Earnings Call: Q3 2018

Apr 26, 2018

Good afternoon, and welcome to the Ethan Allens Earnings Release Conference Call. It is now my pleasure to introduce your host, Mr. Corey Whiteley, Executive Vice President Administration and CFO. Thank you. You may begin. Thank you, Anna. Good afternoon, and welcome to Ethan Allen's conference call for our fiscal third quarter ended March 31, 2018. This conference call is being recorded and webcast live on Ethanolen.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, 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, Faroo Kathuari, provides his opening, we Arks, I will follow with some details on the financial results. With them, provide further updates on our ongoing business initiatives, before opening up the Thank you, Corey, and good to have you all on our earnings call. As we discussed in our April 10th Investor Meeting, we are positioned well to grow and service our business. We have strengthened many initiatives including expanding our presence as a premier interior design destination, multiplying our fashionable and relevant offerings, leveraging our vertically integrated manufacturing and logistics, and most importantly, increasing our marketing. We are also pleased that we have continued to increase our cash dividends this year by 64.7%. We've also repurchased our 2 cent for outstanding shares this month, and the Board of Directors increased share repurchases to 3,000,000 shares. After Cory provides a brief financial overview, I will provide further information and open for questions and comments. Cody? Yes, thank you, Farooq. Consolidated net sales for the third quarter of fiscal 2018 increased 0.5 percent to $181,400,000. Our manufacturing made good progress during the quarter, in working through the production challenges from the first half, which helped drive the 7.3% increase in wholesale sales. Retail sales decreased 3.6%, primarily due to delayed shipments from wholesale. The retail backlog increased 15% compared to prior year. And now with our manufacturing moving past the earlier production challenges, we expect the retail order backlogs to come back down over the next months. Our consolidated gross margin for the quarter The mix of retail sales as a percent of consolidated sales was 75.5% for the quarter, compared to 78.6% in the prior year. Strong wholesale shipments, including shipments to retail and for the government contract drove the change in mix, which was a primary impact to gross margin. Higher raw material costs also impacted our gross margin. Our adjusted the 20% during the quarter. Turning to the balance sheet, our cash and securities totaled 52,100,000 During the quarter, we paid out paid $24,300,000 in dividends, a 65% increase over the prior year period. We ended the quarter with no debt out standing under our credit facility. Our effective tax rate was 31.2 percent for the quarter and 24.4 percent for the fiscal year to date period, as a result of the Tax Cut And Jobs Act. We expect our effective rate for the full fiscal year will be approximately 26% And for fiscal 2019, we expect the effective rate to be approximately 25%. With that, I will turn it back over to Farooq. Thank you, Corey. As I mentioned, our many initiatives should help us grow our sales and provide stronger profitability and cash flow as we reinforce our position as a leading interior design company. Our areas of focus remain, strengthening our talent with about 1500 interior design associates in North America and 2000 internationally, we are well regarded as the leading interior design company. We continue to attract and retain this talent. The right locations, we have 300 design centers in total, domestically and Internationally, 200 of which are in North America. More than 60% of our design centers in North America have been relocated during the last 15 years. The process continues. Our offerings continue to be strengthened. In May, as we introduced the timeless attainable elegance of Uptown and in September, with the introduction of Artisan, a modern projection of mid century style with all the attention to detail and quality that Ethan Allen is known for. We have increased our marketing by 20% from last year quarter, including the strong national television presence. We continue to increase our advertising in the 4th quarter by about 11%. In addition, due to a larger wholesale business, we expect We have expanded our vertically integrated structure of manufacturing and logistics to be in a better position to service our North American retail international and U. S. Government business. Adding technology on all areas is a priority. Last quarter, we shipped out more than 1000 newer tablets to our interior designers to enable them to be productive and provide personal service with the technology clients expect. We also continue to invest in state of the art machinery and software find and improve our manufacturing business. Conducting our business in a socially responsible manner continues to be a priority both within our organization and in all our relationships As we mentioned in our April 24th press release, the company will pay a regular dividend of $0.09 with a record date of July 10, and a payment date of July 25. We also advise that in April, the company repurchased approximately 2% of our outstanding shares and the board authorized a repurchase of up to 3,000,000 additional shares. We plan to repurchase in keeping with our policy of prudence and the goal of maintaining a strong position of liquidity. I'm now pleased to open the discussion for any questions and comments. And are we ready? And we have a question from Christina Fernandez. Yes. Hi. Good afternoon. Farooq, I wanted to clarify your comment on the gross margin for the 4th quarter that it would be similar to the 3rd quarter. Wanted