Ethan Allen Interiors Inc (ETD) 2004 Q2 法說會逐字稿

May I have your attention, please. I'd like to welcome everyone to Ethan Allen conference call with the chair person Farooq Kathwari. I'd like to let everyone know. Currently, you're on a listen mode only. We will open up for a Q&A session afterwards. To go into the queue, you have to press star followed by 1 on a touch tone phone. You'll be placed into the queue until you are announced. If someone has asked your question, you may erase your question by placing the pound sign. I'll turn the call over to you, Mr. Kathwari.

Good morning. I'm Farooq Kathwari, Chairman and CEO of Ethan Allen. I'm joined today by Jeff Hoyt, our Vice President of Finance. Today we are reporting results for the three and six months ended December 31, 2003.

We are pleased with the second quarter results. As the U.S. economy continues to improve, we are seeing a greater willingness on the part of consumers to invest in their homes. As stated last quarter, these factors continue to positively impact our incomingorder rate written sales and backlog, allowing us to successfully maintain healthy revenues, margins, earnings, and cash flow. I will elaborate on these positive trends and their impact on our business a bit later. First, let me give you the key financial highlights for the three and six-month periods.

For the quarter earnings per share amounted to 64 cents, net income of $24.4m as compared to 60 cents and $33.1 million respectively in the prior year quarter. Sales increased 5% to $241.2 million from $229.7 million in the prior year quarter. During that period, wholesale sales increased 3.4% to $163.7 million while retail sales increased 7.4% to $149.6 million and comparable store delivered sales increased 1.8%.

For the six-month period, earnings per share amounted to $1.13, a net income of $43.3 million, as compared to $1.11 and $43.2 million respectively in the prior year period. On a year to date basis, sales increased 4% to $463.9 million versus $446.2 million in the prior year. Wholesale sales increased 2% to 332.6 million during the three-year period, while retail sales increased 8.7% to $282.3 million and comparable store sales increased 1.3%.

For the quarter, total written orders decreased 0.4% as compared to the prior year. And the wholesale levels decreased 3.2% as a result of the company having conducted two separate regional conferences during calendar 2003 as compared to only one during calendar 2002. This impacted the timing of floor sample orders for new products introduced as these conferences, resulting in a greater number of orders being placed during the first quarter of fiscal 2004 as opposed to the second quarter of fiscal 2003. Eliminating the effects of conference orders, net orders booked at the wholesale level increased 1.9%. Meanwhile, at the retail level, written sales increased 8.1%, and comparable store written sales increased 2.5%. Year to date, total written orders increased 5.3% from the prior year period. At the wholesale level, net orders booked increased 4.3% while retail written sales increased 8.2%, and comparable store written sales increased 0.5%.

For the quarter, consolidated gross margin was 48.2% as compared to 50.4% in the prior year period while consolidated operating margins remained unchanged at 16.2%. The wholesale operating margin increased to 18.5% from 17.7% last year. The increase is due primarily to a 19% reduction in operating expenses, which is a direct result of the company's continued efforts to control costs as well as initiatives undertaken in recent periods to streamline our U.S. manufacturing operations. Offsetting these benefits to some degree are the costs associated with excessive manufacturing down time experienced earlier this year. As expected, however as a result of prior consolidation efforts and introduction of the New Country collection earlier this year, manufacturing downtime has started to stabilize in recent months, enabling the wholesale division to begin operating more efficiently and reducing excess capacity.

The retail operating margin was 4% as compared to 5.8% a year ago, and 0.2% in our first quarter of this fiscal year. The retail margin has improved greatly from that noted last quarter when the division undertook efforts to sell off floor samples necessary to make room for new product offerings. In the current level of delivered sales can be sustained. We continue to believe that retail operating margins are 5 to 6% of tenable in the near term and higher as we go forward.

For the six-month period, we maintained strong overall margins. Gross margins of 49.9%, operating margins of 14.6%, wholesale operating margin of 17.7%, and our retail margins were lower, 2.2% for the six-month period.

