Ethan Allen Interiors ETH RECOMMENDATION BUY Background

Ethan Allen Interiors (ETH) RECOMMENDATION: BUY

Background • Ethan Allen Inc. is a leading manufacturer and retailer of quality home furnishings, offering a full range of furniture products and accessories. Ethan Allen manufactures and distributes three principal product lines: • case goods (wood furnishings), consisting primarily of bedroom and dining room furniture, wall units and tables • upholstered products, consisting primarily of sofas, loveseats, chairs, and recliners • home accessories, and other, including carpeting and area rugs, lighting products, clocks, wall decor, bedding ensembles, draperies, decorative accessories and indooroutdoor furnishings. • The Company's operations are classified into two main businesses: wholesale and retail home furnishings. The wholesale home furnishings business is principally involved in the manufacture, sale and distribution of home furnishing products to a network of independently-owned and Ethan Allen-owned stores. The retail business exclusively sells Ethan Allen's products though a network of 309 retail stores (73 owned and operated by ETH, 215 independent retailers, 21 stores abroad). Ethan Allen is one of the ten largest manufacturers of household furniture in the United States. Ethan Allen manufactures and/or assembles approximately 90% of its products at 21 manufacturing facilities which includes 3 saw mills, thereby maintaining control over cost, quality and service to its consumers. Ethan Allen distributes its products primarily through eight regional distribution centers and terminals strategically located throughout the United States.

Background • Ethan Allen's policy is to sell its products at the same delivered cost to all dealers nationwide, regardless of their shipping point. The adoption of this policy has discouraged dealers from carrying significant inventory in their own warehouses. As a result, Ethan Allen obtains accurate information regarding sales to dealers to better plan production runs and manage inventory. Having one national landed cost has permitted Ethan Allen to provide one national suggested retail price which, in turn, helps facilitate a national advertising program. Ethan Allen television advertising is aired approximately 27 weeks per year. • Ethan Allen's product strategy has been to expand its home furnishings collections to appeal to a broader consumer base while providing good quality and value. Management believes that the two most important style categories in home furnishings today are Classic (style which includes English 18 th Century and 19 th Century Neo-Classic styling) and Casual (style is based on classic contemporary design elements). Each collection includes case goods, upholstered products and accessories, each styled with distinct design characteristics. Ethan Allen's store concept allows for the display of these categories in complete room settings which utilize the related collections to project the category lifestyle.

Background

Honors / Management • Furniture Today (a leading industry publication) published a survey of America's Top 100 Furniture Retailers for 1999. Ethan Allen was ranked No. 2 in terms of furniture, beddings and accessary sales for dealer-owned and company-owned stores and was ranked No. 1 as the largest single-source store network for home furnishings in the country. • Worth Magazine named ETH CEO Farooq Kathwari in the top 50 for successfully reinventing the Ethan Allen Brand. In the past 7 years, he has introduced furninture with a more casual, classic style, cut prices, designed new customer friendly stores and launched a $67. 5 M national advertising campaign in 1998

• What’s up ? (Firm) First quarter sales and EPS increased 14. 1% and 18. 4% respectively. EPS(Q) at 0. 45 was a 4. 65% surprise. This is the 17 th consecutive quarter ETH has been able to report significant growth in sales and earnings. • Approximately 90% of the Company's products have been redesigned over the last six years. This allows the Company to maintain focused lines within each style category which enhances efficiencies. In 1992, Ethan Allen instituted a new image and logo program. Additionally, Ethan Allen undertook a program to renovate the exterior of its stores. As of June 30, 1999, this renovation program has been substantially completed with 297 or 96% of all stores (including dealer-owned and Ethan Allen-owned stores) having either implemented new exteriors or are currently under renovation. The store is divided into three-stores-in-one and positions Ethan Allen as specialists in casual styles, classic designs and decorative accessory retailing. It features two fully designed show homes to inspire consumers and show them how product could look in their homes. In addition, it presents products in focused vignettes that are easy and relatively inexpensive to update each season. In the last six years 130 new stores were opened, many of them relocations. Sales to independent dealer-owned stores accounted for approximately 60% of total net sales of the Company in fiscal 1999. In fiscal year 1999, the Company's focus was on introducing the Avenue and Ethan Allen Kids lines of home furnishings. These products have recently been introduced at the retail level and revenues to date have not been significant. Also, in fiscal year 1999, the Company initiated its Internet distribution strategy, which is expected to be launched in the second quarter of fiscal year 2000. • “We’re expanding our reach, our relationship…There’s no reason not to help decorate the client’s children’s room and garden. ” (CEO)

