Ethan Allen Interiors Inc (ETD) 2008 Q3 法說會逐字稿

Good day ladies and gentlemen, welcome to the earnings release conference call. (OPERATOR INSTRUCTIONS).

I would like to introduce your host for today's conference Mr. Farooq Kathwari, Chairman and CEO of Ethan Allen. You may begin.

Thank you and good morning. I am Farooq Kathwari Chairman and CEO. With me are David Callen our Vice President of Finance and Peg Lupton, Director of Investor Relations and several of our other associates. Today we are reporting the results for the three and nine months ended March 31, 2008. I will provide an overview and David will give detailed information of our financial and I will give a business update and then open for questions. During the third quarter we continued to operate in a weak economic environment. Our sales decreased by 4.3%. While the retail division sales increased by 3% they were not enough to cover the costs associated with the major activity of opening four new design centers of which all were relocations and the adoption of many design centers acquired and opened during the last 15 months.

During the quarter we took step to say consolidate and close several design centers. This was the result of -- this resulted in impacting our operating expenses and gross margins. Now, our EPS ex-restructuring was $0.39 versus $0.54 last year. EPS change consisted of impact on gross margins with a negative of $0.06, effect on operating expenses, the result of fuller impact of design centers opened in fiscal 2007 and the new in fiscal 2008 had an impact of negative $0.10 to our EPS. On the normal operating activities the effect of change in shares outstanding had a positive impact of $0.06 and the less other income utilizing it for repurchase was a negative $0.04. We have continued to to make major progress in positioning the Company as a preferred brand, providing decorative solutions. I will discuss in greater details our initiatives after David provides the financial update.

Thanks, Farooq. Good morning. Please note that in the earnings release last evening and in the course of our prepared remarks, reference has been made to certain non-GAAP information which excludes the effects of restructuring and impairment charges recorded during the quarter and year-to-date ended March 31, 2008. Credits records during the quarter ended March 31, 2007 and charges recorded year-to-date March 31, 2007. A reconciliation of this non-GAAP information to the most directly comparable GAAP measure is available on the website.

Net sales in the third quarter decreased 4.3% over the prior year quarter to $235.9 million. The Companies retail division posted an increase in net sales of 3% to $172.8 million while comparable design center delivered sales were down 1.1%. Total written sales in retail decreased 3. 8% and comparable written sales decreased 6.8% versus the prior year third quarter. Wholesale net delivered sales were $156.3 million in the quarter down 9.1% from last year's third quarter. The quarterly consolidated gross margin was 53.1% as compared to 52.1% in the prior year period reflecting improved efficiencies in our manufacturing and the increase in our proportion of retail sales to our total sales. While we continue to benefit in the quarter from less overhead from previously closed facilities and operational efficiencies in the wholesale divisions our retail division margin was negatively effected by markdowns taken to sell off floor inventory at seven design centers that were consolidated and another four that were relocated and several others that completed their product conversion over to the life style presentation in the quarter.

During the current quarter, consolidated operating margin was 6.6%. Excluding the $4 million in restructuring and impairment charges consolidated operating margin was 8.3%. The wholesale operating margin was 17.1 percent while retail operating loss was 4.9% or 2.6% excluding the restructuring and impairment charges. Selling expenses increased $1.2 million as we invested in increased TV advertising and incurred higher retail compensation on higher volume of retail sales in the quarter. The total operating expenses also reflect an increase in general and administrative cost of $3.8 million primarily for the cost of occupying and running eight additional Company owned design centers in the retail division. Diluted earnings per share for the quarter were $0.30 on net income of $8.8 million. Excluding restructuring and impairment, diluted earnings per share we're $0.39. This compares to diluted EPS of $0.54 per share and net income of 17.5 million or 17.4 excluding restructuring and impairment credit in the prior year comparable period.

