Earnings Call: Q4 2019

Jul 31, 2019

Good afternoon, and welcome to the Ethan's Allen's Fiscal 2019 4th Quarter Analyst Conference Call. All lines have been placed on mute to prevent any background noise. Thank you. It is now my pleasure to introduce you to your host Corey Whiteley, Executive Vice President, Administration And Chief Financial Officer. Thank you. You may begin. Thank you, John. Good afternoon and welcome to Ethan Allen's conference call for our fiscal year and 4th quarter ended June 30, 2019. This conference call is being recorded and webcast live on ethanallen.com. Where you will also find 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 is our Chairman and CEO, Faroo Kafwari and our Vice President, Corporate Controller, Matt McNulty. After our Chairman and CEO, Crew Kaffore provides his opening remarks, I will follow with some details on the financial results. Frupa then provide further updates on our ongoing business initiatives before opening up the telephone lines for questions. With that, here's Farooq Cafore. Thank you, Corey, and thank you all for participating in the call. For fiscal 2019 fourth quarter, while being challenged with a number of factors including lower sales to international markets, particularly China, we were able to increase profitability. Orders in sales to China and Canada were impacted by the imposition of tariffs. We are unique in shipping substantially more products to China than we purchased from them. Our sales to China were also impacted with higher inventory levels held by our retailer in China going into the fiscal year and then the softening of sales there. We are encouraged by the recent actions our retailer is taking to increase marketing relating to Ethanol And Programs throughout China. During the year, the imposition of tariffs in Canada also impact negatively on our sales and profitability. With the end of the tariffs, our business in Canada has started to grow. During the fiscal year, despite lower sales, we were able to improve our adjusted gross margins to 55.1 percent from 54.2%. Our adjusted earnings per share during the year and the quarter increased 15.6% and 7%, respectively, which helped to generate strong cash flow, allowing us to have paid out $47,000,000 in dividends for the fiscal year, a 59.2% increase. During the year, our orders from the U S. Government contract increased 50.5% resulting in a stronger contract order backlog were negatively impacted due to domestic and international disruptions. In July, we see stronger consumer confidence returning. We have continued to improve the efficiencies of our vertically integrated enterprise including continued strengthening of our talent, having relevant product offerings in place, transformation of our retail network, more efficient manufacturing and logistics and investment in technology at all levels. After Kory provides a brief overview of the financials, which were provided in detail in our press release. I will discuss our various initiatives to grow our sales. Continue to increase profitability and cash generation. In particular, I will discuss our differentiation in developing a retail network That is relevant, combining great personal service and technology and also discuss a strong marketing initiative plan for this fall. We believe we are positioned well to increase sales and profitability. Thank you, Farooq. First, an update on our previously announced plans to optimize our manufacturing and logistics operations. During April 2019, we had announced plans to further improve our vertically integrated operations with a number of initiatives including converting our CaseBiz manufacturing plant in North Carolina to a state of the art distribution center and consolidating the Capesys manufacturing operations to Vermont and other plants, adding an 80,000 square foot addition to our North Carolina upholstery plan. And closing our PetSafe, New Jersey facility and moving those distribution operations to North Carolina. We have made great progress with with implementing these initiatives during the fourth quarter. And in connection with these actions, the company recorded pretax restructuring impairment and other related charges during the quarter totaling $8,300,000. This consisted of $3,100,000 in non cash asset impairments $2,800,000 in employee severance, $2,000,000 in inventory write offs and manufacturing variances and $400,000 of other associated costs. These one time charges have been excluded from our adjusted results. As we continue to execute on our optimization plans, we expect these changes to provide the opportunity to benefit gross profit by $5,000,000 to $6,000,000 during fiscal 2020 and then beginning in fiscal 2021 after the completion of these initiatives provide the opportunity for our 100 to 200 basis point improvement to gross margin. Now on to the financial results for the year and 4th quarter ended June 30, 2019. Consolidated net sales for the year of $746,700,000 decreased 2.6%. Our domestic retail sales increased 1.2% while Canada decreased 17.3% resulting in a 0.4% overall increase within our Retail segment. Wholesale sales decreased 7.2% primarily due to a 22,300,000 decline in sales to China. Sales decreased in China due to the extraordinary impact of the trade disputes tariffs and some excess inventories they had built up. Had our sales to China been even with the prior year sales our consolidated year to our North American retail network were lower by $18,300,000, reflecting 8 fewer locations and lower