Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

** **

**(Mark One)**

** **

**x****  QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the quarterly period ended December 31,2009**

** **

**OR**

** **

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

** **

**For the transition period from              to              **

** **

**Commission File Number:  1-11692**

** **

**Ethan Allen Interiors Inc.**

(Exact name of registrantas 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’s telephonenumber, including area code)

 

**N/A**

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

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.   x Yes o No

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or such shorter period that the registrant was required tosubmit and post such files).   o Yes o No

 

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

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of 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 January 29, 2010,there were 28,916,929 shares of Class A Common Stock, par value $.01,outstanding.

 

 

 

----

Table of Contents

 

**TABLE OF CONTENTS**

 
| **Item**                                      | ** ** | ** **                                                                                                                                                                | ** ** | **Page** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                          |       |                                                                                                                                                                      |       |     |
| **Part I —  Financial Information** |
|                                          |       |                                                                                                                                                                      |       |     |
| 1.                                            |       | Financial Statements as of  December 31, 2009 (unaudited) and June 30, 2009 and for the three  and six months ended December 31, 2009 and 2008 (unaudited) |       |     |
|                                          |       |                                                                                                                                                                      |       |     |
|                                          |       | Consolidated  Balance Sheets                                                                                                                                              |       | 2        |
|                                          |       |                                                                                                                                                                      |       |     |
|                                          |       | Consolidated  Statements of Operations                                                                                                                                    |       | 3        |
|                                          |       |                                                                                                                                                                      |       |     |
|                                          |       | Consolidated  Statements of Cash Flows                                                                                                                                    |       | 4        |
|                                          |       |                                                                                                                                                                      |       |     |
|                                          |       | Consolidated  Statements of Shareholders’ Equity                                                                                                                     |       | 5        |
|                                          |       |                                                                                                                                                                      |       |     |
|                                          |       | Notes to Consolidated Financial Statements                                                                                                                                |       | 6        |
|                                          |       |                                                                                                                                                                      |       |     |
| 2.                                            |       | Management’s Discussion  and Analysis of Financial Condition and Results of Operations                                                                               |       | 25       |
|                                          |       |                                                                                                                                                                      |       |     |
| 3.                                            |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                               |       | 37       |
|                                          |       |                                                                                                                                                                      |       |     |
| 4.                                            |       | Controls and  Procedures                                                                                                                                                  |       | 37       |
|                                          |       |                                                                                                                                                                      |       |     |
| **Part II  - Other Information**         |
|                                          |       |                                                                                                                                                                      |       |     |
| 1.                                            |       | Legal Proceedings                                                                                                                                                         |       | 37       |
|                                          |       |                                                                                                                                                                      |       |     |
| 1A.                                           |       | Risk Factors                                                                                                                                                              |       | 37       |
|                                          |       |                                                                                                                                                                      |       |     |
| 2.                                            |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                              |       | 37       |
|                                          |       |                                                                                                                                                                      |       |     |
| 3.                                            |       | Defaults Upon  Senior Securities                                                                                                                                          |       | 38       |
|                                          |       |                                                                                                                                                                      |       |     |
| 4.                                            |       | Submission of  Matters to a Vote of Security Holders                                                                                                                      |       | 38       |
|                                          |       |                                                                                                                                                                      |       |     |
| 5.                                            |       | Other Information                                                                                                                                                         |       | 38       |
|                                          |       |                                                                                                                                                                      |       |     |
| 6.                                            |       | Exhibits                                                                                                                                                                  |       | 38       |
|                                          |       |                                                                                                                                                                      |       |     |
|                                          |       | Signatures                                                                                                                                                                |       | 39       |

 

1

----

Table of Contents

 

**PART I - FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Consolidated Balance Sheets**

(In thousands, except share data)

 
| ** **                                                                                                                                                                         | ** ** | **December 31,   2009** | ** ** | **June 30,********2009** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **(unaudited)**              | ** ** | ** **                    | ** ** |
| **ASSETS**                                                                                                                                                                         |       |                         |       |                          |       |
| Current  assets:                                                                                                                                                                   |       |                         |       |                          |       |
| Cash  and cash equivalents                                                                                                                                                         |       | $                            | 76,138     |                          | $          | 52,960 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,153 at  December 31, 2009 and $1,362 at June 30, 2009                                                   |       | 12,581                       |       | 13,086                        |       |
| Inventories  (note 4)                                                                                                                                                              |       | 141,991                      |       | 156,519                       |       |
| Prepaid  expenses and other current assets                                                                                                                                         |       | 10,536                       |       | 21,060                        |       |
| Deferred  income taxes                                                                                                                                                             |       | 14,899                       |       | 8,077                         |       |
| Total  current assets                                                                                                                                                              |       | 256,145                      |       | 251,702                       |       |
|                                                                                                                                                                               |       |                         |       |                          |       |
| Property,  plant and equipment, net                                                                                                                                                |       | 313,528                      |       | 333,599                       |       |
| Goodwill  and other intangible assets (notes 6 and 7)                                                                                                                              |       | 45,128                       |       | 45,128                        |       |
| Other  assets                                                                                                                                                                      |       | 17,669                       |       | 16,056                        |       |
| Total  assets                                                                                                                                                                      |       | $                            | 632,470    |                          | $          | 646,485 |   |
|                                                                                                                                                                               |       |                         |       |                          |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                      |       |                         |       |                          |       |
| Current  liabilities:                                                                                                                                                              |       |                         |       |                          |       |
| Current  maturities of long-term debt (note 8)                                                                                                                                     |       | $                            | 43         |                          | $          | 42 |   |
| Customer  deposits                                                                                                                                                                 |       | 36,573                       |       | 31,691                        |       |
| Accounts  payable                                                                                                                                                                  |       | 23,236                       |       | 22,199                        |       |
| Accrued  compensation and benefits                                                                                                                                                 |       | 30,151                       |       | 29,533                        |       |
| Accrued  expenses and other current liabilities (note 5)                                                                                                                           |       | 26,100                       |       | 28,998                        |       |
| Total  current liabilities                                                                                                                                                         |       | 116,103                      |       | 112,463                       |       |
|                                                                                                                                                                               |       |                         |       |                          |       |
| Long-term  debt (note 8)                                                                                                                                                           |       | 203,165                      |       | 203,106                       |       |
| Other  long-term liabilities                                                                                                                                                       |       | 25,323                       |       | 24,993                        |       |
| Total  liabilities                                                                                                                                                                 |       | 344,591                      |       | 340,562                       |       |
|                                                                                                                                                                               |       |                         |       |                          |       |
| Shareholders’  equity:                                                                                                                                                        |       |                         |       |                          |       |
| Class A  common stock, par value $.01, 150,000,000 shares authorized; 48,297,870 shares  issued at December 31, 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 December 31, 2009 and June 30, 2009                          |       | —                       |       | —                        |       |
| Preferred  stock, par value $.01, 1,055,000 shares authorized; no shares issued and  outstanding at December 31, 2009 and June 30, 2009                                  |       | —                       |       | —                        |       |
| Additional  paid-in capital                                                                                                                                                        |       | 357,521                      |       | 356,446                       |       |
|                                                                                                                                                                               |       | 358,004                      |       | 356,929                       |       |
| Less:  Treasury stock (at cost), 19,380,941 shares at December 31, 2009 and  19,380,941 shares at June 30, 2009                                                          |       | (583,220                     | )          | (583,220                      | )          |
| Retained  earnings                                                                                                                                                                 |       | 511,927                      |       | 531,747                       |       |
| Accumulated  other comprehensive income (note 12)                                                                                                                                  |       | 1,168                        |       | 467                           |       |
| Total  shareholders’ equity                                                                                                                                                   |       | 287,879                      |       | 305,923                       |       |
| Total  liabilities and shareholders’ equity                                                                                                                                   |       | $                            | 632,470    |                          | $          | 646,485 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

2

----

Table of Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Consolidated Statements ofOperations (Unaudited)**

**(In thousands, except per sharedata)**

 
| ** **                                                  | ** ** | **Three months ended****December 31****,** | ** ** | **Six months ended****December 31****,** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales                                                  |       | $                                               | 143,302    |                                          | $          | 189,558 |   | $ | 279,492 |   | $ | 395,399 |   |
| Cost of sales                                               |       | 74,278                                          |       | 87,757                                        |       | 152,159 |   | 181,657 |   |
| Gross profit                                                |       | 69,024                                          |       | 101,801                                       |       | 127,333 |   | 213,742 |   |
|                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Operating expenses:                                         |       |                                            |       |                                          |       |   |   |   |   |
| Selling                                                     |       | 33,801                                          |       | 48,721                                        |       | 67,406 |   | 104,023 |   |
| General and administrative                                  |       | 39,729                                          |       | 42,967                                        |       | 79,709 |   | 89,025 |   |
| Restructuring and impairment charge (credit), net  (note 5) |       | 777                                             |       | 26                                            |       | 1,589 |   | (1,604 | ) |
| Total operating expenses                                    |       | 74,307                                          |       | 91,714                                        |       | 148,704 |   | 191,444 |   |
|                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Operating income (loss)                                     |       | (5,283                                          | )          | 10,087                                        |       | (21,371 | ) | 22,298 |   |
| Interest and other miscellaneous income, net                |       | 1,020                                           |       | 1,113                                         |       | 1,817 |   | 2,213 |   |
| Interest and other related financing costs (note 8)         |       | 2,978                                           |       | 2,932                                         |       | 5,959 |   | 5,833 |   |
|                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss) before income taxes                           |       | (7,241                                          | )          | 8,268                                         |       | (25,513 | ) | 18,678 |   |
|                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Income tax expense (benefit) (note 3)                       |       | (3,903                                          | )          | 2,780                                         |       | (8,596 | ) | 5,768 |   |
|                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss)                                           |       | $                                               | (3,338     | )                                             | $          | 5,488 |   | $ | (16,917 | ) | $ | 12,910 |   |
|                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Per share data (note 11):                                   |       |                                            |       |                                          |       |   |   |   |   |
| Basic earnings per common share:                            |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss) per basic share                           |       | $                                               | (0.12      | )                                             | $          | 0.19 |   | $ | (0.58 | ) | $ | 0.45 |   |
| Basic weighted average common shares                        |       | 28,917                                          |       | 28,739                                        |       | 28,922 |   | 28,721 |   |
| Diluted earnings per common share:                          |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss) per diluted share                         |       | $                                               | (0.12      | )                                             | $          | 0.19 |   | $ | (0.58 | ) | $ | 0.45 |   |
| Diluted weighted average common shares                      |       | 28,917                                          |       | 28,739                                        |       | 28,922 |   | 28,793 |   |

 

See accompanying notes to consolidated financial statements.

