Ethan Allen Interiors Inc (ETD) 2005 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the Ethan Allen conference call. At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded. I would now like to introduce your host for today's program, Mr. Farooq Kathwari.

Good morning. I am Farooq Kathwari, Chairman and CEO of Ethan Allen. I am joined today by Jeff Hoyt, our Vice President of Finance. Today we are reporting the results for the first quarter ended September 30, 2004. I am sorry for the delay. I understand there is a lot of backlog of calls and they were taking all kinds of the e-mails so I told them to stop taking e-mails and get people on.

Now let me give you some key financial highlights. Our sales increased 3.4 percent to 230.3 million. Total retail sales increased 6.8 percent with comparable sales increasing 4.9 percent. Our wholesale sales increased 1.5 percent. As you must have noted, we did not provide information about wholesale net orders booked as we believe timing of our conferences had a major impact on the wholesale orders booked. For example, last year we had a special conference in June 2003 impacting net orders booked and this year we had a conference in September 2004.

We believe as we go forward, the written sales at retail more accurately reflect the booked orders. However, at this time I will share the information of our wholesale orders to allay any concerns why we are discontinuing these numbers.

As of September 30, we showed a decline of 8.3 percent in our wholesale orders. Last year we had a conference at the end of June impacting our net orders booked in the first quarter. This year we had a conference in September of 2005 impacting our business this quarter. For instance as of now, our net orders booked are slightly ahead of last year so you can understand the impact of our conferences.

Retail comparable business, in our written sales in our retail decreased 0.2 percent and comparable written sales decreased 1.7 percent. Our gross margin was 47.9 percent compared to 48.7 percent in the prior year period. Gross margins were impacted by several factors. During the quarter we continued to absorb the variance from closed plants and in the first quarter we absorbed 1.8 million from our closed plants. This alone would have made our gross margins fairly close to the last year's gross margins.

We also have absorbed price increases in raw materials, energy, health costs. The everyday pricing has also had an impact on our gross margins. Despite all of these factors we have maintained a healthy gross margin.

Our operating margins are also good. The wholesale margin, 17.5 percent versus 17 percent last year. Retail margin at 2.3 percent versus 0.2 percent last year and for the Company, our operating margins were 13.6 percent versus 12.8 percent. Operating income increased 9.3 percent with a relatively small increase in sales.

Our net income was 18.9 million in both periods. Last year we had $2 million of extraordinary income which we did not have this year. Our tax rate this year is 39 percent versus 38.2 percent of last year. The difference in tax rates had an impact of about 1 cent to our earnings this year.

Our EPS is 51 cents versus 50 cents. Special factors to keep in mind, the impact of extraordinary income last year had about 4 cents positive impact on EPS last year. The impact of higher tax rates this year reduced our EPS by about 1 cent. Repurchase of shares benefited our EPS this year by about 1.5 cents. The net difference is about 3.5 cents positive last year.

Our financial position remains strong. We generated cash flow of 37.4 million, used 7.5 million for capital expenditures versus 4 million last year. We repurchased 634,500 shares for 21.8 million. In second quarter so far we have repurchased 477,000 shares at 16.6 million. During the quarter last quarter -- during our first quarter we announced a 50 percent increase in dividends to 15 cents per share. Our inventories decreased 7.7 million from June 30, '04. Our EBITDA was 36.4 million or 15.8 percent of sales.

Let me now give you a brief update on developments in our marketing and operations. We continue to focus on our strategy to provide solutions to the consumer. We have greatly improved our ability to provide these solutions by continuous improvements of our business. Let me give you a few examples.

Our products are a solution. By next year spring we would have changed 70 percent of our products reaching a larger consumer base with stylish, good quality and better value products. After spending 2 years to reinvent our formal products, we have now started to introduce new products in the casual and contemporary lifestyles. We will introduce these products on a plan basis from winter of this year to spring of 2005.

We have strengthened our store network. We have taken many initiatives. First, we continue to open new and relocated stores in important markets. In the last 4 years, 15 new stores with an average of 40 percent increase in size have been opened up in key markets. Last quarter we opened 9 new stores, of which 5 were domestic, 4 overseas. We closed 2 stores, 1 in Dubai, which is going to be relocated and 1 small store in Appleton, Wisconsin. We ended the quarter with 315 stores, 127 operated by the company and 188 by the independents. We believe that the steps we have taken have strengthened our retail network both in the locations and the operations of our stores.