sales due to the more challenging retailer environment, especially in fourth quarter. These decreases were partially offset by positive gains in our contract sales business, which grew by $19,500,000, primarily due to higher sales from the GSA government contract. Total consolidated international sales decreased $27,400,000, primarily as a result of economic uncertainty caused by the trade disputes and retaliatory tariffs during the fiscal year in both China and Canada. We are pleased that the Canadian import tax on upholstery products recently ended in May. We are now seeing modest improvement in Canada and our retailer in China has started to increase marketing. For the fourth quarter, consolidated sales, which were $11,600,000 lower year over year and the weaker retail environment. Gross margin for the fiscal year increased to 54.8% from 54.2% and adjusted gross margin increased to 55.1%. For the fourth quarter, adjusted gross margin of 55.9 percent reflected the higher portion of retail sales to our consolidated sales. For Operating expenses for the fiscal year of $375,500,000 at 50.3 percent of sales compared to 3 $67,100,000 and impairment charges. These non recurring charges consist of $6,300,000 related to our manufacturing and logistics optimization plan, and $12,100,000 of impairment charges within our Retail segment, both of which occurred in the 4th quarter and 0 point $7,000,000 of other restructuring charges that occurred during the year. This compared to $1,300,000 of non recurring charges in the prior fiscal year. The retail impairment charges, which occurred in the 4th quarter, include a $9,900,000 non cash charge for long lived assets held primarily our retail design centers and a $2,200,000 charge, representing the remaining contractual obligation on lease space that we exited as of June 30, Adjusted operating income, which excludes these charges, increased 9.8% for the year with adjusted operating margin of 7.4% compared to 6.5% in the prior year and improved gross margin and lower advertising costs contributed to the growth. Diluted earnings per share for the full year was $0.96 compared to $1.32 in the prior year, and adjusted EPS of $1.56 increased 15.6% compared to $1.35 in the prior year. For the fourth quarter, adjusted EPS was $0.46 compared to $0.43 in the prior year quarter. The effective income tax rate was 24.1 percent for the fiscal year compared with 25.9 percent in the prior year, primarily due to the tax law changes from the Tax Cuts And Jobs Act. We expect the tax rate to be 24.5 percent for fiscal 2020 with some fluctuation throughout $55,200,000 of operating cash, most of which was returned to shareholders and cash dividends paid of 47,000,000 an increase of 59.2 percent from the prior year. Our capital expenditures were $9,100,000 this year compared to the $12,500,000 last year. We expect capital expenditures of $17,000,000 to $20,000,000 for fiscal 2020, which includes approximately 1000 square foot expansion of our Made in North Carolina upholstery manufacturing. Turning to the balance sheet, we ended the quarter with inventory of 160 $400,000, cash of $20,800,000 and no bank debt outstanding. With that, I'll turn the call back over to Farooq. Thank you, Corey. As you all know, During the last 20 years, many industries have been faced with the challenge and opportunities due to globalization commoditization and technology. The home furnishings industry has also been impacted in many areas, including loss and consolidation of U. S. Manufacturing. Major changes in retail with many family retail operation exiting the business and the challenges faced by large commodity sellers, including the impact of online selling. Our strategy has positioned us well, and we believe provides an opportunity to grow sales and continue to have strong profitability. Our main areas of focus are to strengthen our unique vertically integrated enterprise. In manufacturing and logistics, we have maintained a strong manufacturing base, still making about 75% of our product in our facilities. 25 years back, we had 30 manufacturing locations in the United States. And we had 7 national distribution centers. Today, aided by new technology, our manufacturing in the U S is concentrated in Vermont with 2 major plants producing case goods and in Maiden, North Carolina with 2 major plants producing upholstery. To maintain control of our manufacturing and balance outsourcing, we established a large manufacturing campus in Central Mexico and also one plant in Honduras. We believe better for us to operate in North American zone as it provides us better control and efficient cost structure and provides jobs in the opportunity to export internationally to China and other international markets and also serve the U. S. Government including state department families all over the world. In addition, we are starting to build more hospitality focused contract business. Today, the company operates 3 major distribution centers and 27 Retail Service Centers providing excellent service throughout North America with 1 delivered cost and white cloud delivery service. Our retail network continues to change to reflect the changing environment. In the 1960s, Ethan Allen introduced the free standing gallery concept of about 15,000 square feet square foot stores. Over the years, These grave to about 2 fifty locations, almost all operated by independent families. As the families retired, we decided to operate many of them ourselves. And today, 144 of the 184 North American