 

3

----

Table of Contents

 

**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

**Consolidated Statements of CashFlows (Unaudited)**

(In thousands)

 
| ** **                                                                         | ** ** | **Six Months Ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **December  31,** | ** ** |
| ** **                                                                         | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Operating activities:                                                              |       |                   |       |   |   |
| Net income (loss)                                                                  |       | $                      | (16,917    | ) | $ | 12,910 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                   |       |   |   |
| Depreciation and amortization                                                      |       | 18,330                 |       | 12,808 |   |
| Compensation expense related to share-based awards                                 |       | 1,075                  |       | 984 |   |
| Provision (benefit) for deferred income taxes                                      |       | (8,967                 | )          | (3,819 | ) |
| Restructuring and impairment charge (benefit), net                                 |       | (161                   | )          | (3,854 | ) |
| Loss (gain) on disposal of property, plant and  equipment                          |       | (3                     | )          | 59 |   |
| Other                                                                              |       | 110                    |       | 102 |   |
| Change in assets and liabilities, net of the  effects of acquired businesses:      |       |                   |       |   |   |
| Accounts receivable                                                                |       | 505                    |       | 3,543 |   |
| Inventories                                                                        |       | 14,528                 |       | (740 | ) |
| Prepaid and other current assets                                                   |       | 7,969                  |       | 10,769 |   |
| Other assets                                                                       |       | 406                    |       | 97 |   |
| Customer deposits                                                                  |       | 4,882                  |       | (18,172 | ) |
| Accounts payable                                                                   |       | 1,037                  |       | 13 |   |
| Accrued expenses and other current liabilities                                     |       | (2,275                 | )          | 81 |   |
| Other long-term liabilities                                                        |       | 330                    |       | 926 |   |
| Net cash provided by operating activities                                          |       | 20,849                 |       | 15,707 |   |
|                                                                               |       |                   |       |   |   |
| Investing activities:                                                              |       |                   |       |   |   |
| Proceeds from the disposal of property,  plant & equipment                |       | 10,084                 |       | 5,745 |   |
| Capital expenditures                                                               |       | (5,315                 | )          | (16,146 | ) |
| Acquisitions                                                                       |       | —                 |       | (647 | ) |
| Other                                                                              |       | 19                     |       | (213 | ) |
| Net cash provided by (used in) investing activities                                |       | 4,788                  |       | (11,261 | ) |
|                                                                               |       |                   |       |   |   |
| Financing activities:                                                              |       |                   |       |   |   |
| Payments on long-term debt                                                         |       | (21                    | )          | (20 | ) |
| Proceeds from issuance of common stock                                             |       | —                 |       | 2 |   |
| Payment of deferred financing costs                                                |       | (193                   | )          | — |   |
| Payment of cash dividends                                                          |       | (2,897                 | )          | (13,525 | ) |
| Net cash used in financing activities                                              |       | (3,111                 | )          | (13,543 | ) |
| Effect of exchange rate changes on cash                                            |       | 652                    |       | (735 | ) |
| Net increase (decrease) in cash & cash  equivalents                       |       | 23,178                 |       | (9,832 | ) |
| Cash & cash equivalents - beginning of  period                            |       | 52,960                 |       | 74,376 |   |
| Cash & cash equivalents - end of period                                   |       | $                      | 76,138     |   | $ | 64,544 |   |

 

See accompanying notes to consolidated financial statements.

 

4

----

Table of Contents

 

**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

**Consolidated Statements ofShareholders’ Equity**

** Six months ended December 31,2009**

**(Unaudited)**

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

 
| ** **                                 | ** ** | **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) |       | —            |       | 1,075                               |       | —                |       | —                                           |       | —                   |       | 1,075     |       |
|                                       |       |              |       |                                |       |                  |       |                                             |       |                     |       |      |       |
| Dividends declared on common stock         |       | —            |       | —                              |       | —                |       | —                                           |       | (2,903                   | )          | (2,903    | )          |
|                                       |       |              |       |                                |       |                  |       |                                             |       |                     |       |      |       |
| Other comprehensive income (note 12):      |       |              |       |                                |       |                  |       |                                             |       |                     |       |      |       |
| Currency translation adjustments           |       | —            |       | —                              |       | —                |       | 677                                              |       | —                   |       | 677       |       |
| Hedge amortization, net of tax and other   |       | —            |       | —                              |       | —                |       | 24                                               |       | —                   |       | 24        |       |
| Net income (loss)                          |       | —            |       | —                              |       | —                |       | —                                           |       | (16,917                  | )          | (16,917   | )          |
| Total comprehensive income (loss)          |       |              |       |                                |       |                  |       |                                             |       |                     |       | (16,216   | )          |
|                                       |       |              |       |                                |       |                  |       |                                             |       |                     |       |      |       |
| Balance at December 31, 2009          |       | $                 | 483        |                                | $          | 357,521               |       | $                                                | (583,220   | )                        | $          | 1,168     |       | $ | 511,927 |   | $ | 287,879 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

5

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**(1)****       ****Basis of Presentation and RecentAccounting Pronouncements**

 

***Basisof Presentation***

 

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

 

We prepare ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States, which requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period.  Inpreparing these financial statements, the Company has evaluated events andtransactions subsequent to December 31, 2009 through February 5,2010, 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 intangibleassets, goodwill and indefinite-lived intangible asset impairment analyses, theevaluation of uncertain tax positions and the fair value of assets acquired andliabilities assumed in business combinations.

 

***RecentlyAdopted Accounting Pronouncements***

 

In June 2009, theFinancial Accounting Standards Board (“FASB”) issued guidance now codified asFASB Accounting Standards Codification (“ASC”) Topic 105, “Generally AcceptedAccounting Principles,” as the single source of authoritative nongovernmentalU.S. GAAP.  ASC Topic 105 does not changecurrent U.S. GAAP, but is intended to simplify user access to all authoritativeU.S. GAAP by providing all authoritative literature related to a particulartopic in one place. All existing accounting standard documents will besuperseded and all other accounting literature not included in the ASC will beconsidered non-authoritative. These provisions of ASC Topic 105 becameeffective for the Company in the first quarter of fiscal 2010. The adoption ofthis pronouncement did not have an impact on the Company’s financial conditionor results of operations, but will impact our financial reporting process byeliminating all references to pre-codification standards. On the effective dateof this Statement, the ASC superseded all then-existing non-SEC accounting andreporting standards, and all other non-grandfathered non-SEC accountingliterature not included in the ASC became non-authoritative. References to thepre-codification pronouncements are noted in 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 implementation of this pronouncement did not have a material impact on ourconsolidated financial position, results of operations or cash flows.

 

6

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

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, theFASB issued guidance now codified as ASC Topic 260, “Earnings Per Share” (EITF03-6). Under ASC Topic 260, unvested share-based payment awards that containrights to receive non-forfeitable dividends (whether paid or unpaid) areparticipating 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)****       ****Interim Financial Presentation**

 

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 and six months ended December 31, 2009are not 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)****       ****Income Taxes**

 

The Company reviews itsexpected annual effective income tax rates and makes changes on a quarterlybasis as necessary based on certain factors such as changes in forecastedannual operating income; changes to actual or forecasted permanent book to taxdifferences; impacts from future tax audits with state, federal or foreign taxauthorities; or impacts from tax law changes. The Company identifies items which are not normal and are nonrecurringin nature and treats these as discrete events. The tax effect of discrete itemsis recorded in the quarter in which the discrete events occur. Due to thevolatility of these factors, the Company’s consolidated effective income taxrate can change significantly on a quarterly basis.

 

We recognize the taxbenefit from an uncertain tax position only if it is more likely than not thatthe tax position will be sustained on examination by the taxing authorities, basedon the technical merits of the position. All of the unrecognized tax benefits, if recognized, would be recordedas a benefit to income tax expense. Our continuing practice is to recognizeinterest and penalties related to income tax matters as a component of incometax expense.

 

The Company’sconsolidated effective tax rate was 33.7% and 30.9% for the six months ended December 31,2009 and 2008, respectively. In the current quarter, the effective tax rate isprimarily related to the tax benefit on the current quarter loss. The taxbenefit is partially offset by the foreign valuation allowance on the Canadiannet operating losses, by state valuation allowance on certain state netoperating losses and by state income tax expense in states where the Company’ssubsidiaries file on a separate company basis. The prior period effective taxrate benefited from a one time adjustment of $0.7 million made in the firstquarter of fiscal 2009.

 

The Company conductsbusiness 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 

 

7

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

Company is subject toexamination by the taxing authorities in such major jurisdictions as Canada,Mexico and the U.S. As of December 31, 2009, certain subsidiaries of theCompany are currently under audit from 2001 through 2007 in the U.S. It isreasonably possible that some of these audits may be completed during the nexttwelve months. While the amount of uncertain tax benefits with respect to theentities and years under audit may change within the next twelve months, it isnot anticipated that any of the changes will be significant.

 

A valuation allowancemust be established for deferred tax assets when it is more likely than notthat they will not be realized. In prior periods, the Company established avaluation allowance for the state deferred tax assets and Canadian netoperating losses in its Retail segment. As of December 31, 2009, after consideringboth positive and negative evidence, management’s assessment is that avaluation allowance is not needed for the Company’s other deferred taxassets.  Due to the economic times andrecent losses, management will continue to assess the realizability of the taxassets based on actual and forecasted operating results on a quarterly basis,as required under ASC topic 740.  It ispossible during the current fiscal year, that the realization of tax assets isnot reasonably assured due to a of lack of available objective evidence.  Management would then record a valuationallowance against the tax assets which would result in a non-cash charge toearnings.

 

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

 

Inventoriesat December 31, 2009 and June 30, 2009 are summarized as follows (inthousands):

 
| ** **      | ** ** | **December 31,  2009** | ** ** | **June 30,  2009** | ** ** |
|-----------------|------------|-----------------------------|------------|-------------------------|------------|
|            |       |                        |       |                    |       |
| Finished goods  |       | $                           | 114,025    |                    | $          | 130,180 |   |
| Work in process |       | 7,290                       |       | 7,476                   |       |
| Raw materials   |       | 20,676                      |       | 18,863                  |       |
|            |       | $                           | 141,991    |                    | $          | 156,519 |   |

 

Inventories are presentednet of a related valuation allowance of $2.2 million at both December 31,2009 and June 30, 2009.

 

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

 

In recent years, we haveannounced and executed plans to consolidate our operations as part of anoverall strategy to maximize efficiencies and maintain our competitiveadvantage.

 

In fiscal 2009, theCompany consolidated several operations. Upholstery plants in Eldred,Pennsylvania and Chino, California were consolidated into the Maiden, NorthCarolina operations. Sawmill and dimension mill production in Andover, Mainewas transferred to the Beecher Falls, Vermont site.  All remaining case goods plants are beingconverted to produce custom case goods products. Wholesale distributionlocations, and several retail service centers were consolidated. For theseactions, the Company estimates pre-tax restructuring, impairment, accelerateddepreciation and other related charges will ultimately approximate $31 million($24 million wholesale, $7 million retail), consisting of an $18 million impactfrom long-lived assets, $8 million in employee severance and other payroll andbenefit costs, and $5 million in other associated costs.   In thecurrent fiscal year, total costs were $0.2 million of restructuring credits and$6.6 million in accelerated depreciation charges for Wholesale, and $1.3 millionof restructuring charges for the Retail segment. Cumulative charges to date forthese actions totaling $20.7 million have been classified in the Statement ofOperations as restructuring and impairment charges, and $6.6 million ofaccelerated depreciation was recorded in cost of sales.  Adjustments to the restructuring reserve inthe current period consist primarily of gains on the sale of equipment sold andadjustments on non-cancellable leases. The activity in the restructuring reserve related to these plans ispresented in the following table (in thousands) and is classified with accruedexpenses and other current liabilities in the Consolidated Balance Sheets.

