 483                           |       |
| Class B  common stock, par value $.01, 600,000 shares authorized; no shares issued and  outstanding at September 30, 2009 and June 30, 2009                          |       | —                       |       | —                        |       |
| Preferred  stock, par value $.01, 1,055,000 shares authorized; no shares issued and  outstanding at September 30, 2009 and June 30, 2009                                  |       | —                       |       | —                        |       |
| Additional  paid-in capital                                                                                                                                                         |       | 356,969                      |       | 356,446                       |       |
|                                                                                                                                                                                |       | 357,452                      |       | 356,929                       |       |
| Less:  Treasury stock (at cost), 19,380,941 shares at September 30, 2009 and  19,380,941 shares at June 30, 2009                                                          |       | (583,220                     | )          | (583,220                      | )          |
| Retained  earnings                                                                                                                                                                  |       | 516,716                      |       | 531,747                       |       |
| Accumulated  other comprehensive income (note 12)                                                                                                                                   |       | 836                          |       | 467                           |       |
| Total  shareholders’ equity                                                                                                                                                    |       | 291,784                      |       | 305,923                       |       |
| Total  liabilities and shareholders’ equity                                                                                                                                    |       | $                            | 638,565    |                          | $          | 646,485 |   |

 

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****September 30****,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                          | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Net  sales                                          |       | $                                                | 136,190    |   | $ | 205,841 |   |
| Cost of sales                                       |       | 77,881                                           |       | 93,900 |   |
| Gross profit                                        |       | 58,309                                           |       | 111,941 |   |
|                                                |       |                                             |       |   |   |
| Operating expenses:                                 |       |                                             |       |   |   |
| Selling                                             |       | 33,605                                           |       | 55,302 |   |
| General and administrative                          |       | 39,980                                           |       | 46,058 |   |
| Restructuring and impairment charge, net (note 5)   |       | 812                                              |       | (1,630 | ) |
| Total operating expenses                            |       | 74,397                                           |       | 99,730 |   |
|                                                |       |                                             |       |   |   |
| Operating income (loss)                             |       | (16,088                                          | )          | 12,211 |   |
| Interest and other miscellaneous income, net        |       | 797                                              |       | 1,100 |   |
| Interest and other related financing costs (note 8) |       | 2,981                                            |       | 2,901 |   |
|                                                |       |                                             |       |   |   |
| Income (loss) before income taxes                   |       | (18,272                                          | )          | 10,410 |   |
|                                                |       |                                             |       |   |   |
| Income tax expense (benefit) (note 3)               |       | (4,693                                           | )          | 2,988 |   |
|                                                |       |                                             |       |   |   |
| Net income (loss)                                   |       | $                                                | (13,579    | ) | $ | 7,422 |   |
|                                                |       |                                             |       |   |   |
| Per share data (note 11):                           |       |                                             |       |   |   |
| Basic earnings per common share:                    |       |                                             |       |   |   |
| Net income (loss) per basic share                   |       | $                                                | (0.47      | ) | $ | 0.26 |   |
| Basic weighted average common shares                |       | 28,926                                           |       | 28,703 |   |
| Diluted earnings per common share:                  |       |                                             |       |   |   |
| Net income (loss) per diluted share                 |       | $                                                | (0.47      | ) | $ | 0.26 |   |
| Diluted weighted average common shares              |       | 28,926                                           |       | 28,847 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**ETHAN ALLEN INTERIORS INC.AND SUBSIDIARIES**

**ConsolidatedStatements of Cash Flows (Unaudited)**

(In thousands)

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Operating activities:                                                              |       |                   |       |   |   |
| Net income (loss)                                                                  |       | $                      | (13,579    | ) | $ | 7,422 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                   |       |   |   |
| Depreciation and amortization                                                      |       | 12,697                 |       | 6,318 |   |
| Compensation expense related to share-based awards                                 |       | 523                    |       | 394 |   |
| Provision (benefit) for deferred income taxes                                      |       | (5,197                 | )          | (1,850 | ) |
| Restructuring and impairment charge (benefit), net                                 |       | 266                    |       | (3,854 | ) |
| (Gain) loss on disposal of property, plant and  equipment                          |       | (470                   | )          | (5 | ) |
| Other                                                                              |       | 55                     |       | 66 |   |
| Change in assets and liabilities, net of the  effects of acquired businesses:      |       |                   |       |   |   |
| Accounts receivable                                                                |       | 33                     |       | 931 |   |
| Inventories                                                                        |       | 9,858                  |       | (561 | ) |
| Prepaid and other current assets                                                   |       | 6,427                  |       | 9,192 |   |
| Other assets                                                                       |       | 186                    |       | 84 |   |
| Customer deposits                                                                  |       | 7,194                  |       | (5,312 | ) |
| Accounts payable                                                                   |       | (1,122                 | )          | (550 | ) |
| Accrued expenses and other current liabilities                                     |       | (332                   | )          | 5,253 |   |
| Other long-term liabilities                                                        |       | 456                    |       | 547 |   |
| Net cash provided by operating activities                                          |       | 16,995                 |       | 18,075 |   |
|                                                                               |       |                   |       |   |   |
| Investing activities:                                                              |       |                   |       |   |   |
| Proceeds from the disposal of property,  plant & equipment                |       | 5,935                  |       | 5,729 |   |
| Capital expenditures                                                               |       | (2,488                 | )          | (11,093 | ) |
| Acquisitions                                                                       |       | —                 |       | (375 | ) |
| Other                                                                              |       | 6                      |       | (249 | ) |
| Net cash provided by (used in) investing activities                                |       | 3,453                  |       | (5,988 | ) |
|                                                                               |       |                   |       |   |   |
| Financing activities:                                                              |       |                   |       |   |   |
| Payments on long-term debt                                                         |       | (10                    | )          | (10 | ) |
| Proceeds from issuance of common stock                                             |       | —                 |       | 2 |   |
| Payment of deferred financing costs                                                |       | (22                    | )          | — |   |
| Payment of cash dividends                                                          |       | (1,448                 | )          | (6,331 | ) |
| Net cash used in financing activities                                              |       | (1,480                 | )          | (6,339 | ) |
| Effect of exchange rate changes on cash                                            |       | 524                    |       | (207 | ) |
| Net increase in cash & cash equivalents                                   |       | 19,492                 |       | 5,541 |   |
| Cash & cash equivalents - beginning of  period                            |       | 52,960                 |       | 74,376 |   |
| Cash & cash equivalents - end of period                                   |       | $                      | 72,452     |   | $ | 79,917 |   |

 

See accompanying notes to consolidated financial statements.

 

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**ETHAN ALLEN INTERIORS INC.AND SUBSIDIARIES**

**ConsolidatedStatements of Shareholders’ Equity**

**Three Months Ended September 30,2009**

**(Unaudited)**

**(In thousands, except sharedata)**

 
| ** **                                 | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In****Capital** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------|------------|------------------------------------|------------|---------------------|------------|-----------------------------------------------|------------|------------------------|------------|-----------|------------|
| Balance at June 30, 2009              |       | $                 | 483        |                               | $          | 356,446             |       | $                                             | (583,220   | )                      | $          | 467       |       | $ | 531,747 |   | $ | 305,923 |   |
|                                       |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Share-based compensation expense (note 10) |       | —            |       | 523                                |       | —              |       | —                                        |       | —                 |       | 523       |       |
|                                       |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Dividends declared on common stock         |       | —            |       | —                             |       | —              |       | —                                        |       | (1,452                 | )          | (1,452    | )          |
|                                       |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Other comprehensive income (note 12):      |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Currency translation adjustments           |       | —            |       | —                             |       | —              |       | 357                                           |       | —                 |       | 357       |       |
| Hedge amortization, net of tax and other   |       | —            |       | —                             |       | —              |       | 12                                            |       | —                 |       | 12        |       |
| Net income (loss)                          |       | —            |       | —                             |       | —              |       | —                                        |       | (13,579                | )          | (13,579   | )          |
| Total comprehensive income (loss)          |       |              |       |                               |       |                |       |                                          |       |                   |       | (13,210   | )          |
|                                       |       |              |       |                               |       |                |       |                                          |       |                   |       |      |       |
| Balance at September 30, 2009         |       | $                 | 483        |                               | $          | 356,969             |       | $                                             | (583,220   | )                      | $          | 836       |       | $ | 516,716 |   | $ | 291,784 |   |

 

See accompanying notes to consolidated financial statements.

 

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**ETHAN ALLEN 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 accountsand transactions have 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.  Inpreparing these financial statements, the Company has evaluated events andtransactions subsequent to September 30, 2009 through November 9,2009, the date of public issuance of this Quarterly Report on form 10-Q.  Due to the inherent uncertainty involved inmaking 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 June 2009,the Financial Accounting Standards Board (“FASB”) issued guidance now codifiedas FASB Accounting Standards Codification (“ASC”) Topic 105, “GenerallyAccepted Accounting Principles,” as the single source of authoritativenongovernmental U.S. GAAP.  ASC Topic 105does not change current U.S. GAAP, but is intended to simplify user access toall authoritative U.S. GAAP by providing all authoritative literature relatedto a particular topic in one place. All existing accounting standard documentswill be superseded and all other accounting literature not included in the ASCwill be considered non-authoritative. These provisions of ASC Topic 105 areeffective for interim and annual periods ending after September 15, 2009and, accordingly, are effective for the Company for the current fiscalreporting period. The adoption of this pronouncement did not have an impact onthe Company’s financial condition or results of operations, but will impact ourfinancial reporting process by eliminating all references to pre-codificationstandards. On the effective date of this Statement, the ASC superseded allthen-existing non-SEC accounting and reporting standards, and all othernon-grandfathered non-SEC accounting literature not included in the ASC becamenon-authoritative. References to the pre-codification pronouncements are notedin parenthesis.

 

In September 2006,FASB issued guidance now codified as ASC Topic 820, “Fair Value Measurementsand Disclosures,” (SFAS No. 157) which defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements and does not require any new fair value measurements.   In February 2008, the FASB releasedadditional ASC Topic 820 guidance (FSP No. 157-2), which delayed theeffective date of the application of certain guidance related to non-financialassets and non-financial liabilities until July 1, 2009 for the Company,except for items that are recognized or disclosed at fair value in thefinancial statements on a recurring basis. The Company adopted certain provisions of ASC Topic 820 effective July 1,2008, except as it relates to those non-financial assets and non-financialliabilities excluded as noted above.  TheCompany adopted the provisions of ASC Topic 820 with respect to ournon-financial assets and non-financial liabilities effective July 1, 2009.The

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

implementation ofthis pronouncement did not have a material impact on our consolidated financialposition, results of operations or cash flows.

