Earnings Call: Q3 2019

Apr 29, 2019

Good afternoon and welcome to the Ethan Allen 2019 Fiscal Third Quarter Analyst Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question Thank you. It is now my pleasure to introduce your host, Corey Whiteley, Executive Vice President Administration And Chief Financial Officer. Thank you. You may begin. Thank you. Good afternoon and welcome to Ethan Allen's conference call for our third quarter ended March 31, 2019. This conference call is being recorded and webcast live on ethanallen.com, where you will also find our press release which contain supporting details, including reconciliations of 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, which 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. After I provide some brief details on the financial results, our Chairman and CEO, Faroo Katowari, will provide updates on the business and on our ongoing growth initiatives. We'll then open up the telephone lines for your questions. During the third quarter, improved gross margin, cost containment within our expenses and a lower effective tax rate helped drive a 2 33 percent increase in our diluted earnings per share, taking diluted EPS to $0.30, up from $0.09 in the prior year third quarter. Adjusted EPS increased to $0.31, up 182 percent from $0.11 per share. Consolidated net sales were $177,800,000 compared to $181,400,000, An increase of 1.5% for retail net sales was offset by a decrease of 8.9% for wholesale net sales. The lower wholesale net sales were primarily due to a reduction in sales to the North American retail network. The prior year quarter wholesale sale benefited from delayed shipments during the first half that were getting caught up during the third quarter. Contract sales were the source of strength during the current year quarter, while international sales weakened. Consolidated international net sales for the quarter decreased 30.2%, primarily due to lower sales in China. Our retail division written orders reflected a 1.4% increase for the 3rd quarter. Gross profit grew by $1,700,000 in the current year third quarter, driven by a 200 basis point expansion in our gross margin. For the 3 months ended March 31, 2019, gross margin was 55.3%, up from 53 0.3% a year ago due to improved retail and wholesale gross margins, together with a change in the retail sales mix relative to total sales. Retail sales were 78.1 percent of consolidated sales compared with 75.5% in the comparable prior year period. Operating income was $10,700,000 or 6 percent of net sales compared with $3,900,000 or 2.1 percent of net sales in the prior year period. Adjusted operating income was $11,000,000 or 6.2 percent of net sales compared to $4,400,000 or 2.4 percent of net sales for the same prior year period. Significant growth in operating income was primarily due to reduction in national television advertising costs and the benefit of high gross profit. In the prior year due to tax law changes from the Tax Cuts and Jobs Act. During the quarter, we paid $31,800,000 of cash dividends, including a special dividend of $1 per share. 9 months, year to date total dividends paid of $41,900,000 reflect a 73% increase compared to the comparable prior year period. Turning to the balance sheet, we ended the quarter with inventory of 100 and $4,600,000, cash and securities of $25,700,000 $8,000,000 of bank debt outstanding. With that, I'll turn the call over to Farooq. Thank you, Corinne, and thank you all for participating in our third quarter conference call. I'm also pleased that we have also joined by Matt McNulty. He has joined us as the vice president of Corporate Controller, John Bedford, who was in this position for for many, many years retired. The positive impact of our vertical integration and operating at more normalized advertising expenditures resulted in the strong earnings growth that Corey just mentioned. Despite lower consolidated delivered sales of 2%, gross margins increased to 55.3% from 53.3% and adjusted operating income increased by 150.6 percent and adjusted earnings per share increased by 181.8%. We have continued to return cash to stockholders. As Corey mentioned, our cash dividends of 31 800,000 were paid during the quarter, 130% increase over last year. As mentioned in our press release, we continue to strengthen our vertically integrated enterprise with many strategic initiatives including investing in talent, introducing relevant new products, repositioning our retail and our manufacturing and logistics network, investing in technology and operating our enterprise in a socially responsible manner. On April 17, we announced plans to further improve our vertically integrated operations a number of initiatives, including converting our 550,000 square foot case goods manufacturing plant in Old Fort, North Carolina to a state of the art distribution center and consolidating case goods manufacturing to our Vermont and other plants. Also announced addition of 80,000 square foot to our 714,000 square foot upholstery plants in Maiden, North Carolina. And moving our distribution operations from Pasek, New Jersey to North Carolina. So we expect to have consolidation costs $7,000,000 to $8,000,000, 40 percent noncash, invested about $5,000,000 in Maiden, North Carolina, in our upholstery up and additional about $3,000,000 in conversion of the Old Fort, North Carolina location. We expect these changes to provide benefit to gross margins by $5,000,000 to $6,000,000 during fiscal 2020 and beginning in fiscal 2021 after the completion of the initiatives provide the opportunity for 100 to 200 basis point improvements to gross margins. We have strengthened our talent by adding several leaders to our retail network and business development, continuing to develop the strong 1500 professional interior design management and interior designers. We continue to strengthen our marketing initiatives with addition of relevant products