Earnings Call: Q4 2018

Jul 25, 2018

Good afternoon. My name is Terry, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ethan Allen earnings release Thank you. I will now turn the call over to Mr. Corey Whiteley, Executive Vice President And Chief Financial Officer of Ethan Allen. Sir, you may begin. Thank you, Terry. Good afternoon and welcome to Ethan Allen's conference call for our full fiscal year This conference call is being recorded and webcast live on Ethanolen.com, where you will also find our press release, which contains supporting details in including reconciliations of 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 our Chairman and CEO, Frokhathvary provides his opening remarks, I will follow with some details on the financial results. Frokh them provide further updates on our ongoing business initiatives before opening up the telephone lines for questions. With that, here is for Ruth Kapuari. Thank you, Corey. As we mentioned in our press release, We are well positioned to grow our sales and earnings. In fiscal 2018, we accelerated our focus on many initiatives including strengthening our leadership in our vertically integrated business, on taking major product innovation, continuing our retail transformation and increasing spending in advertising which reduced our EPS by about $0.09 over the Third And Fourth quarters. We also made infrastructure investments. We incorporated all of these efforts under the umbrella of a socially responsible approach to business. After Kory provides a brief overview of our financials, I will discuss our initiative in greater detail. Corey? Thank you, Farooq. Consolidated net sales for the 4th quarter increased 5.5 percent to $205,600,000 and increased 0.4% for the full fiscal year. Our manufacturing production levels further increase during increase to our retail network. With our strengthened manufacturing capacity and production levels in place, our retail order backlogs are caught up and back normalized levels. GSA government contract orders continued strong during $1,000,000. Our consolidated gross margin for 0.9% mix of retail sales as a percent of consolidated sales. We expect our retail mix will stay in the 75 percent to 76% range for fiscal 2019 as our wholesale business continues to benefit from strong contract and in an the the 75% of what we sell in our North American workshops and about 50% is produced in the U. S. The balance of our product assortment China. In regards to Canada, some of our upholstery products that we export to Canada that went into effect July 1. We expect this will have a minor impact to our retail margins. Our 4th quarter adjusted operating expenses were $95,000,000, by our advertising expense, which increased 15.8 percent during the quarter as we continued our brand building campaign, which started in Q3. Our full fiscal year advertising was $43,300,000, an increase of 9%. For the quarter, was 7.9 percent, adjusted net income of $11,600,000 with adjusted EPS of $0.43. For the full fiscal year, adjusted EPS was $1.35. Turning to the balance sheet. We generated $42,500,000 of cash operating activities during the fiscal $22,000,000 worth of Our capital expenditures for the fiscal year 2019. Our effective tax rate was 29 percent for the 4th quarter and 25.9 percent for the full fiscal year, as a result of 24.5 percent to 25.5 percent. With that, I will turn it back over to Thank you, Corey. Our many initiatives in 2018 should help us grow sales and profitability in fiscal 2019. They include strengthening our leadership in all areas particularly in marketing, manufacturing logistics and the retail network. We have continued to reposition our interior design network of 200 design centers in North America and about 100 Internationally. 20% of our design centers have been relocated within 5 years and 69% within the past 15 years. During the past year, we opened several new design centers and relocated others in key markets. Including the Buckhead area of Atlanta, Downtown Chicago, and Calgary in Alberta, Canada. Design Centers in Albany, New York, Denver, Colorado, and Rancho Mirage, California are currently under construction. New design centers in China, Taipei, Bangkok, the Philippines and Cambodia are among our 110 International Design Centers. We have continued to refresh our products with an attitude that is modern, but classic. In the 3 years from fall 2015 to fall 2018, we will have revitalized expanded our marketing initiatives. In the Second And Third Quarters, we spent more than $15,000,000 on national television, While We should not have invested as heavily in national television at the expense of other mediums. Starting this quarter, we are returning to a balanced advertising menu that will include direct mail, print, and digital initiatives. Our digital marketing gains, momentum, and reach via a refreshed website email blast, banner ads and live chat, which combines technology with personal service. With Payton. We have also introduced Ethan Allen Home, an augmented reality app that lets clients see Ethan Allen products in their homes. And an all new three d room planner designed specifically for us which our designers are using to enhance customer experience. We continue to invest in clients and 2 major national distribution centers. 