Regarding our balance sheet, cash increased $19 million during the quarter, and inventories decreased $4.7 million, reflecting the servicing of backlog existing at the end of the last quarter. We remain in a strong inventory position with approximately 94% of our case goods items available for shipment within four weeks. We generated strong operating cash flow of $26.5 million during the quarter and utilized $5.2 million for capital expenditures.

Now I would like to give you a brief overview of our business and the prospects as we go forward. As I mentioned during the last several calls, I believe that the best time to make major changes is when business conditions are slow. I am pleased that Ethan Allen today is very well positioned to take advantage of the growing interest in the home and the improving consumer confidence. With introduction of products this spring and summer, we have shifted about 50% of our business to new products. And all of this in about a two-year time frame. Our products today reach a large consumer base, from baby, kids, and all the way up. From classic to country to contemporary. We have focused on differentiating ourselves with products that are stylish, consistency of quality integrate with each other to make home decorating easier. Last year and a half, we introduced Townhouse, Tuscany, EA Kids, New Country, and upholstery in excellence to accompany these programs. And by the summer, we will have introduced our new programs of Newport, furniture for plasma TV and for the bathrooms. Newport is a very important program as it replaced three existing programs -- Georgetown, Georgian Court, and 18th century and Avenue. Newport embraces 18th and 19th century American designs. The Ethan Allen furniture collection for plasma television and Ethan Allen bathroom collection are important additions to enable us to service more consumers.

Our stores are critical to help in providing the decorating solutions to consumers. We have made great progress in placing stores in right places, and most of them in larger size. Our focus has been to relocate stores to increase our visibility and traffic. Within the last five years, we have opened an average of 15 new stores, mostly relocation of existing stores, and during this time, 25% of our entire store network is new. Our objective is to continue and to accelerate in opening new and relocated stores to our network. During the quarter, we opened three new stores, including the second Ethan Allen Kids store. In order to focus on our main competitive advantage -- that is to offer consumers a one-stop decorating solution -- we have taken an important step last quarter to simplify and build more credibility in our suggested pricing to the consumer. About 15 years back, we started a program to establish credible pricing. At that time, we introduced sale prices that were generally 10 to 12% below our regular suggested prices. In January, 2003, we introduced the letter expressions program in a limited number of stock keeping units at a very competitive, everyday value with great results. We took that program to all of our custom upholstery programs last quarter, and this month we expanded it to all of our accessory programs. We're already seeing benefits of simplification of our business, better credibility, and more efficiency, especially in our upholstery manufacturing operations. Starting from this month, our focus in our retail and national advertising has also been to get the message across that Ethan Allen offers decorating solution from great products to design consultants to free in-home delivery and financing options. You may have seen our January direct mail, which was mailed to over 7 million households and has received exceptionally strong response.

Starting from February, we planned to expand this solutions message on national television. We have a strong marketing calendar for the next seven to eight months, with phase introduction of new products and focus on the home decorating solution message to the consumer. On the operations side, we continue to balance the domestic manufacturing and overseas sourcing. Approximately 30% of our business is now from offshore sourcing.

During the quarter, our U.S. manufacturing was more efficient. We still have the opportunity to improve our margins as we continue to utilize more of the manufacturing capacity that we have in the United States. As you know, we continue to generate healthy cash. Our EBITDA of about 19%. We are continuing to access the best use of our growing cash. And at this stage, I would like to open for comments and questions.

We will begin the Q&A session by asking anyone who wishes to ask a question to press star followed by 1 on your touch tone phone. You'll be placed into the queue until your name is announced. If someone else has asked your question, you may remove yourself by pressing the pound sign. If you have a question, please press star 1. First question is from Charles Grom from JP Morgan. You have the floor.

Good morning, Farooq.

Good morning, Charles.

