Earnings Call: Q1 2019

Oct 24, 2018

Good afternoon, and welcome to the Ethan Allen Fiscal 2019 First Quarter Analyst Conference Call. At this time, all lines are in a listen only mode. Later we will conduct a question and answer It is now my pleasure to introduce your host Corey Whiteley, Executive Vice President of Administration And Chief Financial Office sir. Thank you. For our first quarter ended September 30, 2018. Dotcom, where you will also find our press release, which contains supporting details, including reconciliations of non GAAP information, which refer 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. After I provide some brief details on the financial results, our Chairman and CEO, Faroo Kaffari, will provide updates on the business and our ongoing growth initiatives. We'll then open up the telephone lines for questions. We had our 4th consecutive quarter of consolidated net sales $7,800,000 8% increase in wholesale sales and 2.6% increase in retail sales. Sale increase reflected strong shipments to our retail network and increased contract business, including strong GSA orders and shipments during the quarter. Our wholesale backlogs are current and reflect normalized levels. Our consolidated gross margin for the quarter was 54%. Primarily reflecting increased raw material costs in our upholstery programs and the 77.3% mix of retail sales as percent of consolidated trade dispute situation to assess the potential impact on our gross margins. Because we currently make 75% of what we sell in our North American workshops, we believe we were $89,700,000, an increase of 2%. The increase was primarily driven by variable costs related to increased sales, and our advertising expense, which increased 12.8% during the quarter, as we continued to expand our marketing programs. For the quarter, the operating margin was 6.3 percent, net income of $8,800,000 with EPS of $0.33. An increase of 17.9 percent over prior year adjusted EPS. Turning to the balance sheet, we generated 24,400,000 of cash from our operating activities during the quarter. We paid 5,100,000 of dividends and we ended the quarter with cash and securities of $39,600,000. We had no debt outstanding under our credit facility. Our effective tax rate was 24.9 percent of the quarter as a result of the Tax Cut and Jobs Act. Expect our effective rate for the 2019 fiscal year will be in the range of 24.5% to 25.5%. With that, I will turn the call over to Farooq. Thank you, Corey. As we mentioned in our press release, our focus and opportunity are to differentiate ourselves in this fast changing world impacting retail, manufacturing and technology. In our opinion, brick and mortar, and the selling of product as a commodity will continue to lose market share. Service is crucial. With our strong retail network, providing a full range of interior design services. We believe we are positioned well interior designers in our 200 North American interior design centers and 500 designers in our 100 design centers overseas offers personal service, combined with technology, another critical point of differentiation. We continue to focus on 5 important areas. First is the development of talent. Second is a strong marketing program that includes relevant offerings and comprehensive advertising that encompasses both traditional and digital mediums. 3rd, investing in manufacturing, logistics and sourcing to provide products 4th, investment in technology is critical in all areas, including manufacturing and retail. And 5th is a strong focus on social responsibility. We are positioned well for growth as 70% of our products have been refreshed in the last 3 years. This quarter, our autism inspired products were introduced and well received, 2 weeks from now, we will introduce our newest products to more than 500 team members at our annual convention at our Danbury headquarters, where we will also celebrate our associates accomplishments and review our marketing programs, including the new products I just mentioned. The new products are inspired by modern casual living with a planned consumer launch in spring 2019. We continue to expand our marketing in various mediums. In our first quarter, we increased our advertising spend as Corey said by 12.8%. Our objective is to continue strong programs to drive traffic to our digital mediums and importantly, to our design centers. We continue to invest in our infrastructure. As noted earlier, our retail network consists of 200 design centers in North America and 100 Internationally. In North America, we remain focused on transitioning to stronger locations with about 70% of our stores relocated in the past 15 years. Currently, new design centers are under construction in Albany, New York, Coralville, Iowa, Denver, Colorado and Rancho Mirage, California. Internationally, we continue to grow with recent openings in Taiwan, Bangkok, in China, allocation in Cambodia is under construction. While we believe we received the bulk of the state department contracts, the sales amount and gross margins were negatively impacted due to low bidding by a competitor, which was in Chapter 11. Our