 

In December 2007, the FASB issued guidance nowcodified as ASC Topic 805, “*Business Combinations”*(SFAS No. 141(R), which replaced SFAS No. 141).  ASC Topic 805 establishes principles andrequirements for how an acquirer in a business combination recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any controlling interest; recognizes and measures thegoodwill acquired in the business combination or a gain from a bargainpurchase; and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. ASC Topic 805 is to be applied prospectively to businesscombinations for which the acquisition date is on or after an entity’s fiscalyear 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 on the terms, conditionsand details of such acquisitions.

 

In June 2008,the FASB issued guidance now codified as ASC Topic 260, “Earnings Per Share”(EITF 03-6). Under ASC Topic 260, unvested share-based payment awards thatcontain rights to receive non-forfeitable dividends (whether paid or unpaid)are participating securities, and should be included in the two-class method ofcomputing earnings per share. The implementation of this pronouncement did nothave a material impact on our consolidated financial position, results ofoperations or cash flows.

 

**(2)      InterimFinancial 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 three months ended September 30, 2009 arenot necessarily indicative of results that may be expected for the entirefiscal year. 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/A for the year ended June 30,2009.

 

**(3)      IncomeTaxes**

 

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.

 

We recognize thetax benefit from an uncertain tax position only if it is more likely than notthat the tax position will be sustained on examination by the taxingauthorities, based on the technical merits of the position.  Essentially all of the unrecognized taxbenefits, if recognized, would be recorded as a benefit to income tax expense.Our continuing practice is to recognize interest and penalties related toincome tax matters as a component of income tax expense.

 

The Company’sconsolidated effective income tax rate was 25.7% and 28.7% for the three monthsended September 30, 2009 and 2008, respectively. The current effective taxrate, resulting in a tax benefit, was adversely affected by the valuationallowances against certain state and Canadian deferred tax assets. The priorperiod effective tax rate benefitted from a one time adjustment of $0.7 millionmade in the prior year quarter.

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

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 September 30, 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.

 

**(4)      Inventories**

 

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

 

| ** **      | ** ** | **September 30,  2009** | ** ** | **June 30,  2009** | ** ** |
|-----------------|------------|------------------------------|------------|-------------------------|------------|
|            |       |                         |       |                    |       |
| Finished goods  |       | $                            | 119,721    |                    | $          | 130,180 |   |
| Work in process |       | 7,355                        |       | 7,476                   |       |
| Raw materials   |       | 19,585                       |       | 18,863                  |       |
|            |       | $                            | 146,661    |                    | $          | 156,519 |   |

 

Inventories arepresented net of a related valuation allowance of $2.2 million at both September 30,2009 and June 30, 2009.

 

**(5)      Restructuringand Impairment Charges**

 

In recent years,we have announced and executed plans to consolidate our operations as part ofan overall strategy to maximize production efficiencies and maintain ourcompetitive advantage.

 

In fiscal 2009,the Company made several announcements on changes to our operations as wecontinue to improve the structure of our business especially in light of therecent economic downturn.  In January 2009,the Company announced a plan to consolidate the operations of its Eldred,Pennsylvania upholstery manufacturing plant and several of its retail servicecenters. In June 2009, the Company announced the consolidation of itsChino, California operations into its Maiden, North Carolina facility and theconsolidation of its Andover, Maine sawmill and dimension mill to its BeecherFalls, Vermont sawmill and dimension mill operations. For these fiscal 2009actions, the Company estimates pre-tax restructuring, impairment, accelerateddepreciation and other related charges will ultimately approximate $31 million,consisting of an $18 million impact from long-lived assets, $8 million inemployee severance and other payroll and benefit costs, and $5 million in otherassociated costs.  By segment, we expect $24 million in costs for thewholesale segment and $7 million for the retail segment.  Total costs forthese 2009 actions in the current fiscal year by segment are $0.2 million ofrestructuring charges and $6.6 million in accelerated depreciation forWholesale, and $0.4 million of restructuring charges for Retail. Cumulativecharges to date for these actions totaling $20.2 million have been classifiedin the Statement of Operations as restructuring and impairment charges and $6.6million of accelerated depreciation recorded in cost of sales. Approximately800 employee positions and 140 contract worker positions have been or will beeliminated due to these actions.

 

In fiscal 2008, weannounced a plan to consolidate the operations of certain Company-operatedretail design centers and retail service centers. In connection with thisinitiative, we have permanently ceased operations at ten design centers and sixretail service centers which, for the most part, were consolidated into otherexisting operations.  We also implementedour design team concept across the Retail division at the end of fiscal2008.  Costs for the January 2008actions in the current fiscal year by segment totaled $0.2 million, all ofwhich was for the Retail segment, mostly due to net losses on the sale of realestate. Cumulative charges to date for these actions total $5.8 million, all ofwhich have been classified in the Statement of Operations as restructuring andimpairment charges of the Retail segment.

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

Activity in theCompany’s restructuring reserves is summarized in the table below (inthousands) and is classified with accrued expenses and other currentliabilities in the Consolidated Balance Sheets:

 
| ** **                                           | ** ** | **Balance  June 30,  2009** | ** ** | **New  charges  (credits)** | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance  September  30, 2009** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|--------------|------------|-----------------|------------|---------------------------------------|------------|
| Fiscal 2009  Actions                                 |       |                             |       |                        |       |         |       |            |       |                                  |       |
| Employee  severance, other payroll and benefit costs |       | $                                | 3,864      |                        | $          | 96           |       | $               | (1,404     | )                                     | $          | — |   | $ | 2,556 |   |
| Other plant exit  costs                              |       | 654                              |       | 412                         |       | (523         | )          | —          |       | 543                                   |       |
| Write down of  long-lived assets                     |       | —                           |       | 54                          |       | (54          | )          | —          |       | —                                |       |
|                                                 |       | $                                | 4,518      |                        | $          | 562          |       | $               | (1,981     | )                                     | $          | — |   | $ | 3,099 |   |
|                                                 |       |                             |       |                        |       |         |       |            |       |                                  |       |
| Fiscal 2008  Actions                                 |       |                             |       |                        |       |         |       |            |       |                                  |       |
| Employee  severance, other payroll and benefit costs |       | $                                | 369        |                        | $          | —       |       | $               | (10        | )                                     | $          | — |   | $ | 359 |   |
| Other plant exit  costs                              |       | 2,892                            |       | —                      |       | (353         | )          | 38              |       | 2,577                                 |       |
| Write down of long-lived  assets                     |       | —                           |       | —                      |       | (212         | )          | 212             |       | —                                |       |
|                                                 |       | $                                | 3,261      |                        | $          | —       |       | $               | (575       | )                                     | $          | 250 |   | $ | 2,936 |   |

 

**(6)      BusinessAcquisitions**

 

There were noacquisitions completed during the three months ended September 30, 2009.

 

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.

 

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.

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

A summary of ourallocation of purchase price accounting for acquisitions during the threemonths ended September 30, 2008 is provided below (in thousands).

 

| ** **                                              | ** ** | **Three Months Ended  September 30, 2008** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------|------------|
| Business segment                                        |       | Retail                                          |       |
| Total consideration                                     |       | $                                               | 567        |   |
| Fair value of assets  acquired and liabilities assumed: |       |                                            |       |
| Inventory                                               |       | 669                                             |       |
| PP&E and other assets                               |       | 49                                              |       |
| Customer deposits                                       |       | (655                                            | )          |
| A/P and other liabilities                               |       | (200                                            | )          |
| Goodwill                                                |       | $                                               | 704        |   |

 

**(7)      Goodwill,Other Intangible Assets and Goodwill Impairment**

 

At both September 30, 2009 and June 30,2009, we had goodwill and other indefinite-lived intangible assets of $25.4million and $19.7 million, respectively, all of which is included in the Wholesalesegment.  The indefinite-lived intangibleassets represent Ethan Allen trade names. The Company previously had goodwill in the Retail segment, all of whichwas considered impaired and written off during the third quarter of fiscal2009.

 

In accordance with ASC Topic 350,*“Intangibles-Goodwill and Other”*(SFAS No. 142), we donot amortize goodwill or other indefinite-lived intangible assets but, rather,we conduct an annual impairment analysis of goodwill and other indefinite livedintangible assets the first of April each fiscal year, unless events occuror circumstances change that would more likely than not reduce the fair valueof the goodwill or other indefinite lived intangible assets below theircarrying value. In determining whether an interim test is appropriate,management considers several factors including changes in the Company’s stockprice, financial performance, third party ratings on its long term debt, andexpected financial outlook of the business. Methods employed to value theenterprise and the Company’s retail and wholesale segments include the marketapproach and the income approach, which are reconciled with the total marketcapitalization of the Company. These valuation methods use historical revenuesand cash flows, as well as Company and external analysts’ financial projectionsand apply discount rates, weighted average cost of capital rates, totalinvested capital multiples, and premium control multiples. Fair value of ourtrade name is valued using the relief-from-royalty method. Significant factorsused in trade name valuation are royalty rates, future growth and discountrates, and expense rates.

 

The Company performed impairmentevaluations during the second and third quarters of fiscal 2009 as a result ofsudden and dramatic changes in the business climate and the Company’sperformance, and determined as of March 31, 2009 that the $48.4 million ofgoodwill in the Retail segment was considered impaired and fully written off atthat time.  In the fiscal quarter ended June 30,2009, the Company performed its annual impairment test and concluded there wasno additional impairment.

 

During the quarter ending September 30,2009, the business performance was consistent with management’s expectations,revenues and operating costs were on plan, the Company’s average quarterlystock price increased 13% (from $12.11 for the quarter ended June 30,2009, to $13.69 for the quarter ended September 30, 2009), and cashreserves increased to $72.5 million at September 30, 2009 from $53.0million at June 30, 2009. The Company considered these and other factorsand concluded that an interim impairment test was not required.

 

There can be no assurance that theoutcome of future reviews will not result in substantial impairmentcharges.  Impairment assessmentinherently involves judgments as to assumptions about expected future cashflows and the 

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

impact of market conditions on thoseassumptions.  Future events and changingmarket conditions may impact our assumptions as to prices, costs or otherfactors that may result in 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.