and strong advertising initiatives. In June, we plan to introduce our new modern relaxed product programs and a very strong new consumer finance program. We continue to position the design center network with relocations and renovations in both North America and Internationally, while our business in internationally was somewhat down. As Corey just mentioned, we continue to be very proactive in opening new design centers with our partners in China as well as Southeast Asia. Emphasis on customer experience. We have expanded our 3 d digital capabilities and also implementing Salesforce CRM platform. During the quarter, we were impacted by low orders and shipments to China as we have just mentioned. We have strong marketing programs and expect the orders to improve in this quarter. We are also pleased with the growth of the U. S. Government and contract business. With this brief introduction, happy to open for any questions or comments. Our first question comes from the line of Bobby Griffin from Raymond James. Bobby, your line is now open. Yes, thank you, Bobby, and good to have you on the call. The first I wanted to talk on was just the RIN orders. I'm just trying to connect the dots between the 1.4% for the quarter and then the 5% number that we were told through the 1st 2 months of the quarter. Can you help me understand what happened in March? And did the business slowdown? Or was there any timing impacts with shipments that impacted, the 1.4% growth? In March, the incoming written return business was lower and that impacted it. Or anything or Farooq, I guess, in your high level view and an opinion, what do you think drove the change in trajectory? No, it's hard. From month to month, I think that, there is so many factors that people are concerned about what is taking place the economy was taking place internationally, all the news. So I think it was nothing, nothing particular. It was just that most, I mean, I would think that some of that just run to April. Okay. Did you see a bounce back in April? Can you give us any color on what April orders look like so far? Well, it's still, I mean, as you know, it's today and tomorrow, we should get about 20 to 20 between 20% 35% of the business is the last 2 days of the month. So we'll see. And but I rarely, I think that we've got strong programs in place, and I think that we should continue to grow our business as we move into this quarter. Okay. And secondly, I want to talk on the retail segment and maybe just a little farther out view on how or what the pathway is for that profitability in that segment? Is there some structural changes that need to be done there from a cost perspective or is it just all sales growth driven, aspect? Well, our business is sort of unique in the sense that you have to take a look at, our overall margins because our retail margins, our retail sales impact our wholesale margins. So we have we have lots of programs into place and we expect our retail business to grow. And that will have a positive impact on the retail profitability and especially in the wholesale profitability. And if you were just only the retail business, the chances are is some of the retail that we have, we may not have kept them, but they do have a positive impact on our wholesale. End of the day, I want both retail. I want all retail to make money, but our retail does provide an opportunity of improving margins at our wholesale level. If you take a look at, for instance, at operating margin, of our wholesale, was what, Corey about 10% for the quarter? Yes. Actually is about 12% on the quarter, despite somewhat of a lower, I mean, some somewhat lower, sales delivered sales from the wholesale, we increase our gross margins. Part of that is of course efficiency and also the impact of the retail is very positive on our wholesale. It's all we've got to combine the 2 together. That's the nature of our business. Okay. And then I guess lastly for me, it's just on advertising expense. You did mention you're now kind of going to run at more normalized levels here in the third quarter. Is that something we can run run forward in our model as we expect, the introduction of relaxed modern coming on, is there going to be any big uptick in advertising expense for that introduction? No, I see our advertising expense, has run anyway between 4% 6%. If you take a look at the last So I would say at this stage between, between 4 and 6 is our normalized rate. In the last year, these two quarters, which is extraordinary, didn't get the benefit we thought we would. Okay. I appreciate all the detail and thank you again for answering my questions and best of luck going forward. Got it. Thank you. Alright. Your next question comes from the line of Thomas from KeyBanc Capital Markets. Brad, your line is now open. Hello, Brad. How are you? Hi, Farooq. Good afternoon. I wanted to first ask about trends that you're seeing in China. Obviously, in your press release, you referenced some softer trends there. What are you seeing in that market and what's your outlook there? We had a number of factors impacted. First was that they had, I mean, overall business in China has been weak for the for in China. For our, for our partner as well as others. Secondly, last year, they purchased a somewhat of an excess inventory. So they had to get out of that inventory. And third was this whole tariff situation did create issues. People were concerned and about the fact of, as you know, whether how much the duties are going to be and still are concerned to some degree. All those factors impacted us now as we move into the into our fourth quarter, things are somewhat stable in the sense that they are almost out of the excess inventories they had, there is less of a less of attention on the whole issue of these duties. And I would say I and they've been very aggressive. In fact, they just opened up, 2 months back of major design center for us is 15,000 square foot