 

8

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

Fiscal2009 plans:

 
| ** **                                                 | ** ** | **Three months ended  December 31, 2009** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                 | ** ** | **Balance at  September  30,****2009**         | ** ** | **New  charges  (credits)** | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance at  December 31,****2009** | ** ** |
| Employee severance and  other****payroll and benefit costs |       | $                                              | 2,556      |   | $ | 7 |   | $ | (1,968 | ) | $ | 43 |   | $ | 638 |   |
| Other associated costs                                     |       | 543                                            |       | 965 |   | (196 | ) | (48 | ) | 1,264 |   |
| Write down of  long-lived assets                           |       | —                                         |       | — |   | 427 |   | (427 | ) | — |   |
| ** **                                                 |       | $                                              | 3,099      |   | $ | 972 |   | $ | (1,737 | ) | $ | (432 | ) | $ | 1,902 |   |

 

Fiscal2009 plans:

 
| ** **                                                 | ** ** | **Six months ended  December 31, 2009** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                 | ** ** | **Balance at  June 30,****2009**        | ** ** | **New  charges  (credits)** | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance at  December 31,****2009** | ** ** |
| Employee severance and  other****payroll and benefit costs |       | $                                            | 3,864      |   | $ | 103 |   | $ | (3,372 | ) | $ | 43 |   | $ | 638 |   |
| Other associated costs                                     |       | 654                                          |       | 1,377 |   | (719 | ) | (48 | ) | 1,264 |   |
| Write down of  long-lived assets                           |       | —                                       |       | 54 |   | 373 |   | (427 | ) | — |   |
| ** **                                                 |       | $                                            | 4,518      |   | $ | 1,534 |   | $ | (3,718 | ) | $ | (432 | ) | $ | 1,902 |   |

 

In fiscal 2008, we announceda plan to consolidate the operations of certain Ethan Allen-operated retaildesign centers and retail service centers. In connection with this initiative,we permanently ceased operations at ten design centers and six retail servicecenters which, for the most part, were consolidated into other existingoperations.  Costs for these actions inthe current fiscal year totaled $0.5 million, all for the Retail segment, dueto non-cancellable lease adjustments and net losses on the sale of real estate.Cumulative charges to date for these actions total $6.0 million, all of whichhave been classified in the Statement of Operations as restructuring andimpairment charges of the Retail segment.

 

Activity in the Company’srestructuring reserves related to these plans is summarized in the table below(in thousands) and is classified with accrued expenses and other currentliabilities in the Consolidated Balance Sheets:

 

Fiscal2008 plans:

 
| ** **                                                 | ** ** | **Three months ended  December 31, 2009** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                 | ** ** | **Balance at  September  30,****2009**         | ** ** | **New  charges  (credits)** | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance at  December 31,****2009** | ** ** |
| Employee severance and  other****payroll and benefit costs |       | $                                              | 359        |   | $ | — |   | $ | (10 | ) | $ | — |   | $ | 349 |   |
| Other associated costs                                     |       | 2,577                                          |       | 68 |   | (353 | ) | 170 |   | 2,462 |   |
| ** **                                                 |       | $                                              | 2,936      |   | $ | 68 |   | $ | (363 | ) | $ | 170 |   | $ | 2,811 |   |

 

9

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

Fiscal2008 plans:

 
| ** **                                                 | ** ** | **Six months ended  December 31, 2009** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                 | ** ** | **Balance at  June 30,****2009**        | ** ** | **New  charges  (credits)** | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance at  December 31,****2009** | ** ** |
| Employee severance and  other****payroll and benefit costs |       | $                                            | 369        |   | $ | — |   | $ | (20 | ) | $ | — |   | $ | 349 |   |
| Other associated costs                                     |       | 2,892                                        |       | 68 |   | (706 | ) | 208 |   | 2,462 |   |
| Write down of  long-lived assets                           |       | —                                       |       | — |   | (212 | ) | 212 |   | — |   |
| ** **                                                 |       | $                                            | 3,261      |   | $ | 68 |   | $ | (938 | ) | $ | 420 |   | $ | 2,811 |   |

 

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

 

There were noacquisitions completed during the six months ended December 31, 2009.

 

In October 2008, weacquired, in a single transaction, one Ethan Allen retail design center from anindependent retailer for consideration of approximately $0.3 million of cashand forgiveness of receivables.  As aresult of this acquisition, we recorded additional inventory of $0.2 millionand goodwill of $0.1 million.  In August 2008,we acquired 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.

 

A summary of ourallocation of purchase price accounting for acquisitions during the three andsix months ended December 31, 2008 is provided below (in thousands).

 
| ** **                                              | ** ** | **Three  months ended  December 31, 2008** | ** ** | **Six  months ended  December 31, 2008** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| Business segment                                        |       | Retail                                          |       | Retail                                        |       |
| Total consideration                                     |       | $                                               | 344        |                                          | $          | 911 |   |
| Fair value of assets acquired and liabilities  assumed: |       |                                            |       |                                          |       |
| Inventory                                               |       | 157                                             |       | 826                                           |       |
| PP&E and other assets                               |       | 11                                              |       | 60                                            |       |
| Customer deposits                                       |       | 94                                              |       | (561                                          | )          |
| A/P and other liabilities                               |       | 14                                              |       | (186                                          | )          |
| Goodwill                                                |       | $                                               | 68         |                                          | $          | 772 |   |

 

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

 

At both December 31, 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 theWholesale segment.  The indefinite-livedintangible assets represent Ethan Allen trade names.  The Company previously had goodwill in theRetail segment, all of which was considered impaired and written off during thethird quarter of fiscal 2009.

 

10

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

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.

 

In fiscal 2010, the Company concluded forthe first and second quarters that no interim impairment test wasrequired.  During the six months ended December 31,2009, although business performance was slightly below management’sexpectations, our sales, gross profit, operating income, net income and otherindicators improved from the previous quarter, and our long-term outlook hasnot changed.  The Company’s averagequarterly stock price increased 12% (from $12.11 for the quarter ended June 30,2009, to $13.53 for the quarter ended December 31, 2009), and cashbalances increased to $76.1 million at December 31, 2009 from $53.0million at June 30, 2009.

 

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 impact of market conditions on those assumptions.  Future events and changing market conditionsmay impact our assumptions as to prices, costs or other factors that may resultin changes in our estimates of future cash flows.  Although we believe the assumptions we use intesting for impairment are reasonable, significant changes in any of ourassumptions could produce a significantly different result.

 

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

 

Total debt obligations at December 31, 2009 and June 30, 2009consist of the following (in thousands):

 
| ** **                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2009**              | ** ** | **2009**          | ** ** |
| 5.375% Senior Notes due  2015 |       | $                     | 199,078    |              | $          | 198,997 |   |
| Industrial revenue bonds      |       | 3,855                 |       | 3,855             |       |
| Other debt                    |       | 275                   |       | 296               |       |
| Total debt                    |       | 203,208               |       | 203,148           |       |
| Less current maturities       |       | 43                    |       | 42                |       |
| Total long-term debt          |       | $                     | 203,165    |              | $          | 203,106 |   |

 

11

----

Table ofContents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

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 October 23, 2009, the Company expandedto $60 million the three-year senior secured asset-based revolving creditfacility (the “Facility”) established on May 29, 2009.  The Facility provides revolving creditfinancing of up to $60 million, subject to borrowing base availability.  At the Company’s option, revolving loansunder the Agreement bear interest at an annual rate of either:

 

(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 December 31, 2009, we had norevolving loans, and $12.5 million in trade and standby letters of creditoutstanding under the Facility. Remaining availability under the revolvertotaled $47.5 million subject to limitations set forth in the agreement notedabove. We are in compliance with the terms and conditions of the agreement andas a result, the coverage charge ratio, or other restricted payment limitationsdid not apply.  As of December 31,2009, we are in compliance with all covenants of our credit facility.

 

**(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.

 

12

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. ANDSUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

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

 

We are subject to other federal, stateand local environmental protection laws and regulations and are involved, fromtime to time, in investigations and proceedings regarding environmentalmatters.  Such investigations 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 implementing newwaste minimization programs and/or enhancing existing programs with theobjective of (i) reducing the total 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-Based Compensation**

 

On October 10, 2007,the Company’s Board of Directors and M. Farooq Kathwari, our Chairman,President and Chief Executive Officer, 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 with theAgreement, Mr. Kathwari received an award of 20,000 restricted shares withvesting based on continuing service and the performance of the Company’s stockprice during the 32 month period subsequent to the award date as compared tothe Standard and Poor’s 500 index.  On July 1,2008, an additional award of 20,000 restricted shares with the same vestingconditions (over a 36 month period) was granted.  Mr. Kathwari received, as 

 

13

----

Table of Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

per the Agreement, anadditional grant of 20,000 restricted shares on July 1, 2009 with the same36 month vesting, continuing service and performance conditions.

 

Also in connection withthe Agreement, Mr. Kathwari received on November 13, 2007 an award of15,000 restricted shares.  These sharesare service-based with 3,000 shares vesting on June 30 for each of theyears 2008 through 2012.

 

On November 12,2009, the Company awarded options to purchase 83,500 shares of our common stockto a large group of associates at the closing stock price on the grant date of$11.74.  These grants vest in four equalannual installments on the anniversary date of the grant.

 

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

 

Basic and diluted earnings per share are calculated using the followingweighted average share data (in thousands):

 
| ** **                                                                    | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                    | ** ** | **December 31,**   | ** ** | **December 31,** | ** ** |
| ** **                                                                    | ** ** | **2009**                | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Weighted average  common shares outstanding for basic calculation             |       | 28,917                  |       | 28,739                |       | 28,922 |   | 28,721 |   |
| Effect of  dilutive stock options and other share-based awards                |       | —                  |       | —                |       | — |   | 72 |   |
| Weighted average  common shares outstanding adjusted for dilution calculation |       | 28,917                  |       | 28,739                |       | 28,922 |   | 28,793 |   |

 

As of December 31,2009 and 2008, stock options to purchase 2,251,389 and 2,287,725 common shares,respectively, were excluded from the respective diluted earnings per sharecalculation because their impact was anti-dilutive.

 

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

 

Total comprehensive income represents the sum of net income and itemsof “other comprehensive income 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 $1.2 million at December 31,2009 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)****    ****Financial Instruments**

 

ACS Topic 820, *“Fair value measurementsand disclosures”* (SFAS No. 157) defines fair value as the pricethat would be received upon sale of an asset or paid upon transfer of aliability in an orderly transaction between market participants at themeasurement date and in the principal or most advantageous market for thatasset or liability. The fair value should be calculated based on assumptionsthat market participants would use in pricing the asset or 

 

14

----

Tableof Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

liability, not onassumptions specific to the entity. In addition, the fair value of liabilitiesshould include consideration of non-performance risk including our own creditrisk.

 

In addition todefining fair value, ASC Topic 820 expands the disclosure requirements aroundfair value and establishes a fair value hierarchy for valuation inputs. Thehierarchy prioritizes the inputs into three levels based on the extent to whichinputs used in measuring fair value are observable in the market. Eachfair value measurement is reported in one of the three levels which isdetermined by the lowest level input that is significant to the fair valuemeasurement in its entirety. These levels are:

 

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

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

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

 

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

 

The Companypartially adopted ASC Topic 820 on July 1, 2008 due to the fact that aportion 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 (at leastannually).  On July 1, 2009, theCompany adopted the deferred portion of ACS Topic 820.  There was no impact to the Company’sfinancial position or results of operations resulting from the adoption of thedeferred portion of ACS Topic 820.  TheCompany has now fully adopted ASC Topic 820.