to make sure that that's what you meant, the 53.3%. And also, can you help us break down when we look at the gross margin compression for the third quarter. How much was it due to the manufacturing inefficiencies and how much it's really sort of like a true sales mix, with a normalized wholesale margin? Yes. Christina, I did I did mean that our gross margin will be approximately close to the gross margin in the 4th quarter will be close to what we had in the 3rd quarter. Now the 3rd quarter gross margin was impacted by number of factors. The first main one was the retail total retail business to total business. It was about 75.5% versus about close to 79% in the previous year quarter. That mix is a very important factor. As you know, the retail has a higher gross margin. And of course, the positive news was muted that it was due to the fact that we increased our wholesale business mostly to the government contract. The second factor on the gross margin was impacted, I would say about 1% or so if it was impacted due to increase in raw material costs in the 3rd quarter. And those costs are still going to be there, even though we've taken a price increases of April 1st, some of that will show in the later months. Okay. Thanks. And then on the SG and A side, the increase was a little bit less than what we had expected given how much you increased marketing, what were the off it, to that higher marketing spend that allow you to control expenses better? Well, one of the things was, which I had mentioned at the investor meeting, was we decided, as per my and myself included, that we would, that I would not take some of the, the restricted stock that had been given to me, I decided not to take it and that became a credit and reduced our expenses in the 3rd quarter. In addition to this, also some of the restricted stock that was, that would have been given based upon, performance was also went back to, reduction of our expenses. It was about a $1,600,000 credit that we had in expenses in the quarter. Thanks. But we should think about this being just specific to the 3rd quarter and not recurring going forward? That's right. It was specifically 3rd quarter. And your next question comes from Justin Bergner. Yes. Hello, Justin. Hi, good afternoon, Frank. How are you? Thanks very much. Now Justin, we are buying our shares. You see that, right? Mhmm. All right. Go ahead. Okay. Just I wanted to ask a question about that, but just a couple of quick clarifiers. Per the last question, Is the $1,600,000 credit to restricted stock, inclusive of you're not taking the restricted stock that you would normally take, or is that on top of the 1.6 plan? No, it was. Actually, what had happened was, Justin, that in our last year, fiscal 2017, I I told our board that I would not be should not be conceippany cash bonus. And what they did was they decided to give me about $500,000 in restricted stock. And I which were but it was given in fiscal 2018, even though it was for fiscal 2017, this quarter, I decided not to take it. Okay. But that's within the 1.6. So 1.6 doesn't become 2.1? No. It is 1.6. And then secondly, in regards to the comment about the gross margin being similar to Q3 and Q4, The small add back to adjusted wholesale operating margin, that $500,000, does that add back to, the gross margin or does it affect the SG and A? It's an SG and A. Okay. So the gross margin is sort of as reported for purposes of modeling? Yes. Okay. And then on the repurchase, clearly, you've gone from a slow rate of repurchases to a pretty dramatic rate in April. I mean, what is sort of the timeframe that's anticipated for this $3,000,000 share repurchase. And I assume that is beyond what you purchased in April, the $3,000,000? Yes, it is beyond what we purchased, that's right. As I mentioned in my comments, we'll use some good judgment as we have done in the past. I want to make sure that, we continue to buy, repurchase our shares back in keeping in view, liquidity, see how business conditions and, the stock price And, we have purchased now close to 42% of our company back since we went public. So we have been doing that and we'll continue to do that. I don't think that, the prices haven't relatively low. We'll buy it, but I also want to make sure that, we don't put too much pressure on our cash flow. Okay. And then lastly, any comment on, sort of April month to date trends? We get about 50, 60 percent of our business in the last 5, 6 days of the month. So we will see, we have a very, very strong national television campaign, we have seen in the last week or 10 days increase in traffic The first, week or 2 were somewhat slow because Easter Passover fell in the in that time period this year versus last year, it was in March. But in the last week or last week, 10 days, we have seen an increase in traffic. And we expect it to have a positive impact in the next 7, 8 days. And your next question comes from Budd Bukatch. Bukatch. Yes. Yes. Bukatch. Hello, Pat. How are you? I'm alright, Farooq. How are you? Your name is as, as you know, my name is easier than yours, but Well, that's, that's good, Farooq. Talk a bit about advertising. I think it came in a little bit more in terms of expense than you initially told us. And Can you talk about the fourth quarter and where you think it'll come in for the year? But I think we came in pretty close to what we had said. We had said that we would be spending about close to 20%, and that's what we did. And, now in the next quarter, in this one, in this quarter, we are running. We're continuing to run national advertising. We ran it in April. We'll run it in May. And then after that, instead of national, we'll look at perhaps some national cable and things of that nature. I would say that at this stage, we are looking at the spending for in the next quarter, close to, I think, the 4th quarter, most probably we'll spend close to $13,000,000 in advertising. 