Our stock buy back program resulted in 3.3 million or 10.2% fewer weighted average shares outstanding during the quarter versus the third quarter last year. This benefited the remaining shareholders by about $0.06 per diluted share this quarter while the interest income from the cash used would have generated about $0.01 per diluted share . For the nine month period net delivered sales were $744.1 million a decrease of 0.4% from the prior year comparable period. Net delivered sales for the Company's retail division increased 7.2% to $548.1 million while comparable design center delivered sales decreased 0.5%.

Year-to-date written sales in retail increased 2.4% during the period while comparable written sales decreased 4.5%. Wholesale sales were $468.5 million down 5% from the prior year-to-date. The year-to-date consolidated gross margin was 53.5% as compared to 52% in the prior year period reflecting the improved efficiencies in our manufacturing and retail operations as well as the proportional increase in retail sales relative to our total net sales year-to-date. During the nine month period consolidated operating margin was 10.3% or 10.9% excluding the third quarter restructuring and impairment charges.

Wholesale operating margin was 17%, while year-to-date operating loss in retail was 0.2% or an operating gain of 0.5% excluding the restructuring and impairment charges. Diluted earnings per share for the nine period amounted to a $1.58 on net income of $47 million. Excluding the restructuring and impairment charges earnings per diluted share were $1.67. This compared to diluted EPS of $1.50 on net income of $48.7 million in the prior year. Excluding restructuring and impairment charges in the prior year totaling $13.4 million related to the consolidation of two manufacturing facilities, one of which has been converted into a regional distribution center resulted in diluted earning per share of 1.76 in the prior year.

The stock buy back program benefited shareholders year-to-date by about $0.17 cents per diluted share by lowering the weighted average shares outstanding by 2.8 million or 8.6% compared to the prior year-to-date weighted average shares outstanding. The interest income on that cash used would have generated about $0.04 per diluted share.

Now for comments on the financial position of the Company. During the nine month period ended March 31, 2008 we generated operating cash of $67.3 million. We used $69.7 million of our available cash to repurchase 2.3 million shares of our common stock. Also during the year, we used $46.3 million to fund capital expenditures, spent 6.8 million to acquire a cut -and-sew upholstery facility in Mexico and two design centers in the U.S., plus returned at $19.2 million in cash to our share holders through quarterly dividends.

Inventories have increased 2.5% or $4.5 million during the year mainly due to $3 million in inventory acquired with the two design centers and cut and sew operation in Mexico. We remain in a strong service position with respect to incoming orders with over 90% of our case goods items available for shipment within four weeks. EBITDA fot the nine month period totaled $101.9 million or 13.7% of sales as compared to $110.8 million and 14.8% respectively in the prior year-to-date period excluding the aforementioned restructuring and impairment charges. Overall we are pleased with our operating results and financial standing in this challenging economic

Now to Farooq for his comments. Farooq? Thank you, David. On a business update our strategic objectives continue to focus on two key elements. First, migration to an interior design based enterprise and second, to continue to focus on style, quality and value and solutions.

During the quarter we substantially completed the transformation of 153 Company operated retail design centers and many of the independent operated design centers to our Lifestyle projections. We absolved cost of selling the floor products and also incurred additional operating costs. The implementation of the seven Lifestyles provides a stylish projection and is helpful to both our clients and our design consultants and we are pleased that we will have completed this important transformation this physical year. We have continued our investments in training.

During last nine months we provided intensive training to 600 new design consultants at our headquarters and also brought in over 800 of our Senior Designers and Managers for [Danbury] for training and consultations. We have continued our strong advertising program. Despite a tough economic environment we have increased our advertising spending during the quarter by about 20% and about 16% for the nine months ended March 31. Our main message has been to increase the awareness of our complimentary design services. Because that provides a very strong competitive advantage for us. National television and direct mail have been the main mediums in getting this message across. We have made major progress in developing our new website which we plan to introduce in August of this year. The objective of the new website will be to combine the personal service of our designers with technology. We believe that the new website will have a major positive impact on our business. We are also pleased with the work of reposition of our design centers. During the quarter, we opened four new design centers, all of them relocations.