Question on your guidance. It appears your new guidance for 5% sales growth and 10% EPS growth rests at the low end of your former guidance issued last summer. Should we interpret this as you guys being conservative, or is there something that has made you take a more cautious position for the next six months?

Not really, Chuck. I could have easily said 4 to 6%. What was it? 10 to 12%? You should not read anything in it. It basically sort of reconfirms the positive trends that we have. So I mean, it really -- you should not read anything to it that we're trying to be on the lower side. That was not intention.

Okay. Second question, just regards to collections. You know, you've undergone a rapid turnover, like you said, 50% new collections over the past two years. Could you comment on what we should expect this year and into next year in addition to Newport and the bath and the TV collections.

We are continuing to look at our total product programs, making sure that less has to do more. All these new product programs that we've introduced are less in SKUs. They take less space because of the fact they're versatile. They integrate with each other. They don't just -- these programs don't stand on their own. We are now taking a look at all our contemporary programs, and as we go forward, I think you're going to see more additions on the contemporary and the casual side, Chuck.

Thanks a lot. Nice job in the quarter.

Thank you, Chuck.

The next question is from Susan McClarey from UBS.

Good morning, Farooq. Can you talk a little bit about your margins. Your SG&A margin was down, but so was your gross margin. Could you comment on that a little.

Yes. The gross margin reflects two factors. First is that we still are absorbing the manufacturing variances that we had to take in the last six or nine months, in terms of taking time off in our manufacturing. So that is going through our system. It will also still continue in the next quarter or so because, as I said in my comments, our manufacturing is still not being utilized at the level that we would like to utilize it. And if we do it, you know, we build inventories, which we don't want to do. So that is one of the major part of the gross margin. Our retail margin, gross margin was slightly lower too, mostly again because we're cleaning up a lot of our floor inventories and warehouses and things like that to make it clean, which we have done to a great degree. Our operating expenses, to a great degree, reflects our managing our national advertising programs. And there we have a flexibility, and this quarter we decided to lower our expenditures in that respect, and that's what you see.

Okay. So do you view that as a sustainable change that you've made?

Are you talking in the --

In the SG&A.

No. I think that SG&A could fluctuate because it is sustainable if we decide not to invest more in advertising. But as we go forward, we would use our judgment in using our funds for advertising. Last quarter we decided that it would not be -- we decided to cut back. This quarter, we're going to spend some more, perhaps not as much as we did the previous year but it's going to be still somewhat at a higher level. So this will fluctuate, but this is a flexibility we do have.

And can you give us a sense for how many days you took in the quarter, how many down days?

In the second quarter?

Yes.

)1) In the second quarter, we took approximately 30 days, which represented about 7% of our total production days.

Okay. And then, finally, can you just give us a sense for how sales have been over the past several weeks, what the Christmas holiday and New Year's season was like.

You know, we generally don't give information like that, in terms of any specifics, but I think it is fair to say that the last two weeks have generally been positive.

Okay. Thank you.

Next question from Jason Putnam from Credit Suisse. You have the floor.

Hi, Farooq.

Good morning, Jason.

I guess first question. I want to make sure I understand your comments related to the orders specifically with the wholesale. You said because of an additional conference you pulled some orders into the first quarter, and that's why there's such a big disconnect, going from 12% down to a negative 3?

Yes. I think that the six-month numbers are somewhat more accurate because, if you take a look at the orders that we've booked for floor samples in our October convention that we had last year, we're much lower than the numbers -- than what we booked the previous year. Now, this is not real business to the consumers. This is for floor samples to our stores. And that's what -- so by taking the six-month period because this year we had two conferences. Last year we had only one big conference. And that's why my comments were that you should take the two periods together in comparing our orders booked at the wholesale level.

And you said excluding that adjustment, it would have been -- the wholesale orders would have been up 1.9%?

Yeah, 2%. That's right, for the quarter.

