Ethan Allen Interiors Inc (ETD) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Ethan Allen earnings release conference call. [OPERATOR INSTRUCTIONS] I would like to turn the conference over to our host.

Yes, thank you and good morning. I'm Farooq Kathwari, Chairman, and CEO of Ethan Allen, Jeff Hoyt, our Vice President of Finance is unfortunately stuck in traffic, and I am myself in New York. So while I have a fair amount of information with me. Perhaps all of it may not be available if you ask me questions. We'll see as we go along. We've been stuck with this bad weather here in New York.

First, I'd like to begin by providing some key financial highlights. Please note that in the earnings release issued earlier today and in the course of my personal prepared remarks reference has been made to certain non-GAAP information which excludes the effects of the restructuring and impairment charge recorded during the quarter ended September 30, 2005, and then also December 31, 2005. A reconciliation of this non-GAAP information to most directly comparable GAAP measure is available on our website.

For the quarter, net delivered sales, this is for December 31, 2005, sales amounted to 276 million, an increase of 12.5% over the prior year comparable quarter. Net delivered sales for the Company's retail division increased 15.5% to $180 million with comparable store delivered sales increasing 12.5%. Wholesale sales increased 16.2% to 187.5 million during that same period. Sales were favorably impacted during the period by further implementation of our 30-day "mission possible" strategic plan. Because of the progress made to the respective initiatives we were able to ship a considerable amount of our undelivered backlog during the quarter including orders that, if not for this initiative would have likely resulted in delivered sales for the next quarter. I will give more details about it as we go along. As such, delivered sales in future periods will be dependent upon the volume of new written business offering during those periods and will not reflect the added benefit of further one-time backlog reductions as was the case during this quarter.

On a quarter over quarter basis, retail division written sales increased 10.2% and comparable store written sales increased 6.3%. The quarterly consolidated gross margin was 50.7% as compared to 48.7% in the prior year period. The margin improvement reflects the effects of increased sales volume and greater efficiencies in our manufacturing and retail operations. During the current period, the consolidated operating margin was 16% with wholesale operating margin amounting to 17.9% and retail operating margin amounting to 5.2%. Earnings per share for the quarter amounted to $0.77 on net income of 26.2 million. This compares to EPS of $0.63 per share net income of 23.1 million in the prior year comparable quarter.

For the six-month period net delivered sales amounted to 527.3 million, an increase of 10.9% over the prior year comparable period. Net delivered sales for the Company's retail division increased 13.7% to 338.4 million, with comparable store delivered sales increasing 10.8%. Wholesale sales increased 13.4% to 366 million during the same period. On a year-over-year basis, retail division written sales increased 14.2% and comparable store written sales increased 10.9%. At the wholesale level, net orders booked increased 9.2% over the prior year six-month period. As stated previously, in the last conference call it is necessary to examine wholesale orders on a six-month basis as it eliminates the effect of timing associated with our annual retailer conference, thereby presenting a normalized year-over-year comparison.

The consolidated gross margin for the period was 50.5% as compared to 48.3% in the prior year period. Sales volume, operational efficiencies, and to a lesser extent the effects of a modest price increase implemented in July have all benefited our margin in the current year. During the current six-month period, consolidated operating margin which includes a first quarter pretax restructuring and impairment charge of 4.2 million amounted to 13.7%. Excluding the restructuring and impairment charge, consolidated operating margin was 14.5%. For that same period, wholesale operating margin, including the first quarter restructuring and impairment charge, amounted to 17.3%. Excluding the restructuring and impairment charge wholesale operating margin totaled 18.5%. The year to date retail operating margin was 5 -- was 3.3%.

Earnings per share for the six-month period including the first quarter restructuring and impairment charge amounted to $1.26 on net income of 43.3 million. This compares to EPS of $1.14 per share and net income of 41.9 million in the prior year comparable period. Excluding the restructuring and impairment charge, earnings per share for the six months ended December 31, 2005, amounted to $1.34 on net income of 45.9 million. Our financial position remained strong. During the six-months ended December 31, 2005, we generated operating cash of 66.1 million and utilized 51.1 million to repurchase shares of the Company's stock, 22.8 million to fund capital expenditures and acquisitions, and 11.2 million to pay quarterly cash dividends. And inventories increased $2 million from September 30, 2005, about 1%, and about $8 million increase from June 30, 2005. This is a result of somewhat of a higher level of incoming orders and to some degree steps taken to maintain better service position in light of our ongoing 30-day "mission possible" initiative.

