Ethan Allen Interiors Inc (ETD) 2017 Q4 法說會逐字稿

Good afternoon, and welcome to the Ethan Allen 2017 Fiscal Year and Fourth Quarter Conference Call. (Operator Instructions)

It's now my pleasure to introduce your host, Corey Whitely, Executive Vice President, Administration and CFO. Thank you. You may begin.

Thank you. Well, good afternoon, and welcome to Ethan Allen's conference call for our fiscal year and fourth quarter ended June 30, 2017. This conference call is being recorded and webcast live on ethanallen.com, where you will also find our press release, which contains supporting details, including reconciliations of non-GAAP information referred to in the release and on this call.

As a reminder, our comments today will include forward-looking statements that are subject to risks and uncertainties which could cause actual results to differ materially. Please refer to our SEC filings 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 further updates on our ongoing business initiatives before opening up the telephone lines for questions.

With that, here is Farooq Kathwari.

Thank you, Corey, and thank you for participating in our earnings conference call. We discussed our preliminary financial information for quarter and year ended June 30, 2017, at our investor conference on July 19. Our financial results in 2017 were impacted due to a number of factors: a strong previous year comparison, political and economic uncertainty and our planned objective to reduce discounts.

Also, as we stated in our press release, in fiscal 2017, we completed many initiatives and also launched new initiatives. As we enter 2018, we are well positioned to grow with refreshed and relevant product offerings, a strong North American manufacturing, a repositioned retail network and efficient and service-oriented logistics structure. We also, during fiscal 2017, made investments in technology, increased advertising and expanded market channels, including collaboration with Disney and Amazon.

During the fourth quarter, our written orders in April decreased 7.1% and then progressively increased by 7% in May and 6.9% in June, resulting in a 1.9% increase for the quarter compared to the same period in the prior year. So far, in July, written orders have continued a strong, positive trend, and we remain cautiously optimistic.

After Corey provides a brief financial overview, I will go over our business initiatives and then open for questions and comments. Corey?

Thank you, Farooq. For the fourth quarter of fiscal 2017, our results reflect a comparison against the very strong performance in the prior year period. Our consolidated net sales of $194.9 million for the quarter compared to $205.7 million in the prior year. Wholesale net sales were $114.3 million. In the prior year, wholesale sales included strong shipments of new products which should not occur in the current year quarter. Retail net sales for the quarter were $153.2 million. The cadence for written orders during the quarter reflected a weaker April and then a strong May and strong June, ending the quarter up 1.9%.

We ended the fiscal year with consolidated net sales of $763.4 million. Wholesale net sales were $453.3 million. Retail net sales of $603.7 million decreased by 3.6% in total and by 4.8% on a comp store basis. Retail written orders for the year were essentially flat, decreasing 0.6% in total and by 2.6% on a comp store basis.

International sales were 10% of consolidated sales in the current fiscal year compared to 9.2% in the prior period, reflecting an increase in sales to China. The mix of retail segment net sales to consolidated net sales for the fiscal year was 79.1% compared to 78.9% in the prior year.

Improved manufacturing efficiencies and reduced clearance activity helped drive our strong adjusted gross margin of 55.8% for the fiscal year and 55.7% for the fourth quarter.

Our adjusted operating expenses for the quarter were $89.8 million compared to $90.6 million in the prior year. Variable costs decreased relative to sales, which were offset by increased advertising expense, which increased 27.5% for the quarter and 16.5% for the fiscal year.

For the quarter, our adjusted operating margin was 9.5%, and adjusted net income of $0.42 per share compared to $0.57 in the prior year quarter when it had increased 33%.

Adjusted EBITDA for the quarter was 12.1% of sales and 11.1% for the fiscal year.

Our effective tax rate for the fiscal year was 36.5%.

We have a strong balance sheet. At June 30, 2017, our total debt was $14.3 million, down $27.5 million for the prior year-end, and our total cash and securities totaled $65 million. Customer deposits were $63 million.

During the quarter, we paid out dividends of $5.3 million and paid out $20 million in dividends for the full fiscal year. We repurchased 250,000 shares for $6.9 million during the quarter.

Inventory of $149.5 million decreased by $12.8 million from the prior year-end.

With that, I'll turn it back over to Farooq.

Yes. Thank you, Corey. As we mentioned at our Investor Meeting, we are celebrating our 85th year. And for 85 years, Ethan Allen has established a precedent of quality through our craftspeople, provided service through our retail network and talented associates in all areas of our vertically integrated enterprise.

During fiscal 2017, we enhanced our competitive advantages of being a desired and known brand. We increased production capacity in our North American manufacturing where 75% of our furniture products are made. We strengthened our entrepreneurial interior designer teams of 1,500 in North America. And now, over 500 are participating in live chats. During fiscal 2017, we absorbed the major new product introductions in fiscal 2015 and fiscal 2016. And our next new product to launch is slated for fall of this year.