To launch our new products and marketing programs we have decided to expand the distribution of our direct-mail program. During this period, we have mailed 10 million copies of our magazine, representing a 30 percent increase over last year and by January we will mail about 13 million copies which is about a 50 percent increase.

Our latest solution of the everyday pricing is being positively received by our own associates and the consumer. We see continued benefits to our credibility, productivity and profitability from this initiative.

Finally, our operations continue to be strengthened. In the last two years we have consolidated 9 plants. We have now 12 plants; 6 case goods 5 upholstery, 1 accents. Our outsourcing represents about 30 percent. We believe we are now in a good position to maximize efficiencies domestically and also benefit from outsourcing. We believe we have improved many aspects of our enterprise to be ready for the next phase of economic growth.

At this point I would like to open for questions.

(OPERATOR INSTRUCTIONS) Todd Schwartzman from Sidoti.

A question on the EDLP. With respect to your design consultants, what if anything are they doing in-store to wean the consumer from the age-old expectation of sales promotions particularly with in the event when holidays are upcoming?

A number of factors. First is we have spent a great deal of time -- actually the whole of last year in explaining, communicating why this makes sense through conferences, through meetings and they bought into this because they understand that it increases their credibility. It also increases their productivity and explain it to the consumer. We have a lot of point-of-sale information. And now what they have also done, from time to time especially in the last few months we have used financing as an opportunity to create this urgency that you are talking about. That has helped. We have a number of financing options from our installment financing plan to sometimes offering an interest-free for a short period of time. We have used that as an incentive rather than a sale price because offering our whole menu at the best possible price has induced many more people to buy our products today than to wait for a sale.

Okay. And also looking out if you would 4 years, maybe 5 or so, how many case goods plants do you think you will need domestically?

Today we have 6 case goods plants and it is hard to project what is going to happen in the future. We have gone from 27 plants 10 years back to now 12 plants. These case good plants -- we've got 3 in the Southeast, and 3 in the Northeast. They are well located. We have today the opportunity of keeping them operating at a capacity to make them efficient and productive. We are going to take it a step at a time and we will see what makes sense. We would like to continue to maintain our competitive advantage of controlling our sourcing as much of sourcing as possible. But however, a lot of our growth is going to continue from outsourcing because at this stage we are not going to build new plants in the U.S.

So 6 -- looking out 5 years -- 6 domestic plants would be best case scenario?

That is right, yes.

Thank you.

Margaret Whelan from UBS.

It is actually Susan for Margaret. Can you comment, Farooq on some of the current demand trends that you are seeing?

Susan, I think slightly more positive than we saw in May and June. I am sorry, June, July and August. In the summer we saw consumers were more reluctant. I think they are still somewhat conservative; they are still waiting for the elections to be over, but a little bit more positive than we saw them in the last 3 months.

Can you just talk a little bit about this new focus that you have on sending out more catalogs and things as opposed to maybe going down the TV or other advertising mediums that you have used in the past?

Yes. We have for the next 6 months or so -- starting actually now, we will be concentrating on direct-mail and taking some of the money that we have used on national television and diverting it into direct-mail. And 6 months from now our objective would be to again go back into national television and then at that time see what is the appropriate amount to spend on direct-mail.

Okay. Is any of this coming off of your whole solutions campaign and maybe some other specialty retailers that have done well with catalogs and things like, trying to balance that out?

The direct to mail process is a very important competitive advantage because we can get our total message out to consumers in a much more effective manner. In January we will be mailing out about 13 million copies of our direct-mail, which is a 50 percent increase and the messages are going to be our total solutions message and at the same time on a planned basis, introducing the new casual contemporary productlines that we have just introduced and will be introduced into the consumer from December of this year to the spring of next year. And that is one of the major reasons we are using the direct mail to introduce these new products of casual and contemporary product lines.

Okay, thank you.

Budd Bugatch from Raymond James.