During the quarter, we also closed seven design centers, converted four to design studio formats and we also closed two retail service centers. As we indicated during the last few months, we will have completed the bulk of relocations this fiscal year by opening about 20 new design centers.

Going forward we will still open and relocate a few design centers a year and also focus on opening greater numbers of design studios. At the end of March we had 291 design centers, 153 operated by the Company retail division and 138 operated by the independents. During the third quarter we did not acquire any design centers from independent retailers. For nine months we have acquired only two design centers. During the last two years about 12 independent retailers either retired, closed the design centers, and in two or three instances converted to other brands. We have made good progress in replacing these design centers which were in most cases in poorer locations. These replacements include Austin, Texas, to be opened in the first quarter of 2009 by the existing independent retailer, Sarasota, Florida opened this quarter. We have already opened in St. Louis,Cincinnati markets. And this quarter we plan to open new design centers in Denver, Philadelphia, Birmingham, Alabama, Feria, Illinois, Richmond, Virginia, Hilton Head, South Carolina; Jackson, Mississippi; Viera, Florida and importantly, in Manhattan a new flagship design center on third avenue and sixth street is expected to be open early June. All of these openings give us a great opportunity to grow our business; however, they do result in short-term added costs. We are pleased that major bulk of our relocations are completed we expect next fiscal year to reduce our annual capital expenditures which is about 70 million by about 30 to 50%. Our vertically integrated structure continues to provide a competitive advantage, especially in this rising cost environment. Our costs on average have gone up about 3% during the last year or so and we plan to make this up due to continued efficiency and a price increase during the next few months. With this brief business overview I would like to open for you questions.

(OPERATOR INSTRUCTIONS) Our first question is from Todd Schwartzman.

Todd, are you there.

Please check your phone.

Can you hear me?

I can hear you now.

What kind of price increase are you planning?

Todd, the price increase is not going to be all across-the-board. It is going to use up approximately about 2.5% across-the-board. We are taking -- it will affect approximately 30% of our product line across the board with about 2.5% yield.

Is that 30% for starters or it will impact 30% of the product line?

It will affect 30% of the product line when we implement it in the next few months.

Okay. As far as SG&A as percentage of sales has been trending higher for just about four years now do you see the trend reversing any time soon next two or three years?

Yes and that is very much tide to two factors. One is the major investments we have made in new design centers, largest design centers. I am pleased that the bulk of that is now completed. The second is this is a percentage of sales. Our sales in the last couple of years are not what they should be. As we increase the sales from all of the investments we have made and we expect to have our SG&A as percentage of sales come down.

On the TV campaign how much longer are you committed to the current campaign. Not so much in terms of the absolute dollar spend but just the existing message to focus on the design service?

Well, Todd, (inaudible) our competitors the fact that we provide personal decorating services, and most people do not know that. In the last year since we started the current campaign our message is we will help with as little or as much as you like is getting across. (inaudible) We will in fact raise the bar, the message. We want people to come make appointments before they come in. We have 3,000 design consultants. As you can understand, more and more people are now starting to just start making appointments. We want appointment to make a better utilization of our people. We want (inaudible) the consumers to come in and see the design consultants. Better for our client and design consultants if the time is used well. We fully understand before coming there what we do. That is the reason this message is very important, and this message we felt comfortable that our design centers were in the right places. We felt comfortable that we had the right design associates in the last three years. We have put into place at least 50% of our design consultants are new. WE have put in 300 project manangers into place. Once you create expectations that you'll provide service, you better do it. Now that we are doing it we are going to raise the bar and get that message across. I believe that the economy improves we want to make sure the message is out there.

Got it. Could you may be provide some numbers to the statement that the sales decline in April has been reduced?

Todd, I put that in. You asked me this question what happened in April. I had to say that. Now, I also mentioned that our business has been impacted depending on when Easter is because that weekend we don't do much business. This year it was in March. So we also wanted to make sure that while in April our business is better, it is for two factors. First, is the economy is bad. People are concerned. March was unique. We could see that our clients are concerned what was taking place. In April still concerned but less concerned, and Easter behind us, for the last three weeks we would be down just a couple of percentage points relative to last year. In March the percentage decrease was much larger.