13, did you say? Yes. $13,000,000, yes. Okay. Okay. Which is about an 11% increase. Okay. And your backlog is up substantially particularly in wholesale. Will you be able to deliver most of that in the fourth quarter? I would not say most of it, but I think that, yes, we will make a big impact on it in the fourth quarter. And some of it will go into the first quarter of next fiscal year. And can you characterize how the State Department orders have come in for the quarter? And how much of the backlog is state? Well, in our wholesale, we have, Kori mentioned, we have got a 67% increase in wholesale. Right. 67% in wholesale. I would say a fair amount of that is the government tracked, and we will continue to receive new orders, but from the government. Okay. And talk a little bit about the foreign business for the quarter of overseas business. How was that? Of course, this business has also been positive, especially in China. We have also opened up these are licensees. We have just opened up and Ethan Allen in Cambodia. We have opened up a small one, and it and Indonesia opened in a few months back in Taipei. So we're making progress, but China, of course, is a major one. I was recently there for that, as you know, as I mentioned at our investor conference, in a major design center, they opened in Chengdu, which is Capital of Cichan Province. So China has continued to grow. Okay. And You had originally said that you would be probably spending in SG And A for this quarter, 94 to $95,000,000, I think as Christina had expected, and of course, the offset for your turnback of, and the and the, the restricted stock and the incentive comp, took that down. Where do you think we come in at the fourth quarter. Is there a number you're comfortable in talking about for operating expense? Well, I would say that I think Corey and John are here, but I would it is it also depends upon our deliveries, especially in the retail, because as you know, our retail expenses go up based upon deliveries and, and also depends upon how much of business we do this quarter. So I would say that, that it, we expect, again, it all depends on the top line, but really we expect it to be in the range of 44%, 45% of our, of total sales. Thank you very, very much. Thanks, Bob. And your next question comes from Jeremy Hamblin. Yes. Hello, Jeremy. Hi, good evening. Thanks for taking the questions. I want to come back to the gross margins for a second here. I think it sounds like about 100 basis points of the year over year impact is due to raw material costs, some of that's, that's kind of hard to control. How much of it would you attribute to kind of execution inefficiencies on your end versus the competitive pressures that you're seeing out there more discounting from some of your peers on a year over year basis? Jeremy, that's an important challenge and a question because we are there is a pressure of loss of discounting going on. And we are we are meeting there to some degree, not to the level of what we see out there. So I would say that, if I had to characterize it, I would say that was probably, 50% of our gross 50 percent plus is due to this mix. Then we have a prior raw material increases. And then also the impact of, some inefficiencies due to the making of these new products that we have done that we are making in our plans. So, I would say some mixture of all those factors. Okay. And then in terms of it's always a tough call, on incentive compensation, when you you look back at the year, I think it probably, profitability hasn't been quite where I think you guys had envisioned at the start of the year. And just, again, kind of a similar question of, you have seen compression primarily on the gross margin line item, but your overall operating margins are on track to be down, likely over 100 basis points for the year. How much of that again is related to, the competitive set versus prior expectations. I mean, I think anytime when if you're not taking the kind of incentive compensation, it's really an indication that you're maybe disappointed with the overall performance for the year. Could you just speak to that in terms of what do we do moving forward? Do we get more aggressive potentially on, on some of the promotions yourselves? And you've done that in the past and had some success, but, can you see Jeremy, I should, and I'll tell you this, that I take these very, very unusual steps of, of making a decision of not taking something that is due to me sometimes by contract, sometimes by advice, what board gave me, but I the reason I did it because I felt that our many of our associates will not get too much of our or any incentive And even though this was what I decided to give back was for last year, but I decided to give that back. Overall, I think that, that most properly is a smaller impact on our impact on our earnings. On our gross margin, I would say that, it's a come, the mix, maybe 70% or so, as I said earlier, is due to the mix. And the rest is due to price, due to increases in the raw material cost and maybe 15%, 20% impact of somewhat higher, as you say, discounted. Okay. Just that's the honorable thing, certainly to turn that down. Just coming back to the point that you're making about mix. So historically, your wholesale margins have been significantly better. And as you've seen, the percentage of wholesale businesses is up quite a bit this year and your retail segment, is going to be down, I think, $10,000,000 to $15,000,000 I would have thought that might have had a positive impact on your overall mix Is there any conclusion we can draw at this point on the State Department contract? Is that maybe, relative to the rest of your wholesale business? Is that a negative, from