Earnings Call: Q2 2020

Feb 4, 2020

Good afternoon, and welcome to the Itunes Allanes fiscal 20 22nd Quarter Analyst Conference Call. All lines have been placed on mute to prevent any background noise. It is now my pleasure to introduce your host, Curry Whiteley, Executive Vice President Administration And Chief Financial Officer. Thank you. You may begin. Thank you, Jeff. Good afternoon, and welcome to Ethan Allen's conference call for our fiscal second quarter ended December 31, 2019. This conference call is being recorded and webcast live on Ethanolen.com, where you will find a copy of our press release which contains supporting details, including reconciliations of non GAAP information referred to in the release and on this call. As a reminder, our comments today will include forward looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a complete review of those risks. The company assumes no obligation to update or revise any forward looking matters discussed during this call. Joining me on the call is our Chairman and CEO, Frootfari, and Matt McNulty, who we have recently promoted to Vice President Finance. Matt had been serving as our Vice President of Corporate Controller, in his new role, Matt will also be involved in an investor relations together with me. After our Chairman and CEO, Fru Kaffari, provides his opening remarks, I will follow with some details on the financial results, proof will then provide some closing comments before opening up the telephone lines for questions. With that, here's Peru Capwari. Thank you, Corey, and thank you all for participating in this conference call. As Corey mentioned, I'm also pleased that Matt McNulty is making good contributions and taking on more responsibility and says is going to keep on working very hard. As we mentioned in our press release, we continue to strengthen our marketing including the introduction of the member program quarter due to the introduction of this program. We will see continued impact in our 3rd quarter, primarily due to low backlog at the end of the second quarter. We expect stronger order growth in our 3rd 4th quarter positively impacting 4th quarter sales and profitability. We are pleased that our unique vertical structure continues provides strong operating leverage to allow us to return value to shareholders through quarterly dividends, periodic cash dividend and share repurchases. During the second quarter, we paid $5,600,000 in cash dividends. We repurchased 546,000 shares representing 2.1 percent of our outstanding shares. After this purchase, the board authorized further repurchases up to 3,000,000 shares. Just for information since our taking the company public, we have generated strong cash flow. Repurchasing $611,000,000 of our stock, paying $472,000,000 in cash dividends and investing $819,000,000 in capital expenditures. After Cory provides a brief financial overview I will discuss our initiatives to grow sales and profits. Corey? Thank you for During the second quarter of fiscal 2020, our consolidated net sales were 174,600,000 compared with $197,200,000 in the prior year quarter. Net sales were negatively impacted due to the transition to the Ethanol member program along with the decrease in consolidated international net sales, which was primarily related to lower sales to China, and in Canada due to the economic uncertainties surrounding international trade disputes and a challenging global economy. Net sales to China decreased 45.1% and we expect continued headwinds there with emerging concerns around the coronavirus. As we had previously stated, implementation of the Ethanol member program was expected to negatively impact our sales and profitability during the initial year as we transition to the membership model. Our second quarter results reflected this and we expect a similar impact in net sales and profitability for the third quarter ending March 31, 2020. Wholesale segment net sales were $91,900,000 compared with $107,700,000 in the prior year quarter, There were 180 North American Design Centers this year compared to 188 in the prior year period, as we continue to reposition our retail footprint, opening new design centers and closing and relocating older legacy locations. The company has experienced continued growth in contract sales, which grew 66.9%, primarily due to higher sales from the GSA contract and hospitality sales. Our total wholesale orders decreased 21.8% in the 2nd quarter compared with the same quarter last fiscal year. International wholesale orders declined 53.6%. Retail segment net sales were $139,100,000 compared with $158,500,000 in the prior year quarter. There were 144 company operated design centers at the end of the 2nd quarter compared to 146 in the prior year period. Our consolidated adjusted gross margin, which excludes $400,000 in restructuring activities, was 56.1%, reflecting improvement from our optimization initiatives. Retail sales as a percentage of total consolidated net sales was 79.7% compared with 80.4% in the prior year second quarter. Adjusted operating income, which excludes $300,000 in restructuring, was 9,500,000 with an adjusted operating margin of Our adjusted EPS of $0.27 compared with $0.46 a year ago. The effective income tax rate was 23.5 percent for the quarter, compared to 25.1 percent in the prior year. Turning to the balance sheet. We ended the quarter with inventory of 139,000,000 compared to $159,200,000 in the prior year, cash of $28,300,000 and no debt. As Ruth mentioned, during the quarter, we paid regular quarterly dividends of $5,600,000 repurchased 545,727 shares representing 2.1% of the company's outstanding shares. Also, as we announced on January 13, the Board of Directors increased the share repurchase authorization 3,000,000 