29 service centers are operated by the company retail division. We continue to have a strong environmental and social governance program, respect for our associates, the law and the land is fundamental Our first question comes from the line of buddy Buget with Raymond James. Good afternoon. Faroo, good afternoon, Corey. I guess I'm sorry, Say again? I said, how are you? I'm okay. Thank you very much for asking. I hope you are as well. The number that strikes me and just hits me in the face is the comparable and total written orders retail. And I don't understand how that how those jive with what you say is you're being well positioned for growth in the upcoming year end quarters. Please help me connect those dots because those are big numbers being down 11.4% 10.8%. Yes, Scott. And that is a big number. And that is the reason, as I said, that in the second, in the 3rd, in the 4th quarters, we did spend a lot of money on NASH on television. And as I said, the impact of it has been good for our brand, but it lacked the urgency to bring traffic, and our traffic was down resulting in this lower traffic. Now the good news is we started back in June in terms of a more balanced and a very strong balanced advertising program this quarter. So we expect that yes, we have to make up the difference that you say, but we have an opportunity of, making it up with a much stronger balanced advertising program that we have started now. And in fact, slightly sending less money, but we believe that we have an opportunity to get more traffic, and that should help us rebuild the written sales. And are we starting to see that now if you've gone, it started in June. I don't know if you started early June or late June. To do that, but we're now at least much through July. What can you tell us about the impact so far? It's a little bit early in the sense that as you know, we do most of our business. A lot of our business comes in the last few days of July But so far, the prospects look better. They look stronger. And we are looking for a stronger, August September. And of course, time will tell but I think we are getting positive news. And that's why I say that we are back, hindsight is when we shouldn't have spent as much as we did on that TV campaign. It was well. People liked it, but it did not create urgency. And we went back to a more balanced advertising program. And I think we're already seeing some benefits of it in in July, but we'll see a lot more in August September. And going forward, too. Okay. And you talk about increased backlogs, can you kind of parse the backlog for us as to how much of that is backlog associated with the GSA or with the state department program and how much is associated with normal business from dealers or from others? Well, Corey can give you more details. However, at this stage, we are talking about major backlog presented represents, business from the contract, which is GSA, and Internationally. Okay. And two last questions for me. One is kind of a housekeeping question. Can you give us actually the advertising dollars spent in the quarter. You said, I think $15,000,000, I think 15% above what I had got to about $13,500,000 in quarter. So I obviously don't have a number right somewhere. Go ahead, Corey. We have the Yes, the advertising, in the quarter was $13,500,000. It was $13,500,000. Okay. So that is right. And you closed 10 design centers I think internationally, where were they close? But a lot of those were small studios that had been experimenting in Germany, and most of them were in Germany. I see. Okay. Now also, we're talking about tizing budget, as men, Corey mentioned, we spent $13,500,000 as against $11,700,000 in the previous year. And keep in mind also in the first quarter of last fiscal this is what we're going to compare it with this. We spent $7,400,000. So we have a 13.5 And now we spent 77,400,000 in the first quarter of last year. Do you think you're going to spend that much the first quarter of this year again or is it going to be less than the 7.4? No, no, it's going to be about that level. It's going to be much less than what we were running and the 3rd, in fourth quarter. But not less than what you ran last year in the first quarter? No, I don't think so. Your next question comes from the line of Jeremy Hamblin with Dougherty and Company. Hi, good evening, guys. So I want to just come back to the advertising for a second and I think I had like $9,800,000 that you spent in Q1 of 2018. Corey, can you confirm? No, no, that's Q1 of 'eighteen, no. Wasn't 5.4% of sales? It was 7.4%, 4.1% of sales. Okay. And I'm sorry, the number that you're expecting now for this year is going to be? Or the range? Coriam is approximately the same range, Jeremy. Okay. So maybe 7 point $8,000,000. And just in terms of thinking about how to drive your orders. So you weren't happy with, the results from national TV which was, expensive, excuse me, and not that effective. So you're going to go back to more digital spend. You're going to go back to, more targeted spending. I think you used the word balanced. In terms of is there other things that you think you need to do to really drive sales and written order traction. Do you need to crank out more new products? Because seems to be that when you have products that resonate that's been when you've seen an acceleration in orders? In terms of, our advertising, we have the balanced what we did was when we spent as much as we did on national television, Jeremy. We did not spend much or we spend much less on direct mail, and we could see the difference. Our customers, not receiving a direct mail, again, hindsight is 2020, they we could see the difference. We could see the fact of not sending our direct mail to prospects. So we immediately went back, and that's what we did some in June, but we are doing it more aggressively in July and, going forward. In September, we will be introducing our newest product line, which is under that umbrella of artisans, which is more than that. This is a very strong product program that will be getting our design centers next month. And then we start our marketing in September with a very strong mark program, including a 116 page direct mail, beautifully done. It shows the new Wiesen Allen more eclectic. It's more modern and classic, and that will be sent out in September. And October and also with a strong digital advertising to go with it. Okay, thanks. Turning to your gross margins, I believe that there was a comment Cory made that your retail mix act