 

***CashEquivalents***

 

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

 

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

 

At December 31,2009, the Company’s assets and liabilities measured at fair value on arecurring basis consist of $70.0 million in cash equivalents, which were valuedusing Level 1 inputs.

 

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

 

We measure certainassets, including our cost and equity method investments, at fair value on anonrecurring basis. These assets are recognized at fair value when they aredeemed to be other-than-temporarily impaired. During the six months ended December 31,2009, we did not record any other-than-temporary impairments on those assetsrequired to be measured at fair value on a nonrecurring basis.

 

15

----

Tableof Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

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

 

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

 

The wholesale segment isprincipally involved in the development of the Ethan Allen brand, whichencompasses the design, manufacture, domestic and offshore sourcing, sale anddistribution of a full range of home furnishings and accessories to a networkof independently owned and Ethan Allen owned design centers as well as relatedmarketing 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 Ethan Allen.  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 segment sellshome furnishings and accessories to consumers through a network of Companyowned design centers.  Retail revenue isgenerated upon the retail sale and delivery of our product to our customers.  Retail profitability includes (i) theretail gross margin, which represents the difference between the retail salesprice and the cost of goods purchased from the wholesale segment, and (ii) otheroperating 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 evaluate performanceof the respective segments based upon revenues and operating income. While themanner in which our home furnishings and accessories are marketed and sold isconsistent, the nature of the underlying recorded sales (i.e. wholesale versusretail) and the specific services that each operating segment provides (i.e.wholesale manufacturing, sourcing, and distribution versus retail selling) aredifferent.  Within the wholesale segment,we maintain revenue information according to each respective product line (i.e.case goods, upholstery, or home accessories and other).

 

A breakdown of wholesalesales by these product lines for the three and six months ended December 31,2009 and 2008 is provided as follows:

 
| ** **                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**  | ** ** |
|----------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **December 31,**  | ** ** | **December 31,** | ** ** |
| ** **                 | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Case Goods                 |       | 42                     | %          | 42                    | %          | 41 | % | 42 | % |
| Upholstered Products       |       | 44                     |       | 40                    |       | 44 |   | 41 |   |
| Home Accessories and Other |       | 14                     |       | 18                    |       | 15 |   | 17 |   |
|                       |       | 100                    | %          | 100                   | %          | 100 | % | 100 | % |

 

Revenue information byproduct line is not as easily determined within the retail segment. However,because wholesale production and sales are matched, for the most part, toincoming orders, we believe that the allocation of retail sales by product linewould be similar to that of the wholesale segment.

 

16

----

Tableof Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

Segmentinformation for the three and six months ended December 31, 2009 and 2008is set forth as follows:

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**  | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **December 31,**  | ** ** | **December 31,** | ** ** |
| ** **                              | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Net sales:**                          |       |                   |       |                  |       |   |   |   |   |
| Wholesale segment                       |       | $                      | 84,499     |                  | $          | 108,848 |   | $ | 165,780 |   | $ | 230,143 |   |
| Retail segment                          |       | 107,123                |       | 147,183               |       | 210,273 |   | 303,053 |   |
| Elimination of  inter-company sales     |       | (48,320                | )          | (66,473               | )          | (96,561 | ) | (137,797 | ) |
| Consolidated Total                      |       | $                      | 143,302    |                  | $          | 189,558 |   | $ | 279,492 |   | $ | 395,399 |   |
|                                    |       |                   |       |                  |       |   |   |   |   |
| **Operating income (loss):**            |       |                   |       |                  |       |   |   |   |   |
| Wholesale segment (1)(2)                |       | $                      | 1,022      |                  | $          | 8,580 |   | $ | (3,638 | ) | $ | 20,465 |   |
| Retail segment (3)(4)                   |       | (9,792                 | )          | (3,185                | )          | (21,141 | ) | (6,237 | ) |
| Adjustment of inter-company  profit (5) |       | 3,487                  |       | 4,692                 |       | 3,408 |   | 8,070 |   |
| Consolidated Total                      |       | $                      | (5,283     | )                     | $          | 10,087 |   | $ | (21,371 | ) | $ | 22,298 |   |
|                                    |       |                   |       |                  |       |   |   |   |   |
| **Capital expenditures:**               |       |                   |       |                  |       |   |   |   |   |
| Wholesale segment                       |       | $                      | 835        |                  | $          | 682 |   | $ | 1,636 |   | $ | 2,314 |   |
| Retail segment                          |       | 1,992                  |       | 4,371                 |       | 3,679 |   | 13,832 |   |
| Acquisitions (6)(7)                     |       | —                 |       | 272                   |       | — |   | 647 |   |
| Consolidated Total                      |       | $                      | 2,827      |                  | $          | 5,325 |   | $ | 5,315 |   | $ | 16,793 |   |

 
| ** **                       | ** ** | **December 31,** | ** ** | **June 30,** | ** ** | ** ** | ** ** |
|----------------------------------|------------|-----------------------|------------|-------------------|------------|------------|------------|
| ** **                       | ** ** | **2009**              | ** ** | **2009**          | ** ** | ** ** | ** ** |
| **Total assets**                 |       |                  |       |              |       |       |       |
| Wholesale segment                |       | $                     | 273,045    |              | $          | 276,250    |       |   |   |
| Retail segment                   |       | 383,676               |       | 397,877           |       |       |       |
| Inventory profit elimination (8) |       | (24,251               | )          | (27,642           | )          |       |       |
| Consolidated Total               |       | $                     | 632,470    |              | $          | 646,485    |       |   |   |

 

----

(1)     Operating income (loss) for the wholesale segment forthe three months ended December 31, 2009 includes a pre-tax restructuringand impairment net recovery of $0.4 million.

(2)     Operating income (loss) for the wholesale segment forthe six months ended December 31, 2009 and 2008 include a pre-taxrestructuring and impairment net recovery of $0.2 million and charges of $0.4million, respectively.

(3)     Operating income (loss) for the retail segment for thethree months ended December 31, 2009 includes pre-tax restructuring andimpairment charges of $1.2 million.

(4)     Operating income (loss) for the retail segment for thesix months ended December 31, 2009 and 2008 include pre-tax restructuringand impairment charges of $1.8 million and a net recovery of $2.0 million,respectively.

(5)     Represents the change in the inventory profitelimination necessary to adjust for the embedded wholesale profit contained inEthan Allen-owned design center inventory existing at the end of the period.

(6)     Acquisitions for the three months ended December 31,2008 include the purchase of one retail design center.

(7)     Acquisitions for the six months ended December 31,2008 include the purchase of three retail design centers.

(8)     Represents the wholesale profit contained in EthanAllen-owned design center inventory that has not yet been realized. Theseprofits are realized when the related inventory is sold.

 

There were 50 independentretail design centers located outside the United States at December 31,2009. Less than five percent of our net sales were derived from sales to thoseretail design centers.

 

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

 

***EthanAllen declares quarterly cash dividend***

 

Ethan Allen’s Board ofDirectors has declared a quarterly cash dividend of $0.05 per share, which willbe payable to shareholders of record as of April 9, 2010 and paid on April 26,2010.

 

17

----

Tableof Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

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

 

In June 2009, theFASB released additional guidance on ASC Topic 810, “Consolidation” (SFAS No. 167)which will revise previous guidance applicable to variable interest entities (“VIEs”).The new guidance will require ongoing assessments of whether an enterprise isthe primary beneficiary of a VIE, as opposed to reconsideration only whenspecific events occurred, as under present rules. The new guidance will alsoreplace the quantitative approach previously required for determining theprimary beneficiary of a VIE with a qualitative approach, and changes somedisclosure requirements. This revised guidance is effective for fiscalyears beginning after November 15, 2009 (July 1, 1010 for theCompany).  The Company is currentlyevaluating the impact, if any, on our financial statements and results ofoperations.

 

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

 

On September 27,2005, Global (the “Issuer”) issued $200 million aggregate principal amount ofSenior Notes which have been guaranteed on a senior basis by Interiors (the “Parent”),and other wholly owned domestic subsidiaries of the Issuer and the Parent,including Ethan Allen Retail, Inc., Ethan Allen Operations, Inc.,Ethan Allen Realty, LLC, Lake Avenue Associates, Inc. and Manor House, Inc.The subsidiary guarantors (other than the Parent) are collectively called the “Guarantors”.  The guarantees of the Guarantors areunsecured.  All of the guarantees arefull, unconditional and joint and several and the Issuer and each of theGuarantors are 100% owned by the Parent. Ethan Allen (UK) Ltd. (which waslegally dissolved in October 2009), and our other subsidiaries which arenot guarantors are called the “Non-Guarantors”. During the quarter ended December 31,2008, we determined that our international subsidiaries in Canada and Mexicoare non-guarantors. The Company has reclassified, for all prior periodspresented, the financial results of these international subsidiaries to reflecttheir non-guarantor status.

 

The following tables setforth the condensed consolidating balance sheets as of December 31, 2009and June 30, 2009, the condensed consolidating statements of operationsfor the three and six months ended December 31, 2009 and 2008, and thecondensed consolidating statements of cash flows for the six months ended December 31,2009 and 2008 of the Parent, the Issuer, the Guarantors and the Non-Guarantors.

 

18

----

Tableof Contents

 

**ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

(In thousands)

**December 31,2009**

 
| ** **                                      | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                      |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current assets:                                 |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents                       |       | $          | —     |       | $          | 72,802         |       | $                  | 2,125      |             | $          | 1,211            |       | $ | — |   | $ | 76,138 |   |
| Accounts receivable, net                        |       | —     |       | 12,002     |       | 324            |       | 255                |       | —           |       | 12,581           |       |
| Inventories                                     |       | —     |       | —     |       | 161,489        |       | 4,753              |       | (24,251          | )          | 141,991          |       |
| Prepaid expenses and other current assets       |       | —     |       | 19,580     |       | 5,220          |       | 635                |       | —           |       | 25,435           |       |
| Intercompany                                    |       | —     |       | 781,359    |       | 228,088        |       | (3,663             | )          | (1,005,784       | )          | —           |       |
| Total current assets                            |       | —     |       | 885,743    |       | 397,246        |       | 3,191              |       | (1,030,035       | )          | 256,145          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Property, plant and equipment, net              |       | —     |       | 6,667      |       | 301,352        |       | 5,509              |       | —           |       | 313,528          |       |
| Goodwill and other intangible assets            |       | —     |       | 19,740     |       | 25,388         |       | —             |       | —           |       | 45,128           |       |
| Other assets                                    |       | —     |       | 16,972     |       | 693            |       | 4                  |       | —           |       | 17,669           |       |
| Investment in affiliated companies              |       | 597,334    |       | (53,551    | )          | —         |       | —             |       | (543,783         | )          | —           |       |
| Total assets                                    |       | $          | 597,334    |       | $          | 875,571        |       | $                  | 724,679    |             | $          | 8,704            |       | $ | (1,573,818 | ) | $ | 632,470 |   |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| **Liabilities and Shareholders’  Equity**  |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current liabilities:                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Current maturities of long-term debt            |       | $          | —     |       | $          | —         |       | $                  | 43         |             | $          | —           |       | $ | — |   | $ | 43 |   |
| Customer deposits                               |       | —     |       | —     |       | 34,783         |       | 1,790              |       | —           |       | 36,573           |       |
| Accounts payable                                |       | —     |       | 8,143      |       | 14,773         |       | 320                |       | —           |       | 23,236           |       |
| Accrued expenses and other current liabilities  |       | 1,568      |       | 36,599     |       | 17,808         |       | 276                |       | —           |       | 56,251           |       |
| Intercompany                                    |       | 307,887    |       | 597        |       | 691,982        |       | 5,318              |       | (1,005,784       | )          | —           |       |
| Total current liabilities                       |       | 309,455    |       | 45,339     |       | 759,389        |       | 7,704              |       | (1,005,784       | )          | 116,103          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Long-term debt                                  |       | —     |       | 199,078    |       | 4,087          |       | —             |       | —           |       | 203,165          |       |
| Other long-term liabilities                     |       | —     |       | 10,455     |       | 14,729         |       | 139                |       | —           |       | 25,323           |       |
| Deferred income taxes                           |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Total liabilities                               |       | 309,455    |       | 254,872    |       | 778,205        |       | 7,843              |       | (1,005,784       | )          | 344,591          |       |
|                                            |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Shareholders’ equity                       |       | 287,879    |       | 620,699    |       | (53,526        | )          | 861                |       | (568,034         | )          | 287,879          |       |
| Total liabilities and shareholders’ equity |       | $          | 597,334    |       | $          | 875,571        |       | $                  | 724,679    |             | $          | 8,704            |       | $ | (1,573,818 | ) | $ | 632,470 |   |

