ETHAN ALLEN INTERIORS INC (ETD) FY 2023 MD&A

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results.

The MD&A is based upon, and should be read in conjunction with, our Consolidated Financial Statements and related Notes included under Item 8 of this Annual Report on Form 10-K.

Executive Overview

Who We Are. Founded in 1932, Ethan Allen is a leading interior design company, manufacturer and retailer in the home furnishings marketplace. We are a global luxury home fashion brand that is vertically integrated from product design through home delivery, which offers our customers stylish product offerings, artisanal quality and personalized service. We are known for the quality and craftsmanship of our products as well as for the exceptional personal service from design to delivery. We provide complimentary interior design service to our clients and sell a full range of home furnishings through a retail network of design centers located throughout the United States and abroad as well as online at ethanallen.com.

Ethan Allen design centers represent a mix of locations operated by independent licensees and Company-operated locations. As of June 30, 2023, the Company operates 139 retail design centers, 135 located in the United States and four in Canada. Our independently operated design centers are located in the United States, Asia, the Middle East and Europe. We also own and operate ten manufacturing facilities, including four manufacturing plants, one sawmill, one rough mill and a kiln dry lumberyard in the United States, two upholstery manufacturing plants in Mexico and one case goods manufacturing plant in Honduras. Approximately 75% of our products are manufactured or assembled in the North American plants. We also contract with various suppliers located in Europe, Asia and other various countries to produce products that support our business.

During fiscal 2023, we reaffirmed our commitment to maintain and grow our North American workshops, strengthened our product offerings under the umbrella of Classics with a Modern Perspective, maintained our unique and efficient logistics system, invested in technology to both engage and enhance client experience, and enhanced our interior designers with development and training. We strategically relocated two design centers with a more bright, open, modern layout showcasing our best and most current interior design concepts. Our focus on constant reinvention and maintaining an entrepreneurial attitude combined with our great quality, service, and vertically integrated business, with 75% of our products made in our North American manufacturing workshops, has us well positioned as a premier interior design destination.

Business Model. Ethan Allen has a distinct vision of American style, rooted in the kind of substance that we believe differentiates us from our competitors. Our business model is to maintain continued focus on (i) providing relevant product offerings, (ii) capitalizing on the professional and personal service offered to our customers by our interior design professionals, (iii) leveraging the benefits of our vertical integration including a strong manufacturing presence in North America, (iv) regularly investing in new technologies across key aspects of our vertically integrated business, (v) maintaining a strong logistics network, (vi) communicating our messages with strong advertising and marketing campaigns, and (vii) utilizing our website, ethanallen.com, as a key marketing tool to drive traffic to our retail design centers.

We aim to position Ethan Allen as a premier interior design destination and a preferred brand offering products of superior style, quality, and value to customers with a comprehensive, one-stop shopping solution for their home furnishing and interior design needs. We seek to constantly reinvent our projection and product offerings through a broad selection of products, designed to complement one another, reflecting current fashion trends in home furnishing. Our vertical integration is a competitive advantage for us. Our North American manufacturing and logistics operations are an integral part of an overall strategy to maximize production efficiencies and maintain this competitive advantage.

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Talent. As of June 30, 2023, our employee count totaled 3,748, with 2,674 employees in our wholesale segment and 1,074 in our retail segment. We are pleased with the continued strengthening of our teams and the performance of our employee base during fiscal 2023 while at the same time being able to reduce headcount through operational efficiencies. Our employee count decreased 11.6% during fiscal 2023, with 126 fewer employees in retail and 365 fewer in wholesale.

Fiscal 2023 Financial Year in Review (1). Our financial results for fiscal year 2023 are highlighted by strong gross and operating margins, improving lead times from decreasing backlog, disciplined cost and expense controls, strong operating cash flow, increased cash dividends and a robust balance sheet. Our consolidated net sales of $791.4 million declined 3.2% compared to the prior year due to lower delivered unit volumes from softening incoming order demand and reduced manufacturing production from lower backlogs. Sales in the prior year set a near record pace which led to a difficult prior year comparison as we had built up a significant backlog as a result of the heightened demand driven by the impact of COVID-19. While our retail segment written orders were down 12.3% compared to fiscal 2022, retail orders were up 0.8% compared to fiscal 2019 which was prior to the COVID-19 pandemic and more reflective of historical levels. Wholesale segment written orders were lower by 9.0% compared to last year, and down 2.1% when compared to fiscal 2019. We ended the fiscal 2023 year with wholesale backlog of $74.0 million, down 27.7% from a year ago as we were able to reduce the number of weeks of backlog. Consolidated gross margin was 60.7% compared to 59.3% due to favorable sales mix, disciplined promotional activity and lower input costs partially offset by lower delivered unit volume. Adjusted operating margin was 16.9% compared to 16.4% as we carefully managed expenses in a declining net sales environment. Adjusted diluted earnings per share (“EPS”) increased 2.5% to $4.03.

We ended fiscal 2023 with a strong balance sheet, including cash, cash equivalents and investments of $172.7 million and no outstanding debt. We generated $100.7 million of cash from operating activities, a 45.1% increase over the prior year driven by strong profit performance and a reduction in inventory carrying levels and accounts receivable partially offset by a decline in customer deposits. Our inventory levels decreased $27.3 million during fiscal 2023 as we restore our operating inventory levels to more historical levels as backlog decreases while also ensuring appropriate amounts of inventory are on hand to service our customers. Our Board increased our regular quarterly cash dividend by 12.5% and declared a special cash dividend of $0.50 per share, bringing the total amount of dividends paid to $46.4 million during fiscal 2023. As of June 30, 2023, our employee count was 3,748, down 11.6% in the past 12 months, as we continue to identify additional operational efficiencies and leverage the use of technology to streamline workflows.