 

**(8)      Borrowings**

 

Totaldebt obligations at September 30, 2009 and June 30, 2009 consist ofthe following (in thousands):

 
| ** **                    | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|-------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2009**               | ** ** | **2009**          | ** ** |
| 5.375%  Senior Notes due 2015 |       | $                      | 199,037    |              | $          | 198,997 |   |
| Industrial  revenue bonds     |       | 3,855                  |       | 3,855             |       |
| Other  debt                   |       | 286                    |       | 296               |       |
| Total  debt                   |       | 203,178                |       | 203,148           |       |
| Less  current maturities      |       | 42                     |       | 42                |       |
| Total  long-term debt         |       | $                      | 203,136    |              | $          | 203,106 |   |

 

In September 2005,we completed a private offering of $200.0 million in ten-year senior unsecurednotes due 2015 (the “Senior Notes”). TheSenior Notes were offered by Global and have an annual coupon rate of 5.375%with interest payable semi-annually in arrears on April 1 and October 1of each year.  Wehave used the net proceeds of $198.4 million to expand our retail network,invest in our manufacturing and logistics operations, and for other generalcorporate purposes.

 

On May 29, 2009, the Company enteredinto a three-year, $40 million senior secured asset-based revolving creditfacility (“the “Facility”). The Facility provides revolving credit financing ofup to $40 million, subject to borrowing base availability, and includes anaccordion feature which, if exercised, would provide up to an additional $20million of financing.    At the Company’soption, revolving loans under the Agreement bear interest at an annual rate ofeither:

 

(a) London Interbank Offered rate(“LIBOR”) plus 3.25% to 4.25%, based on the average availability, or

(b) the higher of (i) a primerate, (ii) the federal funds effective rate plus 0.50%, or (iii) aLIBOR rate plus 1.00% plus, in each case, an additional 2.25% to 3.25%, basedon average availability.

 

The Facility is secured by all propertyowned, leased or operated by the Company in the United States excluding anyreal property owned by the Company and also excludes any intellectual propertyowned by the Company unless availability is less than or equal to $17.5million, and contains customary covenants which may limit the Company’s abilityto incur debt; engage in mergers and consolidations; make restricted payments(including dividends); sell certain assets; and make investments.

 

At September 30,2009, we had no revolving loans, and $12.5 million in trade and standby lettersof credit outstanding under the Facility. Remaining availability under therevolver totaled $27.5 million subject to limitations set forth in theagreement noted above. We are in compliance with the terms and conditions ofthe agreement and as a result, the coverage charge ratio, or other restrictedpayment limitations did not apply. As of September 30, 2009, we are incompliance with all covenants of our credit facility.

 

On October 23, 2009, the Facilitywas expanded to $60 million. See Note 15 - Subsequent Events for additionaldetails.

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

**(9)      Litigation**

 

Environmental Matters

 

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 fiscal year ending June 30,2009, our liability with respect to three active sites currently listed, orproposed for inclusion, on the National Priorities List (“NPL”) under theComprehensive Environmental Response, Compensation and Liability Act of 1980,as amended (“CERCLA”), where we and/or our subsidiaries had been named as aPotentially Responsive Party (“PRP”) located in Southington, Connecticut; HighPoint, North Carolina; and Atlanta, Georgia has been resolved.

 

In each case we were not a majorcontributor based on the very small volume of waste generated by us in relationto total volume at those sites and were able to take part in de minimussettlement arrangements.  Specifically,with respect to the Southington site, our volumetric share is less than 1% ofover 51 million gallons disposed of at the site and there are more than 1,000PRPs.  With respect to the High Pointsite, our volumetric share is less than 1% of over 18 million gallons disposedof at the site and there are more than 2,000 PRPs, including more than 1,000 deminimis parties (of which we are one). With respect to the Atlanta site, aformer solvent recycling/reclamation facility, our volumetric share is lessthan 1% of over 20 million gallons disposed of at the site by more than 1,700PRPs.

 

In addition to the now settled actionsdiscussed above, in July 2000, we were notified by the State of New York(the “State”) that we may be named a PRP in a separate, unrelated matter withrespect to a site located in Carroll, New York.   In May, 2009, we were notified by the Statethat it had conducted an initial environmental study and that we have beennamed as a PRP.  We believe that we arenot a major contributor; however, a review of the initial environmental studyis ongoing.

 

Liability under CERCLA may be joint andseveral. As such, to the extent certain named PRPs are unable, or unwilling, toaccept responsibility and pay their apportioned costs, we could be required topay in excess of our pro rata share of incurred remediation costs. Ourunderstanding of the financial strength of other PRPs has been considered,where appropriate, in the determination of our estimated liability.

 

As of September 30, 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 andproceedings typically concern air emissions, water discharges, and/ormanagement of solid and hazardous wastes. We believe that our facilities are inmaterial compliance with all such applicable 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

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

volume of waste, (ii) limiting theliability associated with waste disposal, and (iii) continuously improvingenvironmental and job safety programs on the factory floor which serve tominimize emissions and safety risks for employees. We will continue to evaluatethe most appropriate, cost effective, control technologies for finishingoperations and design production methods to reduce the use of hazardousmaterials in the manufacturing process.

 

**(10)    Share-BasedCompensation**

 

On October 10, 2007, the Company’s Board ofDirectors and Mr. Kathwari agreed to the terms of a new employmentagreement 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, options to purchase an additional 90,000 shares on July 1, 2008, andoptions to purchase an additional 60,000 shares on July 1, 2009, in eachcase 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.  The2009 grant was issued at an exercise price of $10.68 and vests on June 30,2010. All options awarded under the Agreement have a contractual term of 10years.

 

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 received, as per theAgreement, an additional grant of 20,000 restricted shares on July 1, 2009with the same 36 month vesting, continuing service and performance conditions.

 

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.

 

**(11)    EarningsPer Share**

 

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

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **September 30,** | ** ** |
| ** **                                                                    | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Weighted average common shares outstanding for basic  calculation             |       | 28,926                 |       | 28,703 |   |
| Effect of dilutive stock options and other share-based  awards                |       | —                 |       | 144 |   |
| Weighted average common shares outstanding adjusted  for dilution calculation |       | 28,926                 |       | 28,847 |   |

 

As of September 30,2009 and 2008, stock options to purchase 2,251,389 and 1,813,855 common shares,respectively, were excluded from the respective diluted earnings per sharecalculation because their impact was anti-dilutive.

 

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

 

**(12)    ComprehensiveIncome**

 

Total comprehensiveincome represents the sum of net income and items of “other comprehensiveincome or loss” that are reported directly in equity.  Such items, which are generally presented ona net of tax basis, may include foreign currency translation adjustments,minimum pension liability adjustments (i.e. gains and losses) on certainderivative instruments, and unrealized gains and losses on certain investmentsin debt and equity securities.  We havereported our total comprehensive income in the Consolidated Statements ofShareholders’ Equity.

 

Accumulated othercomprehensive income, comprised of losses on certain derivative instruments andaccumulated foreign currency translation adjustments, totaled $0.8 million at September 30,2009 and $0.5 million at June 30, 2009. Losses on derivative instruments are the result of cash flow hedgingcontracts entered into in connection with the issuance of the Senior Notes (seeNote 8).  Foreign currency translationadjustments are the result of changes in foreign currency exchange ratesrelated to our operation of five Ethan Allen owned retail design centerslocated in Canada and our cut and sew plant located in Mexico.  Foreign currency translation adjustmentsexclude income tax expense (benefit) given that the earnings of non-U.S.subsidiaries are deemed to be reinvested for an indefinite period of time.

 

**(13)    FinancialInstruments**

 

ACSTopic 820, *“Fair value measurements and disclosures”*(SFAS No. 157) defines fair value as the price that would be received uponsale of an asset or paid upon transfer of a liability in an orderly transactionbetween market participants at the measurement date and in the principal ormost advantageous market for that asset or liability. The fair value should becalculated based on assumptions that market participants would use in pricingthe asset or liability, not on assumptions specific to the entity. In addition,the fair value of liabilities should include consideration of non-performancerisk including our own credit risk.

 

Inaddition to defining fair value, ASC Topic 820 expands the disclosure requirementsaround fair value and establishes a fair value hierarchy for valuation inputs.The hierarchy prioritizes the inputs into three levels based on the extent towhich inputs used in measuring fair value are observable in themarket. Each fair value measurement is reported in one of the three levelswhich is determined by the lowest level input that is significant to the fairvalue measurement in its entirety. These levels are:

 

·                  Level 1 — inputs are based upon unadjusted quoted prices for identicalinstruments traded in active markets.

 

·                  Level 2 — inputs are based upon quoted prices for similar instrumentsin active markets, quoted prices for identical or similar instruments inmarkets that are not active, and model-based valuation techniques for which allsignificant assumptions are observable in the market or can be corroborated byobservable market data for substantially the full term of the assets orliabilities.

 

·                  Level 3 — inputs are generally unobservable and typically reflectmanagement’s estimates of assumptions that market participants would use inpricing the asset or liability. The fair values are therefore determined usingmodel-based techniques that include option pricing models, discounted cash flowmodels, and similar techniques.

 

The followingsection describes the valuation methodologies we use to measure differentfinancial assets and liabilities at fair value.

 

TheCompany partially adopted ASC Topic 820 on July 1, 2008 due to the factthat a portion of ASC Topic 820 was previously deferred for one year for allnonfinancial assets and nonfinancial liabilities that were not recognized ordisclosed at fair value in the financial statements on a recurring basis (atleast annually).  On July 1, 2009,the Company adopted the deferred portion of ACS Topic 820.  There was no impact to the Company’sfinancial position

 

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

 

orresults of operations resulting from the adoption of the deferred portion ofACS Topic 820.  The Company has now fullyadopted ASC Topic 820.

 

***CashEquivalents***

 

Cashequivalents consist of money market accounts and mutual funds in U.S.government and agency securities.  We usequoted prices in active markets for identical assets or liabilities todetermine fair value.  This pricingmethodology applies to our Level 1 cash equivalents.  We do not hold any Level 2 or Level 3investments in our cash equivalents.

 

***Assetsand Liabilities Measured at Fair Value on a Recurring Basis***

 

At September 30,2009, the Company’s assets and liabilities measured at fair value on arecurring basis consist of $59.7 million in cash equivalents, which were valuedusing Level 1 inputs.

 

***Assetsand Liabilities Measured at Fair Value on a Nonrecurring Basis***

 

Wemeasure certain assets, including our cost and equity method investments, atfair value on a nonrecurring basis. These assets are recognized at fair valuewhen they are deemed to be other-than-temporarily impaired. During the threemonths ended September 30, 2009, we did not record anyother-than-temporary impairments on those assets required to be measured atfair value on a nonrecurring basis.