in Wuhan, China. And they're continuing to all also develop some strong advertising and marketing programs as we move forward in the next two quarters. So I would think that it would appear to me that the worst is over and we are moving towards more positive direction. That's helpful. And then within the wholesale segment, can you give us some more color on where the state department came in in terms of its contribution to 3Q? And how you're thinking about the trajectory of that business in your fourth quarter? Right. We don't give the numbers, but I would say that it is positive, both in terms of sales and also margins. Because as you know, last year, we were committing against a business that was in bankruptcy and it really impacted our margins So we are back to normalized margins. And, and also the business is increasing. So I were, is positive development. Great. And then just lastly for me, I guess as we think about the consumer backdrop for a lot of questions about tax refunds and salt taxes and such. I guess as you go back and look at your sales in your fiscal third quarter, do you think there was any particular noise or pressure that you experienced because of, how tax rates have changed for your customers? There is an impact, especially if you are living, especially, let's say, in the well-to-do East Coast communities, there, people haven't impacted with the fact that, we can't deduct the taxes and the taxes are real estate taxes are pretty high. So we have seen some. But overall, I think that, even though there is a lot of, you know, a lot of competitions out there, as you know, we have people selling a product at sort of pretty major discounts, But I see overall things are somewhat positive as we go into the 4th quarter. Alright. Thank you. Your next question comes from the line of Jeremy Hamblin from Dorothy And Company. Hi, thanks for taking the questions. I wanted to come back to the commentary on China for a second. You've seen pretty significant expansion of the number of, retail centers that you have in that geography. I think from, 88 a year ago, up 102, given your comments, that it's been sluggish you and your partner there. Is there risk? Is there concern, that we potentially have a closure the number of centers there, can you give us a kind of a state of affairs in terms of how your 3rd party partner there is looking at the business, going forward? Well, we have we have seen them being very proactive, aggressive. And, and, and I would say that also being on, that's they're not slowed down, but on the other hand, they have been impacted by us by the slower consumer attitude, more competition over there, But I haven't we have not seen any slowdown from them as yet. In fact, if anything they're growing, And they are also making major renovations and in fact, introducing our newer products in the next 6 months in some sort of an aggressive manner. They have more competition, but so far, they're holding strong. Okay. And then I wanted to come back another point that was made. You talked about your wholesale segment, which sales were down about $10,000,000 in that segment year over year, saw a 500 basis point improvement in the operating margins. And I don't know if that's entirely tied to like allocation of advertising expense or but I wanted to see if you could just walk us through that change in profitability dynamic, either you or Corey, just in how we're arriving at that 500 basis point higher, op margin, despite sales being down $10,000,000. Yes. I think Corey can add to it, but I would say it's a combination of lower advertising expenses. And are manufacturing, operating at, more efficiently. Including this question of the state department, the government contract, with higher margins. So I would say it's a combination of the two factors that has resulted in this increase in gross margins, right, Corey? Yes, that's primarily the advertising benefit that helped as well, but really it's our manufacturing efficiency and improved, production, And now as you know, our objective, we have one of the few ones, which are still manufacturing as much of manufacturing as we have in the in North America. Fashion in the United States. This changes that we have made will help us to increase our production in Vermont in case goods and continue to be very strong in upholstery in North Carolina. Supported by our operation in, in Mexico, our case, but is also supported by operations in Honduras, And, keep in mind, we opened all those, both those plants in the last 12 years, Honduras 6 years back, and Mexico about 12 or 13 years back. And those are very vibrant, but combination of our United States and the rest of this North American plants gives us a competitive advantage. And as we go forward, should further help our, our margins operating margins, gross margins at the wholesale level. Okay. That's how And then I just want to, your backlog looks like it's down about 12% in your retail segment. It's down 22% in your wholesale segment, at the end of Q3. And you had a pretty strong Q4 last year where sales were total sales were 5.5%. I wanted to just get a sense of I know you don't provide quarter to quarter guidance. But with those kind of starting points on your backlog and lapping some pretty tough compares from last year, how should we be thinking about, the June quarter? Is this kind of an assumption that sales will be down given that, the starting points on your backlog as well as, written orders that were there wasn't significant growth in Q3? Well, I think Corey can also add to this, but I would just say that two perspectives on this in the Last year, our delivered sales were then got benefit from the high backlogs we ended up in the 3rd quarter. Due to, number of factors, including that. We've got a fair amount of state department orders that we had than we delivered those in the fourth quarter. So our consolidated deliveries last, I mean, such cases