Fiscal 2024 and Beyond. Ethan Allen was recently named to Newsweek’s list of America’s Best Retailers 2023. This prestigious award is presented by Newsweek and Statista Inc., a leading statistics portal and industry ranking provider. The final assessment and rankings were the result of an independent survey of more than 9,000 customers who have shopped at retail stores in person in the past three years and based on the likelihood of recommendation and the evaluation of products, customer service, atmosphere, accessibility and store layout. We are pleased to be recognized as one of America’s Best Retailers 2023, including as the #1 retailer of Premium Furniture. This award is a reflection of our associates, who continue each day to uphold the Ethan Allen reputation for quality, craftsmanship, and exemplary service.

As we enter the post COVID-19 era, our focus will be to continue to strengthen the various areas of our vertically integrated structure, including developing a strong team which is entrepreneurial and disciplined, enhancing our product offerings under the umbrella of Classics with a Modern Perspective, repositioning our retail network as an interior design destination, finalizing each design center projection refresh and ongoing investments in technology to further enhance our marketing, our North American manufacturing and our logistics. While we understand the challenges of a slower economy and the reduction of consumer focus on the home, we remain cautiously optimistic that our current business model, strategy, and balance sheet will enable us to fulfill our many initiatives over the next fiscal year.

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Key Operating Metrics

A summary of our key operating metrics is presented in the following table (in millions, except per share data).

Results of Operations

For an understanding of the significant factors that influenced our financial performance in fiscal 2023 compared with fiscal 2022, the following discussion should be read in conjunction with the consolidated financial statements and related notes presented under Item 8 in this Annual Report on Form 10-K. Refer to Results of Operations under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in Part II of our Annual Report on Form 10-K for the fiscal year ended June 30, 2022, filed with the SEC on August 29, 2022, for an analysis of the fiscal year 2022 results as compared to fiscal year 2021.

Impact of COVID-19 on our Business

We experienced significant changes in our business resulting from the COVID-19 pandemic, which began in fiscal 2020. In response to the COVID-19 pandemic, we implemented certain business continuity plans to ensure the ongoing availability of our products and services, while prioritizing health and safety of our associates and customers, including enhanced cleaning and hygiene protocols. In addition, we temporarily closed our retail and manufacturing locations due to state and local restrictions. When our retail and manufacturing locations reopened during fiscal 2021, we experienced strong demand for our products as customers allocated greater amounts of discretionary spending to home furnishings than at the start of the COVID-19 pandemic. During this time, our backlog increased to record levels due to the strong pace of incoming written orders outpacing production combined with logistical challenges, due to supply chain disruptions, which created additional delays in order fulfillment and increased order backlogs. We took several actions to increase our manufacturing capacity including adding headcount as well as second and weekend production shifts to our North American plants and as a result our fiscal 2022 sales set new records, with each quarter exceeding the comparable prior period quarter. During fiscal 2023 sales demand trends have slowed relative to those experienced during the peak of the pandemic but remain comparable to pre-pandemic levels as we work through our high backlog. Our backlog still remains higher than pre-pandemic levels, but we are effectively managing the business to work through this order backlog and to service our customers.

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Consolidated Net Sales

Consolidated net sales in fiscal 2023 decreased $26.4 million or 3.2% compared to the prior year period due to lower wholesale net sales of 7.1% and lower retail net sales of 4.0%. While the pace of demand has slowed compared to last year, we experienced a strong first half of the year as production levels were increased to deliver the significant backlog generated as a result of the heightened demand driven by the impact of COVID-19. Prior year constraints, including COVID-related delays, labor disruptions, supply chain challenges, extended shipping lead times and raw material availability, have eased, which reduced the time to convert written orders to delivered shipments. For the second half of fiscal 2023, we experienced lower delivered unit volumes from softening demand, which led to reduced manufacturing production. Sales in fiscal 2022 set a near record pace whereby each quarter consistently exceeded prior year comparable quarters leading to near historically high quarterly results for net sales. This growth led to more adverse prior year comparisons during fiscal 2023.

Wholesale Net Sales

Wholesale net sales in fiscal 2023 decreased $34.3 million or 7.1% compared to the prior year primarily due to a reduction in intersegment sales to our Company-operated design centers and lower shipments to domestic and international dealers, which was partially offset by higher contract sales. Reduced sales were primarily from lower incoming written orders combined with a decline in delivered volume as our level of backlog comes down. Excluding intersegment sales to our retail segment, wholesale net sales increased $0.9 million or 0.7% compared to the prior year period from higher contract sales offset by lower shipments to domestic and international dealers. Our international net sales were down 38.4% compared to the prior year period due to a reduction in net sales to China. Sales to international independent retailers represented 1.8% of total wholesale net sales compared to 2.6% in the prior year period.