 

**(14)    SegmentInformation**

 

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 wholesalesales price and the cost associated with manufacturing and/or sourcing therelated product, and (ii) other operating costs associated with wholesalesegment activities.

 

The retail segmentsells home furnishings and accessories to consumers through a network ofCompany owned design centers.  Retailrevenue is generated 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).

 

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

 

A breakdown ofwholesale sales by these product lines for the three months ended September 30,2009 and 2008 is provided as follows:

 

| ** **                 | ** ** | **Three Months Ended** | ** ** |
|----------------------------|------------|------------------------|------------|
| ** **                 | ** ** | **September 30,** | ** ** |
| ** **                 | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Case Goods                 |       | 40                     | %          | 41 | % |
| Upholstered Products       |       | 45                     |       | 42 |   |
| Home Accessories and Other |       | 15                     |       | 17 |   |
|                       |       | 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.

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

Segmentinformation for the three months ended September 30, 2009 and 2008 is setforth as follows:

 
| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **September 30,** | ** ** |
| ** **                              | ** ** | **2009**               | ** ** | **2008** | ** ** |
| **Net sales:**                          |       |                   |       |   |   |
| Wholesale segment                       |       | $                      | 81,281     |   | $ | 121,295 |   |
| Retail segment                          |       | 103,150                |       | 155,870 |   |
| Elimination of  inter-company sales     |       | (48,241                | )          | (71,324 | ) |
| Consolidated Total                      |       | $                      | 136,190    |   | $ | 205,841 |   |
|                                    |       |                   |       |   |   |
| **Operating income (loss):**            |       |                   |       |   |   |
| Wholesale segment (1)                   |       | $                      | (4,660     | ) | $ | 11,885 |   |
| Retail segment (2)                      |       | (11,349                | )          | (3,052 | ) |
| Adjustment of inter-company  profit (3) |       | (79                    | )          | 3,378 |   |
| Consolidated Total                      |       | $                      | (16,088    | ) | $ | 12,211 |   |
|                                    |       |                   |       |   |   |
| **Capital expenditures:**               |       |                   |       |   |   |
| Wholesale segment                       |       | $                      | 801        |   | $ | 1,632 |   |
| Retail segment                          |       | 1,687                  |       | 9,461 |   |
| Acquisitions (4)                        |       | —                 |       | 375 |   |
| Consolidated Total                      |       | $                      | 2,488      |   | $ | 11,468 |   |

 
| ** **                        | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|-----------------------------------|------------|------------------------|------------|-------------------|------------|
| **Total assets**                  | ** ** | **2009**               | ** ** | **2009**          | ** ** |
| Wholesale segment                 |       | $                      | 281,075    |              | $          | 276,250 |   |
| Retail segment                    |       | 385,279                |       | 397,877           |       |
| Inventory profit  elimination (5) |       | (27,789                | )          | (27,642           | )          |
| Consolidated Total                |       | $                      | 638,565    |              | $          | 646,485 |   |

 

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(1)          Operating income (loss) for the wholesalesegment for the three months ended September 30, 2009 and 2008 includespre-tax restructuring and impairment charges of $0.2 million and $0.4 million,respectively.

(2)          Operating income (loss) for the retail segment for thethree months ended September 30, 2009 and 2008 includes pre-taxrestructuring and impairment charges of $0.7 million and a net recovery of $2.0million, respectively.

(3)          Represents the change in the inventoryprofit elimination necessary to adjust for the embedded wholesale profitcontained in Ethan Allen-owned design center inventory existing at the end ofthe period.

(4)          Acquisitions for the three months ended September 30,2008 include the purchase of two retail design centers.

(5)          Represents the wholesale profit containedin Ethan Allen-owned design center inventory that has not yet been realized.These profits are realized when the related inventory is sold.

 

There were 49 independent retail design centerslocated outside the United States at September 30, 2009. Less than fivepercent of our net sales were derived from sales to those retail designcenters.

 

**(15)    SubsequentEvents**

 

***Ethan Allen declares quarterlycash dividend***

 

Ethan Allen’s Board of Directors has declared aquarterly cash dividend of $0.05 per share, which will be payable toshareholders of record as of October 9, 2009 and paid on October 26,2009.

 

***Ethan Allen expands revolving******credit facility***

 

On October 23, 2009, the Companyamended its three-year revolving credit facility by increasing the creditfinancing by $20 million, with total borrowing under the agreement (subject toborrowing base availability) of up to $60 

 

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**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

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

 

million. The Amended Facility is securedby all assets owned, leased or operated by the Company in the United Statesincluding intellectual property, and excludes any real estate owned by theCompany.

 

***Standard & Poor’s lowerscredit rating***

 

On November 2, 2009, Standard &Poor’s Rating Services lowered its corporate credit and senior unsecured debtratings to ‘B+’ from ‘BB’ and indicated the outlook was negative. The ratingagency cited very weak operating performance due to lower consumer spending anda tough retail environment in its rating action. The Company believes thischange does not materially affect its ability to operate and further believesit has adequate liquidity and cash flow to meet current business needs.

 

**(16)    FinancialInformation About the Parent, 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 theParent, 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 theGuarantors are unsecured.  All of theguarantees are full, unconditional and joint and several and the Issuer andeach of the Guarantors are 100% owned by the Parent. Ethan Allen (UK) Ltd.(which was legally dissolved in October 2009), and our other subsidiarieswhich are not guarantors are called the “Non-Guarantors”. During the quarterended December 31, 2008, we determined that our international subsidiariesin Canada and Mexico are non-guarantors. The Company has reclassified, for allprior periods presented, the financial results of these internationalsubsidiaries to reflect their non-guarantor status.

 

The following tables setforth the condensed consolidating balance sheets as of September 30, 2009and June 30, 2009, the condensed consolidating statements of operationsfor the three months ended September 30, 2009 and 2008, and the condensedconsolidating statements of cash flows for the three months ended September 30,2009 and 2008 of the Parent, the Issuer, the Guarantors and the Non-Guarantors.

 

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**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

(In thousands)

**September 30,2009**

 
| ** **                                      | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                      |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current assets:                                 |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents                       |       | $          | —     |       | $          | 68,296         |       | $                  | 2,888      |             | $          | 1,268            |       | $ | — |   | $ | 72,452 |   |
| Accounts receivable, net                        |       | —     |       | 12,269     |       | 540            |       | 244                |       | —           |       | 13,053           |       |
| Inventories                                     |       | —     |       | —     |       | 169,742        |       | 4,708              |       | (27,789          | )          | 146,661          |       |
| Prepaid expenses and other current assets       |       | —     |       | 12,736     |       | 6,469          |       | 620                |       | —           |       | 19,825           |       |
| Intercompany                                    |       | —     |       | 767,471    |       | 229,281        |       | (3,294             | )          | (993,458         | )          | —           |       |
| Total current assets                            |       | —     |       | 860,772    |       | 408,920        |       | 3,546              |       | (1,021,247       | )          | 251,991          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Property, plant and equipment, net              |       | —     |       | 11,201     |       | 304,005        |       | 4,978              |       | —           |       | 320,184          |       |
| Goodwill and other intangible assets            |       | —     |       | 37,905     |       | 7,223          |       | —             |       | —           |       | 45,128           |       |
| Other assets                                    |       | —     |       | 20,454     |       | 802            |       | 6                  |       | —           |       | 21,262           |       |
| Investment in affiliated companies              |       | 599,745    |       | (39,991    | )          | —         |       | —             |       | (559,754         | )          | —           |       |
| Total assets                                    |       | $          | 599,745    |       | $          | 890,341        |       | $                  | 720,950    |             | $          | 8,530            |       | $ | (1,581,001 | ) | $ | 638,565 |   |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| **Liabilities and Shareholders’  Equity**  |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current liabilities:                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current maturities of long-term debt            |       | $          | —     |       | $          | —         |       | $                  | 42         |             | $          | —           |       | $ | — |   | $ | 42 |   |
| Customer deposits                               |       | —     |       | —     |       | 37,175         |       | 1,710              |       | —           |       | 38,885           |       |
| Accounts payable                                |       | —     |       | 6,278      |       | 14,559         |       | 240                |       | —           |       | 21,077           |       |
| Accrued expenses and other current liabilities  |       | 1,559      |       | 39,363     |       | 16,968         |       | 302                |       | —           |       | 58,192           |       |
| Intercompany                                    |       | 306,402    |       | 8,123      |       | 673,183        |       | 5,750              |       | (993,458         | )          | —           |       |
| Total current liabilities                       |       | 307,961    |       | 53,764     |       | 741,927        |       | 8,002              |       | (993,458         | )          | 118,196          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Long-term debt                                  |       | —     |       | 199,038    |       | 4,098          |       | —             |       | —           |       | 203,136          |       |
| Other long-term liabilities                     |       | —     |       | 10,571     |       | 14,737         |       | 141                |       | —           |       | 25,449           |       |
| Deferred income taxes                           |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Total liabilities                               |       | 307,961    |       | 263,373    |       | 760,762        |       | 8,143              |       | (993,458         | )          | 346,781          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Shareholders’ equity                       |       | 291,784    |       | 626,968    |       | (39,812        | )          | 387                |       | (587,543         | )          | 291,784          |       |
| Total liabilities and shareholders’ equity |       | $          | 599,745    |       | $          | 890,341        |       | $                  | 720,950    |             | $          | 8,530            |       | $ | (1,581,001 | ) | $ | 638,565 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

(In thousands)