So it still seems like it would be a little bit of a deceleration. Is there anything else that's really going on? The other stores outside of your network -- it looks like your retail stores are performing about the same as they did last quarter. Are the other stores performing worst, or is this just --

I think really they're all doing reasonably well. I don't think there's anything to read into this, Jason. I think overall we're up 2%. We don't do a lot of discounting and things of that nature, and I think that, you know, comparing it to the previous year, I think that timing could have been a -- could be a factor, but I would not read anything into it.

Okay. Fair enough. Next question, could you give us kind of an update on some of your new programs and products. I guess, specifically, New Country, how that launch has gone, and also, you know, your early phases with the EA Kids stores and kind of what you're thinking about that going forward, if anything has changed.

Jason, the New Country has been very, very well accepted. It's running at a rate of 40, $50 million at wholesale, which means about, you know, 75, $80 million at retail. So it's very, very well accepted. Kids is also the same. In Kids, we did have -- we were somewhat impacted in the sense that our delivery position in the Kids going to December was not good. We oversold to our projections. We did much, much better than we thought we would, so we had to catch up. But it did extremely well. So we are now in -- coming now in January, we have caught up. We're in a better position. The Kids store, we opened one store in a mall and one store in a outside mall, sort of a towncenter, and we are trying to assess which works well. So far, the towncenter is doing better than the mall store, but in the next few months, we'll have a better understanding, as we also are in a position to deliver our products. The reason I talk of deliveries is because, in the mall, it's critical that you have inventory to deliver. In our regular stores, people are used to waiting. In a mall, they don't wait. We'll have a better understanding of how the mall store will work in a much better inventory position, which we will have going forward.

Do you have any additional stores for the EA Kids variety planned for the next year?

We are looking at a number of locations, but I don't want to make that decision until I have a better understanding of how these two stores work.

Okay. And then just last question. Kind of a little bit more color in terms of what you're thinking as far as the legislation, where we're at on that. I know it's obviously moving forward at the end of January we're supposed to get the next step of that. Just kind of how you're planning for that strategically and any comments you have on that.

We are watching it very, very carefully. You know, it's obviously will have some implications if there is tariffs imposed on bedroom furniture. Overall, our bedroom furniture is relatively small, and we will see if there is tariff, the extent of that tariff, and then whether it will make sense for us to make that furniture in the United States or in China or elsewhere. So we have a number of options. And we have a number of alternatives and options that we are considering right now. I mean, I don't think it's going to be, you know, negative to us because of the fact that the options that we have.

Do you have an opinion on how likely this is to pass at this point? Do you think it's pretty likely and you kind of expect it now, or do you have no idea?

I think it's still 50-50.

It's still pretty close?

Yeah.

And if it does go through, do you think there's a chance of lot of production comes back to the U.S. instead of moving to countries like Vietnam. Or is moving back to the U.S. for short term?

I think short term it's possible for it to come back to the United States, but in the longer term, it might move elsewhere.

Thanks very much.

The next question is from Budd Bugatch from Raymond James. You have the floor.

Good morning, Budd.

Good morning, Farooq. A couple of questions. One, I do know we had some high cost inventory, as you told us last quarter, that would flow through the cost of goods sold line this quarter. Can you quantify that at all in terms of giving us an idea of how much the variance cost margins in the quarter?

You're talking of inefficiency through our manufacturing variances?

Yeah, the variances that got captured in inventory of the past quarter that was -- that now flows through cost of goods sold in this quarter.

Well, you know, I think that if you take a look at -- as you mean, that we were to assume that we were operating at the margin level that we did in the previous year, we still have approximately seven, eight cents impact on these variances this quarter also.

So it was seven to eight cents impact in this quarter?

Yeah.

In this quarter too, I noticed working through the numbers that there was a profit pull-in of about $2.8 million from, I guess, what a line would be the inter-segment eliminations line to get to the total operating income. And that's about four cents. Can you explain how that developed?