a margin standpoint versus the rest of your wholesale business? No, it is not. I think that we had in the quarter, we had, the impact of, expanding increasing our capacities in especially in North Carolina. And because of the government contract, and there is a lot of inefficiencies you hire a lot of new people and you put a lot of new product in, but most of that I think it is behind us. Okay, great. Last question. I want to just come back to the Amazon relationship. I think that was kind of an exploratory deal, from last summer. I don't know that it's gained significant traction at this point, but, any learnings that you've had from that, that partnership, that's helping you to drive, or change the way that you're doing your own e commerce. Business? No, our e commerce is increasing from a relatively smaller base 40%, fifty percent increase we have seen in the last few years, still relatively small. And what's happening is this that, At Amazon, we've got a great relationship with them. We have a great looking designs, Ethan Allen Design Studio on their site What we are not doing is really spending a lot of money in advertising on their site, which makes it possible for you to have your products go up. People are coming in. If they want to look at Ethan Allen, it is there. They can live chat with our designers through the Amazon site or they come to us. So as you know, our objective is to bring more people to our digital sites because 60, 70 percent of the folks do their window shopping on our digital mediums So any mediums where they are able to get to our digital mediums and help us bring traffic into our stores is important. And that's what that we are doing with Amazon. Great. Thanks for taking my questions. Good luck for the rest of the year. Alright, Jeremy. Thanks. And your next question comes from Justin Bergner with Gabelli and Company. Thanks for taking my follow-up. With respect to the 4th quarter gross margin, what are you are you expecting the retail sales as a percentage of overall sales to also be consistent with the 3rd quarter? Yes, Corey, is that right? Yes. Yes, it's about that. I mean, it would be in that range, about 75%. So we had 75.5%. And in that range, what it's going to be. And that's okay as long as the reason it is at 75.5, not 78 is because we got higher business in the wholesale. Objective really is as we move forward is to improve our operating margin. Sure. And then the raw material headwinds, which I think you said were about half of the year on year gross margin, sorry, about 100 basis points of the year on year gross margin decline. When and how do you sort of catch up to those raw material headwinds? Well, we did take price increase of about 3% or 4% in April 1st this month. However, as you had also indicated or mentioned earlier, that we have to not only take into account the price raw material increases, we have to also consider the competitive environment or what kind of a discounting we are giving. So all of those factors impact the gross margin, also our ability in terms of improving our efficiencies in our manufacturing is important. So I would say that, in terms of catching up, any business we do in April, generally, it is within 45 to 60 days. It when we start seeing the benefit of that. Okay. I guess what I'm trying to figure out is, you mentioned that the residual impact be beyond mix and beyond, cost pressure was a small amount of sort of I guess pricing impact on gross margin. I'm just trying to figure out, is the pricing impact really larger than that residual impact because you're not going to be able to catch up on that 400 basis points of raw material inflation? Well, as I said, this last quarter, it was 1% the chances are without the price increase, the impact would be greater this 4th quarter, our price increases will help But then also the lot of other variable factors, the question of discounting, how much do we discount our products? The question about, the overall volume increase that also has an impact on our overall margins in terms of efficiency, both at the manufacturing level and our retail level. As you know, we're a vertically integrated company. So we do get leverage on both sides. That is an sales increase. It is positive. In terms of our manufacturing. It has positive impacts on our logistics, positive impacts on our retail. If on the other hand, they go down, it's negative on all of those. That's very helpful. I mean, is there something that changed though to sort of accelerate the competitiveness of the underlying environment versus call it a year ago. It just seems like, things are getting a little more challenging. I was just curious could put your finger on anything. For us, I do not say there was a big the impact from, if you're talking about our sales of margins. On the margin side, I mentioned the factors. As far as overall environment is and of course, it's very competitive. If, it's, most folks in retail are giving all kinds of discounts at every level. So it is certainly competitive, but if it wasn't the fact that we have 1500 interior designers, they we are interior design company and that we are that we have a great, history of quality and great service. The chances are that we would not been a position that we are today. So we're in a much better position than a lot of folks in this industry. And we have no questions at this time. Thank you for being on the call. I know we just had an opportunity of, talking and seeing most of you at our investor conference any other questions, please feel free to let us know. Thanks very much. And thank you, Anna. Thank you. Ladies and gentlemen this concludes today's conference call. You may now disconnect. Thank you for your participation. Ladies and gentlemen, this concludes today's conference call. You may now disconnect.