We track and disclose wholesale written orders, which represent orders booked through all of our channels. Written orders help show the current pace or trend of customer transactions. Written orders are intended only as supplemental information and are not a substitute for net sales presented in accordance with GAAP. Wholesale written orders were down 9.0% in fiscal 2023 compared to the prior year period. As a result of the strong prior year comparison and a reduction of consumer focus on the home, orders from our Company-operated design centers were down 6.0%, contract orders declined 19.2%, independent North American retail network orders were down 13.3% and international orders, including orders from China, declined 33.8%. We experienced a significant increase in demand for our products as customers allocated greater amounts of discretionary spending to home furnishings at the onset of COVID-19 pandemic and that demand was still relatively high during fiscal 2022 which led to a strong, but difficult prior year comparison. When compared to fiscal 2019, which is pre-pandemic and more reflective of historical levels, written orders decreased 2.1% primarily due to challenging economic factors, such as high inflation, elevated interest rates, and uncertainties in the global financial markets. Wholesale backlog was $74.0 million as of June 30, 2023, down 27.7% from a year ago as we were able to reduce the number of weeks of backlog. Manufacturing productivity and related shipments outpaced incoming written orders which helped reduce backlog and improve our delivery times during fiscal 2023. However, our wholesale backlog remains approximately 60% higher than pre-pandemic levels and our strategy remains focused on servicing our customers on a timely basis.

Retail Net Sales

Retail net sales from Company-operated design centers decreased $27.3 million or 4.0% during fiscal 2023 compared to the prior year period. There was a 3.5% decrease in net sales in the United States, while sales from our Canadian design centers decreased 20.2%. The decline in retail net sales was primarily from declining written orders and lower manufacturing production levels partially offset by pricing actions taken, increased premier home delivery revenue and additional clearance sales. Canadian retail net sales were negatively impacted by one less design center in Canada combined with temporary disruptions within the local service center that impacted delivery timing during the first quarter. The disruptions were temporary and the local Canadian service center resumed full operations by the second quarter of fiscal 2023. Retail written orders declined 12.3% year over year primarily due to a strong prior year comparable and a reduction of consumer focus on the home which led to lower in-store traffic partially offset by an increase in average selling price and closure rate. When compared to fiscal 2019, retail written orders increased 0.8%. We remain focused on providing exceptional personal service through our strong network of entrepreneurial leaders and interior designers as we continue to strengthen our product offerings under the umbrella of classics with a modern perspective. As of June 30, 2023, there were 139 Company-operated design centers compared to 141 last year. Our strategic initiatives include the repositioning of our retail network as an interior design destination and we plan on completing this design center refresh project during the first half of fiscal 2024, which we believe will increase traffic.

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Consolidated Gross Profit and Margin

Consolidated gross profit in fiscal 2023 decreased $4.3 million or 0.9% compared with the prior year period due to sales declines within both our wholesale and retail segments, a change in the sales mix with a shift to more wholesale sales which carries lower margins, retail gross margin decline, and lower delivered unit volume. These decreases were partially offset by wholesale margin expansion from lower input costs including declining inbound freight, product pricing actions taken, disciplined promotional activity, manufacturing efficiencies, a favorable product mix, and an increase in average ticket price. Wholesale gross profit increased 320 basis points primarily due to gross margin expansion from product pricing actions taken combined with declining input costs (inbound freight and materials) partially offset by a 7.1% reduction in net sales. While production capacity remains strong, we have reduced our production levels to reflect lower weeks of backlog and the decline in incoming written orders. Retail gross profit decreased 480 basis points primarily due to the 4.0% decrease in net shipments, increased designer floor sample sales, and increased fees to offer our customers interest free financing partially offset by higher premier home delivery revenue and an increase in average ticket sale.

Consolidated gross margin was 60.7% compared with 59.3% in the prior year period due to favorable product mix and lower input costs including reduced inbound freight and raw material costs partially offset by a change in sales mix and lower delivered unit volume. The just completed fourth quarter of fiscal 2023 reported a consolidated gross margin of 61.5%, our 9th consecutive quarter that consolidated gross margin exceeded 58%. Wholesale gross margin increased 340 basis points over the prior year period due to product pricing actions that were taken during fiscal 2022 to offset inflationary pressures. These pricing actions combined with manufacturing efficiencies, raw material and freight cost stabilization in the second half of fiscal 2023, and increased contracts sales, contributed to the growth in our wholesale gross margin. Retail sales, when expressed as a percentage of total consolidated sales, decreased to 83.7% in fiscal 2023, down from 84.4% in the prior year period, which negatively affected consolidated gross margin. Retail gross margin decreased 40 basis points compared to the prior year due to change in product mix, increased designer floor sample sales and rising consumer financing fees partially offset by higher premier home delivery revenue and an increase in average ticket sale.

SG&A Expenses

SG&A expenses for fiscal 2023 decreased $4.0 million or 1.1% compared to the prior year period due to decreased selling expenses of 1.0% combined with a 1.4% decrease in general and administrative expenses. When expressed as a percentage of sales, SG&A expenses were 43.8% of net sales, a 90-basis point increase compared with the prior year, primarily due to decreased operating leverage driven by the lower sales volume relative to fixed costs. The 1.0% decrease in selling expenses was from lower selling costs associated with the 3.2% decrease in sales volume. Retail selling expenses rose 1.1% as delivery contract rates and fuel surcharges increased compared to fiscal 2022 combined with higher direct mail marketing spend partially offset by the 4.0% decrease in Retail net sales, which drove a decrease in our variable costs including delivery and designer commissions. Wholesale selling costs, which includes our logistics operation, were down 6.8% primarily from declining freight rates and a 7.1% reduction in sales volume, which led to lower variable distribution and freight costs. Our consolidated advertising spend was equal to 2.2% of net sales, up from 1.9% in the prior year period as we increased our direct mail campaigns focusing on being the premier interior design destination with new product introductions. General and administrative expenses decreased 1.4% during fiscal 2023 primarily due to lower employee compensation from reduced headcount and reduced retail occupancy costs from a smaller retail footprint partially offset by unfavorable employee benefit costs, including higher group insurance, and new product display, merchandising and sample costs incurred in connection with the refresh of our design centers.

