Ethan Allen Interiors Inc (ETD) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ethan Allen earnings release conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference, David Callen. Mr. Callen, you may begin.

Thank you, Nicki and thank you to everyone on the call and good morning. I am David Callen, Ethan Allen's Vice President of Finance and Treasurer.

Welcome to Ethan Allen earnings conference call for the first fiscal quarter ended September 30, 2011. This call is being webcast live on www.ethanallen.com, where you can find our press release which contains supporting details including reconciliations of non-GAAP information referred to in the release and on this call.

Our comments today will include forward-looking statements that are subject to risks, which may cause the actual results to be materially different than expected when making those statements. Please refer to our filings with the SEC for a complete review of those risks. The Company assumes no obligation to update or revise any forward-looking matters discussed during this call.

After our Chairman and CEO Farooq Kathwari, provides his opening remarks, I will follow with some details on the financial results. Farooq will then provide more details about our ongoing business initiatives before opening up the telephone lines for questions. With that here is Farooq Kathwari.

Thank you, Dave, and thank you for participating in our first quarter fiscal 2012 conference call. As I stated in our press release, we are gratified with our results. With sales increase of 12.2%, we had an adjusted net income per share increase of 127%. This increase is a result of many factors including initiatives implemented in the last 3 years are helping us operate more effectively and efficiently. We are vertically integrated enterprise from concept of ideas, operating a saw mill, case goods and upholstery manufacturing plants, an [action] manufacturing plant, a national network of logistic centers and a retail network.

When all operate more efficiently, we have positive impact on our financial performance. We have motivated and knowledgeable associates. The great recession has given us an opportunity to add very qualified associates in all our operations, especially in manufacturing and retail. In the last 1 year, we have added 440 associates, an increase of 10%. Our retail division is also more effective resulting in overall contribution to our profitability.

After Dave provides a financial overview, I will again go over with a brief overview of our business focus. And Dave --

Thank you, Farooq. Net sales for the quarter were $184.9 million, that's up 12.2% from the prior year quarter. Our retail segment reported net sales of $141.2 million, which is an increase of 16.7% versus the prior year quarter and included comparable design center net sales growth of 14.9%. Written orders booked during the quarter by a retail division increased 13.2%, including an 11.4% growth in comparable design centers written orders.

The Company operated retail group finished the quarter with 146 design centers, which is a net increase of 3 from the end of Q1 last year. This is the primary driver between the differences in total division versus comparable design center metrics.

Our wholesale segment net sales were $116.4 million, which reflects an increase of 8.2% over the strong 32.2% growth reported in the prior year quarter. Our consolidated gross margin for the quarter was 52.9%. This compares to the 50%, as reported in the prior year quarter or 50.4%, after adjusting out our final round of reported plant transition costs.

Our retail segment made up 76.3% of our consolidated net sales for the quarter, compared with 73.4% the first quarter of fiscal 2011. Please keep in mind that the higher mix of retail business drives a higher consolidated gross margin rate, but also drives higher operating expenses as a percentage of consolidated net sales.

Our income before taxes, for the quarter $11.3 million, up 127.4%, excluding special items from both periods. This improvement in profitability was on a 12.2% increase in net sales, demonstrating our significant leverage opportunity on incremental business. Our income tax rate continues to be affected by the need for valuation reserves against our deferred tax assets. As a result, the reported tax rate for the quarter was 40.3%.

These non cash reserves may reverse in future quarters, resulting in tax benefits that will cause fluctuations from our normalized tax rate, which is approximately 36.5%. When adjusted for the items noted above in both periods, the earnings per diluted share for the quarter were $0.25 compared to $0.11 per share last year.

We ended the quarter with $105.9 million in total cash and securities. An increase of $15.2 million since September 30 last year. This growth in cash was achieved despite reducing debt by $38.1 million, including a reduction of $2.2 million this first fiscal quarter and stock repurchases of $800,000 this quarter at an average price of $16.19.

Also, during the quarter, we invested $3.4 million in capital expansions and paid $2 million in dividends to shareholders. Inventory, at the end of Q1, was $141.1 million, down slightly from the $141.7 million, at the end of fiscal 2011. The financial health and position of the company give us the strength to aggressively pursue our business growth initiatives. However, we continue to keep a wary eye on macroeconomic developments in case contingent actions become warranted.