Design Centers are operated with a company retail division. We have a structure of about 100 retail leaders with strong interior design and service backgrounds and about 1500 interior designers. We are pleased that during fiscal 2019, we added 4 strong retail vice presidents With more professional interior designers and the introduction of technology, the nature of our retail is undergoing a major change. We are now focused on retail locations under 10,000 square feet and even developing locations that are 3000 to 7000 square feet. During fiscal 2019, we relocated design centers in Albany, New York in Cincinnati, An Arbor, Michigan, Coralville, Iowa, and superior, Colorado, that's Denver, Colorado. Currently, we are in the process of opening new, relocated design centers in Lancaster, Pennsylvania, San Mateo, which is in San Francisco, California, Tysons Corner Virginia, Rancho Mirage, California, Oxnard, which is also in Los Angeles, California, and Houston, Texas. And also an important location which is a great experimental new design center of 3000 square feet in the prominent westchester mall in White Plains, New York, opening in the middle of August. Combining technology with personal service is key to our strategy. Today, over 500 of RNG designers are chatting online and in our design centers, our interior designers are utilizing our high definition three d room planning tools, our augmented reality app touchscreen technology, with product customization and visualization tools and our website. We have continued to introduce relevant product programs with a focus on expanding our reach and maintaining quality and value. During fiscal 2019, we introduced our relaxed modern product line, a casual, doable transitional design made of mixed materials, as well as expanded our home and garden collection which continues our focus on providing classic designs with a modern attitude. We continue to strengthen our marketing at the national, regional and local levels, utilizing print, digital and social mediums. In October, we plan to introduce a major marketing campaign introducing a new loyalty program. We will provide additional details as you move along. Now with this, I would like to open for any questions or comments. John. At this time, I would like to remind everyone First question coming from the line of Brad Thomas from KeyBanc Capital. Your line is now open. Brad? I wanted to start with a question about trends that you saw in the quarter and how you're feeling about the start of this new fiscal year. I guess, maybe just starting with China, if we've done the math right, it looks like that was down about 8% as a part of your wholesale segment in the quarter, which would have been better than the I believe you said double digit decline last quarter. I guess, are we doing the math right there and how are you feeling about trends in China? Well, Corey and Matt are checking the math. Let me say this, that it has been a challenge in China. I meant I referred to it also in the last quarter that, they started with, somewhat higher inventory. And business somewhat softened in China. On top of it, the tariffs really created a major impediment to business. From both in perspective of the fact that consumers in China were, did not like the tariffs and also, that, combined with the softer economy, we felt that. Now what's happening is this, that their inventory to a great degree in the fourth quarter has been, used up. And in fact, starting just in, in a couple of weeks, a couple of our team members are going to China. They are having an event in 5 major cities, introducing and marketing Ethanol And Programs in a major way. So they are now ready to re engage in marketing well while in the last year, all the external factors held it back. Got you. Okay. That's helpful Farooq. And so I guess Cory, I don't know if you've had a chance to check the math. Is has China did China get worse this quarter or is it a little less bad than last quarter. I guess I'm trying to get a sense if we're, approaching an inflection point here. Yes. So China, this, quarter, from a decreased standpoint, as we mentioned in the press release, was down about $10,000,000 in sales. So that's it. This quarter, they were up against a larger quarter last year, in their shipments, because the tariffs hadn't really become that effective at that point in time. It was earlier in these trade disputes. So it was a bigger decrease this quarter at 10,000,000 than what we had seen. But I think that, we'll see how it progresses as we go forward. Brad, the fact is this quarter, really, I mean, I tell you the numbers we had, one of the major reasons our sales were down is because our sales to China, our shippers to China were down. So maybe you can come up with some numbers and give it to Brad. That's helpful commentary. Thank you for thanks Corey. I guess just as a follow-up, it's been a difficult first half of the calendar year for the furniture industry. We've seen it in the industry numbers and a lot competitors. I guess, how are you feeling about the health of the U. S. Consumer and the U. S. Market? And the outlook for the second half of this calendar year? Yes, Brad. Good question. I would say that, I would say that we are now going moving forward more in a positive manner than I have seen in the last 6 or 6 months or so. This is what I'm getting from our retail network. Our people are feeling somewhat more confident. The last quarter, especially May June and more in June, there was a negative feelings with