Okay. Finally, can you talk a little bit about what you are seeing in raw materials now. Thanks.

Our raw materials is a mixed situation. Our domestic raw materials like lumber have been holding prices because supply and demand is less. Anything to do with petroleum based is a major factor. Utility costs have gone up 8%. Mostly a 40% increase in the cost of diesel fuel. We deliver the products nationally ourselves. We have the best delivered price to the consumer's home. Fuel is an important factor. Our petroleum based products realting to foam, to some fabrics, all of those and finishing materials is up. I would say that if you take a look from a selling percentage point and gross margin perspective we would end up approximately having an annual cost increase of 2.5%. That is what we want to take care of in our price increase.

Thank you.

Our next question is from Joe Feldman. Your line is open.

Good morning. The first question was about the CapEx it looks like you are cutting for '09 it looks like 30 to 50% and then going forward from there should we just expect it to be normalized off this new base or will it come back up to the 70 million level?

Well, it will come up only if we have a great opportunity to increase business and expand our business. At this stage I would say that it would remain at the reduced level that I have talked about.

Got it. Then another question was about the inventory. It seems to grow in line with the sales for the retail business. We were curious as to the complexion of it. You are were trying to clear out the inventory from the stores that were closed and how you feel about the current inventory situation.

I always believe that--- it should be lower, to make it lower it does require many, many structural initiatives. Over the years we have substantially increased our presence in retail without having much of an of an increase in inventory. The reason has been, (inaudible) every day best price has helped us in a number of ways. (inaudible) It has helped to make sure our products go to our retail service centers in deliverable manners. Chairs go with tables and sofas are delivered on time. We also cut down on our delivery time. Right now over 90% of our cases are shipped within four weeks. Which means, 60 to 70% is shipped within a week or 10 days. At this time 70% of our upholstery is shipped within four weeks. All of that has resulted in faster turnover, 60 to 70%-- 87% of our products in our retail service center are sold. We want to reduce that. I would say that as we continue to improve our efficiencies and our structure, we should have the rate of increase (inaudible) lower than the increase in the sales.

The one last one I wanted to ask. On same-store sales came in pretty well from my perspective given the current environment. We were trying to figure out the complexion of that and really what drove it. Was the fact you have more relocated stores that are coming back into the comp base at this point. What helped drive the comp?

We are not happy with this number. I am not happy with all of the work that we have done. The results we did better than anybody else. I know that. We have the opportunity of even doing better. The results have been this whole focus of the fact that we are today providing the service. You know today I was in the market a couple of weeks back. Anybody who is just selling a product at a price, (inaudible) had a rough rough time. If we did not have the service element of 3,000 professionals we would not have the same-sales we just mentioned. (inaudible) We have increased the gross margin despite the tough economic environment. The service model that we have is helping us in better same-store sales as well as maintaining our margins.

Thank you very much. Good luck with the quarter.

Our next question is from Laura Champine. Your line is open.

Wanted to ask about the cut-and-sew facility in Mexico, I think you commented that part of the reason inventories were up was because of that maybe you could talk about what the longer-term implications are for inventories for margins on that product, how much of the leather goods will be using that facility, and maybe more generally why when the rest of the industry have gone to fully finished leather out of China you are putting a cut-and-sew facility in Mexico.

Your last question. Our model versus others. If you have a model that you are depending on finished products, then perhaps southeast Asia does make sense. If your model is like ours with 95% custom product with about 3,000 different fabrics, those are made in the United States. Time is very, very important. Our cut-and-sew operations in Mexico helps the domestic manufacturing of this custom product. Having it closer to the United States made sense for us. In terms of the future we have a great future because in the United States cut-and-sew operations is not only costly but hard to get people. So it is one area where we had a tough time getting sewers. In central Mexico there are great people. They have a background in textiles and cutting and sewing. We see that growing and contributing to the cost efficiency of the manufacturing in the United States.