Restructuring and Other Impairment Charges, Net of Gains

Restructuring and other impairment charges, net of gains for fiscal 2023 was a gain of $3.7 million compared to a gain of $4.5 million in the prior year. The current year gain of $3.7 million included $4.2 million from the sale-leaseback transaction completed in August 2022 as well as a gain of $0.3 million on the sale of a property partially offset by $0.7 million of severance and other lease exit costs. The prior year gain of $4.5 million primarily related to the sale of three properties for a pre-tax gain of $5.4 million partially offset by $0.9 million in severance and other lease exit costs.

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Consolidated Operating Income

Consolidated operating income for fiscal 2023 decreased $1.1 million or 0.8% and when expressed as a percentage of net sales was 17.3%, up from 16.9% in the prior year period. Adjusted operating income, which excludes restructuring and other charges, net of gains, was $133.5 million, or 16.9% of net sales compared with $134.2 million, or 16.4% of net sales in the prior year period. The 50-basis point improvement was driven by consolidated gross margin expansion and our ability to maintain a disciplined approach to cost savings and expense control in a declining net sales environment. Specific drivers of consolidated operating income growth were consolidated gross margin expansion, strong cost containment measures, reduced employee compensation from lower headcount, and lower retail occupancy costs primarily offset by a 3.2% decrease in consolidated net sales, higher retail delivery costs, increased marketing spend, and higher benefit costs. Compared to a year ago, our headcount is down 491 associates (365 wholesale and 126 retail) or 11.6% as we continue to identify additional operational efficiencies and leverage the use of technology to streamline workflows. Our ability to operate the business more efficiently with less headcount has helped improve our operating margin. Restructuring and other charges, net of gains, increased operating income by $3.7 million during fiscal 2023 compared to a $4.5 million increase in the prior year period.

Wholesale Operating Income

Wholesale operating income for fiscal 2023 increased $4.9 million or 7.6% and as a percentage of wholesale net sales was 15.3%, compared to 13.2% in the prior year period. Adjusted wholesale operating income was $69.0 million, or 15.3% of wholesale net sales compared with $60.7 million, or 12.6% of wholesale net sales in the prior year period. The increase is due to a significant improvement in wholesale gross margin, declining freight and raw material input costs, and lower compensation from reduced headcount partially offset by reduced fixed cost leverage from lower net sales of $34.3 million or 7.1%. When expressed as a percentage of sales, wholesale SG&A expenses were 19.4% of wholesale net sales, a 70-basis point increase, due to lower operating leverage from decreased sales relative to our fixed costs partially offset by lower expenses. Wholesale SG&A expenses were down 3.8% while wholesale net sales declined at a faster rate of 7.1%, which led to decreased operating leverage. Restructuring and other charges, net of gains, increased wholesale operating income in the prior year by $3.2 million which included a $2.0 million gain from the sale of the Atoka, Oklahoma distribution center.

Retail Operating Income

Retail operating income for fiscal 2023 decreased $13.2 million or 16.4% and as a percentage of retail net sales was 10.2%, compared to 11.7% in the prior year period. Adjusted retail operating income, which excludes restructuring and other charges, net of gains, was $63.4 million, or 9.6% of net sales compared with $79.7 million, or 11.5% of net sales in the prior year period. The decrease in retail operating income was driven by the $27.3 million or 4.0% decrease in net sales, a 40-basis point reduction in retail gross margin, higher delivery costs, increased marketing spend, higher benefit expenses and new product display, merchandising and sample costs partially offset by a decrease in incremental delivery costs and reduced designer variable compensation from lower sales, lower compensation from reduced headcount, and lower occupancy expenses. Restructuring and other charges, net of gains, increased retail operating income by $3.9 million during fiscal 2023 compared to a $1.3 million increase in the prior year period.

Income Tax Expense

Income tax expense for fiscal 2023 was $35.2 million compared with $34.8 million in the prior year period. Our consolidated effective tax rate was 25.0% compared with 25.2% in the prior year. Our effective tax rate of 25.0% varies from the 21% federal statutory rate primarily due to state taxes.

Net Income

Net income for fiscal 2023 increased by $2.5 million or 2.4% compared with the prior year period. Adjusted net income, which removes the after-tax impact of restructuring and other charges, net of gains, was $103.1 million an increase of 2.8% compared to $100.3 million in the prior year period due to an improved consolidated gross margin and our ability to reduce SG&A expenses through cost containment measures partially offset by the decrease in net sales.

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Diluted EPS

Diluted EPS for fiscal 2023 was $4.13 compared to $4.05 per diluted share in the prior year period. Adjusted diluted EPS was $4.03, up 2.5% compared to $3.93 in the prior year period. The increase in diluted EPS was driven by an improved consolidated gross margin and our ability to reduce SG&A expenses through cost containment measures partially offset by the decrease in net sales.

Regulation G Reconciliations of Non-GAAP Financial Measures

To supplement the financial measures prepared in accordance with GAAP, we use non-GAAP financial measures, including adjusted operating income and margin, adjusted wholesale operating income and margin, adjusted retail operating income and margin, adjusted net income and adjusted diluted earnings per share. The reconciliations of these non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are shown in the tables below.

These non-GAAP measures are derived from the consolidated financial statements but are not presented in accordance with GAAP. We believe these non-GAAP measures provide a meaningful comparison of our results to others in our industry and our prior year results. Investors should consider these non-GAAP financial measures in addition to, and not as a substitute for, our financial performance measures prepared in accordance with GAAP. Moreover, these non-GAAP financial measures have limitations in that they do not reflect all the items associated with the operations of the business as determined in accordance with GAAP. Other companies may calculate similarly titled non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes. Despite the limitations of these non-GAAP financial measures, we believe these adjusted financial measures and the information they provide are useful in viewing our performance using the same tools that management uses to assess progress in achieving our goals. Adjusted measures may also facilitate comparisons to our historical performance.