What’s up ? (Industry 1/2) • BAC (10/04): Home furnishings is $125 billion industry (accounting for 2. 2% of total annual consumer spending). Consumers spend an average of $1, 215 per household per year on home furnishings of which 46% of that figure on furniture. According to BAC the industry is not as volatile as investors think with only three years of declining growth since 1970. Three areas besides furniture are housewares, accessories and textiles that are growing at a faster rate. Sector has been holding share better than most other product sectors. Growth for home furnishings segment has a rate of 8% since 1970 • BAC enumerated four ``growth drivers'' for the home furnishings industry: · Favorable Demographics -- 35 -54 -year-olds represent 52% of home furnishings purchases and this age group is estimated to increase 33% to 46 million people by 2010. · Home Ownership - home ownership is at record levels in the U. S. , up 67% since 1970. And, homes are larger these days, requires more furnishing. · Influence of Media - a dramatic increase in home magazine readership (up 13% since 1995) illustrates a growing consumer interest. Home furnishings television programming has also gained enthusiasts. · Renovations are at an all-time high, having totaled $164 billion in 1998. In the last seven years, home renovation spending has increased 74%. Increase in renovation has come about particularly as more Americans begin to work from home offices. Last year, 3. 6 million Americans were paid to work at home 89% more than in 1991.

What’s up ? (Industry 2/2) • Finally, Hale (BAC) outlined some of the trends that will continue to characterize the home furnishings industry, including: the polarization of spending; a focus on value at the low-end; increased dominance of brands at the high-end; new retail concepts from national players; and ``do-it-for-me'' one-stop redecorating resources offered by companies like The Home Depot and Sears. • AG Edwards (10/04): believes that the broad economic environment has been quite conductive to solid growth and profitability in the home furnishings arena…we expect those trends to continue…at a somewhat slower more sustainable pace over the next year or two. Virtually all of the economic variables necessary to drive growth in this segment are positive – house activity, interest rates, consumer confidence, employment levels and demographic trends such as the middle aging of the baby boomers • Brand names (including Ethan Allen as one of five mentioned) are key to expansion in the retail industry.

Balance Sheet BV per sh • 1999: 8. 58 • 1998: 7. 28 • 1997: 6. 05 • 1996: 5. 15 • 1995: 4. 49

Cash Flow Statement Capital expenditures have increased due to new store openings and expanding manufacturing capacity. Financing flows include buying back of stock (due to stock options given to management) so that earnings are not diluted.

Income Statement • Fantastic Margins !!!! • Margins that are greater than any competitor’s and the industry’s

Growth/Assumptions for model

Proforma Income Statement Estimates • First Call: ‘ 00 2. 17 ‘ 01 2. 47 • Schwab: ‘ 00 2. 17 ‘ 01 2. 47 • Value Line: ‘ 00 2. 20 ‘ 04 2. 80 • Zacks: ‘ 00 mean 2. 18 ‘ 01 mean 2. 47

Stock Price Estimate

Du. Pont Analysis • Profit Margin increasing • More sales generated from assets • Less leverage

Firm Ratios and Comparisons

Why ETH? (as opposed to FBN) • Significantly better margins • Vertically integrated company taking advantage of cost savings and advantageous margins. Also lower risk. • Initiation of Internet presence • Proven management

Determining the Value of ETH based on Free Cash Flow • FCF = NI+Depreciation-Capital Exp-WCCF • TV = FCF 3 * (1+g) / (WACC - g) • Value = PVFCF (=FCF/1+WACC) + PV TV • Share Price = Value / 42 M

Summary • Increase in EPS since 1991 (17 consecutive quarters with significant increase in sales and eps) • Overall performing better than industry and peers with higher profit margins • Proven management that has revived the firm • Firm is adaptive to current market trends and takes advantage of them • Attractive stock price (P/E to EPS growth ~ 1. 2, broke through 50, 100, 150 moving day average, below P/E high of 27 with current P/E at 17) • Future looks stable with growth potential and sustainability in the long term RECOMMENDATION: BUY