shares. With that, I'll turn the call back We continue to strengthen our vertically integrated structure of our retail network, manufacturing and logistics. By strengthening our product offerings, projection in our design centers, enhanced marketing and continued investments in technology. Our key areas of focus include: strengthening talent, Developing strong entrepreneurial leaders in retail continues a major focus, and we have made good progress. In corporates, Rodney Hutton joined as Chief Marketing Officer on January 1st after a 3 month consultancy arrangement. Matt McNulty, as you heard, with a strong financial and accounting background, was promoted to Vice President Finance and it'll be reporting to Corey, Corey Whiteley. The second area is our marketing. This month, we have enhanced the marketing program. In October, the membership program was launched. And for all practical purposes, customers had to become a member to purchase our products, which did impact our traffic and sales. As of now, we have made a change So we have expanded our program so that nonmembers can also purchase products at special savings in effect at that time. The members will continue to secure enhanced benefits, including 20% savings on all our products from our everyday best price, free in home delivery and 24 month financing. We have also expanded our marketing and advertising to include radio, television and increasing presence in digital mediums. On our service, our manufacturing in North America and our unique logistics network is in excellent position to service our growth. We completed the consolidating initiatives in manufacturing and logistics started last year. About 75% of our products are made in our North American facilities. The next focus is, has always been on technology, and this is a major focus to implement new technologies in all areas of our enterprise. And finally, social responsibility continues to be a major focus to maintain our leadership in this very important area. With this, we are ready for any comments or questions. Jeff, you can go ahead and give the instructions for people to We have one question from Bobby Griffin. Sir Griffin, your line is now Hello, Bobby. How are you? Good, Farooq. Thank you for taking my questions. Hope you and everyone there is doing well. My first question, I just wanted to see if we can can you help us understand a little bit more what happened during the quarter? How did consumers react to the membership program how much of the sales decline would you attribute to just a little bit of the learnings of the new program versus the overall environment? And then What are you seeing kind of as the progression of the business? Are you starting to see sales get better as more people get used to the program? Anything like that to help us frame up what exactly took place during the quarter? No, Bobby, this is a good question. This is something that we are constantly working on. We introduced the program where we decided that we call the fund of the the structure that we have with about 1500 interior designers that it makes sense for them to work and provide their service to their clients without having to, you might say, have to worry about cost and sales. So we decided that the member program will give certain benefits. The benefits of special savings from everyday best price, special financing, complementary interior design service, complimentary in home delivery, all great things. And our interior designers love it. Our clients love it. However, the issue rate was that it did not create urgency. Whereby we used to have end of month sales. And that did create an urgency. That's number 1. The second thing was that the way we introduced the member program was that in all practical purposes, everybody had to become a member to take advantage of the benefits. As of February, we made some changes. We just now have implemented a program that nonmembers can also purchase based upon whatever the special savings are at that time, for instance, right now, we're running a special savings on our living room products. Now what that will do is that will enhance people coming in because the way we started it it did impact our traffic and traffic impact sales. So I think that the, in addition to the learning curve, in addition to not having the sense of urgency, all those factors contributed to lower sales. So we have now taken some steps First is people are learning. They la our designers love it. Our customers love it because they want to do the, to have great homes. They don't want to have to wait till new sales come in. But in the real world, people do wait for sales. There are customers, there are not members. So we have, Bobby taken steps to improve it. And I believe that we're going to start seeing benefits of that while maintaining the membership program. Okay. I guess 2 follow ups real quickly on that. When you took the steps to add some benefits for the nonmembers. Have you seen anything, in the traffic results yet, or is it still too early to tell? It is too early because just started this month. And I think that, it also reflected the way we are marketing. See, we are marketing in the our 2nd quarter basically was to get members. Now our marketing reflects to get members, but also expanded to all others to come in. So we have made some changes. Hindsight is always 2020. Okay. And then does the way the program still work now though, the members would still get the absolute lowest price that price is even better than the special savings going on at the time? Yes, they will get because for them, it is a special savings. In addition to that, they will get complimentary, the in home delivery And because those are 2 important benefits they will continue to get. They'll get the best price