among others, I think you said 75% to 76%. Now when you've been seeing sales down at those levels, your gross margins have been more in the, let's call it, 53.5to50 4.5% range. Is that kind of what we should be expecting in 2019, Corey? Well, what you'll see this year is a little bit of a benefit in that our manufacturing has gotten through all that first production challenges of making that new product for the state department. So we'll have a little bit of a gain on the efficiency side. So that 54.5% is still probably the neighborhood of where we'll see the margins, 54% to 50 0.5%. And Jeremy, if you take a look at our third quarter, this fiscal 2018, we had a 53.3% gross margin. And we ended up the 4th quarter with 54.1%. And despite the fact that we did have a strong, presence in and shipments in for our state department as well as Internationally, because when the retail overall retail division sales and the percentage of the total are lower, that does impact the gross margin. Despite that, Our improvements in our manufacturing in the 4th quarter reflected in 54.1 percent gross margin from a 53 0.3% in the previous quarter. So that range approximately is something that we should be looking at. Then also in the fourth quarter, Jerry, we didn't get the full benefit of the price increase that we took in April. It took a little while to work that through the system. Did that have any of any negative impact on your orders, the price increase? You know, I mean, even though Corey talks about price increase, the fact is Jeremy, as you know, on one hand, we take price increases. On the other hand, we do give even better values and sales to the customers. So the net net, it is our products are not more expense or higher priced. So I think at the best, we sort of come close to breaking even. Okay, fair enough. As I look ahead at your SG and A, clearly, you're expressing some regret on the ineffectiveness of the advertising, the additional dollars And that was certainly a decent chunk of your overall increase for the year. I think it was about $6,000,000 or $5,500,000, $6,000,000 of incremental SG and A spent you look at your business now and it's hard to project any significant kinds of sales acceleration. Do you feel comfortable with the level of SG and A spend? Do you think that there are is a need to maybe tighten that down a little bit? Are there opportunities to tighten that down? Well, Jeremy, we always look every year when you are all our budgets are based on a 0 based budgets always. We take a look at what we need to do the last quarter 4, we had we spent $95,000,000 of our SG and A was $95,000,000. And again, you're right, advertising increased it. In the first quarter of last fiscal year, there were a SGA was $88,000,000. So, and this was a fairly important increase that took place. So I think that if you take a look at between $90,000,000 $95,000,000 somewhere we have that opportunity. Okay. So, but nothing will mean From the 290. Nothing of advertising, yes. Okay. Fair enough. And then I just wanted to clarify, Cory, did you say the tax rate to expect for next year? Was it 23.5 percent to 25 percent. Is that the number you said? 24.5 to 25.5. Oh, 24.5. Great. Thanks for taking the questions. I'll hop back in the queue. All right, Jeremy. Thanks. Your next question comes from the line of Christina Fernandez with Telsey Advisory Group. Hi, good afternoon. So following up on Jeremy's question with all the puts and takes, I mean, is your expectation that the operating margin would be flattish for fiscal year 2019 or could you see some expansion and where would that come from? Well, our operating margins in fiscal If you take a look at our fiscal 2018, our operating margins, excluding any special items, was, 0.5%. And in the last, for the 4th quarter, it was 7.9%. And so I would say that we already made improvements in terms of taking it to almost 8% So I would say that the opportunity, of course, it has we have a tremendous leverage when sales increase, we have operating leverage at all levels from retail to manufacturing. So, you know, we have an opportunity between age and I mean, around 8% or so, is an opportunity that we have. Okay. And then just going back to the sales and how the quarter progress. You stayed high on promotions with a fair amount of free delivery offers. How is the customer responding to those? And also, can you talk about the reception to the Uptown collection that was launched in May? Now, where our first opt out has been extremely well received all across the country. And, we continue. The passcode has also been well received, which was done before that. And I believe that the reaction by our own teams to the new artisan has been extremely strong, and we're going to start getting it into our design centers next month. And as I said, September, we start launching the national, our major advertising campaign nationally, lot in direct mail and digital. As far as the question was on On the promotions, the promotional, when you're doing It's it's hard to tell that from time to time, but for instance, we just gave last, about 2 weeks back, we had a 4 day special celebration, basically it was like prime days with no delivery. It does. It does help. What it does to help in those senses, it takes people who are on the or holding back perhaps it would close in the end of the month or next month, it helps them close. So that's what happened. That's what happened. And we want to use it very select because once you give it, make it available all the time, then it loses its effectiveness. And one last one. The inventory was about $13,500,000 year over year. You talked on the press release about supporting the backlog and an expanded stocking program. Can you clarify what that's about? Well, the inventory was up again. Yes. First, with this, the GSA created an inventory increase both at the manufacturing level and in the