The following tables below show a reconciliation of non-GAAP financial measures used in this filing to the most directly comparable GAAP financial measures.

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* Adjustments to reported GAAP financial measures including operating income and margin, net income, and diluted EPS have been adjusted by the following:

Liquidity

We are committed to maintaining a strong balance sheet in order to weather difficult industry conditions, take advantage of short and long-term opportunities and execute our strategic initiatives. Our sources of liquidity include cash, cash equivalents, short-term investments, cash generated from operations and amounts available under our credit facility. We believe these sources remain adequate to meet our short-term and long-term liquidity requirements, finance our long-term growth plans, invest in capital expenditures and fulfill other cash requirements for day-to-day operations and contractual obligations. We continue to monitor our liquidity closely during this continued period of economic uncertainty and volatility.

As of June 30, 2023, the Company had available liquidity of $293.7 million as summarized below (in thousands).

As of June 30, 2023, we had working capital of $196.4 million and a current ratio of 2.20 compared with $131.1 million and 1.61 a year ago. Our non-U.S. subsidiaries held $3.7 million in cash and cash equivalents at June 30, 2023, which we have determined to be indefinitely reinvested. A year ago, our non-U.S. subsidiaries held $8.1 million in cash and cash equivalents, a higher amount than as of June 30, 2023 due to significant capital expenditures incurred during fiscal 2023.

Summary of Cash Flows

At June 30, 2023, we held cash and cash equivalents of $62.1 million compared with $109.9 million at June 30, 2022. Cash and cash equivalents aggregated to 8.3% of our total assets at June 30, 2023, compared with 15.3% a year ago. In addition to cash and cash equivalents of $62.1 million, we had short-term investments of $110.6 million at June 30, 2023, compared with $11.2 million a year ago. Our short-term investments at June 30, 2023 are within United States Treasury Bills with maturities of less than one year, and to which we expect will further enhance our returns on excess cash.

Our cash and cash equivalents decreased $47.8 million or 43.5% during fiscal 2023 due to $97.5 million in net purchases of short-term investments, $46.4 million in cash dividends paid, and capital expenditures of $13.9 million partially offset by net cash provided by operating activities of $100.7 million, $8.1 million in proceeds received from the sale-leaseback transaction completed in August 2022 and $1.8 million in proceeds received from the sale of a property in April 2023.

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The following table illustrates the main components of our cash flows for each of the last three fiscal years.

Cash Provided by (Used in) Operating Activities.

We generated $100.7 million in cash from operating activities, an increase from $69.4 million in the prior year period primarily due to a reduction in inventory carrying levels and accounts receivable combined with higher net income partially offset by a decline in customer deposits. Our inventory decreased $27.3 million since June 30, 2022 as we restore our operating inventory levels to more historical levels as backlog declines. Inventory balances continue to decrease as we seek to reduce our inventory while also ensuring appropriate levels are maintained to service our customer base. These benefits were partially offset by a decrease in customer deposits as net shipments outpaced incoming written orders, which also helped reduce backlog, and a decrease in accounts payable. Restructuring payments made during fiscal 2023 were $1.0 million compared to $1.6 million in the prior year and related primarily to severance and lease exit costs paid.

Cash Provided by (Used in) Investing Activities.

Cash used in investing activities was $101.5 million during fiscal 2023, an increase from $14.0 million in the prior year period due to $97.5 million of net purchases of investments (net of proceeds from sales of investments) and capital expenditures of $13.9 million, partially offset by $8.1 in proceeds received from the sale-leaseback transaction completed in August 2022 as well as the sale of a property for $1.8 million in April 2023. During fiscal 2023, we purchased $219.5 million in short-term United States Treasury Bills, with maturities ranging from 90 days to a maximum of one year, of which $109.5 million matured during fiscal 2023 for a net investment of $110.6 million as of June 30, 2023. We also liquidated our previously held investments in municipal bonds, commercial paper and certificates of deposit during the first quarter of fiscal 2023, which had totaled $11.2 million as of June 30, 2022. Our short-term investments are reported within Investments in our consolidated balance sheets as of June 30, 2023 and 2022. Capital expenditures of $13.9 million during fiscal 2023 primarily related to efficiency and safety upgrades to our manufacturing plants, spending on design center relocations and improvements and investments in technology upgrades and infrastructure.

Cash Provided by (Used in) Financing Activities.

Cash used in financing activities was $47.6 million during fiscal 2023, a decrease from $49.0 million in the prior year period primarily from a lower special dividend paid, which was $0.50 per share in fiscal 2023 compared with $0.75 a year ago. This decrease was partially offset by a 12.5% increase to the regular quarterly cash dividend. The Board increased the regular quarterly cash dividend to $0.36 per share on April 25, 2023, which was paid on May 25, 2023. There were no repurchases of common stock under our existing share repurchase program during fiscal 2023 or 2022.

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Restricted Cash

We present restricted cash as a component of total cash and cash equivalents on our consolidated statements of cash flows and within Other Assets on our consolidated balance sheets. At June 30, 2023 and 2022, we held $0.5 million and $1.0 million, respectively, of restricted cash related to the Ethan Allen insurance captive.

Exchange Rate Changes

Due to changes in exchange rates, our cash and cash equivalents were positively impacted by $0.2 million during fiscal 2023 compared with a $0.1 million negative impact in the prior year period. These changes had an immaterial impact on our cash balances held in Canada, Mexico, and Honduras.