This is actually Chris Normsbury (ph) on behalf of Budd this morning. Just had a quick question with regards to the gross margin year-over-year decline. You mentioned some of the factors that impacted that. My question is in reference to the plant closures flowing through the inventory. How long do you expect that to affect the gross margin in the next couple of quarters?

It is going to start declining, for instance, this first quarter we had 1 million 8, and then next quarter, about $900,000 and it will progressively decline.

Okay, thank you. That is helpful. What was the driver for the decline in the selling expenses year-over-year in the quarter? I saw that selling expenses went down from about 20 percent of sales to 18.8 percent. Could y explain a little bit of that?

Most of it is the fact that we decided in this election year it did not makes sense to spend a lot of money on national television and we reduced it.

Okay. The next question is referring to the retail system. It looks like the operating margin increased about 2.3 percent. What were some of the major drivers between the increase in probability in the retail system and where do you see that going over the next few quarters, the operating margins in the retail system?

The positive factors this year versus last year were that last year as I mentioned last year, is that we were selling off a lot of products, discontinued products and all products from our stores which impacted the margins last year. This year that was not the case and we were able to get better margins. That was the positive. The negative was we were impacted by lower sales especially in the Southeast and Florida due to these hurricanes which did impact our overall sales and also sales in our retail division to some degree.

I think overall, I think as we go forward our objective is to at least double these operating margins that you see.

Okay. So around 4 to 5 percent or so?

That is correct.

The last question is more of a housekeeping issue. The guidance you issue is greater than or equal to -- equal to or greater to consensus of sales growth of about 5 percent, EPS was about 8 percent or more for fiscal year '05. In your EPS growth outlook does that include any share repurchases that you have done thus far or any that you plan in the future?

You know we have taken some of that into consideration, not all.

Okay and how much do you have left of the share repurchase authorization?

As of now we have a little over 700,000 shares.

Thank you Farooq.

Laura Champine from Morgan Keegan.

Good morning. Farooq, could you break out unit growth in the first quarter?

Yes. Our unit growth -- Jeff, tell me, what is this? Our unit increased by 10 percent, Laura, during the quarter.

Wow. So that implies a shift in mix that drove prices beyond roughly 7 percent? Am I reading that right?

Approximately, 7 percent -- (indiscernible) yes.

Can I extrapolate from that that to grow the top line 5 percent this year you would actually need 12 percent unit growth?

Well, you'd just take a look at it. We grew 3.5 percent while our units declined 7 percent. That is right, but this is actually 1 quarter. I would not take it for the whole year. I think that we have had an impact of not only the everyday pricing but also a greater focus on some of our most probably, you might say better value priced products. I would not -- I think this is somewhat of a larger unit increase that we have seen. I think as we go forward I do not see that there will be this much of a disparity. But there will be still some disparity.

So some of this was just the rolling out the everyday value pricing?

Right.

I noticed in the quarter on the balance sheet that prepaids were up fairly significantly. Can you comment on the reason for that increase?

On the prepaids?

A portion of that prepaid expense and other current assets is actually the deferred tax asset which changed during the period. The prepaids are up marginally but not as much as that would indicate.

Great. Thank you.

Carlos Robera (ph) from Credit Suisse.

A couple of (indiscernible) here actually. The share repurchase -- can you repeat the actual share repurchase during the quarter? I actually missed that.

All right.

On a trade-name (ph) basis?

No, just the total number.

The share repurchase during the quarter was 624,500.

And you said roughly 21 million?

21.8 million. That is the trade date basis.

Can you quantify at all the raw material impact on gross margins this quarter?

I would say that we have been looking at it because as you know there is a lot of news about raw material increases. I would say that for us raw material energy and all of that has most probably impacted ours by about 1.5 percent to our gross margin.

And just lastly, a follow-up to a couple of previous questions. Your advertising expense in '04 was down about 12 million year-over-year from "03. As you start ramping up perhaps some TV advertising down later this year would you expect it go back to the '03 level?

We have that opportunity -- that's right -- of taking it back there, especially as we see business conditions improving, we would then -- I would say that we would increase it. I don't know whether it will go completely to the '03 level but our objective would be to spend more money on national television advertising next year.