Thank you.

Our next question is from Budd Bugatch, your line is open. (inaudible)

Good morning.

Good morning. Just a couple of questions. Talk a little bit about the store landscape now the new design centers. How many are there? Are they included in the 291 number? The design studios?

That is right, they are. At this stage, bud, we have converted four to design studios. These are existing design centers in smaller markets. If you are an interior designer you have a studio and have clients . (inaudible) It was not sufficient it was not rights for us to have a big design center with the operating costs. In the last three weeks interesting things are happening. Our designers numbering two to three, that is all that is operating in 70 to 80% of the business in the four design centers have informed their clients that the design studio and they should come and make an appointment and see them and they would make house calls. It is working very well. We are going to see more of those as we go

There are four total in the chain right now in the Company right now?

That's right.

They are all Company owned?

Yes.

What is the opportunity and what is the size of a design studio?

The one that we have we took the current ones that were anywhere from 9,000 to 12 or 13,000 square feet. We took the existing buildings and converted them. As we go forward they will be substantially smaller. Today technology will play a very important role. It is going to be important the website is going to provide all kinds of information which in the past you needed a big store to do. So you are going to see us go from 2000 to 5,000 square feet.

What do you think the opportunity the nation wide?

It is major.

You have done it again. You have gone substantially and major in two sentences without any numbers. I got the 2 to 5,000. Can you give us a feel?

Bud, we will open 50 first. That is our plan then we will see where to go.

By when.

I would say by, I like to do these things throw were then I feel comfortable. Then we will go fast. You will see us open four or five in the next few months. Then after that we will open it a little bit faster.

Of the 50 tey are all Company owned?

Most of them are Company owned. Our independents are also very interested in it. I want to first make sure we get the bugs out of the system and it works.

You said you have the lifestyle presentation now, and I think substantially all of the 153 Company owned design centers. How many of the independents are in lifestyle presentation?

Between 50 and 60%.

Okay. Tell me about the service centers. What do you think you are going to do on that? You have closed two. How many are left now? How many stores can they service?

Well, it is also I am doing a lot of competitive information here. We have already done it.

Sorry.

We are operating approximately 30 some centers in the United States. For instance, we closed one in Pittsburgh which is now the products are delivered from the metropolitan Washington area. We closed the one in Orlando. It is being delivered from Florida. We are covering a wider area. A number of years back we had 12 service centers. Today we have one delivers $100 million. In Connecticut we have one delivers $80 million. In Washington one is delivered 70 or $80 million. We had 8 or 10 delivering one-third of the business. That is why we are managing our costs.

That is very, very helpful. Do you see any restructuring charges beyond the fourth quarter?

At this stage we don't have anything planned. I keep on looking at how to improve the structure and if we are going to make structural changes we will have charges.

Good luck on the quarter and on the year.

Our next question is from Anthony (inaudible) Your line is open.

Good morning. I had a question in terms of any differences that you are seeing in performance geographically. Are there any regions of country doing better or worse or is it even throughout the country?

I am thinking. There are places doing better because of the fact that this area did not involve that much in new home construction. Areas in Arizona, southern California has been more negatively impacted. In Nevada, in Florida, southwest ends to be doing better especially in Texas as because of the oil. It has been we have seen weakness across the country. Some areas have been impacted more as I have just stated.

I wanted to follow up. There has been a number of furniture retails going out of business recently. I wonder if you are seeing any impact on your business from going out of business sales?

Yes, it did because of the fact you are right. We have seen this almost in every market. We've have chains that have gone out of business and independents have gone out of business. This is one of the toughest periods we have seen in the last 30 or 40 years. And when businesses go out they are all kinds of going out sales. It has impacted our business. A lot of business customer business is diverted to these going out of business sales and they are still continuing.

Thank you. That is helpful.

(OPERATOR INSTRUCTIONS)

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Thank you very much. If you have any more questions, please call Peg Lupton.

Have a great day.