EBITDA for the six-month period excluding the aforementioned restructuring and impairment charge was 88.5 million, or 16.8% of sales as compared to 79.4 million and 16.7% respectively in the prior year period. Overall we continue to be pleased with our operating results and financial standing in this challenging environment.

At this stage, I would just like to give you a brief update, a business update. The sales increase of 12.5% was a result of increase in both wholesale sales and increase -- of wholesale sales increase of 16.2% and the retail sales of 15.5% with comparable retail increasing 12.5%. As mentioned previously, our "mission possible" initiative has made it possible for us to reduce our delivery time to the consumer. While not an exact science, I know this is a question that is on some of your minds, that is, the impact of this initiative to the third quarter. We could infer that about 33% of our increase in sales of $31 million, that's approximately $10 million, could have been delivered in the third quarter which roughly translates to about $0.03 per share.

The increase in sales and other initiatives resulted in gross margins increasing to a very healthy 50.7% from 48.7%. The operating margin of 16% benefited from the higher sales leverage both at wholesale and retail. This is especially the case in retail, where we will note that despite a great deal of investments in strengthening our structure the volume increase resulted in operating margin increasing to 5.2% from 3.8%, and our EBITDA increased to 18.4% from 17.6%.

Our focus on differentiating Ethan Allen in the sea of sameness is making good progress. Today retail is extremes. While the mass merchants are taking a greater share in all categories, the opportunity is creating a business focused on style, quality, value, and service. In fact, I believe that the new luxury for consumers is good customer service. To that end, we continue to strengthen all aspects of our programs. Our product programs have been strengthened with the introduction of the Mason program in the second quarter and well received by consumers. We have continued to invest in coordinated media from national television to direct mail and other mediums. We have continued to strengthen the caliber of our professionals at our retail network. In fact, a great deal of my time and our senior associates has been involved in recruitment.

Our focus to reduce delivery time is a result of creating a structure that makes it possible. The elements are a disciplined product program, a national advertising, and a marketing program, a national distribution and logistics network that has taken us the last 20 years to refine, focus on good information systems, and very important, the implementation of the every day best price which helps us in providing credible and efficient customer service and thereby reducing delivery times. As we go forward we have the opportunity of reducing our inventories and improving inventory turns as well.

Our repositioning of stores in strong retail areas continues. During this fiscal year for the last six months we have opened nine new stores, five by our independents, including three overseas, and four by the company. In the next six months we plan to open at least ten new stores, all located in the United States. At 12/31/05 we had 313 stores 181 operated by independents, and 132 by the Company.

As far as our guidance, given in the press release, the faster deliveries does mean lower backlogs which also could mean more volatility from quarter to quarter. The second quarter was somewhat unique that initiatives of the last one year had the most impact on this quarter. Our comments in the press release would indicate that if we were to combine the results of second and third quarter, we have an opportunity of increasing our EPS by about 15% for the two quarters ending March 31, 2006. Overall, we have made good progress and are focused on creating a solutions-based business continues. With that I would like to open it for any questions or comments.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from Jerry Epperson from Ferris, Baker Watts.

Good morning, Jerry. Jerry, good morning.

Yes, can you hear me?

Yes, I can hear you, yes.

Actually this is Adam Cohen. I have a couple of questions. Over the past year a lot of your competitors have recently implemented some new strategic initiatives to reduce their raw material costs by establishing a better line of communication with their suppliers. If you could provide some color today on the call for what you guys are planning on doing, or in the process of doing to reduce your raw material costs by establishing a better line of communication with your suppliers.

Yes, well, of course, I should have mentioned that. Raw material costs especially in the upholstery end of the business has been a major factor. In addition to that, our transportation costs this year compared to the previous quarter also been an issue. In the raw materials, form has been a big issue. In fact, it has impacted about 1% of our gross margin in our upholstery business in the last quarter alone. It is despite that we are able to show the results that we are showing.