**June 30,2009**

 
| ** **                                      | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                      |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current assets:                                 |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents                       |       | $          | —     |       | $          | 47,712         |       | $                  | 3,592      |             | $          | 1,656            |       | $ | — |   | $ | 52,960 |   |
| Accounts receivable, net                        |       | —     |       | 12,049     |       | 783            |       | 254                |       | —           |       | 13,086           |       |
| Inventories                                     |       | —     |       | —     |       | 179,705        |       | 4,456              |       | (27,642          | )          | 156,519          |       |
| Prepaid expenses and other current assets       |       | —     |       | 20,509     |       | 8,084          |       | 544                |       | —           |       | 29,137           |       |
| Intercompany receivables                        |       | —     |       | 782,736    |       | 227,453        |       | (3,010             | )          | (1,007,179       | )          | —           |       |
| Total current assets                            |       | —     |       | 863,006    |       | 419,617        |       | 3,900              |       | (1,034,821       | )          | 251,702          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Property, plant and equipment, net              |       | —     |       | 11,748     |       | 317,144        |       | 4,707              |       | —           |       | 333,599          |       |
| Goodwill and other intangible assets            |       | —     |       | 37,905     |       | 7,223          |       | —             |       | —           |       | 45,128           |       |
| Other assets                                    |       | —     |       | 15,323     |       | 727            |       | 6                  |       | —           |       | 16,056           |       |
| Investment in affiliated companies              |       | 612,391    |       | (20,616    | )          | —         |       | —             |       | (591,775         | )          | —           |       |
| Total assets                                    |       | 612,391    |       | 907,366    |       | 744,711        |       | 8,613              |       | (1,626,596       | )          | 646,485          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| **Liabilities and Shareholders’  Equity**  |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current liabilities:                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current maturities of long-term debt            |       | —     |       | —     |       | 42             |       | —             |       | —           |       | 42               |       |
| Customer deposits                               |       | —     |       | —     |       | 30,412         |       | 1,279              |       | —           |       | 31,691           |       |
| Accounts payable                                |       | —     |       | 8,851      |       | 13,106         |       | 242                |       | —           |       | 22,199           |       |
| Accrued expenses and other current liabilities  |       | 1,552      |       | 41,004     |       | 15,707         |       | 268                |       | —           |       | 58,531           |       |
| Intercompany payables                           |       | 304,917    |       | 8,123      |       | 687,826        |       | 6,313              |       | (1,007,179       | )          | —           |       |
| Total current liabilities                       |       | 306,469    |       | 57,978     |       | 747,093        |       | 8,102              |       | (1,007,179       | )          | 112,463          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Long-term debt                                  |       | —     |       | 198,998    |       | 4,108          |       | —             |       | —           |       | 203,106          |       |
| Other long-term liabilities                     |       | —     |       | 10,565     |       | 14,290         |       | 138                |       | —           |       | 24,993           |       |
| Deferred income taxes                           |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Total liabilities                               |       | 306,469    |       | 267,541    |       | 765,491        |       | 8,240              |       | (1,007,179       | )          | 340,562          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Shareholders’ equity                       |       | 305,922    |       | 639,825    |       | (20,780        | )          | 373                |       | (619,417         | )          | 305,923          |       |
| Total liabilities and shareholders’ equity |       | $          | 612,391    |       | $          | 907,366        |       | $                  | 744,711    |             | $          | 8,613            |       | $ | (1,626,596 | ) | $ | 646,485 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

(In thousands)

**Three Months Ended September 30, 2009**

 
| ** **                                        | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                         |       | $          | —     |       | $          | 81,410         |       | $                  | 136,996    |             | $          | 4,899            |       | $ | (87,115 | ) | $ | 136,190 |   |
| Cost of sales                                     |       | —     |       | 66,961     |       | 95,200         |       | 2,703              |       | (86,983          | )          | 77,881           |       |
| Gross profit                                      |       | —     |       | 14,449     |       | 41,796         |       | 2,196              |       | (132             | )          | 58,309           |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general and administrative expenses      |       | 41         |       | 11,032     |       | 59,973         |       | 2,539              |       | —           |       | 73,585           |       |
| Restructuring and impairment charge, (credit) net |       | —     |       | —     |       | 812            |       | —             |       | —           |       | 812              |       |
| Total operating expenses                          |       | 41         |       | 11,032     |       | 60,785         |       | 2,539              |       | —           |       | 74,397           |       |
| Operating income (loss)                           |       | (41        | )          | 3,417      |       | (18,989        | )          | (343               | )          | (132             | )          | (16,088          | )          |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and other miscellaneous income, net      |       | (13,538    | )          | (18,596    | )          | 33             |       | —             |       | 32,898           |       | 797              |       |
| Interest and other related financing costs        |       | —     |       | 2,905      |       | 76             |       | —             |       | —           |       | 2,981            |       |
| Income (loss) before income tax expense           |       | (13,579    | )          | (18,084    | )          | (19,032        | )          | (343               | )          | 32,766           |       | (18,272          | )          |
| Income tax expense                                |       | —     |       | (4,693     | )          | —         |       | —             |       | —           |       | (4,693           | )          |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income (loss)                                 |       | $          | (13,579    | )          | $          | (13,391        | )          | $                  | (19,032    | )                | $          | (343             | )          | $ | 32,766 |   | $ | (13,579 | ) |

 

**Three Months Ended September 30, 2008**

 
| ** **                                        | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                         |       | $          | —     |       | $          | 121,596        |       | $                  | 208,800    |             | $          | 6,080            |       | $ | (130,635 | ) | $ | 205,841 |   |
| Cost of sales                                     |       | —     |       | 88,405     |       | 136,394        |       | 3,272              |       | (134,171         | )          | 93,900           |       |
| Gross profit                                      |       | —     |       | 33,191     |       | 72,406         |       | 2,808              |       | 3,536            |       | 111,941          |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general and administrative expenses      |       | 41         |       | 13,291     |       | 84,986         |       | 3,042              |       | —           |       | 101,360          |       |
| Restructuring and impairment charge, (credit) net |       | —     |       | —     |       | (1,630         | )          | —             |       | —           |       | (1,630           | )          |
| Total operating expenses                          |       | 41         |       | 13,291     |       | 83,356         |       | 3,042              |       | —           |       | 99,730           |       |
| Operating income (loss)                           |       | (41        | )          | 19,900     |       | (10,950        | )          | (234               | )          | 3,536            |       | 12,211           |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and other miscellaneous income, net      |       | 7,463      |       | (10,136    | )          | 2              |       | 6                  |       | 3,765            |       | 1,100            |       |
| Interest and other related financing costs        |       | —     |       | 2,825      |       | 76             |       | —             |       | —           |       | 2,901            |       |
| Income (loss) before income tax expense           |       | 7,422      |       | 6,939      |       | (11,024        | )          | (228               | )          | 7,301            |       | 10,410           |       |
| Income tax expense                                |       | —     |       | 2,988      |       | —         |       | —             |       | —           |       | 2,988            |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income (loss)                                 |       | $          | 7,422      |       | $          | 3,951          |       | $                  | (11,024    | )                | $          | (228             | )          | $ | 7,301 |   | $ | 7,422 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

(In thousands)

**Three Months Ended September 30, 2009**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                                   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net cash provided by (used in) operating activities          |       | $          | 1,448      |       | $          | 20,697         |       | $                  | (4,238     | )                | $          | (912             | )          | $ | — |   | $ | 16,995 |   |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from investing activities:                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Capital expenditures                                         |       | —     |       | (97        | )          | (2,391         | )          | —             |       | —           |       | (2,488           | )          |
| Acquisitions                                                 |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Proceeds from the disposal of property, plant and  equipment |       | —     |       | —     |       | 5,935          |       | —             |       | —           |       | 5,935            |       |
| Other                                                        |       | —     |       | 6          |       | —         |       | —             |       | —           |       | 6                |       |
| Net cash used in investing activities                        |       | —     |       | (91        | )          | 3,544          |       | —             |       | —           |       | 3,453            |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from financing activities:                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Payments on long-term debt                                   |       | —     |       | —     |       | (10            | )          | —             |       | —           |       | (10              | )          |
| Purchases and other retirements of company stock             |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Proceeds from issuance of common stock                       |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Payment of deferred financing costs                          |       | —     |       | (22        | )          | —         |       | —             |       | —           |       | (22              | )          |
| Dividends paid                                               |       | (1,448     | )          | —     |       | —         |       | —             |       | —           |       | (1,448           | )          |
| Net cash provided by (used in) financing activities          |       | (1,448     | )          | (22        | )          | (10            | )          | —             |       | —           |       | (1,480           | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Effect of exchange rate changes on cash                      |       | —     |       | —     |       | —         |       | 524                |       | —           |       | 524              |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net increase (decrease) in cash and cash  equivalents        |       | —     |       | 20,584     |       | (704           | )          | (388               | )          | —           |       | 19,492           |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents — beginning of period         |       | —     |       | 47,712     |       | 3,592          |       | 1,656              |       | —           |       | 52,960           |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents — end of period               |       | $          | —     |       | $          | 68,296         |       | $                  | 2,888      |             | $          | 1,268            |       | $ | — |   | $ | 72,452 |   |

 

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**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

(In thousands)

**Three Months Ended September 30, 2008**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                                   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net cash provided by (used in) operating activities          |       | $          | 6,329      |       | $          | 6,500          |       | $                  | 5,807      |             | $          | (561             | )          | $ | — |   | $ | 18,075 |   |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from investing activities:                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Capital expenditures                                         |       | —     |       | (644       | )          | (10,445        | )          | (4                 | )          | —           |       | (11,093          | )          |
| Acquisitions                                                 |       | —     |       | —     |       | (375           | )          | —             |       | —           |       | (375             | )          |
| Proceeds from the disposal of property, plant and  equipment |       | —     |       | 19         |       | 5,710          |       | —             |       | —           |       | 5,729            |       |
| Other                                                        |       | —     |       | (32        | )          | (217           | )          | —             |       | —           |       | (249             | )          |
| Net cash used in investing activities                        |       | —     |       | (657       | )          | (5,327         | )          | (4                 | )          | —           |       | (5,988           | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from financing activities:                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Payments on long-term debt                                   |       | —     |       | —     |       | (10            | )          | —             |       | —           |       | (10              | )          |
| Purchases and other retirements of company stock             |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Proceeds from issuance of common stock                       |       | 2          |       | —     |       | —         |       | —             |       | —           |       | 2                |       |
| Excess tax benefits from share-based payment  arrangements   |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Dividends paid                                               |       | (6,331     | )          | —     |       | —         |       | —             |       | —           |       | (6,331           | )          |
| Net cash provided by (used in) financing activities          |       | (6,329     | )          | —     |       | (10            | )          | —             |       | —           |       | (6,339           | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Effect of exchange rate changes on cash                      |       | —     |       | —     |       | —         |       | (207               | )          | —           |       | (207             | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net increase (decrease) in cash and cash  equivalents        |       | —     |       | 5,843      |       | 470            |       | (772               | )          | —           |       | 5,541            |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents — beginning of period         |       | —     |       | 71,117     |       | 1,307          |       | 1,952              |       | —           |       | 74,376           |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents — end of period               |       | $          | —     |       | $          | 76,960         |       | $                  | 1,777      |             | $          | 1,180            |       | $ | — |   | $ | 79,917 |   |

 

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**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

 

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

 

The following discussionof financial condition and results of operations should be read in conjunctionwith (i) our Consolidated Financial Statements, and notes thereto, as setforth in this Quarterly Report on Form 10-Q and (ii) our AnnualReport on Form 10-K/A for the year ended June 30, 2009.