Farooq will now walk you through the details on the many business initiatives underway.

Thanks, Dave. Our focus continues on our 5 areas of priorities. Enhancing the relevance of our product offerings. We have continued to invest in product development.

Last week, we had our international conference at our Danbury headquarters with over 300 partners and associates attending from North America and overseas. We introduced 1 of the largest product introductions, substantially strengthening the 5 Lifestyles of Modern, Romance, Explorer, Vintage and Elegance.

These products will be phased in our design centers, in the first 5 months of calendar 2012, supported with national and regional advertising. These products will further make us more relevant to a larger consumer base.

We continue to project our message under the umbrella of being aspirational and attainable. We continue to utilize mediums such as national television, direct mail, digital mediums and print. We have strengthened our retail network.

As of September 30, as Dave mentioned we had 294 design centers, 146 operated by the company and 148 operated by licensees. This represents an increase of 13 from September 30, 2010. We continue our focus on international growth with 60 locations in China. Also, about 60% of products sold in China are shipped from the US.

Our focus is technology and we continue to invest in technology in all areas of our enterprise from manufacturing to retail to marketing. We have made great progress and are benefiting from the various initiatives to rationalize our operations.

We are operating more efficiently in our domestic manufacturing, especially convergent to custom manufacturing in our case goods, and the consolidation of several national distribution and retail service centers.

I know the big question is what happens in the next few quarters? The economic environment remains challenging. We remain cautiously optimistic due to the implementation of our marketing and operational initiatives. We note that for the second quarter, the range of analysts for sales is $183 million to $190 million, with consensus of $187 million, representing an 8% increase in sales. The EPS range is $0.19 to $0.27, with a consensus of $0.23, representing an increase of 23% from second quarter fiscal 2011.

At this stage, while in the past we have not commented on future prospects, we do believe that despite the difficult economic environment, the consensus range is achievable. With that I'd like to open it up for questions and comments.

(Operator Instructions) Matthew Fassler, Goldman Sachs your line is open.

Good morning, Farooq and David. Congratulations on the good showing this quarter. Two questions for you. First of all, can you please comment on the promotional cadence of the September quarter? Whether it relates to the number of promotions and the timing of promotions and any similar comments you might make on your expectations for the December quarter, and then I will follow up.

First of all, Matt, I did listen to you last time and I did give some ideas about the future. Because you said, you folks, don't give us any guidance.

It is helpful and we appreciate that.

All right. In the September quarter last year, we were on the older promotional calendar of having 2 sales. This year, we had 3. As you know, starting January of this year, we started having a monthly sale. I think that also does have somewhat of a positive impact.

In our second fiscal quarter last year, we had 2 major sale events in October and November. And for us, as you know, December is not that strong while we do have some sales, especially on clearance of merchandise. So this quarter, we'll have the same. We'll have sale in October and November and December we'll primarily be for the clearance. Now we need more time on clearance because as I mentioned, we have a very large product introductions that we have undertaken, which is going to start getting into our design centers in January.

Right. Great. And then the second question I have, if you think about gross margin drivers, obviously, the mix shift to retail was helpful. The gross margin improvement was quite pronounced and we were wondering if there were any other constructive drivers behind that gross margin increase?

Yes, Matt. The retail is a very major one. The second one is the gross margins at a wholesale level based on manufacturing. Our manufacturing is operating more efficiently. We had no down time. Our case goods conversion to custom was a major undertaking about 1.5 years back. It's now complete. That's also giving us an efficiency. So our gross margins for our domestic manufacturing is also a driver to that increase. So I would say, at this stage, is probably 50%. Dave has the numbers. I'm giving you just a rough estimate, 50% due to retail and 50% due to operating efficiencies.

And finally, by way of follow up, in each of the past 2 fiscal years, the gross margin in the first quarter, the September quarter, was actually the lowest gross margin of the year. So from a seasonal perspective, things only got better in a different quarter for peak, I guess. 2 years ago, the second to the last 3 quarters were close to one another, a little more volatility last year, but the September quarter in each instance was the lowest. Would you expect that pattern to repeat itself this year, such that gross margin in subsequent quarters would still be higher than in Q1?