Capital Resources, including Material Cash Requirements

Sources of Liquidity

Capital Needs. On January 26, 2022, we entered into a Third Amended and Restated Credit Agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. as administrative agent and syndication agent and Capital One, National Association, as documentation agent. The Credit Agreement amended and restated the Second Amended and Restated Credit Agreement, dated as of December 21, 2018, as amended. The Credit Agreement provides for a $125 million revolving credit facility (the “Facility”), subject to borrowing base availability, with a maturity date of January 26, 2027. The Credit Agreement also provides us with an option to increase the size of the Facility up to an additional amount of $60 million. Availability under the Facility fluctuates according to a borrowing base calculated on eligible accounts receivable and inventory, net of customer deposits and reserves. The Facility includes covenants that apply under certain circumstances, including a fixed-charge coverage ratio requirement that applies when excess availability under the credit line is less than certain thresholds. As of June 30, 2023, we were not subject to the fixed-charge coverage ratio requirement, had no borrowings outstanding under the Facility, were in compliance with all other covenants, and had borrowing availability of $121.0 million of the $125.0 million credit commitment. We incurred financing costs of $0.5 million during fiscal 2022, which are being amortized as interest expense over the remaining life of the Facility using the effective interest method. See Note 11, Credit Agreement, to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K, for a further description of the Credit Agreement.

Letters of Credit. At both June 30, 2023 and 2022 there were $4.0 million of standby letters of credit outstanding under the Facility.

Uses of Liquidity

Capital Expenditures. Capital expenditures in fiscal 2023 totaled $13.9 million compared with $13.4 million in the prior year period. The increase is primarily related to $6.2 million of spending within our Upholstery and Case Goods manufacturing facilities to further improve their capacity, safety, equipment and efficiency. The remaining spend of $7.7 million was primarily for retail design center openings, relocations and floor projection changes, as well as additional investments in technology used throughout each design center and within our corporate support services.

We have no material contractual commitments outstanding for future capital expenditures and anticipate that cash from operations will be sufficient to fund future capital expenditures. We expect our fiscal 2024 capital expenditures to be slightly above fiscal 2023 levels as we refresh the majority of our design center projections, further invest in technology, and open new or relocate multiple design centers.

Dividends. Our Board of Directors has sole authority to determine if and when we will declare future dividends and on what terms. We have a strong history of returning capital to shareholders and continued this practice during fiscal 2023 as the following actions were taken pertaining to dividends.

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During fiscal 2023 we paid a total of $1.82 per share in cash dividends for an aggregate total of $46.4 million. This included the special dividend paid in August 2022 totaling $12.7 million. In the prior year period, total dividends paid were $48.3 million. With our dividends, we have returned $206.4 million to shareholders over the past five years and $620.9 million since our initial public offering in 1993.

Ethan Allen has a long history of returning capital to shareholders and is pleased to pay a special cash dividend, which highlights the Company’s strong balance sheet and operating results. We have paid a special cash dividend each of the past three years and paid an annual cash dividend every year since 1996. Although we expect to continue to declare and pay comparable quarterly cash dividends for the foreseeable future, the payment of future cash dividends is within the discretion of our Board of Directors and will depend on our earnings, operations, financial condition, capital requirements and general business outlook, among other factors. Our credit agreement also includes covenants that includes limitations on our ability to pay dividends.

Share Repurchase Program. There were no share repurchases under our existing multi-year share repurchase program during fiscal 2023 or 2022. At June 30, 2023, we had a remaining Board authorization to repurchase 2,007,364 shares of our common stock pursuant to our share repurchase program. The timing and amount of any future share repurchases in the open market and through privately negotiated transactions will be determined by the Company’s officers at their discretion and based on a number of factors, including an evaluation of market and economic conditions while also maintaining financial flexibility.

Material Cash Requirements from Contractual Obligations

Fluctuations in our operating results, levels of inventory on hand, operating lease commitments, the degree of success of our accounts receivable collection efforts, the timing of tax and other payments, the rate of written orders and net sales, levels of customer deposits on hand, as well as necessary capital expenditures to support growth of our operations will impact our liquidity and cash flows in future periods. The effect of our contractual obligations on our liquidity and capital resources in future periods should be considered in conjunction with the factors mentioned here. As of June 30, 2023, we had total contractual obligations of $199.1 million, an increase from $193.2 million a year ago due to $40.2 million in operating lease liabilities from new leases and modifications to existing leases entered into throughout fiscal 2023 partially offset by operating lease payments of $31.0 million during fiscal 2023. Except for operating leases, there were no other material changes, outside of the ordinary course of business, in our contractual obligations during the fiscal year.

Our material cash requirements for our contractual obligations as of June 30, 2023 were as follows:

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

For a discussion of our liquidity and capital resources and our cash flow activities for the fiscal year ended June 30, 2022 and 2021, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2022, filed with the SEC on August 29, 2022.

Other Arrangements

We do not utilize or employ any other arrangements in operating our business. As such, we do not maintain any retained or contingent interests, derivative instruments or variable interests which could serve as a source of potential risk to our future liquidity, capital resources and results of operations.

Product Warranties. As of June 30, 2023 and 2022, our product warranty liability totaled $1.3 million and $1.2 million, respectively. Our products, including our case goods, upholstery and home accents, generally carry explicit product warranties and are provided based on terms that are generally accepted in the industry. All our domestic independent retailers are required to enter into and perform in accordance with the terms and conditions of a warranty service agreement. We record provisions for estimated warranty and other related costs at time of sale based on historical warranty loss experience and make periodic adjustments to those provisions to reflect actual experience. On rare occasions, certain warranty and other related claims involve matters of dispute that ultimately are resolved by negotiation, arbitration or litigation. We provide for such warranty issues as they become known and are deemed to be both probable and estimable.