North American manufacturing facilities produced about 75% of our furniture offerings. During the last two years, we have doubled our go upholstery manufacturing to about 600,000 square feet, increasing our workforce and investing in technology. We continue to invest in technology in our U. S. And Honduras manufacturing plants, and we also continue to invest in our logistics network delivering products at one cost in North America and premier in home delivery to our clients. Finally, we continue our strong focus on social responsibility with the philosophy of respecting our people, respecting the law and respecting the land. As I mentioned, we are well positioned as a provider of interior design service, supported with relevant and desirable products, great quality and excellent value. I'm now pleased to open the call for comments and questions. And, James, are you gonna go ahead and open the call? All right. James, you're there. Questions. Our first question comes from Budd Bugatch with Raymond James. Your line is now open. Yes. Good. Hello. Name, but a lot, you got to we got to fix your name. Well, I think we'll have to, we'll have to work on that, Farooq. We have an extra syllable in the names today, so that was, it was all good. Talk to us a little bit about order rates. You talk in the release about the fact that rates were down because order rates were down overall in retail because of the Canada situation. Can you give us a little bit of a feel of how that developed over the quarter as well. I think you may have ended better than you began because of the introduction of the lifestyle product. Yes. We did mention that our order we're talking about orders in our retail division. Yes, sir. Right. And there, what we see is that we increase them The overall increased by about 0.9%. As I said, the Canadian Design Center were down about 25%. But again, in July, our orders written orders decreased 8.9% on August increased by 4.1% and September increased by 5.2%. And so far, we're in October now. And can you, is the momentum continuing, or is it as it subsided? Well, as you know, the last week of the month is where we get about almost 40% or 30% to 50% of our business So look, we have very strong programs. People are confident, but the next, 5, 6, 7 days will determine what happens October. But overall, we've got very, very strong programs out there. Okay. And you say you've increased advertising by 12.8%. If I'm That number, is it about $8,300,000? Is that the number you have or do we have a wrong beginning number? No, that's exactly right. It's $8,300,000. And just about as I'm sure this question will come on advertising. I'll also just mention it upfront. You know, as we move forward, last year, we spent 8,600,000, which was about 4.3% of advertising our second quarter. But then we expand, we spent a lot of money in the 3rd and the 4th quarter. As you know, in 3rd quarter, we spent 13.8 $13,800,000. And in the 4th quarter, we spent $13,500,000. And it was on a very strong national, television campaign. It did get our message across, but as we know, it didn't have as much of an impact in bringing sales So we all know that. So this year, the good news is we'll spend money, strong money, but we are not going to spend $13,800,000 the 3rd fourth quarter. We'll still be strong, but we'll spend less money. Okay. And can you quantify for us, the amount of GSA orders or GSA revenues that are in the wholesale segment? Corey, as I said, Budd, you know, it the orders have been negatively impacted because of the competitor was bidding at such, such low prices, government benefited, it had an impact on lowering the sales and also lowering the margins. But, Corey, I mean, it is public what can we give? Yes, we don't give it out or I won't get in the habit of giving it out every quarter. But it does fluctuate, but we had about, $6,000,000 in sales in the quarter. You're talking of this quarter or you're talking about the last year, but I'm talking about I was talking about the current quarter, Farooq, trying to understand what it is. And that competitor is now gone, right? That with the the equipment was, was auctioned off last week. Is that true or not? Well, it was this sold off, their name, they sold off other things. I do not know what's if they sold this contract or not or whether they can, they can even sell it more likely not. So I think that as we move forward, the chances are that, we are 4 more years to this contract. That's the good news. So we have an opportunity of doing well. One of the reasons we did very aggressively bid on it, even though we didn't make much money, we did make money, but was the fact that we wanted our products in all the diplomatic homes internationally. And that had a very positive impact. We was, people like what we do, and they were happy that we were able to provide the Ethanol products and programs So I think it looks very positive, Budd. And also in the release, you gave some cautionary language about international revenues, I take it that must be China, because that's where the bulk of your international, stores are located. Could you give us some