 

**Forward-LookingStatements**

 

Management’s discussionand analysis of financial condition and results of operations and othersections of this Quarterly Report contain forward-looking statements relatingto our future results. Such forward-looking statements are identified by use offorward-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/Afor the year ended June 30, 2009 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**

 

The Company’sconsolidated financial statements are based on the accounting policiesused.  Certain accounting polices requirethat estimates and assumptions be made by management for use in the preparationof the financial statements.  Criticalaccounting policies are those that are central to the presentation of theCompany’s financial condition and results and that require subjective orcomplex estimates by management.  TheCompany updated its disclosure regarding Impairment of Long-Lived Assets andGoodwill.  For further informationregarding the Company’s other critical accounting policies, see the Company’s2009 Annual Report on Form 10-K/A filed with the SEC on August 27,2009

 

***Impairmentof Long-Lived Assets and Goodwill —***We periodically evaluate whether eventsor circumstances have occurred that indicate that long-lived andindefinite-lived assets may not be recoverable or that the remaining usefullife may warrant revision.  When suchevents or circumstances are present, the Company determines whether thecarrying value exceeds the fair value as described below.

 

In accordance with ASCTopic 360, “Property, Plant and Equipment” (SFAS No. 144), therecoverability of long-lived assets are evaluated for impairment by determiningwhether the carrying value will be recovered through the expected undiscountedfuture cash flows resulting from the use of the asset.  In the event the sum of the expectedundiscounted future cash flows is less than the carrying value of the asset, animpairment loss equal to the excess of the asset’s carrying value over its fairvalue is recorded.  The long-term natureof these assets requires the estimation of cash inflows and outflows severalyears into the future and only takes into consideration technological advancesknown at the time of the impairment test.

 

In accordance with ASCTopic 350, “Intangibles-Goodwill and Other” (SFAS No. 142), goodwill andother indefinite-lived intangible assets are evaluated for impairment on anannual basis and between annual tests

 

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whenever events orcircumstances indicate that the carrying value of the goodwill or otherintangible asset may exceed its fair value. We conduct our required annualimpairment test of goodwill and other intangible assets during the fourthquarter of each fiscal year.

 

To evaluate goodwill, theCompany determines the current fair value of the Reporting Units using acombination of “Market” and “Income” approaches.  In the Market approach, the “GuidelineCompany” method is used, which focuses on comparing the Company’s risk profileand growth prospects to reasonably similar publicly traded companies.  Key assumptions used for the GuidelineCompany method are total invested capital (“TIC”) multiples for revenues andoperating cash flows, as well as consideration of control premiums.  The TIC multiples are determined based onpublic furniture companies within our peer group, and if appropriate, recentcomparable transactions are also considered. Control premiums are determinedusing recent comparable transactions in the open market. Under the Incomeapproach, a discounted cash flow method is used, which includes a terminalvalue, and is based on external analyst financial projection estimates, as wellas internal financial projection estimates prepared by management. Thelong-term terminal growth rate assumptions reflect our current long-term viewof the market in which we compete. Discount rates use the weighted average cost of capital for companieswithin our peer group, adjusted for specific company risk premium factors.

 

The fair value of ourtrade name, which is the Company’s only indefinite lived intangible asset otherthan goodwill, is valued using the relief-from-royalty method. Significantfactors used in trade name valuation are rates for royalties, future growth,and a discount factor.  Royalty rates aredetermined using an average of recent comparable values.  Future growth rates are based on theCompany’s perception of the long term values in the market in which we compete,and the discount rate is determined using the weighted average cost of capitalfor companies within our peer group, adjusted for specific company risk premiumfactors. The fair value of the trade name substantially exceeded the carryingvalue in fiscal 2009.

 

As a result of the economicdownturn that began in the fall of 2008, the Company’s revenues and operatingmargins were negatively impacted.  Inresponse, the Company reduced headcount, consolidated its manufacturing,retail, and logistics footprint and repositioned its marketing approach.  As a result of these changes, the Company’scash flow forecasts were continually updated to reflect the rapid changes inthe business and the industry.  During fiscal2009, the Company determinedthat $48.4 million of goodwill in the Retail segment was considered impairedand fully written off. The cash flow projections used inits fair value evaluations are the best estimates of the Company and requiresignificant management judgment.

 

In the fiscal quarterended June 30, 2009, the Company performed its annual impairment test andno impairment of goodwill was appropriate as the fair value of the wholesalereporting unit net assets exceeded the book value by approximately 10%. Duringthe quarter ending September 30, 2009, the business performance wasconsistent with the previous quarter, revenues and operating costs were onplan, the Company’saverage quarterly stock price increased 13% (from $12.11 for the quarter ended June 30,2009, to $13.69 for the quarter ended September 30, 2009), andcash reserves increased to $72.5 million at September 30, 2009 from $53.0million at June 30, 2009. The Company considered these and other factorsand concluded that an interim impairment test was not required. There can be noassurance that the outcome of future reviews will not result in substantialimpairment charges.

 

To calculate fair valueof the assets described above, management relies on estimates and assumptionswhich by their nature have varying degrees of uncertainty. Wherever possible,management therefore looks for third party transactions as described above toprovide the best possible support for the assumptions incorporated. Managementconsiders several factors to be significant when estimating fair valueincluding expected financial outlook of the business, changes in the Company’sstock price, the impact of changing market conditions on financial performanceand expected future cash flows, and other factors. Deterioration in any ofthese factors may result in a lower fair value assessment which could lead toimpairment of the long-lived assets and goodwill of the Company.

 

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**Resultsof Operations**

 

Our Company has been severely impacted by the economicfactors in the United States and abroad which we began to feel in earnestduring our second quarter of fiscal 2009. Weakness in the U.S. economy from continued high unemployment, volatilecapital markets, depressed housing prices and tight consumer spending have allput negative stress on the economy which continues to have a negative impact onour business.  As we work through thesedifficult times, we have taken dramatic actions to significantly reduce ourinfrastructure in all facets of our business including closing and realigningmanufacturing plants, consolidating logistics operations, and closingunder-performing retail design centers. We have also launched initiatives toincrease sales, such as special savings product promotions, our designeraffiliate program and converting our case goods business to custom.

 

In fiscal 2009, theCompany made several announcements on changes to our operations.  In January 2009, the Company announced aplan to consolidate the operations of its Eldred, Pennsylvania upholsterymanufacturing plant and several of its retail service centers. In June 2009,the Company announced the consolidation of its Chino, California operationsinto its Maiden, North Carolina facility and the consolidation of its Andover,Maine sawmill and dimension mill to its Beecher Falls, Vermont sawmill anddimension mill operations which will continue to operate while the othermanufacturing operations from Beecher Falls were moved to our plant in Orleans,Vermont. In large part, these efforts to realign our manufacturing operationswere concluded in this first quarter of fiscal 2009. The Company estimatespre-tax restructuring, impairment, accelerated depreciation and other relatedcharges for all of the fiscal 2009 actions will ultimately approximate $31million, consisting of an $18 million impact from long-lived assets, $8 millionin employee severance and other payroll and benefit costs, and $5 million inother associated costs.  By segment, we expect $24 million in costs forthe wholesale segment and $7 million for the retail segment.  Total costsfor these 2009 actions in the current fiscal year by segment are $0.2 millionof restructuring charges and $6.6 million in accelerated depreciation for Wholesale,and $0.4 million of restructuring charges for Retail. Cumulative charges todate for these actions totaling $20.2 million have been classified in theStatement of Operations as restructuring and impairment charges and $6.6million of accelerated depreciation recorded in cost of sales. Approximately800 employee positions and 140 contract worker positions have been or will beeliminated due to these actions.

 

In fiscal 2008, weannounced a plan to consolidate the operations of certain Company-operatedretail design centers and retail service centers. In connection with thisinitiative, we have permanently ceased operations at ten design centers and sixretail service centers which, for the most part, were consolidated into otherexisting operations.  We also implementedour design team concept across the Retail division at the end of fiscal2008.  Costs for the January 2008actions in the current fiscal year totaled $0.2 million, all of which was forthe Retail segment, mostly due to net losses on the sale of real estate.Cumulative charges to date for these actions total $5.8 million, all of whichhave been classified in the Statement of Operations as restructuring andimpairment charges of the Retail segment.

 

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 months ended September 30, 2009 and2008 for the components of consolidated revenue and operating income, capitalexpenditures, and total assets by segment.

 

***QuarterEnded September 30, 2009 Compared to Quarter Ended September 30, 2008***

 

**Consolidated revenue**for the three months ended September 30, 2009 decreased 33.8% to $136.2million, from $205.8 million for the three months ended September 30,2008. During the quarter, sales continue to be affected by the negativeeconomic stresses mentioned earlier, as well as the use of highly-promotionalpricing strategies by the Company’s competitors.  These factors were partially offset by (i) severalnew marketing initiatives including

 

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our rewards program andspecial savings pricing, and our new interactive web site ethanalleninc.com, (ii) thecontinued use of national television media, where we emphasize to clients ourinterior design services and the full line of our quality product offerings,and (iii) the positive effects of efforts to reposition the retailnetwork.

 

**Wholesalerevenue** for the first quarter of fiscal 2009decreased 33.0% to $81.3 million from $121.3 million in the prior yearcomparable period.  The quarter-over-quarterdecrease was primarilyattributable to a decline in the incoming order rate due to a continued softretail environment for home furnishings noted throughout the current period. Thesedecreases were partially offset by our rewards program and celebration pricingduring the quarter.  In addition, there were two moreindependent retail design centers at September 30, 2009, which increasedto 134 from 132, including two locations transferred into the company’s Retaildivision during the year. There were the same number ofshipping days in the quarter both this year and last year.

 

**Retailrevenue** from Ethan Allen-owned design centersfor the three months ended September 30, 2009 decreased 33.8% to $103.2million from $155.9 million for the three months ended September 30,2008.  We believe the decrease in retailsales by Ethan Allen-operated design centers is due to the same soft marketconditions experienced by the wholesale segment, as evidenced by a 35.3%decrease in comparable store sales, a net $2.1 million decrease in new/closedstore sales, and a net decrease in the number of Ethan Allen-operated designcenters to 155 as of September 30, 2009 as compared to 160 as of September 30,2008.  These decreases were partiallyoffset by our rewards program and celebration pricing during the quarter.  During the quarter, we opened two (includingone relocation) and closed five 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 19.5% whilecomparable design centers written business decreased 20.0%.  Over that same period, wholesale ordersdecreased 21.4%.  Both retail andwholesale written business reflect the softer retail environment for homefurnishings noted throughout the period as a result of continued negativeeconomic stresses previously discussed.