Now, what we have done is we have of course worked very, very close with our suppliers, we have great relationships with them. We were not impacted negatively in terms of holding back production. In fact, we could not have shipped what we shipped in the second quarter if we had not received and continue to receive raw materials, which, of course, as you know, was not consistent in our industry. This is a tough situation. I think that we've had major increases of 30 to 40% increases in the form prices. It looks like they're stable. Our other raw materials to a great degree are holding up, so upholstery is where the issue is. We have also just announced that we are going to take a price increase which would have an impact of approximately adding 2% on the average to our gross margins effective March 1, 2006.

What would you say the risk moving forward for major raw materials are like steel and resins and what would you say is probably your biggest concern with -- which raw material is your biggest concern for '06?

The biggest raw material concern still at this time is petroleum-related. It is, of course, fabrics that have petroleum base as well as foam and materials of that nature, which also, of course, also involves lacquer. I think still the petroleum based products are the biggest increases in addition to of course our transportation costs.

What do you think the risk moving forward is for those types of raw materials? Do you see it leveling off this year or is there a big risk?

I think they should come down. We've taken enough increases. We're fighting hard and I don't want any more price increases.

Very good. I really like what I'm hearing. Final question. What would you say your top three goals are for 2006 that you plan to accomplish to reduce costs?

To reduce costs, you said?

Yes.

I think that our biggest initiative has been -- number one has been at the retail level to improve our caliber of the people joining our retail networks so we reduce turnover. Turnover is the biggest cost that any business has, and that is the reason I said that I've been spending a great deal of my time along with my senior associates on the whole issue of recruitment so that we can get better qualified people and reduced turnover. That has a tremendous implication in cost and also productivity. The second is that we continue to refine our structure, because you've got to make structural changes to reduce costs, not just keep on reducing costs for the sake of it. Ethan Allen we will continue to do that. I believe this "mission possible", as we keep on refining it, it will have an impact of continuing to reduce costs at all levels of our business.

Okay. Perfect. Thank you very much. Congratulations on the good quarter. I like seeing your stock today.

Thanks.

Our next question is coming from Ivy Zelman from Credit Suisse.

Ivy, good morning.

Good morning, Farooq. Actually, it's Dennis on for Ivy. Just a couple quick ones. You had mentioned earlier on the delivery times. Where are you at today versus say a year ago and how does that vary between the case goods and upholstery side of the business?

I can't give you because of -- this is something -- this strategic -- we've given a lot of information out but overall on the average we are about 25% less time than we were a year back.

But you don't want to share the absolute delivery time?

No, not yet.

On the price increase, you had mentioned that 2%, was that just on your upholstery product?

No, it was across the board, it was a little bit more on upholstery. It affected about, I think, I don't have the numbers in front of me, but approximately, I think, 25 or 30% of our case goods and about 50% of our accents. And the net of is it 2%.

Then lastly, can you talk about how much of the sales growth is due to traffic improvement from some of the marketing initiatives you made and how much is due to the conversion rate from some of the initiatives you made with the sales force?

I would say 50% and 50%. 50% due to traffic and 50% due to improvement of our conversion rate.

All right. That's very helpful. Thank you, Farooq.

Our next question is coming from John Baugh from Stifel Nicolaus.

Hi, John, good morning.

Good morning, Farooq. Did you -- can you just discuss the advertising, both dollars and what you did year-over-year, and your credit promotion and how those two factors may influence sales?

Well, I'm not going to give you a lot of details. Overall, we did, for instance in this second quarter, we did run the national television, which we had not run the year before, because as you know, nine months back or so I decided that our programs were in place and it made sense for to us start investing in national television. I had held it up for some period because I felt that until we had all the programs that we were comfortable with, we didn't want to spend the money in building our brand, or at least we temporarily sort of held it up. So national television was important, our direct mail was important, and I think that you will see when you get the overall numbers -- I don't have them in front of me, but you're going to see a continued increase of overall spending by the Company.

And was there a credit promotion or something special you did also year-over-year?

Well, I would say that, yes, we have been running every quarter a financing that is about 10 or 11 months, financing program for the consumer, but I think we also had it the previous year also, so that was not -- I don't believe it was that different from the year before.

Okay. And is the guidance for the March quarter which is, I guess, you didn't give a sales number, but it would seemingly imply lower growth rates year-over-year than what you achieved for the December quarter. Is that strictly due to "mission possible" and basically working down backlogs or has the incoming written order rate in the last, I don't know, 45 days or so slowed?