Government Contracts

Other than standard provisions contained in our contracts with the United States government, we do not believe that any significant portion of our business is subject to material renegotiation of profits or termination of contracts or subcontracts at the election of government entities. The Company sells to the United States government both through General Services Administration (“GSA”) Multiple Award Schedule Contracts and through competitive bids. The GSA Multiple Award Schedule Contract pricing is principally based upon our commercial price list in effect when the contract is initiated. We are required to receive GSA approval to apply list price increases during the term of the Multiple Award Schedule Contract period.

Contingencies

We are involved in various claims and litigation as well as environmental matters, which arise in the normal course of business. Although the final outcome of these legal and environmental matters cannot be determined, based on the facts presently known, it is our opinion that the final resolution of these matters will not have a material adverse effect on our financial position or future results of operations.

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

Critical Accounting Estimates

We prepare our consolidated financial statements in conformity with GAAP. In some cases, these principles require management to make difficult and subjective judgments regarding uncertainties and, as a result, such estimates and assumptions may significantly impact our financial results and disclosures. We consider an accounting estimate to be critical if: (i) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (ii) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. We base our estimates on currently known facts and circumstances, prior experience and other assumptions we believe to be reasonable. We use our best judgment in valuing these estimates and may, as warranted, use external advice. Actual results could differ from these estimates, assumptions, and judgments and these differences could be significant. We make frequent comparisons throughout the year of actual experience to our assumptions to reduce the likelihood of significant adjustments and will record adjustments when differences are known.

The following critical accounting estimates affect our consolidated financial statements.

Impairment of Long-Lived Assets, including the Assessment of the Carrying Value of Retail Design Center Long-lived Assets

The recoverability of our retail design centers’ long-lived assets is evaluated for impairment whenever events or changes in circumstances indicate that we may not be able to recover the carrying amount of an asset or asset group. Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of an asset, change in the intended use of an asset, a product recall or an adverse action or assessment by a regulator. If the sum of the estimated undiscounted future cash flows over the remaining life of the primary asset is less than the carrying value, we recognize a loss equal to the difference between the carrying value and the fair value, usually determined by the estimated discounted cash flow analysis or independent third-party appraisal of the asset or asset group. While determining fair value requires a variety of input assumptions and judgment, we believe our estimates of fair value are reasonable. The asset group is defined as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of other groups of assets, which for our retail segment is the individual design center. For retail design center level long-lived assets, expected cash flows are determined based on our estimate of future net sales, margin rates and expenses over the remaining expected terms of the leases.

Goodwill and Indefinite-Lived Intangible Assets

We review the carrying value of our goodwill and other intangible assets with indefinite lives at least annually, during the fourth quarter, or more frequently if an event occurs or circumstances change, for possible impairment. Both goodwill and indefinite-lived intangible assets are assigned to our wholesale reporting unit which is principally involved in the development of the Ethan Allen brand and encompasses all aspects of design, manufacturing, sourcing, marketing, sale and distribution of the Company’s broad range of home furnishings and accents.

Goodwill. We may elect to evaluate qualitative factors to determine if it is more likely than not that the fair value of a reporting unit or fair value of indefinite lived intangible assets is less than its carrying value. If the qualitative evaluation indicates that it is more likely than not that the fair value of a reporting unit or indefinite lived intangible asset is less than its carrying amount, a quantitative impairment test is required. Alternatively, we may bypass the qualitative assessment for a reporting unit or indefinite lived intangible asset and directly perform a quantitative assessment.

A quantitative impairment test involves estimating the fair value of each reporting unit and indefinite lived intangible asset and comparing these estimated fair values with the respective reporting unit or indefinite lived intangible asset carrying value. If the carrying value of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to such excess, limited to the total amount of goodwill allocated to the reporting unit. If the carrying value of an individual indefinite lived intangible asset exceeds its fair value, such individual indefinite lived intangible asset is written down by an amount equal to such excess. Estimating the fair value of reporting units and indefinite lived intangible assets involves the use of significant assumptions, estimates and judgments with respect to a number of factors, including sales, gross margin, general and administrative expenses, capital expenditures, EBITDA and cash flows, the selection of an appropriate discount rate, as well as market values and multiples of earnings and revenue of comparable public companies.

To evaluate goodwill in a quantitative impairment test, the fair value of the reporting units is estimated using a combination of Market and Income approaches. The Market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). In the Market approach, the method focuses on comparing the Company’s risk profile and growth prospects to reasonably similar publicly traded companies. Key assumptions used include multiples for revenues, EBITDA and operating cash flows, as well as consideration of control premiums. The selected multiples are determined based on public companies within our peer group, and if appropriate, recent comparable transactions are also considered. Control premiums are determined using recent comparable transactions in the open market. Under the Income approach, a discounted cash flow method is used, which includes a terminal value, and is based on management’s forecasts and budgets. The long-term terminal growth rate assumptions reflect our current long-term view of the market in which we compete. Discount rates use the weighted average cost of capital for companies within our peer group, adjusted for specific company risk premium factors.

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

The Company performed its annual goodwill impairment test during the fourth quarter of fiscal 2023 utilizing a qualitative analysis and concluded it was more likely than not the fair value of our wholesale reporting unit was greater than its respective carrying value and no impairment charge was required. In performing the qualitative assessment, we considered such factors as macroeconomic conditions, industry and market conditions in which we operate including the competitive environment and any significant changes in demand. We also considered our stock price both in absolute terms and in relation to peer companies.