First, commenting on the question of the fact that we have done better this first quarter compared to other quarters because of the fact that sales are up. We're operating more efficiently. We did major, major consolidations of our manufacturing, our service centers, even some retail. A lot of that is behind us.

Now going forward, it will depend also on the factors relating to the retail to the total sales will be a factor. But I would think on a manufacturing side, as long as business reasonably holds up, we will continue to operate efficiently.

Right. Got it. Okay. Thank you so much, guys.

Thanks, Matt.

Brad Thomas, KeyBanc Capital Your line is open.

Hi, Brad. Good morning.

Hi, actually [Panaza Chalivantin] in for Brad Thomas.

Good morning.

Good morning. I was wondering if you could talk, in general terms about (inaudible) just how the current second quarter is running.

It's a little bit too early to say that. We do not -- our second quarter just started in October. And having these monthly sales that we have now, the last few days really represents a major element of business. So I would think that obviously, we do not comment on a month to month basis. However, it will be harder to do that because the month is not ended.

Okay. And as a follow-up, in your press release you mentioned that you're preparing for contingencies if the overall economic conditions were to deteriorate. You guys have held them pretty well despite macro economic concerns recently. In the case that things were to deteriorate, what would be some of the levers you could pull within the business to manage expenses?

Well, we are running pretty lean. And however, inventory management becomes very important, so we are watching in very carefully. On the one hand, we are introducing a lot of new products. So we have to produce the products. We have to back it up with inventory. And we're also watching carefully to see if there is a potential downside, so that we can manage our inventory.

Second is cash. Same thing, of course, inventory and cash are connected. We are going to take a look at-- which as in the past we've had to do-- we don't like to do it but obviously we have had to take down time in the past, when business slowed down.

We are now operating with -- we have now 1 major campus in upholstery in Maiden, North Carolina supported by our plants in Mexico as against 7 upholstery plants. We used to have at 1 time 15 case goods plants, a few years back 5. Now we are operating with 2 major ones supported by a saw mill.

So we are very much, in terms of efficient, but having said this, cash conservation and expense control all of those we will be much more cautious about.

Great, thanks.

Todd Schwartzman Sidoti & Company. Your line is open.

Hi, Todd. Good morning.

Good morning, gentlemen. For the past 2 quarters, Q1 and Q4 of '11, you've got a gross margin of 52.9% and that is considerably above your published opportunity scenarios implied. And all this was achieved on an annual run rate volume between $712 million and $740 million. Has anything changed in terms of your internal assumptions?

Yes, Todd. I'm also looking at those opportunity scenarios, which I think we gave 2 years back. What I would say is that one of the changes that is reflecting in an increase in gross margin is the fact that our retail sales to total sales has increased, which has an impact of increasing our gross margin. And also as Dave said earlier, it does increase our operating expenses so from an operating income point of view there may not much of a change. But, it does increase our gross margin and in our scenarios, I believe, that our assumption was that we would have somewhat of a different mix which is more wholesale and not as much retail.

But, that is the reason why you see a higher increase in gross margin. Having said that, I'm sure you've already done the calculations. We are pretty much running close to the various scenarios between $700 million and $800 million, if you annualize what we did in the first quarter.

What was the previous assumption as to retail wholesale mix?

I don't have it in front of me, but we will take a look at it to see. I think it was probably 70/30 rather than where it is today. Right now, it's close to 75% in that range.

Okay. And as for SG&A on a year over year basis, you've got 100 basis point improvement. Looking out for the rest of this year, what if anything can we, should we extrapolate from that?

Our SG&A, based on where we were previously, we have reduced quite a bit. But, right now, I think you've got to take a look at what your assumption is on sales. If your assumption on sales is [follow the mean] $187 million, you'll have to then use the assumption based on what we're doing now, in terms of expenses.

Maybe if you could speak a little bit to the effectiveness, the efficiency of the design consultants. Maybe throw some numbers out. Close ratios, percentage home visits, anything that you think might help us looking at the quarter versus prior year.

I don't have a lot of information to share with you, except in the fact that our average ticket has gone up, gone up by 8% or 10% from where we were last year. We have much more qualified interior designers that we have been getting. As you know, I mentioned in the past, that we have been acquiring interior designers, most of them who ran their own businesses.