Well, Jeff, I can do a better job, but let me try. What happens is this. If we have got -- at the end of the period, we have less inventory in our retail division that means that inventory has been sold to the consumer at the wholesale level. Until that inventory is sold to the consumer, we don't take the wholesale profits. When the inventory is sold to the consumer, we then take the benefit of that to the wholesale margins, and that's what happened because retail inventories at the end of the quarter were lower than the beginning of the quarter.

And can you give us an idea -- quantify how much lower?

6 million. Jeff says 6 million.

$6 million lower. Okay. When you look at the selling expenses, they were down about 201 basis points year over year. I know you said you curbed advertising in the quarter. Does that account for most of that 200 basis point decline?

Yeah, most of it.

It does?

Yeah.

So you think that will -- we will see that go back up in two, three, and four?

It will. Not go up, as I said earlier, to the entire amount, but it could go up, you know. We should not count on it being not there as we go forward.

Okay. And my final question has to do with that number on the balance sheet. It is becoming one of the larger numbers on the balance sheet. There are not too many that are bigger than that, which is the first one on the -- underneath the asset column, the cash and cash equivalents. Any plans for that? You said you were assessing that. I take it that means you didn't buy any stock in the quarter.

No, we did not. And I wanted to say this so you folks won't ask me these questions.

What questions? What are you going to do with the cash?

We are for the time being, it's good to keep it in the bank until we decide to use it, and I don't want to use it frivolously. So we have a number of options. We can always buy our stock back. We can increase the dividends. And we are going to accelerate, as I said, even opening up more stores. As you know, most of the stores that we do open up, what we like to do is to own the stores in terms of land and building the stores because that is where we get a tremendous long-term operating benefits. We will see what's the best way of doing it. As I said, those are three or four options that we have, and that's what we've done in the past also.

I lied. I have one more question then. In the next 12 months, how many stores do you think you'll open that will be company owned, and will that be a net addition, or will that be simply relocations?

We will open up between 10 and 15 stores, and most of those will be relocations. I would say 60 to 70% will be relocations. The rest will be new stores.

Okay. So maybe a net new of four stores?

Right.

Okay. Thank you, sir.

All right, Budd.

The next question is from Todd Schwartzman from Sidoti and company.

Farooq, good morning.

Good morning, Todd.

Just a quick follow-up on the SG&A. I wonder if you could walk us through the thought process for reducing the national advertising at this point in time in light of where we are with the consumer confidence picking up and consumers returning to the marketplace.

We think that it would be better for us to spend that money in February and March rather than in November and December. We looked at it -- we looked at the benefit we got of spending that money in the past year and came to the conclusion that it would -- we would not have a material impact if we cut back this year, and that's what we did. But we are going to go back and spending money as we go forward. But, again, we are looking at how best to utilize our advertising money. You know, nobody says that we got to keep on spending that money. And what happened is, you know, sometimes you just keep on spending it because you have done it in the past. I've taken somewhat of a base zero approach on all of our advertising, and that review said we didn't have to spend it in November, December.

Okay, thanks.

The next question is from Laura Champine from Morgan Keegan. You have the floor.

Good morning, Laura.

Good morning. Could you comment on what percentage of your products you have already implemented the 10 to 12% price cuts you mentioned as you go to everyday low pricing.

Approximately 50%.

Okay. And I would assume the other 50% rolls out at some point over the next year. Is that accurate?

We're going to look at it. We're going to see how it goes. We're going to take it a step at a time. But, yes, if it goes according to our plans, on a plan basis, we will do that also.

And what impact would that likely have to margins in your estimation?

I think by themselves, I don't think it will have any significant impact on margins. It is possible that the net result of being efficient and all that, it could sort of -- it would be a wash. But overall, I think the margins would be improved because of the fact that it will improve our overall efficiencies at retail and in manufacturing.

Okay.

Because, remember, we were selling over 80% or more of our products, off our product lines at the sale prices.

Okay. So, I guess, with that in mind, what are your estimations for what it would do to your pricing overall? If we assume that the sale periods go away so you've got less discounting then but clearly everyday low pricing throughout the year, what do you think -- would you see at Ethan Allen a deflation in prices this year, or would it be relatively neutral?