flavor of what's happening over there, Well, there are a number of factors. First is, they are very positive about the Ethanolin programs. They're projecting them very, very strongly and they are, in fact, in the process of repositioning their offerings in most of their leadership stores, reflecting our newer products. Because as you know, it's interesting. I mentioned, we've changed 70% of our product line 2 years back in China, the markets were somewhat interested in more what you might say formal and traditional. Now they are much more interested in our new product lines, which are somewhat more, you might say more towards the classic, but with a modern attitude. So they are very very eager and, in and aggressively going to reposition the design centers. Having said this, they've also been cautious on this whole issue of tariffs. So that has been, has been an issue. Although from our perspective, because of the fact we make most of our products in North America, they will be less impacted. So I think overall, it's positive. Some impacts they were cautious. They held up some orders. But as I see it, but the chances are they're going to be all right and go and keep on building our very good business in China and in some other countries in Southeast Asia. Okay. Well, My last comment is, thank you very much for, Corey for getting in the queue, out with the release. Appreciate that very much and good luck on the quarter. Thanks very much. Thank you. Our next question comes from Brad Thomas with KeyBanc Capital. Your line is now open. This is actually Andrew on for Brad. We were hoping you would comment a little bit more on the cadence of the business in the quarter and how you feel about the business in recent months. Well, as I mentioned increased in the months starting in July, we were we had a decrease of 8.9%. August increased 4.1% in September increased 5.2%. So we did see good growth as we went into the last quarter as our advertising with strong advertising pro A lot of it was spent the late latter half of August September, and we started seeing the results. And now of course, a little bit early for this quarter. We'll see how the month ends. We have strong programs, and we're looking forward at this stage continuing our positive trends. Your questions. We know you're operating a lot of stores in China. Do you mind sharing any comments regarding the health of the consumer in that region? Yes. No, it's a good question. In China overall, as we read, that the Chinese consumer is also becoming cautious. On the second and on the other hand, the competition for home furnishings and other areas increasing considerably. So there's a more competition, and it is Jim in terms of their pricing, what they have to do. But overall, while there's some caution, I would say, still, it is a question of major growth, not as much as what they did the previous year. Thank you. Our next question comes from Jeremy Hembling with Dougherty. Your line is now open. Hello, Jeremy. Hi, good evening. Thanks for taking the questions. Wanted to come back to the commentary about, kind of struggling competitor going out of business here as it relates to the government contract. Cory, can you quantify what the basis point impact was to margin, on the quarter, both from a consolidated basis, but then also specific to just the wholesale business? Tough question, but he can. But, Corey, can we give specifics? I mean, how much, what information can we give? We don't really break out the gross margin by the product lines, to that degree, but it did have an impact on our wholesale margins with the with the GEO, the going out of business, so the Chapter 11, I would say around 50 basis points, probably on the close to 50 or 40 basis points on the consolidated gross margin line. Was the impact from the lower wholesale margin. Okay. I asked because wholesale margins were down 70 basis points overall despite the fact that you had 5% growth in that segment. So I would say most companies would probably provide some color if there was an unusual circumstance. That was on the wholesale margin line, Jeremy, it was also raw material cost increases that had an impact on that. As well as the low pricing due to the competitive bidding on the state department. I would say, Jeremy, it's 70% because of the state department impact 30% due to increases in costs. Okay. And on that point on cost, that was my next follow-up. What are you seeing? It looks like we've seen some change in trend, on costs in the last month or 2, how should we think about that in terms of impact here on the December quarter? Well, we also took an October price increase because of the fact we were impacted. This raw material was increasing, especially relating to more on the poultry side, And also with all the major changes in our product offerings, Jeremy, we still have to continue to sell product from our floors and the clearance product. That also has an impact on our overall gross margins. And it has been taking place in the last few years because in the last years, we've changed 70 percent of our offerings. It'll that also will continue in the next