The written business in December is obviously lower than compared to October and November. That's how our business tends to be. We had strong written in October and November, and now we are building the backlog up again, and what you're going to see is as I said in my comments, is there is a possibility of volatility because we are now shipping what we get. So we are very fast in shipping. So all the business that we're going to get in January and February, that is you might say, instead of the negative of delivering faster, is that you don't have much backlog. And we don't want backlog. So that's why it's somewhat hard to make these kinds of projections until we are in sort of almost two months into a quarter. Our thinking reflects the fact that we don't have -- we have much less backlog. We will now depend upon the business coming in just so generally our feedback from our retail network is positive.

Okay. Thank you so much.

Our next question is coming from Joel Havard from BB&T Capital Markets.

Good morning, Joel.

Good morning, Farooq. First question is kind of need some help on this guidance that you're issuing here. Your outlook for 8 to 12% right now implies about $0.54 to $0.56. Consensus right now is more like, let's call it $0.60. What is the fuzz factor that you're allowing for in the discrepancy on those two ranges?

What do you mean, fuzz?

Well, there's -- they don't jibe exactly, and I'm just wondering, do you have some variable in your mind right now? You've talked a lot about maybe you've pulled some volume from Q3 into Q1, and I want to come back to that in just a second--?

I've said that the best estimate I gave was that about $10 million could have been shipped in Q3.

Right. So I mean, should I read your statement then, that you're comfortable right now with the 8 to 12%, meaning $0.54 to $0.56, and that given a couple of these variables we're talking about today, you could still, what, be within reach of the more like consensus currently?

Well, let's, Joel, take a look at it. This quarter the consensus was what $0.65. It came to $0.77. You folks are forgetting it.

Farooq, you know how we worry about these pennies.

I don't know what's wrong with you, Joel. I mean, $0.77, take some of it for the next quarter.

Okay. The issue on the pull-through, or whatever, that actually, when I saw that, when you're talking this morning, went back and looked at the last three, four years, it really has been -- there's been no clear pattern the last, I think, three or four fiscal years on a, quote, normal Q2 to Q3 trend. What's going on with the Company's, I don't know, approach to the market that's had you up one year, down the next, that sort of thing?

Joel, we are making so many structural changes, and, for instance, when we introduced our everyday pricing, that has a major impact. When we introduced the sole issue of "mission possible" that has had an impact. Our advertising has had an impact. In other words, we are operating in a newer environment than we did two years back. For -- until two years back, for 15 years we ran six sale events year after year. Year after year. So we developed a certain sense of consistency. In the last two years we started to change it and the right thing to do. So as we go forward, it is going to now create a new environment. We're going to find out what happens, how do we operate in this. Certainly to me, one option for us was to have less shipments in the second quarter so we could hold some for the third. That's not a good option. We have been working very hard to make sure we improve our deliveries, and I don't -- and we shipped whatever we could, deliver whatever we could, and it just came to that we had $0.77 of earnings this quarter. That's a lot of difference from $0.65.

You bet.

If you were managing earnings you would sort of not do it, but we are not doing it. We are going to have it fall where it falls, and that's why there might be some volatility.

Okay. Is there an outline of the current plan, in other words, John touched on it, with a little bit of more aggressive advertising spend commitment, those sorts of things, that you're proactively trying to drive volume in Q3 with right now?

Yes, we have to be careful that we don't overspend, and then we've got to make sure we continue to have healthy margins, healthy cash flow, and so we will continue to keep on spending, but again, we just don't want to do it in one quarter and spend all our money. We're going to do it on a consistent basis and I think as we go forward you're going to see our continued consistency in our advertising programs as well as the benefit of these store repositionings. The store repositionings are critical, and they have been critical. We would not be in a position today and while we are talking of the advertising, while we are talking about our new products, it is also the store relocations that has been a very important factor in the growth that we are seeing.

Maybe you could leave me with that point today. How many stores are teed up for the last two quarters of this fiscal year to be replaced or remodeled?

About at least ten.

Ten more. Okay. Thanks. And Farooq, again, congratulations, great quarter.

Thanks, Joel.

Our next question is coming from Laura Champine from Morgan Keegan.

Good morning, Laura.

Good morning. My question is on the balance sheet. The vast majority of the cash from the $200 million debt raise is still on your balance sheet. What is -- what are your goals with that cash, and what's the timing on its deployment?