 

19

----

Table of Contents

 

**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 |   |

 

20

----

Tableof Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

(In thousands)

**Three months ended December 31, 2009**

 
| ** **                                        | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                         |       | $          | —     |       | $          | 84,465         |       | $                  | 144,000    |             | $          | 5,527            |       | $ | (90,690 | ) | $ | 143,302 |   |
| Cost of sales                                     |       | —     |       | 69,012     |       | 96,688         |       | 2,821              |       | (94,243          | )          | 74,278           |       |
| Gross profit                                      |       | —     |       | 15,453     |       | 47,312         |       | 2,706              |       | 3,553            |       | 69,024           |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general and administrative expenses      |       | 42         |       | 10,738     |       | 60,189         |       | 2,561              |       | —           |       | 73,530           |       |
| Restructuring and impairment charge, (credit) net |       | —     |       | —     |       | 777            |       | —             |       | —           |       | 777              |       |
| Total operating expenses                          |       | 42         |       | 10,738     |       | 60,966         |       | 2,561              |       | —           |       | 74,307           |       |
| Operating income (loss)                           |       | (42        | )          | 4,715      |       | (13,654        | )          | 145                |       | 3,553            |       | (5,283           | )          |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and other miscellaneous income, net      |       | (3,296     | )          | (12,550    | )          | 16             |       | 9                  |       | 16,841           |       | 1,020            |       |
| Interest and other related financing costs        |       | —     |       | 2,902      |       | 76             |       | —             |       | —           |       | 2,978            |       |
| Income (loss) before income tax expense           |       | (3,338     | )          | (10,737    | )          | (13,714        | )          | 154                |       | 20,394           |       | (7,241           | )          |
| Income tax expense                                |       | —     |       | (3,903     | )          | —         |       | —             |       | —           |       | (3,903           | )          |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income (loss)                                 |       | $          | (3,338     | )          | $          | (6,834         | )          | $                  | (13,714    | )                | $          | 154              |       | $ | 20,394 |   | $ | (3,338 | ) |

 

**Three Months Ended December 31, 2008**

** **
| ** **                                        | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                         |       | $          | —     |       | $          | 109,126        |       | $                  | 194,648    |             | $          | 5,981            |       | $ | (120,197 | ) | $ | 189,558 |   |
| Cost of sales                                     |       | —     |       | 80,998     |       | 128,343        |       | 3,469              |       | (125,053         | )          | 87,757           |       |
| Gross profit                                      |       | —     |       | 28,128     |       | 66,305         |       | 2,512              |       | 4,856            |       | 101,801          |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general and administrative expenses      |       | 42         |       | 11,644     |       | 77,394         |       | 2,608              |       | —           |       | 91,688           |       |
| Restructuring and impairment charge, (credit) net |       | —     |       | —     |       | 26             |       | —             |       | —           |       | 26               |       |
| Total operating expenses                          |       | 42         |       | 11,644     |       | 77,420         |       | 2,608              |       | —           |       | 91,714           |       |
| Operating income (loss)                           |       | (42        | )          | 16,484     |       | (11,115        | )          | (96                | )          | 4,856            |       | 10,087           |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and other miscellaneous income, net      |       | 5,530      |       | (10,157    | )          | 6              |       | (2                 | )          | 5,736            |       | 1,113            |       |
| Interest and other related financing costs        |       | —     |       | 2,856      |       | 76             |       | —             |       | —           |       | 2,932            |       |
| Income before income tax expense                  |       | 5,488      |       | 3,471      |       | (11,185        | )          | (98                | )          | 10,592           |       | 8,268            |       |
| Income tax expense                                |       | —     |       | 2,780      |       | —         |       | —             |       | —           |       | 2,780            |       |
|                                              |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income (loss)                                 |       | $          | 5,488      |       | $          | 691            |       | $                  | (11,185    | )                | $          | (98              | )          | $ | 10,592 |   | $ | 5,488 |   |

 

21

----

Table of Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

(In thousands)

**Six Months Ended December 31, 2009**

 
| ** **                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                    |       | $          | —     |       | $          | 165,875        |       | $                  | 280,996    |             | $          | 10,426           |       | $ | (177,805 | ) | $ | 279,492 |   |
| Cost of sales                                |       | —     |       | 135,973    |       | 191,888        |       | 5,524              |       | (181,226         | )          | 152,159          |       |
| Gross profit                                 |       | —     |       | 29,902     |       | 89,108         |       | 4,902              |       | 3,421            |       | 127,333          |       |
|                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general and administrative expenses |       | 83         |       | 21,770     |       | 120,162        |       | 5,100              |       | —           |       | 147,115          |       |
| Restructuring and impairment charge, net     |       | —     |       | —     |       | 1,589          |       | —             |       | —           |       | 1,589            |       |
| Total operating expenses                     |       | 83         |       | 21,770     |       | 121,751        |       | 5,100              |       | —           |       | 148,704          |       |
| Operating income (loss)                      |       | (83        | )          | 8,132      |       | (32,643        | )          | (198               | )          | 3,421            |       | (21,371          | )          |
|                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and other miscellaneous income, net |       | (16,834    | )          | (31,146    | )          | 49             |       | 9                  |       | 49,739           |       | 1,817            |       |
| Interest and other related financing costs   |       | —     |       | 5,807      |       | 152            |       | —             |       | —           |       | 5,959            |       |
| Income before income tax expense             |       | (16,917    | )          | (28,821    | )          | (32,746        | )          | (189               | )          | 53,160           |       | (25,513          | )          |
| Income tax expense                           |       | —     |       | (8,596     | )          | —         |       | —             |       | —           |       | (8,596           | )          |
|                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income (loss)                            |       | $          | (16,917    | )          | $          | (20,225        | )          | $                  | (32,746    | )                | $          | (189             | )          | $ | 53,160 |   | $ | (16,917 | ) |

 

**Six Months Ended December 31, 2008**

** **
| ** **                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net sales                                    |       | $          | —     |       | $          | 230,722        |       | $                  | 403,448    |             | $          | 12,061           |       | $ | (250,832 | ) | $ | 395,399 |   |
| Cost of sales                                |       | —     |       | 169,403    |       | 264,737        |       | 6,741              |       | (259,224         | )          | 181,657          |       |
| Gross profit                                 |       | —     |       | 61,319     |       | 138,711        |       | 5,320              |       | 8,392            |       | 213,742          |       |
|                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Selling, general and administrative expenses |       | 83         |       | 24,935     |       | 162,380        |       | 5,650              |       | —           |       | 193,048          |       |
| Restructuring and impairment charge, net     |       | —     |       | —     |       | (1,604         | )          | —             |       | —           |       | (1,604           | )          |
| Total operating expenses                     |       | 83         |       | 24,935     |       | 160,776        |       | 5,650              |       | —           |       | 191,444          |       |
| Operating income (loss)                      |       | (83        | )          | 36,384     |       | (22,065        | )          | (330               | )          | 8,392            |       | 22,298           |       |
|                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Interest and other miscellaneous income, net |       | 12,993     |       | (20,293    | )          | 8              |       | 4                  |       | 9,501            |       | 2,213            |       |
| Interest and other related financing costs   |       | —     |       | 5,681      |       | 152            |       | —             |       | —           |       | 5,833            |       |
| Income before income tax expense             |       | 12,910     |       | 10,410     |       | (22,209        | )          | (326               | )          | 17,893           |       | 18,678           |       |
| Income tax expense                           |       | —     |       | 5,768      |       | —         |       | —             |       | —           |       | 5,768            |       |
|                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net income (loss)                            |       | $          | 12,910     |       | $          | 4,642          |       | $                  | (22,209    | )                | $          | (326             | )          | $ | 17,893 |   | $ | 12,910 |   |

 

22

----

Tableof Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

(In thousands)

**Six months ended December 31, 2009**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                                   |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net cash provided by (used in) operating activities          |       | $          | 2,897      |       | $          | 25,505         |       | $                  | (7,501     | )                | $          | (52              | )          | $ | — |   | $ | 20,849 |   |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from investing activities:                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Capital expenditures                                         |       | —     |       | (241       | )          | (4,029         | )          | (1,045             | )          | —           |       | (5,315           | )          |
| Acquisitions                                                 |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Proceeds from the disposal of property, plant and  equipment |       | —     |       | —     |       | 10,084         |       | —             |       | —           |       | 10,084           |       |
| Other                                                        |       | —     |       | 19         |       | —         |       | —             |       | —           |       | 19               |       |
| Net cash used in investing activities                        |       | —     |       | (222       | )          | 6,055          |       | (1,045             | )          | —           |       | 4,788            |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from financing activities:                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Payments on long-term debt                                   |       | —     |       | —     |       | (21            | )          | —             |       | —           |       | (21              | )          |
| Increase in deferred financing costs                         |       | —     |       | (193       | )          | —         |       | —             |       | —           |       | (193             | )          |
| Proceeds from issuance of common stock                       |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Excess tax benefits from share-based payment  arrangements   |       | —     |       | —     |       | —         |       | —             |       | —           |       | —           |       |
| Dividends paid                                               |       | (2,897     | )          | —     |       | —         |       | —             |       | —           |       | (2,897           | )          |
| Net cash provided by (used in) financing activities          |       | (2,897     | )          | (193       | )          | (21            | )          | —             |       | —           |       | (3,111           | )          |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Effect of exchange rate changes on cash                      |       | —     |       | —     |       | —         |       | 652                |       | —           |       | 652              |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net decrease in cash and cash equivalents                    |       | —     |       | 25,090     |       | (1,467         | )          | (445               | )          | —           |       | 23,178           |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents – beginning of period         |       | —     |       | 47,712     |       | 3,592          |       | 1,656              |       | —           |       | 52,960           |       |
|                                                         |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents – end of period               |       | $          | —     |       | $          | 72,802         |       | $                  | 2,125      |             | $          | 1,211            |       | $ | — |   | $ | 76,138 |   |

 

23

----

Table of Contents

 

**ETHANALLEN INTERIORS INC. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

(In thousands)