Is it safe to say that the majority of the declines from '03 to '04 in terms of advertising that was all national television reduction?

That is right.

Thank you guys.

Keith Hughes from SunTrust Robinson Humphrey.

The comparable store sales of 4.9 -- delivered sales of 4.9 percent was different than the written sales of decrease of 1.7. What is the disparity there? You really didn't come to the quarter with a lot of backlog.

It's a number of factors. One is our ability to deliver what we write. It also depends on our stock position. If our stock position was better, our ability to get business and deliver it faster this quarter was better than what we had last year. I think it is reflected is what ever orders we got in, we delivered them.

What kind of lead times are you seeing on case goods and upholstery right now?

Case goods we have about 80, 85 percent of our case goods are in stock, about 90 percent is within 4 weeks. So we are delivering to the consumer our case goods I would say anywhere between 3 to 4 and our upholstery is anywhere from 6 to 8 weeks.

Could you give me the ending share count as of the end of the quarter?

I will let Peg Lupton get to you because we are not in the office right now and they will give you the exact count, because what we have right now is averages.

That is fine. Thank you.

(OPERATOR INSTRUCTIONS) Michael Cox from Piper Jaffray.

In terms of the gross profit margin contracts, you mentioned that EDLP, have you considered or -- what is your stance on raising prices following the price that you have enacted over the past 12 months?

We are studying that very closely.

But no changes at this point?

When we announce it, then you will know.

In terms of capital expenditures of the $7.5 million level, is that fair to assume over the next couple of quarters as well?

No. I believe it will increase because most of this money was spent on our retail expansion and you're going to see it increase in the next few quarters.

In terms of store openings for the balance of the year, will it be the same net for stores per quarter -- is that fair to model? Or will it be more than that?

We would open up I believe 12 to 15 new stores in the next 12 months, so it is approximately 4 stores.

In terms of the tax rate is it safe to model 39 percent through the balance of the year? Is that the correct run rate?

I am very upset over Jeff here, for taking it from 38.2 to 39 percent but he tells me that we need to be more conservative and create more reserves which we have done. As we go forward, it may be wise to keep 39 but it is possible as we go forward, it might be slightly lower.

Okay. Thanks a lot.

Sam Harvey (ph), Harvey Investments (ph).

Farooq, let me ask you 1 question and it is just a comment on the same subject but when you purchase a store from an independent or open a new store and it is really a relocation, how long does it generally take you to know whether you have succeeded or failed in what you are doing? Have the ones -- the extensive work that you have done in the last 3 years -- is it hard to tell from a return on capital standpoint how you have done because the economy has been muted? Do you think that there is some sort of invisible leverage that is in what you have done that has not shown up but would show up quickly if demand picked up?

All of the above, Sam. That is we have made a tremendous amount of progress in relocating stores to the right places and we can see it fairly fast. In fact, other than most probably 1 or 2 stores, or practically every store that we have moved has been extremely positive to our sales and to profitability. I believe that the amount of work we have done in our retail network in relocating stores, opening new stores and most importantly having the right kind of people managing our stores both in terms of the Company-operated stores and our independent retailers and a tremendous amount of effort in training of our people. We have been doing all of those things and I would think that as the economy improves and we have the opportunity of getting better consumer confidence, I believe that we are in a good position to benefit from that.

Would the return on capital have shown up yet in what you have done in those stores or do you think that remains to come down the road? Just in terms -- the money you put into them as far as better locations, better land?

We are seeing some of it. The fact that we are able today to maintain our business in a very tough economic environment when many, many people in our industry are really not showing the kind of progress we have shown. It is because the fact that we have continued to have relocated stores. But having said this, I believe that the amount of work we have done in the last 3 years, we have not seen the benefits of it as much as I believe we will that is once the economy improves because it is important to be ready before the economy improves and I think we have done a lot of that.

Thank you very much.

(OPERATOR INSTRUCTIONS) Jeff Feinberg from JLF Asset Management.

Good job in a soft tough environment, Farooq. Just a quick question. I think you touched upon earlier in one of your questions saying that you have see a slightly more positive perspective with regard to the consumer or some of the trends. Can you just elaborate what are some the things do you look at? Is that average ticket, traffic or what is the key that's giving you a little bit more better feeling there?