finished goods. And good news is we have to consolidate it. We have to keep it in our distribution centers. So half of that increase really reflected the increase of the state department contract. And now as we move forward, our objective is to have somewhat lower inventories than what you see. Thank you. All right. Your next question comes from the line of Justin Bergner with Gabelli Group. My first question just relates to the various partnerships that you have in progress As we look sort of on a go forward basis, is the $15,000,000 run rate for Disney still meaningful? And are other partnerships, like selling through Amazon, some of your hotel deals or real estate agency deals, are those contributing meaningfully or does it sort of drop down materially after that $15,000,000 or so from No, I think the main, it's a good question. Our main, of course, major has been the state department contract. The second is our contract programs that we are launching, something like the like the Margaritaville program that we have in Orlando, where we are purchasing 1100, what, a 1000 homes and a hotel that has those those are important components of our outside business. 3rd one is we had a fairly we have a good increase in our international business. So international business, our GSA business, our contract business, Disney, we have got we have started getting some good business on contract for Disney. The Disney product line that introduce is holding up a little bit lower than the number that you have mentioned. It has not grown up significantly. Our Amazon business also is about the same as last year. And in both cases, we have really not given it a tremendous amount of advertising per Okay. So should I assume then I mean, just the sequence of the relationship you mentioned after Disney, it drops off pretty materially? Or is the Amazon contribution material No, I think the material one, as I said, is the government and other contract hotel business. No, in fact, the first is the first is international. 2nd is and especially China. And the second is stage bottoms contract of the GSA. And then third is our other contract business like Margarita Will and even in Disney. And how did in the State Department contract, how did the orders of $24,000,000, I think, compared to the revenue And sort of now that that, operation is running a little bit more smoothly, sort of, what uptick to margin can we expect from a smooth GSA operation? Justin, this is done on a competitive bidding. This is almost like eBay. So we're almost to get this contract and we really have to be very, very aggressive, which we have been. And that does have an impact on margins. It has a double impact on margins because most of this product to win, we had to be very competitive. 2nd we had to make this product in our plants the first time. So it affected the plant margins. But as Corey said, in the fourth quarter, our plant margins went up. Our overall gross margins went up. And we have now in the process of, I mean, we've gotten it through through the system, and it will it is going to make positive contributions. But as I said, we have $24,000,000 very competitively bid. Okay. So is the 4th quarter then representative of normal operating conditions with the exception of sort of the seasonality that tends to make 4th quarter higher revenue quarter? Yes, I would say that if you are looking from a gross margin and operating margin level more or less, I think those are good, those are numbers that you can utilize. Okay. And then finally, and this is sort of an open ended questioncomment. I mean, given the difficulty in the retail environment with sort of the consumer dollar seemingly moving a little bit away from the furniture category versus prior years. I mean, are there sort of out of the box things that Ethan Allen can consider partnerships, mergers above and beyond sort of out of the box organic initiatives. I mean, are there things that are you're thinking about maybe you haven't discussed that fit that bill that, might be able to sort of take the company some of this trap that we're seeing in the retail and furniture space? Justin, we are always looking at options and we're always open to options because we all must So yes, you are right to the retail. There has been so much of change that has taken place in retail at all levels. And so, we have a great opportunity of leveraging what we have done. We do need, which as you see, even in our fourth quarter, that we did have an increase in sales with an increase in gross margins, our operating margin would work good, but they could earn much, much better if you didn't have this big advertising expenditures that we have. So we are positioned well. And our leverage is that we need to increase the top line. We have to increase our written sales not go down as we did last quarter. So we have that opportunity and our biggest opportunity is taking the retail network of 200 design centers and leveraging that and doing more business. Having said this, we are always looking at opportunities that will be consistent with our business, with our philosophy, and all of that we're always open to look at. Okay. Thank you And we do have a follow-up question from the line of Buddy Bugatch with Raymond James. I've got a few more questions. You talked about the fact that the state and GSA was a $24,000,000 number for the year. If I remember the State Department contract, it's like about $60,000,000 a year that if that's true because it was a $300,000,000 5 year contract. Did they underspend on that or did you was your penetration around 40% of the government spending? That's a good question, but I'll tell you, it did stop 60,000,000, but that was when it was not on a competitive bid. When they put it on a competitive bid, the government really benefited because that reduced it by a certain amount. The second is possible that the government, the state as the