 

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.  We believe that implementation of the “team”concept has helped us continue to improve the customer service experience.  We also believe that over time, we willbenefit from (i) our repositioning of the retail network, (ii) newproduct introductions, (iii) new marketing initiatives such as our rewardsprogram, special savings pricing, and our new interior design affiliate (IDA)program, (iv) continued use of technology including our state-of-the-artwebsite coupled with personal service from our design professionals, and (iv) ongoinguse of national television and shelter magazines as advertising media.

 

**Grossprofit** decreased during the quarter to $58.3million from $111.9 million in the prior year comparable quarter.  The 47.9% decrease in gross profit wasprimarily attributable to (i) the reduction in net sales of 33.8%, with anoverall decrease in shipments in both market segments, (ii) lower marginpercentages within the wholesale segment due to accelerated depreciation fromclosed manufacturing operations totaling $6.6 million, under absorption ofplant overhead costs on the lower production volume, and other plant transitioncosts related to the restructuring of our manufacturing plants, and (iii) lowermargins within the retail segment, due to discounted sales through our rewardsprogram and celebration pricing initiatives and sales of discontinued productand floor samples.  The sales mixremained constant with retail sales representing 76% of total sales in both thecurrent and prior year period. Consolidated gross margin decreased to 42.8%from 54.4% in the prior year as a result, primarily, of the factors set forthabove.

 

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**Operatingprofit**, the elements of which are discussed ingreater detail below, was impacted by the following items during the threemonths ended September 30, 2009 and 2008:

 

**Operatingexpenses** decreased 25.4% to $74.4 million, butincreased to 54.6% of sales in the current quarter from $99.7 million, or 48.5%of sales in the prior year quarter. Selling expenses were down in absolute terms due to actions taken andlower sales volume.  Salary related costsdecreased due to the reduced number of employees and other cost cutting effortstaken by the Company.  Advertisingexpenses were down $2.3 million versus the previous year first fiscal quarter.

 

**Consolidatedoperating income (loss)** for the three month period ended September 30,2009 was a loss of $16.1 million, or 11.8% of sales, as compared to income of$12.2 million, or 5.9% of sales, for the three months ended September 30,2008.  This decrease of $28.3 million isdue to a decrease in gross profit mostly due to reduced sales, and accelerateddepreciation charges due to restructuring activities, partly offset by adecrease in period over period operating expenses, both of which were discussedpreviously.

 

**Wholesaleoperating income (loss)** for the three months ended September 30,2009 totaled a loss of $4.7 million, or a negative 5.7% of sales, as comparedto income of $11.9 million, or 9.8% of sales, in the prior year comparablequarter. The decrease of $16.5 million was primarily attributable to a decreasein sales volume, and the plant transition costs including the $6.6 million ofaccelerated depreciation noted above relating to the closure of manufacturingplants as discussed previously.

 

**Retailoperating loss** increased $8.3 million to a loss of$11.3 million, or a negative 11.0% of sales, for the first quarter of fiscal2010 from a loss of $3.1 million, or a negative 2.0% of sales, for the firstquarter of fiscal 2009.  The increase inretail operating loss generated by Ethan Allen-operated design centers wasprimarily due to reduced sales attributed to the weak retail environment forhome furnishings offset partially by cost cutting actions taken.

 

**Interestand other miscellaneous income, net**decreased $0.3 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.

 

**Interestand other related financing 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.

 

**Incometax expense** for the three months ended September 30,2009 totaled a benefit of $4.7 million as compared to an expense of $3.0million for the three months ended September 30, 2008.  Our effective tax rate for the currentquarter was 25.7% compared to 28.7% in the prior year quarter. The currenteffective tax rate, resulting in a tax benefit, was adversely affected byvaluation allowances against certain state and Canadian deferred tax assets.The prior period tax rate benefitted from a one time adjustment of $0.7 millionmade in the prior year quarter.

 

**Netincome (loss)** for the three months ended September 30,2009, was a loss of $13.6 million as compared to net income of $7.4 million inthe prior year comparable period.  Thisresulted in a net loss per diluted share of $0.47 in the current quarter andnet income per diluted share of $0.26 in the prior year quarter.

 

**Liquidityand Capital Resources**

 

At September 30,2009, we held cash and cash equivalents of $72.5 million.  Our principal sources of liquidity includecash and cash equivalents, cash flow from operations, the revolving line ofcredit, and borrowings.  The globaleconomy continues to be unsettled, and capital markets continue to be disruptedand volatile.  The cost and availabilityof funding has been and may continue to be adversely affected by illiquidcredit markets. Some lenders have reduced or, in some cases, ceased to providefunding to borrowers.  However, ourlenders have not

 

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indicated to usthat they would not continue to provide funding to us or not honor or be ableto 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 or ifthe assets used to determine the borrowing base availability fall below thetotal available credit under the facility. Continued turbulence in the financial markets could also adverselyaffect the cost and availability of financing to us in the future.

 

On May 29, 2009, the Company enteredinto a three-year, $40 million senior secured asset-based revolving creditfacility (“the “Facility”). The Facility provides revolving credit financing ofup to $40 million, subject to borrowing base availability, and includes anaccordion feature which, if exercised, would provide up to an additional $20million of financing.    At the Company’soption, revolving loans under the Agreement bear interest at an annual rate ofeither:

 

(a) LondonInterbank Offered rate (“LIBOR”) plus 3.25% to 4.25%, based on the averageavailability, or

(b) thehigher of (i) a prime rate, (ii) the federal funds effective rateplus 0.50%, or (iii) a LIBOR rate plus 1.00% plus, in each case, anadditional 2.25% to 3.25%, based on average availability.

 

The Facility is secured by all propertyowned, leased or operated by the Company in the United States excluding anyreal property owned by the Company and, at September 30, 2009, alsoexcluded any intellectual property owned by the Company unless availability wasless than or equal to $17.5 million.  TheFacility contains customary covenants which may limit the Company’s ability toincur debt; engage in mergers and consolidations; make restricted payments(including dividends); sell certain assets; and make investments. The Companymay make restricted payments (including dividends) as long as availabilityequals or exceeds the greater of (i) 25% of the aggregate commitment or (ii) $12million.  If the average monthlyavailability is less than the greater of (i) 15% of the aggregatecommitment and (ii) $9 million, the Company is also required to meet afixed charge coverage ratio financial covenant which may not be less than 1 to1 for any period of four consecutive fiscal quarters. The Facility alsocontains customary borrowing conditions and events of default, the occurrenceof which would entitle the lenders to accelerate the maturity of anyoutstanding borrowings and terminate their commitment to make future loans.

 

The Company has not drawn any cashadvances against the facility, and has no plans to do so.  At September 30, 2009, after excludingthe $12.5 million we had utilized in letters of credit, remaining availabilityunder the revolver totaled $27.5 million subject to limitations set forth inthe agreement noted above. We are in compliance with the terms and conditionsof the agreement and as a result, the coverage charge ratio, or otherrestricted payment limitations did not apply. As of September 30, 2009, we are in compliance with all covenantsof our credit facility.

 

On October 23, 2009, the Companyamended the revolving credit facility, increasing the line by $20 million, withtotal borrowing under the agreement (subject to borrowing base availability andlimitations set forth in the agreement noted above) of up to $60 million. Theamended facility is secured by all assets owned, leased or operated by theCompany in the United States including intellectual property, other than realestate owned by the Company.

 

In September 2005, we completed aprivate offering of $200.0 million in ten-year senior unsecured notes due 2015(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.  We haveused the net proceeds of $198.4 million to expand our retail network, invest inour manufacturing and logistics operations, and for other general corporatepurposes.

 

In June 2009, Moodys InvestorsService lowered our corporate and senior unsecured credit ratings to Ba1 fromBaa3, and Standard & Poor’s (“S&P”) lowered our corporate andsenior unsecured credit ratings to BB from BBB-. In November 2009 S&Plowered our corporate and senior unsecured credit ratings to B+. Both ratingservices

 

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pointed to the Company’s depressedoperating performance due to lower consumer spending and a tough retailenvironment as reasons for the downgrades. While the change in our credit rating had no impact on our existingcredit facilities, the S&P rating, if not improved to investment grade by March 2010,the issuer of our private label credit cards has a right to demand astandby letter of credit of up to $12 million, which would reduce availabilityunder the revolving credit agreement. It does not appear likely that theS&P rating will improve to investment grade prior to March 2010.  The Company believes it has sufficient cashand access to credit (including its ability to expand the $40 million creditfacility to $60 million) to fund operations and growth plans.

 

A summary of net cashprovided by (used in) operating, investing, and financing activities for thethree month periods ended September 30, 2009 and 2008 is provided below(in millions):

 
| ** **                                                 | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                 | ** ** | **September 30,** | ** ** |
| ** **                                                 | ** ** | **2009**               | ** ** | **2008** | ** ** |
| **Operating Activities**                                   |       |                   |       |   |   |
| Net income plus  depreciation and amortization             |       | $                      |  (0.9 | ) | $ |  13.7 |   |
| Working capital                                            |       | 22.1                   |       | 9.0 |   |
| Excess tax benefits from  share-based payment arrangements |       | —                 |       | — |   |
| Other (non-cash items,  long-term assets and liabilities)  |       | (4.2                   | )          | (4.6 | ) |
| Total provided by operating  activities                    |       | $                      |  17.0 |   | $ |  18.1 |   |
|                                                       |       |                   |       |   |   |
| **Investing Activities**                                   |       |                   |       |   |   |
| Capital expenditures                                       |       | $                      |  (2.5 | ) | $ |  (11.1 | ) |
| Acquisitions                                               |       | —                 |       | (0.4 | ) |
| Asset sales                                                |       | 5.9                    |       | 5.7 |   |
| Other                                                      |       | —                 |       | (0.2 | ) |
| Total provided by (used in)  investing activities          |       | $                      |  3.4  |   | $ |  (6.0 | ) |
|                                                       |       |                   |       |   |   |
| **Financing Activities**                                   |       |                   |       |   |   |
| Issuances of common stock                                  |       | —                 |       | — |   |
| Purchases of company stock                                 |       | —                 |       | — |   |
| Payment of dividends                                       |       | (1.5                   | )          | (6.3 | ) |
| Payment of deferred  financing costs                       |       | —                 |       | — |   |
| Excess tax benefits from  share-based payment arrangements |       | —                 |       | — |   |
| Total provided by (used in)  financing activities          |       | $                      |  (1.5 | ) | $ |  (6.3 | ) |

 

***OperatingActivities***

 

As compared to thesame period in fiscal year 2009, cash provided by operating activitiesdecreased $1.1 million mostly because of the $21.0 million decrease in netincome (partially offset by $6.6 million in depreciation charges due torestructuring activities).  Cash generatedfrom working capital (accounts receivable, inventories, prepaid and othercurrent assets, customer deposits, payables, accrued expenses, and othercurrent liabilities) increased cash by $13.1 million, largely from inventoryreduction initiatives taken, income tax refunds, and an increase in customer deposits, offset by decreases inaccrued expenses.  The $0.4 million incash generated from other items was largely a result of restructuring charges,partially offset by a net increase in deferred tax benefits.