So, there is certainly an improvement in their close ratios. We normally don't share a lot of this information. And--however, all of that is working in a positive manner. Our close rations are improving. Our home calls are improving.

Having said this, we're working in a tough economic environment where everybody is very, very cautious. The reason we have been able to do what we are doing is because of the fact of acquiring these strong interior designers and also improving our offerings.

The combination of the 2 has been very important and I'm sure you noticed that we have since about 1 year or so developed a very strong advertising and communications program, which also includes not only television, print, but an increasingly strong presence in digital mediums.

Okay. And Farooq, I know you've talked a lot about the impact of individual portfolios' performance on spending on the parts of your consumer. Thus far, relative to the June through September quarter, the stock market stabilized a little bit that should portend some good things for this quarter, barring any major change. But, have you seen any evidence in the September quarter or October, of the trade down effect on the part of your consumer?

This is a good question because we were also very concerned, especially in September. When you take a look at the major negative impacts of the stock markets. And our customers do watch and have their investments in the stocks.

What we did, Todd, in the last 2 years, we decided that we had to increase our presence with people with somewhat of a higher income range than we would have normally done in the last few years. These folks were trading down, so to say.

Because of the fact that Ethan Allen represents great quality, what's happening is those who were folks buying $5000 beds, now find that $1500-$1800, Ethan Allen offers a great value. Same thing in all our other product lines.

Interesting that the higher income groups, in the last 2 years have doubled as a percentage of consumers who shop at Ethan Allen. Now that's good, but as we go forward we want to also make sure that we expand our reach to folks below household income of $150,000, which is where most of our growth has come in the last 2 years.

Thanks, guys.

Thanks, Todd.

Dillard Watt, Stifel Nicolaus.

Good morning, in for John. You talked about ad spending a little bit in terms of going from the 6 week cycle to the 4 week cycle. In addition to that have you guys increased in terms of the percentage of revenue or gross dollars or anything like that versus the prior year? Any type of comment you can give on that?

You're talking of our advertising money?

Yes.

It has been, as you know last year we did increase it, but this September quarter, we were pretty flat with what we spent the last year.

And with the new sales events, have you increased the percentage of items that are on sale? Or are those items now at a deeper discount than they had been previously?

Generally speaking, our discounts have been more or less similar to what they have been in the past. We have not increased our discounts. The number of products that are on sale varies. I would say that if you're compared to last year, most probably we have more products offered on sale, but not a big amount because we rotated and we are still doing the same. What has happened as I mentioned earlier, we went to 3 periods rather than 2 periods in the September quarter.

Great. All right. That's all for me. Thanks, guys.

All right.

and our next question comes from Barry Vogel from Barry Vogel & Associates. Your line is open.

Hey, Barry. Good morning.

Good morning. Most of my questions have been answered. But I have got a couple of little questions. First of all, let me congratulate you on your results. I think you've done a spectacular job in the last few years using these initiatives and coming out with tremendous results relative to what's happening in the marketplace.

Thank you, Barry. I know you have been following us since we went public. So I know that, so good to hear from you.

Okay, good. The Mexican expansion, has that been completed? And is it helping profitability?

I'm sorry, what did you say?

The Mexican expansion.

Oh, the Mexico. Let me say that that has really been a major undertaking and a very positive undertaking. We started -- we purchased about a 35,000 square foot plant about 4 years back, which was cutting and sewing all our leather products. And we have every year, in the last 4 years, substantially increased the capacities. And now from 35,000 square foot we've just completed and now that plant is 240,000 square feet.

And we've undertaken this and continue to do business and maintained our quality and maintained our service and also not had a major negative impact, as you can see, on our profitability. In fact we [have absorbed] those cost of training and everything else. That operation today is doing over 70% of all our fabrics are being cut and sewn in Mexico and it's operating very, very well for us.

Are we going to see more of a contribution, for example this year than last year, because of you finishing the last of the expansion? Or are we at, right now, that level of profitability?

One of the reasons profitability has also improved is because of the factory contribution of the Mexico. You're going to see some, but on the other hand we also continue to gear up. It also is continuing to cost us in training people.