Yes, and I think that's a good question, Laura, because the impact of that, of course, in our interest expense is negative to our earnings. However, our objective is to continue to accelerate our development of the store programs and we are somewhat aggressive in that, and you're going to see us becoming more aggressive as we go forward.

Does that mean that I should look for that total store count, the 313, to expand significantly, or are these mostly remodelings, relocations?

They are remodelings, relocations, average size, as I mentioned goes from anywhere 15 to 20%, so that's where we're getting the greatest growth by increasing the size and of course putting the stores in the right locations.

Should I be on the lookout for a major buy-in of franchise stores at some point in the near future?

No, not a major. I think that what you will see is a continued one or two or three stores in a quarter or in a six-month period, nothing major. These are folks who are retiring, who the average association of Ethan Allen dealers is over 30 years with us. And very fortunately for us that in the last ten years on a very planned basis we have been able to transition many of the retiring retailers into the Ethan Allen system. And we will continue to do that, on the other hand our independent retailers are also growing. Many of these new stores, relocations are being done by our independent retailers. The Company is more aggressive but about 40% of all the new stores are being relocated by existing independent retailers.

It still seems like you've got a whole lot of cash if it's just for remodeling and relocations. Is there a major share buyback that we need to be looking for?

Well, there is always that possibility. We will -- we have 2 million share authorization right now, so that's a possibility, too.

Great. Thank you.

And our final question is coming from Budd Bugatch from Raymond James.

Good morning, Budd.

Hi this is Chris Thornsberry on behalf of Budd. Good morning. I guess piggybacking on Laura's question, again, the debt -- you mentioned last quarter on the conference call that we would get a little bit more clarity as to what you were going to do with the proceeds from that debt. Is that basically how we should look into it? Increased more aggressive remodeling and relocation of the stores and also share buybacks? Anything else you could use that cash for?

And on a continued basis buying some of the, as I said, on a planned basis also, buying some of the independent retailers where it makes sense, yes. Those will be the main factors.

All right. And Farooq, you said you had nine new stores year to date this fiscal year; is that correct? Nine new stores in the program?

That's right, yes.

How many of those are relocations? How many of those are new stores?

The relocations are six, and three are new.

And of the ten-plus that you have scheduled for the end of this year, the back half of this year, how many of those are going to be relocations? Is it still about 70% as planned?

About 80%.

80% relocations. And of those, of the new ones, how many company-owned? Maybe half of those?

Good question. I don't have the information in front of me. If you call up Peg, she will let you know.

Great. Just a couple more quick questions, for you, Farooq, if I may. You had a pretty good leverage on the G&A line in the second quarter that we didn't see in the first quarter. If I look at my model correctly here it looks like you had G&A as a percentage of sales, were just under 15% versus just under 17% in Q1. Is that all due to sales -- higher sales leverage, or is that also due to lower project manager expenses in Q2 versus Q1 and lower option expenses in Q2 versus Q1?

Well, yes, two factors. One is, of course, the leverage of sales. Also we -- lower option expenses. The project management costs are actually overall have increased, not gone down.

As you've hired more in that's going to increase as you go forward.

Right.

And my last question, Farooq, was again, on the advertising, I think you touched on that earlier, last quarter you mentioned incrementally you had $5 million additional advertising spending year-over-year this quarter was it about that level? Higher or lower? I know you hesitate to give a number on that.

It was approximately $4 million in national advertising.

Do we look for that to stay around the same the back half of the year.

Yes.

Thank you very much. Congrats on a good quarter.

We have a final question coming from Virginia Chambliss from JP Morgan.

Hi, Farooq, how are you? Just one -- another sort of follow-up on the uses of cash. I think in the past one of the other areas for potential investment was some offshore manufacturing, but that wasn't one of the areas that you noted a few moments ago. Is that -- are plans for that sort of off the table, or is it just timing uncertain at this point? Can you give us a little insight there?

No, it is not off the table, but it is -- it will depend upon the right kind of a situation developing. And, in fact, I'm glad you pointed that out. I should have said that also.

Okay. Thanks.

Okay. All right. Well, thank you very much, and if you have any first questions please give a call to Peg Lupton. Thanks very much.

Thank you everyone for your participation in today's conference this does conclude the program. You may now disconnect your line. Have a great day.