**Six months ended December 31, 2008**

 
| ** **                                                  | ** ** | **Parent** | ** ** | **Issuer** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                                  |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net cash provided by (used in) operating activities         |       | $          | 13,523     |       | $          | (7,350         | )          | $                  | 9,740      |             | $          | (206             | )          | $ | — |   | $ | 15,707 |   |
|                                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from investing activities:                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Capital expenditures                                        |       | —     |       | (1,085     | )          | (14,968        | )          | (93                | )          | —           |       | (16,146          | )          |
| Acquisitions                                                |       | —     |       | —     |       | (647           | )          | —             |       | —           |       | (647             | )          |
| Proceeds from the disposal of property, plant and equipment |       | —     |       | 19         |       | 5,726          |       | —             |       | —           |       | 5,745            |       |
| Other                                                       |       | —     |       | (32        | )          | (181           | )          | —             |       | —           |       | (213             | )          |
| Net cash used in investing activities                       |       | —     |       | (1,098     | )          | (10,070        | )          | (93                | )          | —           |       | (11,261          | )          |
|                                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash flows from financing activities:                       |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Payments on long-term debt                                  |       | —     |       | —     |       | (20            | )          | —             |       | —           |       | (20              | )          |
| 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                                              |       | (13,525    | )          | —     |       | —         |       | —             |       | —           |       | (13,525          | )          |
| Net cash provided by (used in) financing activities         |       | (13,523    | )          | —     |       | (20            | )          | —             |       | —           |       | (13,543          | )          |
|                                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Effect of exchange rate changes on cash                     |       | —     |       | —     |       | —         |       | (735               | )          | —           |       | (735             | )          |
|                                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Net increase (decrease) in cash and cash equivalents        |       | —     |       | (8,448     | )          | (350           | )          | (1,034             | )          | —           |       | (9,832           | )          |
|                                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents – beginning of period        |       | —     |       | 71,117     |       | 1,307          |       | 1,952              |       | —           |       | 74,376           |       |
|                                                        |       |       |       |       |       |           |       |               |       |             |       |             |       |
| Cash and cash equivalents – end of period              |       | $          | —     |       | $          | 62,669         |       | $                  | 957        |             | $          | 918              |       | $ | — |   | $ | 64,544 |   |

 

24

----

Table of Contents

 

**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. These forward-lookingstatements are subject to management decisions and various assumptions, risksand uncertainties, including, but not limited to: the effects of terroristattacks or conflicts or wars involving the United States or its allies ortrading partners; the effects of labor strikes; weather conditions that mayaffect sales; volatility in fuel, utility, transportation and security costs;changes in global or regional political or economic conditions, includingchanges in governmental and central bank policies; changes in businessconditions in the furniture industry, including changes in consumer spendingpatterns and demand for home furnishings; effects of our brand awareness andmarketing programs, including changes in demand for our existing and newproducts; our ability to locate new design center sites and/or negotiatefavorable lease terms for additional design centers or for the expansion ofexisting design centers; competitive factors, including changes in products ormarketing efforts of others; pricing pressures; fluctuations in interest ratesand the cost, availability and quality of raw materials; those mattersdiscussed in Items 1A and 7A of our Annual Report on Form 10-K/A for theyear ended June 30, 2009 and in our SEC filings; and our future decisions.Accordingly, actual circumstances and results could differ materially fromthose 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’s critical accounting policies regarding Impairment of Long-LivedAssets and Goodwill are described below. For information regarding the Company’s other critical accountingpolicies, see the Company’s 2009 Annual Report on Form 10-K/A filed withthe 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), the recoverabilityof long-lived assets are evaluated for impairment by determining whether thecarrying value will be recovered through the expected undiscounted future cashflows resulting from the use of the asset. In the event the sum of the expected undiscounted future cash flows isless than the carrying value of the asset, an impairment loss equal to theexcess of the asset’s carrying value over its fair value is recorded.  The long-term nature of these assets requiresthe estimation of cash inflows and outflows several years into the future andonly takes into consideration technological advances known at the time of theimpairment 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 

 

25

----

Tableof Contents

 

whenever events or circumstancesindicate that the carrying value of the goodwill or other intangible asset mayexceed its fair value. We conduct our required annual impairment test ofgoodwill and other intangible assets during the fourth quarter of each fiscalyear.

 

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 determined using recent comparable transactions inthe open market. Under the Income approach, a discounted cash flow method isused, which includes a terminal value, and is based on external analystfinancial projection estimates, as well as internal financial projectionestimates prepared by management. The long-term terminal growth rateassumptions reflect our current long-term view of the market in which wecompete.  Discount rates use the weightedaverage cost of capital for companies within our peer group, adjusted for specificcompany 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 the Company’sperception of the long-term values in the market in which we compete, and thediscount rate is determined using the weighted average cost of capital forcompanies 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 theeconomic downturn that began in the fall of 2008, the Company’s revenues andoperating margins were negatively impacted. In response, the Company reduced headcount, consolidated itsmanufacturing, retail, and logistics footprint and repositioned its marketingapproach.  As a result of these changes,the Company’s cash flow forecasts were continually updated to reflect the rapidchanges in the business and the industry. During fiscal 2009, the Companydetermined that $48.4 million of goodwill in the Retail segment was consideredimpaired and fully written off. The cash flow projectionsused in its fair value evaluations are the best estimates of the Company andrequire significant 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%.  Infiscal 2010, the Company concluded for the first and second quarters that nointerim impairment test was required. During the six months ended December 31, 2009, although businessperformance was slightly below management’s expectations, our sales, grossprofit, operating income, net income and other indicators improved from theprevious quarter, and our long-term outlook has not changed.  The Company’s average quarterly stock priceincreased 12% (from $12.11 for the quarter ended June 30, 2009, to $13.53for the quarter ended December 31, 2009), and cash balances increased to$76.1 million at December 31, 2009 from $53.0 million at June 30,2009.  There can beno assurance 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 

 

26

----

Tableof Contents

 

financial performance andexpected future cash flows, and other factors. Deterioration in any of thesefactors may result in a lower fair value assessment, which could lead toimpairment of the long-lived assets and goodwill of the Company.

 

**Resultsof Operations**

 

Our business has beenseverely impacted by the economic factors in the United States and abroad whichwe began to feel in earnest during our second quarter of fiscal 2009.  Weakness in the U.S. economy from continuedhigh unemployment, volatile capital markets, depressed housing prices and tightconsumer spending have all put negative stress on the economy which continuesto have a negative impact on our business. As we work through these difficult times, we have taken dramatic actionsto significantly reduce costs in all facets of our business including closingand realigning manufacturing plants, consolidating logistics operations, andclosing under-performing retail design centers. These actions have been takenwith appropriate consideration for demand and management believes it hasretained sufficient scalable capacity.  Wehave also launched initiatives to increase sales, such as special savings productpromotions, our designer affiliate program and conversion of our case goods productsto custom.

 

In fiscal 2009, theCompany consolidated several operations. Upholstery plants in Eldred,Pennsylvania and Chino, California were consolidated into the Maiden, NorthCarolina operations. Sawmill and dimension mill production in Andover, Mainewas transferred to the Beecher Falls, Vermont site.  All remaining case goods plants are beingconverted to produce custom case goods products. Wholesale distribution locations,and several retail service centers were consolidated. For these actions, theCompany estimates pre-tax restructuring, impairment, accelerated depreciationand other related charges will ultimately approximate $31 million ($24 millionwholesale, $7 million retail), consisting of an $18 million impact fromlong-lived assets, $8 million in employee severance and other payroll andbenefit costs, and $5 million in other associated costs.   In thecurrent fiscal year, total costs were $0.2 million of restructuring credits and$6.6 million in accelerated depreciation charges for Wholesale, and $1.3million of restructuring charges for the Retail segment. Cumulative charges todate for these actions totaling $20.7 million have been classified in the Statementof Operations as restructuring and impairment charges, and $6.6 million ofaccelerated depreciation was recorded in cost of sales.  Adjustments to the restructuring reserve inthe current period consist primarily of gains on the sale of equipment sold andadjustments on non-cancellable leases.

 

In fiscal 2008, weannounced a plan to consolidate the operations of certain Ethan Allen-operatedretail design centers and retail service centers. In connection with thisinitiative, we permanently ceased operations at ten design centers and sixretail service centers which, for the most part, were consolidated into otherexisting operations.  Costs for theseactions in the current fiscal year totaled $0.5 million, all for the Retailsegment, due to non-cancellable lease adjustments and net losses on the sale ofreal estate. Cumulative charges to date for these actions total $6.0 million,all of which have been classified in the Statement of Operations asrestructuring and impairment 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 and six months ended December 31,2009 and 2008 for the components of consolidated revenue and operating income,capital expenditures, and total assets by segment.

 

27

----

Tableof Contents

 

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

 

**Consolidated revenue** for the three months ended December 31,2009 decreased 24.4% to $143.3 million, from $189.6 million for the three monthsended December 31, 2008. During the quarter, sales continued to beaffected by the negative economic stresses mentioned earlier, as well as theuse of highly promotional pricing strategies by the Company’s competitors.  These factors were partially offset by (i) severalnew marketing initiatives including our special savings pricing, and our newinteractive web site ethanalleninc.com, (ii) the continued use of nationaltelevision media, where we emphasize to clients our interior design servicesand the full line of our quality product offerings, and (iii) the positiveeffects of efforts to reposition the retail network.

 

**Wholesalerevenue** for thesecond quarter of fiscal 2010 decreased 22.4% to $84.5 million from $108.8million in the prior year comparable period. The quarter-over-quarter decrease was primarily attributable to adecline in the incoming order rate due to a continued soft retail environmentfor home furnishings noted throughout the current period. These decreases werepartially offset by our special savings pricing during the quarter.  In addition, there were three moreindependent retail design centers at December 31, 2009, which increased to134 from 131 at December 31, 2008, and twelve fewer Ethan Allen-operateddesign centers as noted below.** **There were the same number ofshipping days in the quarter both this year and last year.

 

**Retailrevenue** fromEthan Allen-owned design centers for the three months ended December 31,2009 decreased 27.2% to $107.1 million from $147.2 million for the three monthsended December 31, 2008.  We believethe decrease in retail sales by Ethan Allen-operated design centers is due tothe same soft market conditions experienced by the wholesale segment, asevidenced by a 25.3% decrease in comparable store sales, a net $6.0 milliondecrease in new/closed store sales, and a net decrease in the number of EthanAllen-operated design centers to 150 as of December 31, 2009 as comparedto 162 as of December 31, 2008. These decreases were partially offset by more aggressive marketingcampaigns including special savings pricing during the quarter.  During the quarter, we opened one (arelocation) and closed five design centers.

 

Comparable design centersare 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 9.0% whilecomparable design centers written business decreased 6.1%.  Over that same period, wholesale ordersdecreased 18.2%.  Both retail andwholesale written business reflect the softer retail environment for homefurnishings noted throughout the period as a result of the continued negativeeconomic stresses previously discussed.

 

We have made considerableinvestment within the retail network to strengthen the level of service,professionalism, interior design competence, efficiency, and effectiveness ofthe retail design center personnel.  Wealso believe that over time, we will benefit from (i) our repositioning ofthe retail network, (ii) new product introductions, (iii) newmarketing initiatives such as our special savings pricing, and our new interiordesign affiliate (IDA) program, (iv) continued use of technology includingour state-of-the-art website coupled with personal service from our designprofessionals, and (v) ongoing use of national television and sheltermagazines as advertising media.