As I said I just have a feeling of when this question was asked to me earlier, it is still somewhat early. People are still worried and I think that we've got about 2 more weeks to go before this election which has created a lot of concern in the last few months. What we do see is that people are willing to make somewhat of more of a commitment today. We've taken luckily call performance index that is a conversion of traffic of people that come into our stores and how many are converted. Our conversion rate has gone up.

How recently has that been the case?

It has continued to go up but I'm just telling you there is a sense of it. I'm not making any economic predictions. I believe that there is a little bit sense in what we see even though I have been hearing all of -- and read all the news and the news is still very contradictory out there. I think we still have to wait for the next few weeks after things settle down to really see and I would say we're are going to start seeing the benefits I hope of this better consumer confidence from January or February of next year.

Okay. Just to make sure I understand, with regard to the comment you made in the press release about being comfortable with the earnings growth rate of 8 percent, does that incorporate any improvement in consumer confidence or is that just if things stay as they are?

I just reconfirmed what the analysts have said out there. I think that if we could make all kind of judgments, it is too early. I think those numbers -- we know that we have a very good opportunity of doing it and as I said in the press release, we could perhaps do even better.

Okay, thank you very much.

Joel Havard from BB&T.

I was having trouble apparently with my button. A couple of clarifications on the store forecast that is a net 12 to 15, what number of those do you think would wind up being Company stores that you have already gotten on the books this year?

I would say approximately 60 percent or so is going to be Company stores and 40 percent independents. That is what we have done so far. In fact, in these 9 stores we opened, I think 70 were independent and 30 were Company but as we go forward it will be 60/40.

Okay. On the gross margin in your first comments you said the variance of 1.8 million, that looks like the total variance from last year. I thought I heard you say that that was related to the plant closure, the disruption issues and at all of that. Was the raw material energy, health care which you referenced a few moments ago -- which you said may have had another 1.5 percent impact, was that in addition to the 1.8 million manufacturing related variance?

That is right. On the positive side we also got the benefit of closing the plants at operating expenses. We got benefit of having our plants operate more efficiently for instance, in the first quarter we had no downtime days.

You anticipated my question. I was going to say this suggests that your capacity utilization has improved pretty dramatically then?

Absolutely. It is because of the fact that we still are absorbing all of these costs. You don't see the benefit of the plants now operating at 40 hours a week, which has not been the case for a long time.

Okay. Are you all the way there as we move toward the close of Q2? As far as absorbing the closure and disruption issues, should we sort of assume the high 90 capacity utilization for the rest of this year?

I would that we're so operating less than 90 but we're operating at good capacities. We are gearing them up because we can't gear them up right away. As far as the cost from the plant closings, I think most of that would be over by the second-quarter.

End of the line. That was the only things we had. Thanks and congratulations.

David Ricci from William Blair.

Just one point of clarification, your total advertising budget for the next 3 quarters, how would that compare to a year ago?

Going forward?

Yes.

It is a little bit early to tell because we have taken some of that national advertising money now and we are putting into direct-mail. As we go forward we're going to look at it from quarter to quarter to see how much money we put into national advertising. We are getting ready for the launch of some of our casual contemporary product lines and some of them are very -- 1 or 2 programs are extremely important and we believe has tremendous potential. We are getting ready for use of television in those 2. It is a little bit early to tell. We will take a look at the market conditions, economic conditions. Fortunately we have the flexibility of determining what we do and whether we spend the money or not spend the money.

If things are good and it sounds like you are going to invest behind the product.

We will if we see that the consumer confidence is improving, things are settling down which I believe is going to be the case. Then we will end up spending more money but I would expect to have more sales and better probability.

Okay, thank you.

(OPERATOR INSTRUCTIONS)

I think that is it, Jonathan.

I'm not showing any further questions in the queue at this time.

Thanks very much and if there are any more questions, let us know. Peg Lupton is ready to help you and again thanks for all the support.

Thank you ladies and gentlemen for your participation in today's program. This does conclude the conference. You may now disconnect. Good day.