rest of the government is spending less money this year than they did in the past. I mean, from information we have, we got a very substantial portion of the order. And yet, of course, most of the orders do come at the end of the fiscal year, which is going to be October of this year. That's just in the last 6 weeks or so, the government does give fairly large orders and that we will see what had happened. But a lot of this, the $60,000,000 was impacted by this competitive bidding and the discounts everybody were giving. And how much was the state or the government business during the fourth quarter? What percentage? What was the the number of the business of the $24,000,000, how much was in the 4th quarter? Corey, I mean, we want to take a look at it and maybe get that but I don't have it here, but let Cory will look at it. And also we'll see how much of information we can give this out even I'm surprised that Corey gave this number out of 4,000,000. Normally, we don't say, but he had already said it that we have that It's hard to put that. That's hard to put that toothpaste back in the tube. Guess. I know. I know. I thought it was our 1st year. I'd give you just an idea. He used the toothpaste to have parts, okay. And so then the next question I have is, do you expect that retail sales? I think the comparable retail sales delivered retail sales for the quarter was 2.3%. If I did the math right, when you gave the comparable numbers, do you expect retail to be up in the first quarter. It doesn't look like with a negative order number that you can do that. It's going to would be a yeoman recovery. So I don't think you would see up retail revenues in quarter 1. Is that a fair commentary? It's just fair. Also depends upon our July business, our August business, because today, one of the other things that we have done, which is positive and also challenging, we have reduced our delivery times, which creates an opportunity for us to deliver faster. But on the negative side, It also creates an issue in our 14 weeks, our manufacturing was always running consistently. Now when we do the way we are doing and orders don't come consistently. We have to reduce our work in our manufacture So a lot of factors have to be taken into account, but it is going to be somewhat of a challenge this quarter, but we are looking forward to July August to see how much of we are able to make up? Well, nothing happens bad by running the business on a more efficient way. So I think that's at all positive. But, I'm just trying to, we have a job to do to try to come up with estimates and we want them to have rational basis So I'm trying to make sure that, at least Let me give a few comments of fair that I think that, as I said, And I know that, you had also looked at that advertising and you're a smart fellow. You had given me your comments in a what was March or so. This beautifully done very well, received by all our network got standing Ovation, but there's something missing which was it did not drive traffic. So we have changed it. We've seen the impact of it. I would take what happened in our 2nd and third I mean, 3rd and 4th quarter, somewhat extraordinary. We're going to be back to where we need to be, but we got to build the business as you're right. Said, I believe that we'll be able to do a fair amount of it. Now can we deliver it in the quarter that will be somewhat of a challenge? Because as as you also saw that we have caught up in the deliveries on the retail side. Okay. And my last question is when will the KB issued? Expected, in the next week or so. Much. Okay. Thank you, Bud. And we have a follow-up question from the line of Justin Bergner with Gabelli Group Company. Thanks again. The tariffs, sorry, the 6% that you import from China, will that be subject to tariffs such that you'll have a leg up on competitors that import more from China? Well, one of our competitive advantage is the fact that we manufacture 75% of our products in North America ourselves. It challenge also, challenges that if we are not keeping them busy, we are we have an impact on margins. It's positive when we have leverage. It's also negative when we are not keeping our manufacturing busy. If you're buying products from overseas, and we don't have to worry about manufacturing and variances and all that stuff. Having said all of this, we do have an advantage relative to folks who are buying a lot of product from, at this stage, it is China, as you know, products, it doesn't not come from China also. It comes from Vietnam. It comes from other countries as well. So we do have an advantage from that perspective. But are tariffs actually in effect on that 6% or part of that 6%? No, it's not. I think this is something that is pause and is going through some review. And then they will, based upon based on review, they will then make the final determination, as I understand, it. Okay, got it. That's what I thought, but just wanted to clarify. And then, there was a small adjustment, I think, in one of the segments an add back, what did that relate to? A couple of 100,000? Yes, that was related to the costs associated with the purchase of that's in our retail. There are no further questions at this time. Do you have any closing remarks? No, well, good. I imagine these are good questions as you all said, we had a good quarter in terms of deliveries, in terms of earnings. The challenge was the written. And I know we do understand it, and that's why we've been working hard to make show we put into place programs that we can increase our written and that will help us use our operating leverage on the retail side as well as on the manufacturing side. And we have that opportunity. So thank Thank you for participating and any other questions, please let us know. Terry, thank you very much. You're very welcome. Thank you for participating. This does conclude today's call. You may now disconnect.