 

**Grossprofit** decreasedduring the quarter to $69.0 million from $101.8 million in the prior yearcomparable quarter.  The 32.2% decreasein gross profit was primarily attributable to (i) the reduction in netsales of 24.4%, with an overall decrease in shipments in both market segments, (ii) planttransition costs related to the restructuring of our manufacturing plants,ramping up upholstery production, and transition to custom case goods, and (iii) lowermargins within the retail segment, due to discounted sales through our specialsavings 

 

28

----

Tableof Contents

 

pricing initiatives andsales of discontinued product and floor samples.  The sales mix had a slightly unfavorableshift with retail sales representing a lower proportionate share of total salesin the current quarter (75%) compared to the prior year period (78%).Consolidated gross margin decreased to 48.2% from 53.7% in the prior year as aresult, primarily, of the factors set forth above.

 

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

 

**Operatingexpenses**decreased 19.0% to $74.3 million, but increased to 51.9% of sales in the currentquarter from $91.7 million, or 48.4% of sales in the prior year quarter.  Selling expenses were down in absolute termsdue to cost cutting actions taken and lower sales volume, and increased as apercentage of sales due to significantly lower sales volume.  Salary related costs decreased due to thereduced number of employees and other cost cutting efforts taken by theCompany.

 

**Consolidatedoperating income (loss)** for the three month period ended December 31, 2009 was a loss of$5.2 million, or 3.7% of sales, as compared to income of $10.1 million, or 5.3%of sales, for the three months ended December 31, 2008.  This decrease of $15.4 million is due to adecrease in gross profit mostly due to reduced sales, and transitional costsdue to restructuring activities, partly offset by a decrease in period overperiod operating expenses, both of which were discussed previously.

 

**Wholesaleoperating income**forthe three months ended December 31, 2009 was $1.0 million, or 1.2% ofsales, as compared to income of $8.6 million, or 7.9% of sales, in the prioryear comparable quarter. The decrease of $7.6 million was primarilyattributable to a decrease in sales volume, and the plant transition costsrelating to the closure of manufacturing plants as discussed previously.

 

**Retailoperating loss**increased $6.6 million to a loss of $9.8 million, or a negative 9.1% of sales,for the second quarter of fiscal 2010 from a loss of $3.2 million, or anegative 2.2% of sales, for the second quarter of fiscal 2009.  The increase in retail operating lossgenerated by Ethan Allen-operated design centers was primarily due to reducedsales attributed to the weak retail environment for home furnishings offsetpartially by cost cutting actions taken.

 

**Interestand other miscellaneous income, net** decreased $0.1 million from the prior year comparablequarter.  The decrease was due, primarilyto lower rates of interest during the current period.

 

**Interestand other related financing costs** amounted to just under $3.0 million in both the currentand prior year periods.  This amountconsists, primarily, of interest expense incurred in connection with ourissuance of senior unsecured debt in September 2005.

 

**IncomeTax Expense**forthe three months ended December 31, 2009 totaled a benefit of $3.9 millionas compared to an expense of $2.8 million for the three months ended December 31,2008. Our effective tax rate for the current quarter was 53.9% compared to33.6% in the prior year quarter. In the current quarter, the effective tax rateis primarily related to the tax benefit on the current quarter loss. The taxbenefit is partially offset by the foreign valuation allowance on the Canadiannet operating losses, by state valuation allowance on certain state netoperating losses and by state income tax expense in states where the Company’ssubsidiaries file on a separate company basis. The prior period effective taxrate benefited from a one time adjustment of $0.7 million made in the firstquarter of fiscal 2009.

 

**Netincome (loss)** forthe three months ended December 31, 2009, was a loss of $3.3 million ascompared to net income of $5.5 million in the prior year comparableperiod.  This resulted in a net loss perdiluted share of $0.12 in the current quarter and net income per diluted shareof $0.19 in the prior year quarter.

 

29

----

Tableof Contents

 

***SixMonths Ended December 31, 2009 Compared to Six Months Ended December 31,2008***

 

**Consolidated revenue** for the six months ended December 31,2009 decreased 29.3% to $279.5 million, from $395.4 million for the six monthsended December 31, 2008. During the period, sales continue to be affectedby the negative economic stresses mentioned earlier, as well as the use of highlypromotional pricing strategies by the Company’s competitors.  These factors were partially offset by (i) severalnew marketing initiatives including our special savings pricing, and our newinteractive web site ethanalleninc.com, (ii) the continued use of nationaltelevision media, where we emphasize to clients our interior design servicesand the full line of our quality product offerings, and (iii) the positiveeffects of efforts to reposition the retail network.

 

**Wholesalerevenue** for thefirst six months of fiscal 2010 decreased 28.0% to $165.8 million from $230.1million in the prior year comparable period. The period-over-period decrease wasprimarily attributable to a decline in the incoming order rate due to a continuedsoft retail environment for home furnishings noted throughout the currentperiod. These decreases were partially offset by our specialsavings pricing during the quarter.  In addition, there were three moreindependent retail design centers at December 31, 2009, which increased to134 from 131, and twelve fewer Ethan Allen-operated design centers as notedbelow. There were the same number of shipping days in thecurrent six month period both this year and last year.

 

**Retailrevenue** fromEthan Allen-owned design centers for the six months ended December 31,2009 decreased 30.6% to $210.3 million from $303.1 million for the six monthsended December 31, 2008.  We believethe decrease in retail sales by Ethan Allen-operated design centers is due tothe same soft market conditions experienced by the wholesale segment, asevidenced by a 30.5% decrease in comparable store sales, a net $8.2 milliondecrease in new/closed store sales, and a net decrease in the number of EthanAllen-operated design centers to 150 as of December 31, 2009 as comparedto 162 as of December 31, 2008. These decreases were partially offset by our special savings pricingduring the period.  During the period, weopened six (including four relocations) and closed fifteen design centers.

 

Comparable design centersare 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.

 

Year-over-year, writtenbusiness of Ethan Allen-owned design centers decreased 14.9% while comparabledesign centers written business decreased 13.9%.  Over that same period, wholesale ordersdecreased 19.9%.  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 made considerableinvestment within the retail network to strengthen the level of service,professionalism, interior design competence, efficiency, and effectiveness ofthe retail design center personnel.  Wealso believe that over time, we will benefit from (i) our repositioning ofthe retail network, (ii) new product introductions, (iii) newmarketing initiatives such as our special savings pricing, and our new interiordesign affiliate (IDA) program, (iv) continued use of technology includingour state-of-the-art website coupled with personal service from our designprofessionals, and (iv) ongoing use of national television and sheltermagazines as advertising media.

 

**Grossprofit** decreasedduring the six months to $127.3 million from $213.7 million in the prior yearcomparable period.  The 40.4% decrease ingross profit was primarily attributable to (i) the reduction in net salesof 29.3%, with an overall decrease in shipments in both market segments, (ii) lowermargin percentages within the wholesale segment due to accelerated depreciationfrom closed manufacturing operations totaling $6.6 million, under absorption ofplant overhead costs on the lower production volume, both in the first fiscalquarter, and 

 

30

----

Table ofContents

 

other plant transitioncosts related to the restructuring of our manufacturing plants throughout thesix month period, and (iii) lower margins within the retail segment, dueto discounted sales through our special pricing initiatives and sales ofdiscontinued product and floor samples. The sales mix had a slightly unfavorable shift with retail salesrepresenting a lower proportionate share of total sales in the current sixmonth period (75%) compared to the prior year (77%).   Consolidated gross margin decreased to 45.6%from 54.1% in the prior year as a result, primarily, of the factors set forthabove.

 

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

 

**Operatingexpenses**decreased 22.3% to $148.7 million, but increased to 53.2% of sales in thecurrent quarter from $191.4 million, or 48.4% of sales in the prior six monthperiod.  Selling expenses were down inabsolute terms due to cost cutting actions taken and lower sales volume.  Salary related costs decreased due to thereduced number of employees and other cost cutting efforts taken by theCompany.  Advertising expenses were down$3.7 million versus the previous year.

 

**Consolidatedoperating income (loss)** for the six month period ended December 31, 2009 was a loss of$21.4 million, or a negative 7.6% of sales, as compared to income of $22.3million, or 5.6% of sales, for the six months ended December 31,2008.  This decrease of $43.7 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 six months ended December 31, 2009 totaled a loss of $3.6million, or a negative 2.2% of sales, as compared to income of $20.4 million,or 8.9% of sales, in the prior year comparable period. The decrease of $24.1million was primarily attributable to a decrease in sales volume, and to planttransition costs including the $6.6 million of accelerated depreciationrelating to the closure of manufacturing plants as discussed previously.

 

**Retailoperating loss**increased $14.9 million to a loss of $21.1 million, or a negative 10.1% ofsales, for the first six months of fiscal 2010 from a loss of $6.2 million, ora negative 2.1% of sales, for the comparable period of fiscal 2009.  The increase in retail operating lossgenerated by Ethan Allen-operated design centers was primarily due to reducedsales attributable to the weak retail environment for home furnishings offsetpartially by cost cutting actions taken.

 

**Interestand other miscellaneous income, net** decreased $0.4 million from the prior year comparableperiod.  The decrease was due, primarilyto a decrease in investment income resulting from lower rates of interestduring the current period.

 

**Interestand other related financing costs** amounted to just under $6.0 million in both thecurrent and prior year periods.  Thisamount consists, primarily, of interest expense incurred in connection with ourissuance of senior unsecured debt in September 2005.

 

**Incometax expense** forthe six months ended December 31, 2009 totaled a benefit of $8.6 millionas compared to an expense of $5.8 million for the six months ended December 31,2008. Our effective tax rate for the current period was 33.7% compared to 30.9%in the prior year period. In the current period, the effective tax rate isprimarily related to the tax benefit on the current period loss. The taxbenefit is partially offset by the foreign valuation allowance on the Canadiannet operating losses, by state valuation allowance on certain state netoperating losses and by state income tax expense in states where the Company’ssubsidiaries file on a separate company basis. The prior period effective taxrate benefited from a one-time adjustment of $0.7 million made in the firstquarter of fiscal 2009. A valuation allowance must be established for deferredtax assets when it is more likely than not that they will not be realized. Inprior periods, the Company established a valuation allowance for 

 

31

----

Tableof Contents

 

the state deferred tax assets and Canadian net operating losses in itsRetail segment. As of December 31, 2009, after considering both positiveand negative evidence, management’s assessment is that a valuation allowance isnot needed for the Company’s other deferred tax assets.  Due to the economic times and recent losses,management will continue to assess the realizability of the tax assets based onactual and forecasted operating results on a quarterly basis, as required underASC topic 740.  It is possible during thecurrent fiscal year, that the realization of tax assets is not reasonablyassured due to a lack of available objective evidence.  Management would then record a valuationallowance against the tax assets which would result in a non-cash charge toearnings.

 

**Netincome (loss)** forthe six months ended December 31, 2009, was a loss of $16.9 million ascompared to net income of $12.9 million in the prior year comparableperiod.  This resulted in a net loss perdiluted share of $0.58 in the current period and net income per diluted shareof $0.45 in the prior year period.

 

**Liquidityand Capital Resources**

 

At December 31,2009, we held cash and cash equivalents of $76.1 million.  Our principal sources of liquidity includecash and cash equivalents, cash flow from operations, the revolving line ofcredit, and borrowings.