this, with the stock market, with international, troubles, fights, and people held back. And in our case, you know, when they hold back, a lot of that does come back, So I think that what I'm hearing from our retail is that people held back, and it appears to us that they are now coming back. And we this quarter we have an opportunity of regaining what we lost in May June. Got you. That's helpful. Thank you so much. Thanks, Brad. Thank you. Next question coming from the line of Christina Fernandez from Telsey Advisory Group. Your line is now open. Sina. Hi, good afternoon. So I wanted to follow-up on Brett's question about the U. S. And sort of the environment it looks like from your commentary that the quarter started better in April and then decelerated in May June. I mean, I guess, can you talk about where you're seeing, I mean, is it broad based? Is it more focused on markets where the warehousing has been weaker and what are you seeing from competitors? Because you guys have been a little bit more promotional. So maybe you can comment on some of those aspects of the industry? No, I think that Christina, we were surprised that in the consumer attitude in May June. We were we started, as you rightly said, in April, it was, it looked good. People were confident. Then external factors came in in terms of somehow people felt, as we saw it, that they could have to hold back. And, now having said this, we have very strong programs. We have been we have, you're right, being somewhat aggressive in terms of our marketing and giving the promotions, as you have said, And yet, while we have done all of that, still keep in mind, we've been able to increase our gross margins. So that has sort of been a positive factor. We will continue to be, strong in marketing, strong in giving people good values And as Corey said, still able to from as we project of maintaining healthy, healthy gross margins. And following up on the marketing, you spoke about a major campaign in the fall, perhaps a loyalty program. I mean, how would this be different from what you've run-in the past last year when you increased marketing? Some of the aspects like national TV didn't where we see this well. I mean, what is different this time and how should we think about marketing spend in fiscal year 2020? Yes, it's a good question. Christina, before the great recession, we have worked very hard to have everyday best price. That worked very well because we are in the business of interior design. And an interior design means that the customer should be able to buy our products when they want rather than having to worry about what's going to go on sale and what's not going to go on sale. But we did that because after the great recession, having everyday best price everybody got impacted. Our sales were down 40%. So we started at a 10% discount. Now as you know, it's gone up with 20%, 25%. It's gone up more sometimes. So what we're going to what we have what we're going to do is we are going to we are looking at creating a more credible marketing, pricing, but yet offering people a fair amount of opportunity. For instance, right now, in, in, in July for instance, we are offering through a new, financing program that we have done with TD Bank a 36 month financing, which is done very well. So we have a good financing program. You'd hear more about it But what the bottom line is going to be that we will expand our marketing, both in the print in the digital mediums and perhaps even go on more on television than we have in the last 6 or 9 months. It'd be somewhat different than we did say a previous year in terms of the message and even, whether it is going to be NASH or regional. So we're looking at all of those things. So creating more credibility, giving an opportunity of savings, that are that people will see and also giving an opportunity for our designers and customers to work when they want with what they want. So those are the main elements and we'll give more information in the next few weeks. Thank you. And is 4% or 5% the right percentage of sales to still think about marketing or could you go above that next year? No, I would say that last year in 1 or 2 quarters, we went up a little over 6%. What are you going to see between 4% 5% is what we are thinking of doing. And that's a good number for us. Okay. And then I have one last question. So the contract business has been a bright spot, including the State Department orders, but some other products as well. Can you talk about what you're doing in that area? And are any other things you're working on that can provide incremental sales for fiscal year 'twenty? Yes, I think this is a this is really a very important area, price area. The government contract first, as you know, we had met discussed it. It was on a competitive bidding last last it's a 5 year contract, but in the 1st year, we did have a competitor that was in bankruptcy And what they did was they basically had products at very, very low prices, almost cost and below cost. That is a and we did compete. It did not make much margin, but then they went then they were liquidated. And there's still others who can compete, but at this stage, we are in a very good position of being a competitor. And also operating at a more normalized margins. So that has been a very important. And as Corey mentioned, we have grown substantially this year, and we continue to see that growth. In addition to that, as you know, last year, we started the program with the Marabrigo will drop in in furnishing a