plus complimentary in home delivery. Okay. And then I guess lastly Plus financing and our complementary interior design sales. Everybody else will also get complimentary design service, but everybody will not get the free in home delivery. Okay. And then I guess lastly, are you can you disclose whether or not kind of what you're seeing in terms of total members? Are you a number or you continue to see them grow month over month, anything to help us get a sense of how the program is going from an adoption standpoint? Bobby, all our business now is members. So we have a great increase in members, but now with what we have just done, it will also expand it to nonmembers. And the fact remains that nonmembers, most of them will become members but they're going to come in first. The reason is this that for $100, they become a member and get a benefit of our free delivery. It costs about 190 dollars for them for delivery if they are buying furniture. Okay. That makes sense. That's it for me for now. I'll jump back in the queue and if I have an else I'll buzz back in. Thank you for the time and thank you for answering the questions. Thank you. Next question from the line of Sanjay Beck of Stony Point Capital. Sir, your line is now open. Hi. This is Angie. Hi. Good. How are you? Hey Corey. Just to drill in on the membership model again, can you help us understand how much of the retail business specifically was impacted by the shift to membership model in the quarter since I think you called out both the membership model transition and some cautious consumer headwind. So I guess, 1, if you could help us bifurcate the 2, that would be great. And maybe asked another way. I think on the last call, you guys previously suggested a 3% to 4% net revenue headwind for the full year from the membership program. But clearly, you're making some changes to the savings offered around the members and nonmembers, etcetera. So is that 3% to 4% number still your belief? Or, how should we think about that, mathematically? Yes. On the 3% to 4% just to clarify that, that was on the piece of the deferred revenue for 4% on total sales. Your question is a good one, which is the impact on sales due to the membership and also due to perhaps the issues in the economy and everything else. I would say that, I would say that 90% of our decline was due to the membership program. There were some external factors in terms of what's taking place in the world, what's taking place in, for instance, unfortunately in China, that that impacted our international business. It has some impact in the United States because we do have a lot of Chinese customers in the United States, especially on the West Coast. But I would say that, I would say that at least ninety dollars plus was due to the fact we implemented a membership program, which is great. As I said, our designers love it And just to give you a perspective, Sanjay, that before the great recession, we used to have an everyday best price, no sales. It was like it was like a membership program without people becoming members. But then with a great recession, we first started with a 10% saving, then 15% saving, then 20% saving and all and all. So going so I believe that, the impact of the membership because people had to get used to it. And secondly, was the fact of while we're giving great savings, but we did not have the end of the month urgency for people to close and quarter end is generally very, very important. So it's a learning process. All our team members believe they tell me again and again. They love it. Their clients love it. But again, for practical reasons, we also have to make sure we create urgency and bring people in. And that's why we have made the changes we have. Right. That's helpful. And I remember the deferred revenue impact that makes sense. Thanks. Next question from the line of John Buff of Stifel. Sir, your line is now open. I am well, Farooq. I hope you are as well. Yeah. Good to hear from you. Yeah. I just wanted a point of clarification on the change for the nonmembers versus the members. So are you still are you running sort of give or take depending on the time 20 percent, 30% of your product at a like 20%, 25% off type sale. And they're going to get, access to that or that's different because here to 4, they've not been a member, they wouldn't have gotten that. Or is there a savings across the board of some 20%, 25% for all the members. All right, John. I understand. Let me just go back a little bit before the membership program. Before the membership program, we had some savings every month, every quarter, And those savings range from anywhere from, say, 15%, 20%, even 25%. So those savings we gave to everybody. And once in a while, we would also give free delivery. So when the membership program started, we said the members are going to get 20 percent savings from our retail prices. We call them our everyday best prices. The members would also get a 24 month financing, and they will also get complimentary interior design service and delivery. That was the plan. And, now what we have done is we've added a savings for which would also not only be for our members, but will also be utilized by nonmembers. Like for instance, in December, we did have a special savings, which was only really meant for our members. But now starting in, in February, we have just announced if you see our marketing, you'll see we have a special 25% savings on all living rooms. That product, those savings are can be utilized by our members because the members will get 30% savings on everything. Non members will get 25% I'm sorry, the members will get 20% savings on everything. And they will now also get 25% savings in the living room, while nonmembers will get savings of 25%. Members also