were $205,000,000. But when you take a look at last year, on our written orders, our written orders in our retail division were down 10.8%. Our wholesale was down 5.9%. So if you take a look at that, we have the opportunity On one hand, yes, the delivered is a challenge. The return gives us an opportunity because last day it was soft. And then with lower backlogs, you had the benefit now of being able to ship product much more timely this year without those high backlogs that we were fighting in the prior good year. So I mean, we had highest, we had higher sales, but this time, it's much more efficient. Understood. Last question for me. I also I noted that you did access some long term debt for the first time in a while. My assumption is that maybe part of that was being used to, to fund the special dividend. You know, and it's not a significant amount, but I think, just under $9,000,000. Wanted to just see if you can give some color on thinking about, capital structure and use of debt going forward, is that something where, you feel comfortable with your cash flow and you may access a little bit more debt? To fund buybacks or other things? Or can any color that you might be able to provide on that would be helpful. First is we wanted to please all our analysts by taking debt because everybody says you folks have no debt. So I'm so I hope the analysts are happy. But having said this, we gave, what was that, over $30,000,000 of dividends. And that was, yes, we needed some cash short term, to some degree, to, to, to use our, cash on hand and, and the debt. As we go forward, we're going to take a look at what makes good sense. I mean, you know, I'm not interested. As you know, I've gone through, all kinds of we had a 90% debt and we had all kinds of stuff. I've gone through all of those things. You know that. So we, I don't mind taking debt. And, but if it makes, but as we go forward, we'll continue to return, money to the stockholders. In the past, we've done it in the repurchase of our company stock. We purchased we spent over $600,000,000 of stock we have purchased. And so when you take a look at this, as we go forward, we'll see whether we need to have, some debt, but I'm not going to have too much debt. I've gone through that period. Got you. Thanks for taking the questions. Good luck. Right. Thanks. Your next question comes from the line of Christina Fernandez from Telsey Advisory. Group. Christina, your line is now open. Hi, good afternoon, Corey and Farooq. I have a couple of questions on the gross margin. So to start on the on this quarter, how should we think about of the 200 basis points improvement, just the natural sort of help from the mix between retail and wholesale versus sort of lapping with those manufacturing inefficiencies you had last year because it seems like that could have been sort of the biggest component of the benefit this year? You know, there was a number of factors. We did take a price increase last September, October. Which also contributed to increase in gross margins. But on the other hand, we are also giving even bigger savings. So, yeah, can have, on one hand, higher margins, but then we give it away on savings. So we got to balance all of these factors. So you got higher, you got a price increase, but then we have higher savings. We have better manufacturing margins. And as you can see, our retail margins and wholesale margins both improved. The wholesale margins, improved the gross margin level and obviously it improved at the operating level because of this question of advertising. So as you go forward, it's hard to say, but I think the levels that you see is there's an opportunity of maintaining those levels. And then looking to fiscal year 2020 and beyond, with the planned consolidation You're doing to quantify $5,000,000 to $6,000,000 next year beyond that another 120 basis points. Can you help us understand is is the initial part just cost savings and what needs to happen to be able to capture that that next leg the 100 to 120 basis points longer term from this specific plan consolidation you're doing? Well, the by producing by increasing our volumes in Vermont, that has an opportunity of increasing our gross margins in Vermont. 2nd, it will also to some degree add products in our Honduras plant, which has higher margins. Thirdly, some of the product will be outsourced. That also increases much So those are three factors that will help us increase our gross margins at the wholesale level, and that we see going forward. And when should we expect this to start contributing next year? Well, as we said in our press release that, we're going to have some benefits in our next fiscal year And then, and we'll continue. I will you should we should see some benefit next year because we will be consolidating this production. We're already doing it and into Vermont and to other plants. It'll also give us an opportunity of, of, certainly, there's some startup costs and things of that nature, but I think we should start seeing the benefit of it starting in next fiscal year. Yes, mostly in the second half of next clear. Okay. Thank you. And then one last question on marketing. If my math is correct, I estimate about 3.5% of sales will spend the marketing this quarter. I think in prior calls, you talked about 5% spend for the year. Is that still the target? Or should we should that come in below that 5%? No, we spent advertising this year, if you take this about 4.1%. So this is what you want. If you take a look at it, that's what we spent this third quarter. And as we go forward, it's going to be between 4% 5%. Okay. Thank At this time, there are no question on queue. Presenters, you may continue. All right. Well, thank you very much. And thanks, everybody. Any questions, comments, anything else, please let us know. Thanks very much. Thank you. And that concludes today's conference. Thank you all for participating. You may now disconnect.