Other Indefinite-Lived Intangible Assets. We also annually evaluate whether our trade name continues to have an indefinite life. Our trade name is reviewed for impairment annually in the fourth quarter and may be reviewed more frequently if indicators of impairment are present. Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of an asset, a product recall or an adverse action or assessment by a regulator. Factors used in the valuation of intangible assets with indefinite lives include, but are not limited to, management’s plans for future operations, recent results of operations and projected future cash flows.

Similar to goodwill, we may elect to perform a qualitative assessment. If the qualitative evaluation indicates that it is more likely than not that the fair value of our trade name was less than its carrying value, a quantitative impairment test is required. Alternatively, we may bypass the qualitative assessment for our indefinite lived intangible asset and directly perform a quantitative assessment. To evaluate our trade name using a quantitative analysis, its fair value is calculated using the relief-from-royalty method. Significant factors used in the trade name valuation are rates for royalties, future revenue growth and a discount factor. Royalty rates are determined using an average of recent comparable values, review of the operating margins and consideration of the specific characteristics of the trade name. Future growth rates are based on the Company’s perception of the long-term values in the market in which we compete, and the discount rate is determined using the weighted average cost of capital for companies within our peer group, adjusted for specific company risk premium factors.

We performed our annual indefinite-lived intangible asset impairment test during the fourth quarter of fiscal 2023 utilizing a qualitative analysis and concluded it was more likely than not the fair value of our trade name was greater than its carrying value and no impairment charge was required. Qualitative factors reviewed included a review for significant adverse changes in customer demand or business climate that could affect the value of the asset, a product recall or an adverse action or assessment by a regulator.

Inventories

Inventories (finished goods, work in process and raw materials) are stated at the lower of cost, determined on a first-in, first-out basis, and net realizable value. Cost is determined based solely on those charges incurred in the acquisition and production of the related inventory (i.e. material, labor and manufacturing overhead costs). We estimate an inventory reserve for excess quantities and obsolete items based on specific identification and historical write-downs, taking into account future demand and market conditions. Our inventory reserves contain uncertainties that require management to make assumptions and to apply judgment regarding a number of factors, including market conditions, the selling environment, historical results and current inventory trends. We adjust our inventory reserves for net realizable value and obsolescence based on trends, aging reports, specific identification and estimates of future retail sales prices. If actual demand or market conditions change from our prior estimates, we adjust our inventory reserves accordingly throughout the period. We have not made any material changes to our assumptions included in the calculations of the lower of cost or net realizable value reserves during the periods presented. At June 30, 2023 and 2022, our inventory reserves totaled $1.9 million and $2.1 million, respectively.

Income Taxes

We are subject to income taxes in the United States and other foreign jurisdictions. Our tax provision is an estimate based on our understanding of laws in Federal, state and foreign tax jurisdictions. These laws can be complicated and are difficult to apply to any business, including ours. The tax laws also require us to allocate our taxable income to many jurisdictions based on subjective allocation methodologies and information collection processes.

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ETHAN ALLEN INTERIORS INC. AND SUBSIDIARIES

We use the asset and liability method to account for income taxes. We recognize deferred tax assets and liabilities based on the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates in effect for the year in which we expect to recover or settle those temporary differences. When we record deferred tax assets, we are required to estimate, based on forecasts of taxable earnings in the relevant tax jurisdiction, whether we are more likely than not to recover them. In making judgments about realizing the value of our deferred tax assets, we consider historic and projected future operating results, the eligible carry-forward period, tax law changes and other relevant considerations.

The Company evaluates, on a quarterly basis, uncertain tax positions taken or expected to be taken on tax returns for recognition, measurement, presentation, and disclosure in its consolidated financial statements. If an income tax position exceeds a 50% probability of success upon tax audit, based solely on the technical merits of the position, the Company recognizes an income tax benefit in its financial statements. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The liability associated with an unrecognized tax benefit is classified as a long-term liability except for the amount for which a cash payment is expected to be made or tax positions settled within one year.

Business Insurance Reserves

We have insurance programs in place for workers’ compensation and health care under certain employee benefit plans provided by the Company. The insurance programs, which are funded through self-insured retention, are subject to various stop-loss limitations. We accrue estimated losses using actuarial models and assumptions based on historical loss experience. As of June 30, 2023, we had a liability of $2.4 million related to health care coverage compared to $2.0 million in the prior year period. We also carry workers’ compensation insurance subject to a deductible amount for which the Company is responsible on each claim. As of June 30, 2023, we had accrued liabilities of $4.2 million related to workers’ compensation claims, primarily for claims that do not meet the per-incident deductible, compared to $3.8 million in the prior year period. These business insurance reserves are recorded within Accrued compensation and benefits on our consolidated balance sheets.

Although we believe that the insurance reserves are adequate, the reserve estimates are based on historical experience, which may not be indicative of current and future losses. In addition, the actuarial calculations used to estimate insurance reserves are based on numerous assumptions, some of which are subjective. We adjust insurance reserves, as needed, in the event that future loss experience differs from historical loss patterns.

Significant Accounting Policies

See Note 3, Summary of Significant Accounting Policies, in the notes to our consolidated financial statements included under Part II, Item 8, for a full description of our significant accounting policies.

Recent Accounting Pronouncements

See Note 3, Summary of Significant Accounting Policies, in the notes to our consolidated financial statements included under Part II, Item 8, for a full description of recent accounting pronouncements, including the expected dates of adoption.