hotel and villas in Orlando. That is also increasing. We have just in the process of adding other hotels to that. And other contract, I we it's very specialized contract. Like the moderator will, in some cases, Disney, we have a contract with Disney in certain cases. All of those things are are important and I believe in the next year they're going to grow. Next question coming from the line of Bobby Griffin from Raymond James. Your line is now open. Hey, how are you? I appreciate you guys taking my questions. First, Fruk, I just want to talk a little bit about relaxed modern. Did it shift as we were expecting with a soft launch in May and then a more full launch in June, any early learnings from the product introductions you can share and Immediately, I was a little surprised with the retail performance given the new products we're shipping. So can you maybe you connect the dots for us there on on the U. S. Retail performance? Yes. The relaxed button, Bobby was well received. However, as we started marketing in our fourth quarter, we did find that overall environment was tough. Now I it is in our design centers. We have, if you have Corey most probably has sent you, if not, It should send you a direct mail in which we are projecting it strongly. It is well received because it is a design that is current It is classic design, but with a very modern perspective. And consumer attitudes are somewhat similar. So I think our product lines are well received, well positioned. We get a tremendous amount of feedback from our 1500 interior designers. They are our biggest critics. And they liked it. So I think Bobby, you go to see us continue to do well there, plus also with the artisan program that we'd introduce last year. That also has done well. And we are also continuing now to further strengthen our offerings, And you will see that as we move forward, our next introduction is going to be some sometimes early spring of next year because we have absorbed all that we have done because we in the last 3 or 4 years, we have changed over 70% of our offering. Okay. And then the reference that you made about, some increased marketing, some loyalty pushes and stuff in the fall, that would of course, include the relaxed modern collection. So we should expect, some higher marketing dollars spend on that collection. Yes, of course, because what it's going to be is going to be part of our total program. So we are going to you're going to see it It's not, as you know, we don't sell collections as such, which is total Ethanolin program. And we are presenting it in our direct mail. We are presenting in our digital mediums on our website. So this will be across the board. And relapsed modern is an important part of that. Okay. And then just lastly to follow-up on Christina's question about the government contract. Is there room for the contract to grow in the next fiscal year or is it kind of you have the most share that you think you can get in? It's kind of a flat line where you have to maintain the revenue and everything, but there's probably not incremental more growth out of the contract on a yearly basis? Well, it's a good question. We have, this last year, increased by about 50%. By 50%, we have increased. And a lot of that actually, we're getting a lot of orders now because the government fiscal year ends in September. So August September is the busiest period, which actually last year did create issues for us in the sense we got a lot of orders at low margins, created disruption to our retail, created high backlogs, which we then shipped in the fourth quarter. So one of the reasons you're seeing lower sales this year was because last year, we had a lot of lot of backlog, a lot of government contract. This year, fortunately, our backlogs are manageable. We don't have any issues. So I think that that we have we also actually this contract we last year, which is now increasing, we were also able to, to get orders from the U. S. Military. And so for instance, we furnish a fairly large, complex for the military in South Korea. So that business is growing, but the good news is it's all part of the product line that is, part of the economic program made in our facilities and either in all of this is made in North America in our facilities. So we are very well positioned to service it And I think that we don't know how much, but certainly we have the opportunity of expanding it to the state department because as you know, we furnish all American diplomats all over the world with this program and also now increasingly government and the military as well. Okay. I appreciate your time and answering my questions. Best of luck going forward. Bobby is, is butt there, but, but how's butt doing? But doing well. But doing well, he's listening right now, but he he's doing well. Make sure it's all You should tell him one thing. That he and I, I have today, marks the 100th consecutive conference call I have taken, and I think he was there in the beginning too with me. So if he's listening, but it's 100 consecutive conference calls. It's like yesterday. All right, Bobby. We look forward to another 100 more, right? Exactly. Yeah. We'll be getting started. Absolutely. Thank you for it. Take care. Presenters there are no further questions at this time. Please continue. All right, John. And thank you very much. Any questions, comments, please let us know. And, I know that Corey is in very much in touch with all of you. So thanks again. This concludes today's conference call. You may now disconnect.