get a benefit of free delivery. So those that's the change we have made. What it does is it expands our reach to more people. What we found was John that that people felt that they had to become a member to come in. And that sort of restricted people coming in. Has an impact on traffic. We have now changed it and I believe it has been very well received by our teams and our marketing is taking care of it. So we don't increase traffic both on our website and to our design centers. And as I said, most of these folks are going to come in The chances are they'll become members, but they're going to come in first, and that's what this program does. Okay. So the members were getting 20% off of everything. And now when you decide to run, say, 25% savings on living room, they're getting 25 percent additional savings. And of course, the nonmembers had nothing percent off. And now when you run a special, in this case, 25 percent of living rooms, they're getting that. Is that correct? No, what's the members will not get additional 25 percent, they will get 25% on the living rooms. And anything else, they'll get 20%. They're not going to get additional 25 percent. Okay. 20% on everything else. Okay. And the non member is saying full price. On everything except the special. That's right. Yes. Okay. As it relates to China and sourcing. Could you update us, again, on your rough percentage of product you're bringing in from there? And or maybe Asian general whether or not you fear, supply disruptions from what's going on there? John, you know, 75% of our furniture is made in our North American facilities. And the other vast majority knowledge of furniture, then I'll come to accents because, which accents represents, at this stage, 20% of our business. Now the other 5% or 10% of our furniture is coming from countries such as Indonesia. And we had already moved most of our production. We didn't have much business in China anywhere. As you know, we sell to China. So from a perspective of our sourcing, we are in very, very good shape. Now there are some products that come from China. They're like lighting and accessories, and they're So far we've not seen a problem, but it's possible that there might be some disruptions pending upon how they handle this issue of the unfortunate situation that's taking place in China. So our main issue in China has been the fact that we have been shipping we sell and ship more to products than we buy. So we were first impacted by the tariffs up 25% and now we are impacted by the fact that most of the locations, our partner there is 100 locations. Most of them are closed now. So our business is already down, I think, close to 60%. So is going to be it's going to go down further, but we're already down 60% due to the tariffs and to some degree, softening of the economy in China. That was going to be my follow-up question on that. It's been down for a while now. So the magnitude of what remaining must be pretty, pretty small. Yes, it still is somewhat. It is smaller. It's not, in fact, this quarter, I think it was more or less pretty close to what it was down from the previous quarter. So good news is as Corey said, we have made good good we have made good very good inroads in the business we do with the GSA, the government, and also some contracts. So that has, that has been good for us. And then, you used the word enhanced marketing programs. What would be the dollars either in gross dollars or percentage of revenue. And I'm thinking maybe more calendar 2020, what should we expect from Ethan Allen in terms of either gross dollars of marketing or ad spend year over year or as percent of sales, flat, down, up? Well, John, if you take a look at this second quarter, we spent $8,500,000, which represented 4.8% of our sales. In the last year in the same quarter, we spent $7,600,000, which represented 3.8% of sales. Now in the next quarter that we are looking at, that is our 3rd quarter that we are in now. Last year, we spent 7.4 $1,000,000 represented about 4.1 percent. I think we're going to spend anywhere between $7,500,000 to $8,000,000 in our third quarter. And again, the percentage of course is impacted with overall sales. So our percentage has gone up because of lower sales. So I would say, John, that, approximately utilizing around 4.5% would be a good number. Okay. And then sort of, and that's very helpful, but as we go sort of June through December quarters, and just stick to dollars since we don't know exactly what sales are going to do although you indicated you would hope June quarter will be better. Just the kind of gross dollars you spend on marketing when you add up to four quarters in calendar 2020 match or exceed likely what you did in 2019 or you just don't know? Well, I think we most probably spend closer $30,000,000 last year and we'll probably spend close to that this year. Okay. That's very helpful. Thank you and good luck. All right, John. Good to talk to you. Next question from the line of Christina Fernandes of TLC Advisory Group. Ma'am, your line is now open. Yes. Hello, Christina. Hi, thank you. Good afternoon. I also wanted to follow-up on the member program and understand the impact it's having on the SG and A. Line items. So of the, I guess, 300 and 800 basis points deleverage this quarter, it seems from your comments on the last call that about 100 of it was marketing. How much of the rest was due to the member program? And I assume mostly the impact of the free delivery was really the reduction in sales and the deleveraging. That's being a vertically structured company. We really benefit when sales increase, but when sales go down, we do get the reverse of that. The advertising was about a 1,000,000 more than where we were last year. So that was probably the biggest