year. And, but I would think that, impact of price increases. I would also say this that, we've had to also provides some more higher discounts at retail. So all those sectors combined, I would think that a gross margin, approximately where we are now is something that what we are expecting. In other words, what you just saw, like the 54% in Q1, that's kind of about the level you're thinking for the December quarter and maybe the next couple of quarters? Yes, at this stage, it's possible. It could potentially go up, but I would say using that would be a, would be a good, good to use it, sir, Jeremy. Okay. And then on the flip side, on the cost basis, you noted that, I think what you said was that your marketing spend, would be down on an absolute dollar basis in this December quarter. Did I catch that correctly? No, I had not in the December December quarter. We, last year, you're talking December. Yes. Last year, we spent in the December quarter, 8,600,000, which was 4.3 of sales pretty close to what we spent. I was referring to the 3rd and the 4th quarter, Jeremy. I see. Okay. But then overall, if I just look at a high level, over the last couple of years, we have seen sales certainly come down from the high point in fiscal 'sixteen. They're up slightly from, fiscal 2015, but you have seen a pretty significant jump in your overall SG and A costs. Have you identified or have you kind of developed any comprehensive plan to, I mean, if your margins are down, is this maybe another lever that you can pull to get your SG and A costs down somewhat from where they were last year? Jeremy, I in the 3rd fourth quarter is where We have an opportunity, while still maintaining a strong advertising program, our marketing expense expenses will go down. Also in the last year, which did impact our margins also, gross margins also. We are we also to, we also increase our production capacities. We want to increase our business and that's our objective and we will increase our business. But if we are not able to service it, then it's a vicious site We are not even interested in buying a lot of product from overseas and having inventory then selling it and increasing a tremendous amount of inventory So that's not our model. Our model is to be extremely conservative on inventories. So we did take a position I mentioned, increasing our capacities in Mexico in Honduras and also investing in Vermont and North Carolina, That did increase our some of our costs, some SG and A, but also on our cost of production. As we move forward, the opportunity that we have is to leverage what we have with more sales. We have a very strong operating leverage. We can see that. We can go from, at a wholesale level, from 8%, 10% to 15% relatively fast depending upon the incremental volume that goes through our wholesale. That's why our retail work is very strong for us because of the our vertical integration, our operating leverage is strong with more output and sales. And that's where our our our focus is. I think we control our we are controlling our SG and and A very well where we have this opportunity as I mentioned was in the marketing. Okay, great. Thanks for taking my questions. Good luck. Alright, Jeremy. Thank you. And our final question comes from the line of Christina Fernandez with to lease the advisory group, sorry. Please go ahead. Hello, Christina. Yes. Hi, good afternoon. I had a couple of follow-up questions as some of the previous ones that have been asked. So on the on the government orders that were lower margin, that's $6,000,000 were A lot of those already delivered here in this first quarter or how much of that impact can we still see in the upcoming December quarter? Well, with Corie, also would have, we'll mention that in addition to that $6,000,000, we also had received for the last fiscal year because he was just referring to this fiscal year, which is basically this quarter. We also had received what was a backlog $12,000,000 or so. Yeah, our backlog was about $10,000,000. $10,000,000 that we had received in the previous year at those low margins will be delivered in this in this fiscal year in the 1st or second quarter. So we do have some impact that we will see as the new bidding starts, what happens. But we do have close to $18,000,000 at wholesale at the lower margins, which we won. That you still have to deliver. Is that the right way to read it? Yes, that's right. That's what we have to deliver. Yes. Okay. Thank you. And then, if I go back on last year at this first quarter, you had a lot of one time or what seemed like one time headwinds from the hurricanes and also from the first run production costs. Are you at the point you'd about manufacturing efficiencies, are you already at the place where you want to be and can manufacture that product at a profitable rate? Well, we were always profitable. It was just a question about how much we operating at fairly good, operating margins, but not as high as what we have we have been used to. The good news is, yes, we are well positioned. Our backlogs are under control. Our manufacturing is geared to not only service, but can even service