 

***Investing Activities***

 

As compared to thesame period in fiscal year 2009, cash used in investing activities decreased$9.4 million during the three months ended September 30, 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.

 

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***Financing Activities***

 

As compared to thesame period in fiscal year 2009, cash used in financing activities decreased$4.8 million during the three months ended September 30, 2009, primarilyas a result of a decrease in dividend payments. The Company has continuously paid dividends every quarter since1996.  On July 21, 2009, the Boarddeclared a dividend of $0.05 per common share, payable on October 26,2009, to shareholders of record as of October 9, 2009.  If adverse economic conditions continue, theCompany may further reduce our quarterly dividends.

 

As of September 30,2009, our outstanding debt totaled $203.2 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 fiscal 2010, $3.9 million in fiscal 2011 and less than$0.1 million in fiscal 2012 and 2013. The balance of our long-term debt ($199.2 million) matures in fiscalyears 2014 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/A for the yearended June 30, 2009 as filed with the Securities and Exchange Commissionon August 27, 2009.

 

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 September 30, 2009, we had working capital of $133.8 millionand a current ratio of 2.1 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.

 

There were norepurchases during the three months ended September 30, 2009 and2008.  As of September 30, 2009, wehad a remaining Board authorization to repurchase 1,567,669 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 were entered into with a major bankinginstitution thereby mitigating the risk of credit loss. Upon issuance of theSenior Notes in September 2005, the related forward contracts weresettled. At the present time we have no current plans to engage in furtherhedging 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 our underlyingrelationship with the benefiting party and the business purpose for which theguarantee or obligation is being provided. Details of those arrangements forwhich we act as guarantor or obligor are provided below.

 

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**Retailer-Related Guarantees**

 

***IndependentRetailer Credit Facility***

 

On June 11,2009, we obligated ourselves, on behalf of one of our independent retailers,with respect to a $0.5 million credit facility (the “AmendedCredit Facility”). The Company had previously guaranteedon April 9, 2009, on behalf of the independent retailer, a $0.9 millioncredit facility (the “Credit Facility”). This obligation requires us, in the event of the retailer’s defaultunder the Amended Credit Facility, to repurchase the retailer’s inventory,applying such purchase price to the retailer’s outstanding indebtedness underthe Amended Credit Facility. Our obligation remains in effect for the life ofthe term loan.  The agreement expires in April 2011.  The maximum potential amount of futurepayments (undiscounted) that we could be required to make under this obligationis limited to the amount outstanding under the Amended Credit Facility at thetime of default (subject to pre-determined lending limits based on the value ofthe underlying inventory) and, as such, is not an estimate of future cashflows.  No specific recourse orcollateral provisions exist that would enable recovery of any portion ofamounts paid under this obligation, except to the extent that we maintain theright to take title to the repurchased inventory. We anticipate that therepurchased inventory could subsequently be sold through our retail designcenter network.

 

As of September 30, 2009, the amountoutstanding under the Amended Credit Facility totaled approximately $0.5million.  Based on the underlyingcreditworthiness of the respective retailer, we believe this obligation willexpire without requiring funding by us.  Ournon-contingent obligations under this arrangement as a result of modificationsmade to the Credit Facility subsequent to January 1, 2003 are notmaterial.

 

***Ethan Allen Consumer Credit Program***

 

The terms and conditionsof our consumer credit program, which is financed and administered by athird-party financial institution on a non-recourse basis to Ethan Allen, areset forth in an agreement between us and that financial service provider (the“Program Agreement”). Any independent retailer choosing to participate in theconsumer credit program is required to enter into a separate agreement withthat same third-party financial institution which sets forth the terms andconditions under which the retailer is to perform in connection with itsoffering of consumer credit to its customers (the “Retailer Agreement”). Wehave obligated ourselves on behalf of any independent retailer choosing toparticipate in our consumer credit program by agreeing, in the event ofdefault, breach, or failure of the independent retailer to perform under suchRetailer Agreement, to take on certain responsibilities of the independentretailer, including, but not limited to, delivery of goods and reimbursement ofcustomer deposits. Customer receivables originated by independent retailersremain non-recourse to Ethan Allen. Our obligation remains in effect for theterm of the Program Agreement which expires in July 2012. While themaximum potential amount of future payments (undiscounted) that we could berequired to make under this obligation is indeterminable, recourse provisionsexist that would enable us to recover, from the independent retailer, anyamount paid or incurred by us related to our performance. Based on theunderlying creditworthiness 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, includingour case goods, upholstery and home accents, generally carry explicit productwarranties that extend from one to ten years and are provided based on termsthat are generally accepted in the industry. All of our domestic independent retailers are required to enter into,and perform in accordance with the terms and conditions of, a warranty serviceagreement. We record provisions for estimated warranty and other related costsat time of sale based on historical warranty loss experience and make periodicadjustments to those provisions to reflect actual experience. On rare occasion,certain warranty and other related claims involve matters of dispute thatultimately are resolved by negotiation, arbitration or litigation.  In certain cases, a material warranty issue mayarise which is beyond the scope of our historical experience. We provide forsuch warranty issues as they become known and are deemed to be both probableand estimable. It is reasonably possible that, from time to

 

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time, additional warrantyand other related claims could arise from disputes or other matters beyond thescope of our historical experience. As of September 30 2009, our productwarranty liability totaled $0.9 million.

 

**BusinessOutlook**

 

Stresses in the U.S.economy from continued high unemployment, volatile capital markets, depressedhousing prices and tight consumer spending continue to have a negative impacton our business.  While we remainoptimistic about our long term outlook, current business conditions have onlymarginally improved in the quarter ended September 30, 2009.  We cannot predict, with any degree ofcertainty when these difficult economic conditions will improve meaningfully.

 

As macro-economic factorschange, 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 may also experience productiondifficulties as we consolidate manufacturing plants and convert our case goodsto custom.  We cannot reasonably predictwhen, or to what extent, such events may occur or what effect, if any, suchevents may have on our consolidated financial condition or results ofoperations.

 

The home furnishingsindustry remains extremely competitive with respect to both the sourcing ofproducts and the retail sale of those products. Domestic manufacturers continueto face pricing pressures as a result of the manufacturing capabilities andsignificant manufacturing capacities developed during recent years in othercountries, specifically within Asia. In response to these pressures, a largenumber of U.S. furniture manufacturers and retailers, including the Company,have increased their overseas sourcing activities in an attempt to maintain acompetitive advantage and retain market share. We continue to believe that abalanced approach to product sourcing, which includes the domestic manufactureof certain product offerings coupled with the import of other selectedproducts, provides the greatest degree of flexibility and is the most effectiveapproach to ensuring that acceptable levels of quality, service and value areattained.

 

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, we believethat our retail strategy, which involves (i) a continued focus onproviding a wide array of product solutions including custom upholstery and casegoods products and superior customer service coupled with state-of-the-arttechnology in our newly launched website, (ii) the opening of new orrelocated design centers in more prominent locations, while encouragingindependent retailers to do the same, and (iii) the development of a moreprofessional, team based structure within our retail network, provides anopportunity to grow our business when the current difficult economic conditionsimprove.

 

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

 

There have been nomaterial changes to the market risks disclosed in our Annual Report on Form 10-K/Afor the year ended June 30, 2009 as filed with the Securities and ExchangeCommission on August 27, 2009.

 

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**Item 4.Controls and Procedures**

 

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

 

Our management, including the Chairman of the Boardand Chief Executive Officer (“CEO”) and the Vice President-Finance (“VPF”),conducted an evaluation of the effectiveness of disclosure controls andprocedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on such evaluation, the CEO andVPF have concluded that, as of September 30, 2009, our disclosure controlsand procedures were effective in ensuring that material information relating tous (including our consolidated subsidiaries), which is required to be disclosedby us in our periodic reports filed or submitted under the Exchange Act is (i) recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms, and (ii) accumulated and communicated tomanagement, including the CEO and VPF, as appropriate, to allow timelydecisions regarding required disclosure.

 

**Changesin Internal Control over Financial Reporting**

 

There have been no changes in our internal controlover financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II- OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

There have been nomaterial changes to the matters discussed in Part I, Item 3 - *Legal Proceedings* in our Annual Report on Form 10-K/Afor the year ended June 30, 2009 as filed with the Securities and ExchangeCommission on August 27, 2009.

 

**Item 1A.Risk Factors**

 

There have been no material changes to the marketrisks disclosed in our Annual Report on Form 10-K/A for the year ended June 30,2009 as filed with the Securities and Exchange Commission on August 27,2009.

 

**Item 2. Unregistered Sales of Equity Securitiesand 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 September 30, 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.

 

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

 

Not applicable.

 

**Item 5.Other Information**

 

Not applicable.

 

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**Item 6.Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                              |
|---------------------|------------|----------------------------------------------------------------------------------------------|
| 10.(g) -3      |       | Amendment one dated   October 23, 2009 to Credit Agreement dated May 29, 2009 |
| 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:  November 9, 2009   | BY:                                                             | /s/ M. Farooq Kathwari |
|-------------------------------------|-----------------------------------------------------------------|------------------------|
|                                | Farooq Kathwari                                                 |
|                                | Chairman, President and  Chief Executive Officer                |
|                                | (Principal Executive  Officer)                                  |
|                                |                                                            |
|                                |                                                            |
| DATE:  November  9,, 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**                                                                            |
|---------------------|------------|----------------------------------------------------------------------------------------|
| 10.(g) -3      |       | Amendment one dated October 23, 2009 to Credit  Agreement dated May 29, 2009 |
| 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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