So, I think you'll continue to see some increases, but it's going to be incremental, not major because it's a process that is continuing and will continue, Barry. You're not going to see a major, major one-time event.

We've already been taking advantage of it, on one hand and on the other hand, we are continuing to gear up and train people, which we will continue to do. The bottom line is there'll be some net positive contribution as we go forward. But, not something major. We are already getting advantage of it.

One last question, has to do with what you're doing with the cash generation and your very good balance sheet. I know you've been even handed, in terms of bond purchases, in the last 2 years, as well as, some stock purchases. And looking at your vertical capital expenditure requirements for fiscal '12, why did you only buy $800,000 of shares in the quarter just ended?

You're right. We are conservative. And with this economy and the world, one has to be careful. You know 50%, approximately 50% of $100 million are customer deposits, Barry. So, we've got to be careful. While we have the cash, it really is not ours. I want to watch it very carefully.

We're very prudently using this cash to reduce our debt. We have now $38 million in debt. We buy some stock and it will basically cover some options, and although I think at the end of the day for our stockholders, it becomes neutral. We'll watch it very carefully. But, I don't want to overdo it and then have some major events in the economy and our cash runs out. We are conservative, in that respect, Barry.

Thank you very much. Keep up the great work.

Thanks very much.

Budd Bugatch, Raymond James. Your line is open.

Good morning, Farooq. Congratulations. Most of my questions have been answered, but let me try to go forward to Thursday and see what we might be seeing there. I understand you've done significant product introductions. Could you maybe frame how many and what might the financial impact be in the near term and the longer term?

The products that we are introducing, Budd and I'm looking forward to having all of you. Please do come and attend this Investor Conference on Thursday. We just ended our retail conference last week, where we had over 300 plus associates and was extremely, extremely successful and well received.

We have been working very hard in the last 1 year, 1.5 years, in developing products to expand our reach both in design and value to more consumers. By middle of next year, within 1 year, we will have changed 60% of our offerings. That's a major, major undertaking and that's what you're going to see here.

So, will there be an additional Lifestyle? Or how many patterns?

It's 5 Lifestyles, but each 1 having a number of different attitudes. When you come here, you'll see them. And you're going to be excited, as our people were.

More importantly, I believe they have a great opportunity of being well received and expanding our reach to consumers from middle up, all the way up. That's what our objective is. Because today, as you know, you are a student of this industry, that in the last 10, 15 years, our industry has been impacted by globalization and commoditization.

On one hand, we have mass retailers who have taken over the responsibility of thousands of small family-owned businesses. Nothing dissimilar to what happened in hardware, electronics, and everything else. On the other hand you have Lifestyle companies, Crate and Barrel and others, who have also done a good job. And then you have some of the traditional retailers in the middle and top, who are in trouble.

Our focus is to go from the middle to middle high to all the way up. And that's a great opportunity in providing products that have style, quality, aspirational with great interior design services and that's what you're going to see over here. I believe that you have to take market share, you have to provide great, great differentiation. And that's what we have been working on, Budd, and look forward to seeing you on Thursday.

And one other last one. You talked about the appeal and the household income of your typical customer. Can you talk a little bit about traffic and ticket, during the quarter, in the Company-owned stores, at least if not, the whole system?

You know, overall I would say that you would have next week when-- next Thursday when you are here we will also webcast our conference and the comments, so that everybody can hear it. Interesting, but not unusual, what's happened in the last year, has been that our traffic has been down. However, our close ratio is up because advertising is more targeted.

We are getting more qualified households-- consumers coming into our Design Centers and buying. And at this time, intentionally we felt it was more important than reaching a lot of folks who were not able to buy. And close ratios is higher. Our traffic is down, but qualified traffic is up and our sales are up.

Okay, thank you. We look forward to seeing you on Thursday.

Okay, Budd.

(Operator Instructions) Joe Feldman, Telsey Advisory Group.

Good morning. So, have a question. I know that the way you guys have re-engineered your manufacturing here in the US has certainly been helpful. And your inventory, I think, in this quarter, is reflective of that as the gross margin as well.

The question I had was as you launch new products, how does that impact things? And especially I'm also thinking about the custom side of things. And are people customizing the assortment, as you guys had envisioned a couple years ago?