more production. So we're in a good position and the opportunity of having that's why our folks is ready to get more sales. And as we do that, we have the ability to produce it because last year, this time, we had very we had backlogs, because of the fact we had lots of new products being made for the stage department, and it did create a lot of disruptions last year in the second quarter, even flowing into 3rd quarter, this year, we're in a much better position. And my last question, can you talk about the performance of your new stores in metro markets like Flat Island, Chicago, some of the new stores you've opened traffic locations. What has the ramp up been on those stores? Are you happy with those? Well, we're not happy because the rents are so high that, the it has been tough, both in the downtown Chicago. We opened Downtown Chicago. We opened Downtown Manhattan. We opened in the Buckard area. They're all gearing up, but still, we will some ways to go, where we would be somewhat happier in terms of, you know, losing less money because in these very, very expensive market The costs are so high. The objective is to lose less, and that's what our plan is. Thank you. And good luck with this next quarter. Thank you. And we do actually have a follow-up from Jeremy Hamblin's line. Alright, Jeremy. Thanks for taking one more here. I wanted to see, can you give me, what your online sales as a percent total were in the quarter? Got it. Roughly? Less than 5%. Yes, you know, it's under 5. It's less than 5, Jerry, because our biggest opportunity, what we really, really want folks to do is come into our design center to interact with our designers, we that's, that's really is our focus, although it has increased, but still relatively small. Right. You caught my attention with your opening comments about brick and mortar continuing to that you're expect to continue to lose share in brick and mortar. I agree that service is the key, but what do you think your competitors are seeing a much higher penetration rate in terms of online sales as a percent of total. Even your competitors that are at similar price points. And I just wanted to get a sense for what do you think is not connecting, with Ethan Allen or the brand or the service model on why that penetration rate is not significantly higher and frankly, double digits at this point, which I, you know, most of your competitors are well in excess of that? Jeremy, that's a good question. The number of factors. First is, of these competitors that you mentioned, most of a lot of their business is basically on accessories and smaller That's what they did with a lot of business. That's number 1. The second is that our Our focus is to bring people into our design centers to meet our designers. That's where we get not only, not only with pride and great service, it also helps us have less control service, less returns. Returns is a big factor on furniture, So I think those are two factors. I know that the number of the competitors that you may be referring to, they have fairly large some furniture, but a lot of it is all non furniture products, which they do to promote and they sell. We don't promote a lot of non furniture as they do. Is that a consideration then to potentially get more aggressive on, if I back a couple of years ago, when you had kind of your last run of nice success, you had a lot of products, but you also got a little more aggressive on your promotions. And you saw a pretty significant jump in sales that allowed that operating leverage, you mentioned that financial leverage to really kick in. Is that something where, that'd be a consideration here, over the next couple of quarters, maybe to get a little more aggressive on that aspect of your business? Well, we got to see how we accomplish it, but it's critical that we we take the opportunity of increasing sales because the leverage we have is major. And so our whole focus is to increase sales now, as I said, our competitive advantage with having 1200 interior designers is a major advantage. We want them to to be the ones of working with clients. We have about we are recognizing 250 of them in 2 weeks do that every year. It's almost like our Academy Watts. It's a different business model because we are uniquely positioned as having, I would say one of the best interior design networks. Yes, our focus here is to increase our sales because that has Okay, great. Well, thank you for taking the extra question. Thanks very much, Jeremy. Thank I show no further questions in queue. So I'd like to turn the call back for closing remarks. Well, thank you very much. And as I mentioned in my any remarks. And in fact, also said in my comments in the press release that more and more I see this opportunity of using our positioning our strength as an interior design company with 200 grade locations, 1200 designers here, plus 500 others internationally to bring traffic in and then be able to utilize our vertical integration to increase sales and profits. Thanks very much. And any further questions, please feel free to give us a call. Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.