 

The global economycontinues to be unsettled, and capital markets continue to be disrupted andvolatile.  The cost and availability offunding has been and may continue to be adversely affected by illiquid creditmarkets. Some lenders have reduced or, in some cases, ceased to provide fundingto borrowers.  However, our lenders havenot indicated to us that they would not continue to provide funding to us ornot honor or be able to fully perform their obligations under the creditfacility.  Our access to the creditfacility could also be negatively affected if operating results fall below prescribedlevels or if the assets used to determine the borrowing base availability fallbelow the total available credit under the facility.  Continued turbulence in the financial marketscould also adversely affect the cost and availability of financing to us in thefuture.

 

On October 23, 2009, the Companyexpanded to $60 million the three-year senior secured asset-based revolvingcredit facility (“the “Facility”) established on May 29, 2009.  The Facility provides revolving creditfinancing of up to $60 million, subject to borrowing base availability.  At the Company’s option, revolving loansunder the Agreement bear interest at an annual rate of either:

 

(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, at December 31, 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.

 

32

----

Table of Contents

 

The Company has not drawn any cashadvances against the facility, and has no plans to do so.  At December 31, 2009, after excludingthe $12.5 million we had utilized in letters of credit, remaining availabilityunder the revolver totaled $47.5 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 December 31, 2009, we are in compliance with all covenants ofour credit facility.

 

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 pointed to the Company’s depressed operating performance due to lowerconsumer spending and a tough retail environment as reasons for thedowngrades.  While the change in ourcredit rating had no impact on our existing credit facilities, if the S&Prating is not improved to investment grade by March 13, 2010, the issuerof our private label credit cards has a right to demand a standby letter ofcredit of up to $12 million, which would reduce availability under therevolving credit agreement. It does not appear likely that the S&P ratingwill improve to investment grade prior to March 13, 2010.  The Company believes it has sufficient cashand access to credit to fund operations and growth plans.

 

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

 
| ** **                                                | ** ** | **Six Months Ended**  | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **December 31,** | ** ** |
| ** **                                                | ** ** | **2009**              | ** ** | **2008** | ** ** |
| **Operating Activities**                                  |       |                  |       |   |   |
| Net income plus depreciation and amortization             |       | $                     | 1.4        |   | $ | 25.7 |   |
| Working capital                                           |       | 26.6                  |       | (4.5 | ) |
| Other (non-cash items, long-term assets and  liabilities) |       | (7.2                  | )          | (5.5 | ) |
| Total provided by operating activities                    |       | $                     | 20.8       |   | $ | 15.7 |   |
|                                                      |       |                  |       |   |   |
| **Investing Activities**                                  |       |                  |       |   |   |
| Capital expenditures                                      |       | $                     | (5.3       | ) | $ | (16.1 | ) |
| Acquisitions                                              |       | —                |       | (0.7 | ) |
| Asset sales                                               |       | 10.1                  |       | 5.7 |   |
| Other                                                     |       | —                |       | (0.2 | ) |
| Total provided by (used in) investing activities          |       | $                     | 4.8        |   | $ | (11.3 | ) |
|                                                      |       |                  |       |   |   |
| **Financing Activities**                                  |       |                  |       |   |   |
| Payment of dividends                                      |       | $                     | (2.9       | ) | $ | (13.5 | ) |
| Payment of deferred financing costs                       |       | (0.2                  | )          | — |   |
| Total provided by (used in) financing activities          |       | $                     | (3.1       | ) | $ | (13.5 | ) |

 

***OperatingActivities***

 

Compared to thesame period in fiscal year 2009, cash provided by operating activitiesincreased $5.1 million.  This occurreddue to the $31.1 million increase in cash generated from working capital(accounts receivable, 

 

33

----

Table ofContents

 

inventories,prepaid and other current assets, customer deposits, payables, accruedexpenses, and other current liabilities) resulting from an increase in customerdeposits, inventory initiatives taken and income tax refunds, offset bydecreases in accounts receivable and accrued expenses.  This was offset by a decrease in net incomeof $29.8 million (partially offset by $6.6 million in depreciation charges dueto restructuring activities).  The $1.7 millionin cash generated from other items was largely a result of restructuringcharges, partially offset by a net increase in deferred tax benefits.

 

***InvestingActivities***

 

As compared to thesame period in fiscal year 2009, cash used in investing activities decreased$16.0 million during the six months ended December 31, 2009 due,primarily, to a reduction in cash utilized to fund capital expenditures andacquisitions and an increase in proceeds from the sale of assets.  We anticipate that cash from operations willbe sufficient to fund future capital expenditures.

 

***FinancingActivities***

 

As compared to thesame period in fiscal year 2009, cash used in financing activities decreased$10.4 million during the six months ended December 31, 2009, primarily asa result of a decrease in dividend payments. The Company has continuously paid dividends every quarter since1996.  On November 16, 2009, theBoard declared a dividend of $0.05 per common share, payable on January 25,2010, to shareholders of record as of January 11, 2010.  On January 19, 2010, the Board declareda dividend of $0.05 per common share, payable on April 26, 2010, toshareholders of record as of April 9, 2010.  If adverse economic conditions continue, theCompany may further reduce our quarterly dividends.

 

As of December 31,2009, our outstanding debt totaled $203.2 million, the current and long-termportions of which amounted to less than $0.1 million and $203.2 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 ($199.3 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 December 31, 2009, we had working capital of $140.0 millionand a current ratio of 2.2 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 six months ended December 31, 2009 and 2008.  As of December 31, 2009, we had aremaining Board authorization to repurchase 1,567,669 shares.

 

34

----

Table of Contents

 

**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 ourunderlying relationship with the benefiting party and the business purpose forwhich the guarantee or obligation is being provided. Details of thosearrangements for which we act as guarantor or obligor are provided below.

 

**Retailer-RelatedGuarantees**

 

***IndependentRetailer Credit Facility***

 

On June 11, 2009, weobligated ourselves, on behalf of one of our independent retailers, withrespect 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 December 31,2009, the amount outstanding under the Amended Credit Facility totaledapproximately $0.5 million.  Based on theunderlying creditworthiness of the respective retailer, we believe thisobligation will expire without requiring funding by us.  Our non-contingent obligations under thisarrangement as a result of modifications made to the Credit Facility subsequentto January 1, 2003 are not material.

 

***Ethan AllenConsumer 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 “ProgramAgreement”). Any independent retailer choosing to participate in the consumercredit program is required to enter into a separate agreement with that samethird-party financial institution which sets forth the terms and conditionsunder which the retailer is to perform in connection with its offering ofconsumer credit to its customers (the “Retailer Agreement”). We have obligatedourselves on behalf of any independent retailer choosing to participate in ourconsumer credit program by agreeing, in the event of default, breach, orfailure of the independent retailer to perform under such Retailer Agreement,to take on certain 

 

35

----

Table of Contents

 

responsibilities of theindependent retailer, including, but not limited to, delivery of goods andreimbursement of customer deposits. Customer receivables originated byindependent retailers remain non-recourse to Ethan Allen. Our obligationremains in effect for the term of the Program Agreement which expires in July 2012.While the maximum potential amount of future payments (undiscounted) that wecould be required to make under this obligation is indeterminable, recourseprovisions exist that would enable us to recover, from the independentretailer, any amount paid or incurred by us related to our performance. Basedon the underlying creditworthiness of our independent retailers, includingtheir historical ability to satisfactorily perform in connection with the termsof our consumer credit program, we believe this obligation will expire withoutrequiring funding by us.

 

**Product Warranties**

 

Our products,including our case goods, upholstery and home accents, generally carry explicitproduct warranties that extend from one to ten years and are provided based onterms that are generally accepted in the industry.  All of our domestic independent retailers arerequired to enter into, and perform in accordance with the terms and conditionsof, a warranty service agreement. We record provisions for estimated warrantyand other related costs at time of sale based on historical warranty lossexperience and make periodic adjustments to those provisions to reflect actualexperience. On rare occasion, certain warranty and other related claims involvematters of dispute that ultimately are resolved by negotiation, arbitration orlitigation.  In certain cases, a materialwarranty issue may arise which is beyond the scope of our historicalexperience. We provide for such warranty issues as they become known and aredeemed to be both probable and estimable. It is reasonably possible that, fromtime to time, additional warranty and other related claims could arise fromdisputes or other matters beyond the scope of our historical experience. As of December 31,2009, our product warranty liability totaled $0.8 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.  We remain cautiously optimisticabout our long term outlook, as current business conditions have marginallyimproved in the six months ended December 31, 2009.  We cannot predict, with any degree ofcertainty when these difficult economic conditions will improve meaningfully.

 

As macro-economicfactors change, it is also possible that our costs associated with production(including raw materials, labor and utilities), distribution (including freightand fuel charges), and retail operations (including compensation, benefits,delivery, warehousing, occupancy, and advertising expenses) may increase.  We 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 homefurnishings industry remains extremely competitive with respect to both thesourcing of products and the retail sale of those products. Domestic manufacturerscontinue to face pricing pressures as a result of the manufacturingcapabilities and significant manufacturing capacities developed during recentyears in other countries, specifically within Asia. In response to thesepressures, a large number of U.S. furniture manufacturers and retailers,including the Company, have increased their overseas sourcing activities in anattempt to maintain a competitive advantage and retain market share. Wecontinue to believe that a balanced approach to product sourcing, whichincludes the domestic manufacture of certain product offerings coupled with theimport of other selected products, provides the greatest degree of flexibilityand is the most effective approach to ensuring that acceptable levels ofquality, service and value are attained.

 

We believe that ourexisting business model which includes: (i) an established brand with abroad offering of Company designed quality products; (ii) a comprehensivecomplement of home decorating solutions and complimentary interior designservices and (iii) a vertically-integrated operating structure willposition us well to take advantage of improved economic conditions when theyoccur.

 

36

----

Table ofContents

 

In addition, webelieve that our retail strategy, which involves (i) a continued focus onproviding a wide array of product solutions including custom upholstery andcase goods 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 structure within our retail network, provides an opportunity togrow our business when the current difficult economic conditions improve.

 

**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.

 

**Item 4.Controls and Procedures**

 

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

 

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

 

**Changesin Internal Control over Financial Reporting**

 

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

 

**PART II- OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

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 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.

 

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

 

***IssuerPurchases of Equity Securities***

 

There were no purchasesmade by or on behalf of the Company or any affiliated purchaser (as defined in Rule 10b-18(a)(3) underthe Exchange Act) of our common stock during the three months ended December 31,2009.  The maximum number of shares thatmay yet be purchased under the plans or program is 1,567,669 shares.

 

37

----

Table ofContents

 

**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.

 

**Item 6.Exhibits**

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

 

38

----

Table ofContents

 

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:  February 5, 2010 | BY:    | /s/ M. Farooq Kathwari                                          |
|-------------------------|--------|-----------------------------------------------------------------|
|                    |   | Farooq Kathwari                                                 |
|                    |   | Chairman, President and  Chief Executive Officer                |
|                    |   | (Principal Executive  Officer)                                  |
|                    |   |                                                            |   |
|                    |   |                                                            |   |
| DATE: February 5, 2010  | BY:    | /s/ David R.  Callen                                            |
|                    |   | David R. Callen                                                 |
|                    |   | Vice President,  Finance & Treasurer                        |
|                    |   | (Principal  Financial Officer and Principal Accounting Officer) |

 

39

----

Table of Contents

 

EXHIBIT INDEX

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

 

40

----