On the question of custom, yes. But keep in mind, Joe that our upholstery products have been custom for a long time. It was our domestic case goods that we converted to custom.

Right.

And people like it because we are, also, shipping between 4 to 6 weeks from our plants; custom products one at a time. And we didn't raise our -- I mean, we had some price increases, but overall our objective was to produce the product at the similar price points as if we were making large runs. So, we've been successfully able to do it, a major undertaking.

And customization has helped us obviously in reducing inventory. And the impact of this has been across the board and you will hear it when you come here.

For instance, we now make packaging, 1 package at a time. We used to have several million dollars invested in packaging and a lot of waste. Not only waste in packaging but, we have now found out that by making individual packaging, we are now saving or increasing our capacities in our fleets and trucks by 15%. We were just -- boxes were bigger when we were making the old way.

The impact of customization has been across the board. Inventory reduction, it has implications, amount of space in our design centers. Today, we can have so many different options of finishes and other options which has given an opportunity to sell more from an item, which we could not do before. So, a lot of positive things.

That's great. And another question, given all the pressures on pricing out there with the commodity pressure and lumber, have you guys seen anything different? Obviously, the average ticket is up 8%. Is that because of more pricing? Or is that as people actually putting more in their sort of overall purchase?

I think it's a combination of both. Our price increases are partly responsible for it. When you take a look at our price increases, for instance, our fuel costs in the last quarter have stabilized. But when you go, it's still -- when you compare 12 months, it's 29% higher than it was a year back. So, we have had an increase.

However, we have stabilized and in fact, sequentially, it has gone down. We have not seen--we had a great spurt of price increases in fabrics and petroleum based products, I think, in the last 3 or 4 months, it has somewhat stabilized.

Thanks. And the one last question was, sort of a combination of competition and market share and just -- any changes you're seeing on the competitive front? And then also just for market share, I was wondering if you've seen the effectiveness of all the more robust advertising? Is that translating to increased market share?

No question about it. In this very, very difficult environment to have 12% increase in sales is really due to a lot of factors, but certainly our advertising is helping us bring more qualified people. And then continued improvement in offerings and as I mentioned, also earlier, the more qualified interior designers is helping us.

Also, Joe, keep in mind that the last year we invested about $6 million in adding management to our own retail division. And that has been very helpful because our management -- we have about 200 person strong management team in the retail division. And 90% of them have come from the ranks. We have been in the last 10 years running an MBA program of training interior designers to become financial administrative operational managers, and they really have done a good job with that.

That's great. Thanks for the responses and see you Thursday.

All right.

I'm showing our next question comes from Matthew Fassler, Goldman Sachs. Your line is open.

I just have one quick follow-up. If you look at the cadence of business, the reported sales growth in the retail business and compare it to the reported sales growth in the wholesale business, it looks like that the trends diverged a bit more than they had in prior quarters.

And I'm wondering if that relates to the strength of the Company-owned stores, as a result of the operational improvements that you made relative to perhaps, less of that in the wholesale business or whether there was wholesale backlog that would bring those numbers to converge over time?

The bottom line is over time, they do converge. The wholesale business is impacted by effects of orders due to our conferences, new product introductions. Also, for instance, with China we have, as we indicated last time, that we -- they have now started inventorying products, which they are now using to ship rather than to take from our inventory. All of those factors have had an impact. But, the bottom line is that over a period of time they do converge.

Would you expect that number to grow faster? The wholesale number to grow faster than retail over time, or in the short run to catch up?

I think that, over a period of time, they should more or less be equal because keep in mind our wholesale business represents business that is given to our wholesale by our own retail division and by our independents.

Sure.

And as our independents domestically--most of our growth in the independents has been overseas.

Yes.

As you know, we have now -- we have added Arne Borrey, who just joined us 3 months back as Head of our International. And as he and Dan Grove run our Business Development -- we are looking forward to a strong initiatives of building international business.

Yes.

And most of that will be on the wholesale side.

Got it. Thank you so much.

Thanks, Matt.

I'm showing no further questions at this time.

All right. Well, thank you very much. If any questions, please give a call and let us know. And David Callen, you have his information and look forward to seeing most of you on Thursday.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the conference and you may now disconnect. Everyone have a wonderful day.