impact on the SG and A side. Otherwise, relative to sales, it was fairly well controlled. Hey, Christian, I'll give you, I mean, if you take a look at our total sales, which of course, you will see that in the quarter, we had $175,000,000 versus $197,000,000 And last year, our this, again, it's a question of, if you compare our selling which is last year we had 52,000,000 and this year we had 51,000,000 But where overall our expenses, this quarter were $88,000,000 versus $93,000,000 last year. So we did reduce our expenses as a total, while, also, obviously, as percentage of total sales, our expenses were higher because of they were because of lower sales. Our total dollars went from $93,000,000 to 88,000,000 As a percentage, it was 50.6% versus 47% last year, again, because of sales. Understood. And then I wanted to, I guess, follow-up on, Corey, your commentary about the this next quarter to 3rd quarter. Being an impact similar to what we just saw in the December quarter. Wouldn't some of the changes that you're making like the additional discounts be able to drive a little bit better sales? Or I guess what are you contemplating in that outlook? Well, we do have an opportunity to see, our stronger order growth as a result of our enhanced marketing plans that we have in place However, there's a little bit of a lag time between ordering it and then delivering it out. Therefore, we expect to see our sales benefit beginning in fourth quarter from the stronger orders this 3rd and fourth quarter? Yes, I think as Corey said, we are entering our 3rd quarter with lower backlogs because of lower sales in the second quarter. Now as we become very efficient, we don't have a lot of backlogs. We do deliver fast. So this quarter, 3rd quarter, we expect are that we expect with all the changes we have made and all the marketing we are doing to have improvements in our orders which will reflect then more in the deliveries in the fourth quarter. So on the auto side, we see positive, but the delivery side, obviously, shipments this quarter is going to be lower because of the lower backlogs entering the quarter. And then lastly, on a different topic, can you remind us of new products that you have coming up in the next couple of quarters as we gear towards the bigger spring summer selling season? Yes, it's a very important initiative that we are going right now. In fact, Cory is most probably going to talk to all of you. We're going we'd like to have an investor meeting in May, in Manhattan. Danbury will be a little bit early. He mean, earlier, we can do it, but I think in Manhattan, most more people will come. We are in the process of of also making more improvements in the projection of our design we have very strong product categories of, we might say, classic products with a modern perspective. We are strengthening it. And we're going to be marketing that because those products to some customers want that product back, there's been too much focus on casual contemporary, including us, for some degree. The second important category for us is what we call country, again, with a modern perspective. So you're going to see products introduced in that. You'll also see products introduced in the 1st category that's classic in the olden days, we call them formal, but today they are more classics and livable with a modern perspective. And the third is our version the modern, which is you're going to be pleasantly surprised at the new products, including what we have called Lucy which is a great program in upholstery. In fact, it's going to be in our design center starting next month, and we'll be starting marketing. So these 3 categories, classics with a modern perspective, country with a modern perspective and our modern is products that we're going to be doing a lot of marketing, starting some in this quarter and then some and also in the next quarter. Thank you. Next question from the line of Bradley Thomas of KeyBanc Capital Markets. Sir, your line is now open. Hello, Brad. It's Brad. How are you? Hey, good afternoon for Uke and Kory. This is Andrew on for Brad. I just had a question on the contract side of the business. I wonder if you could tell us how the State Department contract performed during the quarter. And how you are thinking about the contract side of the business going forward? Yes. As Corey said, we had a substantial increase or 50 percent, Corey, right? Or 50 percent of business in the state department during the quarter and also with better margins. Then we've also gotten business. I think we discussed it. We have to have a good, partnership with the Marlborough Grill Grove where we've been furnishing a number of hotels. We've furnished 1 in Orlando. We're doing one in Houston. We are doing in a few other places. We also continue to do some more business with the Disney program in contract. So that is growing because that's a bright spot. Great. Understood. And then I wanted to follow-up on, promotions you are doing in addition to the membership model. Could you give us a sense for how often you plan plan to run these additional promotions going forward? We're going to see how it works But certainly at this time, we would we plan to have in addition to the savings from our members we will continue to have some special savings, which the nonmembers can use, come in. And I believe that most of them will become members. And I believe those programs will most likely have monthly. Thanks very much. There are no further questions at this time. Please continue. Arnold, thank you very much. And if any questions, comments, please let us know and Corey And the Matt team is now going to be ready to talk to you. So take care. That concludes today's conference. Thank you everyone for participating. You may now disconnect.