I think it will be relatively neutral.

Thank you.

Next question from Eric Elbell from Fenimore Asset Management.

Just one question. Going back to your 10 K from last year on capital expenditures expected, you gave an estimate of $45 million, and so far you're at a pace below $10 million. I just wanted to get an update on that figure, what you expect.

We have a number of real estate projects that are under way that are not reflected in the first six months. It will be lower than the $40 million that we had projected earlier because that also reflected the prospects of buying some stores, which we have not done. I would say that, having spent close to, you know, $9.2 million that we have spent so far, I would say that we would end up most probably closer to a $30 million range.

30 million?

Yeah.

Okay. And just to clarify again, you had said you opened three stores during this quarter?

That's right, yeah.

Does that mean there were two closures then? If I'm -- my numbers are correct your total company stores went from 120 to 121?

During the quarter -- yeah, we closed one store from 630, and let me just see. I'll tell you what. Let me have her give you a call, and she'll give you a complete breakdown of what we opened and closed. All the stores we are closing are relatively small stores. And let me see. We had 310 stores as of 9/30, and 12/30, we have 311 stores. We added one store and relocated two.

So two relocates.

Two relocations.

Okay, great. Thank you.

Next question is from Larry from Fair Home Capital. You have the floor.

Congratulations on the solid numbers. I want to preface my question by saying it is not an attempt to, you know, fine tune any near term earnings comments that you've made, but I'm just trying to understand a little bit more some of the long-term potential of the business as it now exists. And I was wondering what you think sales might be able to increase on a percentage basis in a real robust year.

Well, you know, it's relative Larry, to -- we have seen in the past that there have been years that we have increased it by 12, 15%. We've had those numbers too. We have said that on an average, as we have said in the past, that 10% sales plus about a 15% or so earnings is what we have said. From year to year, it's possible to do better too.

Okay. That's fine.

All right, Larry.

Thank you very much. Congratulations again.

Thanks.

Next question is from Kevin Sowers. You have the floor.

I wanted to follow up on a question that was asked earlier regarding a price cut. You kind of said 8 to 10% on 50% of the items. Is that total revenue, or is that retail or wholesale? I got confused there.

I'll tell you, Kevin. No, we did not have price cuts. What I said was, about 15 years back, we changed our suggested pricing to the consumer. At that time, we did what most manufacturers did. That is, you suggest a price, and then which is to be discounted by anywhere from 30 to 40%. So 15 years back we said we want credible pricing, and our suggested regular prices were such that, when we suggested a sale, that we would only give about 10 to 12% discount to the consumer. So this was something that was done 15 years back. Which maintained a very narrow margin between our regular prices and our sale prices. So in effect, after 15 years or so, what's happened is that most of our products were sold at that 10, 12% off because the consumers as well as our own design consultants knew that during the year practically all our products would be put on sale at that savings. So what we have now done is we have made substantially the sale pricing as our everyday low pricing. That's why I said to one of the comments that it's not going to have any material impact on our margins.

Okay. That makes more sense. And then you're talking about a follow-up on the 30% of your stuff is made offshore. Is the savings that you're getting on the offshore, is that being passed along to the consumer, or are you saving some of that and kind of how do you expect that to change over the years as the percent kind of increases?

The offshore product has given the consumer a great product at a good value. There's no question about it. But for us, it also gives us an opportunity of having better margins. So overall, offshore has helped us of averaging our margins, especially at a time when we've had to curtail our own manufacturing in the United States. As our manufacturing in the United States were to increase at a level that our capacities are fully utilized. You know, we've also taken a lot of our plants out of circulation but still we have more capacity. So this overseas product has benefited the consumer and also has benefited our margins.

All right. Thank you.

Sir, there are no more questions at this time, sir.

Well, thanks very much. Any other further questions, please let us know. Thank you very much.