We continue to reposition our retail network of 300 design centers, of which 200 are in North America. Of the 200 locations, 72% have been relocated in the last 15 years with 24% within the past 5 years. In fiscal 2017, we operated new design centers in Cranston, Rhode Island; Rockville, Maryland; Manhattan, the Flatiron area; San Francisco; and Indianapolis, Indiana. And also, several internationally were opened. Last week, we opened a new design center in the Buckhead area of Atlanta, and in September, plan to open in downtown Chicago.

During the year, we launched the Ethan Allen | Disney collection, which is now, on an annual basis, doing about $10 million in retail and growing. In July 2017, we launched in China and plan to launch in several other countries in fiscal 2018, that is the Disney -- Ethan Allen | Disney collection. We were one of the awardees of the U.S. State Department contracts and expect to receive and ship products starting in fiscal 2018. Earlier this month, we launched a collaboration with Amazon with an Ethan Allen Design Studio which reflects our website. The purchase experience for our products will be similar to our website, and our retail network will secure, deliver and receive compensation as our e-commerce business does.

During fiscal 2017, we accelerated our marketing, which included direct mail, strong digital and social and also accelerated national television. As we stated, our advertising spend in the fourth quarter was $11.7 million or 6% of sales versus $9.2 million or 4.5% of sales, a 27% increase. For the full year, we -- our -- we spent 5.2% of sales versus 4.3% of sales in the previous year.

We have accelerated our technology initiatives, including a 360-degree product visualization 3D room plans and 3D augmented reality.

As I've stated, we are well positioned for growth and look forward to an exciting 2018.

With that, we'll open for questions or comments. Dutch?

(Operator Instructions) Your first question comes from the line of Budd Bugatch from Raymond James.

I guess the question that -- a couple of questions I have, one, related to advertising. You said at the Analyst Day that you were evaluating the TV advertising and its effectiveness, and I see the amount of advertising expense going up, which I've been a proponent of. Can you talk about if any of that evaluation has been completed? And what do you think you will spend? Or how do we think about advertising this year?

Yes. Budd, good to have you on the call and good to have you here at our Investor Meeting. Budd, as I stated, we are evaluating. We did have a strong national television presence up to this fourth quarter. We are -- we don't have a strong -- I mean, we don't have a national television program in this first quarter. It is summer, so not the best time to be on national television. However, we are considering utilizing television in August on -- somewhat more on a local basis. Then we are also looking at -- right now, we are at this time, studying going back to national television in the fall. So at this stage, we are evaluating it, and the chances are that we will have national television in the fall as well.

And your next question comes from the line of Brad Thomas with KeyBanc.

This is Sameet Desai on the line for Brad. On the State Department contract, are you seeing any sales traction thus far? Or do you have line of sight for when that might start to materialize? And also, are these orders Quick Ship or custom? And does that impact whether or not we might be seeing any of these deliveries for the contract business in the first quarter?

We have received orders. They are somewhat indirectly due to the State Department contract. We did receive orders because of the fact we placed our products on the GSA list. And because of that, we will receive a reasonable amount of orders. But the State Department orders on the contract have just started coming in, in the last 2 weeks. So I think that we will have about, I would say, at least $2 million, $3 million worth of shipments this quarter. And then after that, we will see. And these are not necessarily directly because of this contract. This is because of the fact that our products were available to be purchased by the government, and they did, which is also good. But the State Department, I think most of it is going to be started being received in the -- in our second quarter. The government fiscal year ends September 30, and then the shipments will start after that.

Okay. And then with the new product launch that you have planned for the fall, is there an opportunity to potentially shift some of the square footage from Disney towards the new launch? Or is that more of just a refresh of other product on the floor?

Well, as you know, when we introduced Disney, we did give it a tremendous amount of attention because we wanted people to know we have it. Part of that, as we move forward, will be integrated to a Disney for product line which, right now is, as you most probably know, has been -- has its own space. But as we go forward, it will be somewhat integrated with the rest of our design centers, so some more space will become available for our new products.

And so if I understood that correctly then, it's -- there may be slightly less square footage attributed directly to Disney?

Yes, that's possible. Not yet, but it is possible. But the fact is that we still will have a very strong presence of Disney in all our design centers.

Okay, great. The last question for me is it looked like your promotional activity picked up over the Fourth of July weekend. And I'm curious if you can provide any additional detail on your planned promotional cadence for the first quarter in total.

It -- as you know, we did have a special event in the first few days of July, and we will continue having our offerings. And as we move forward, in addition to our offerings that we have on a monthly basis, we always consider if there's something special we have to do. We have not finalized it as yet, but that is always under consideration.

Your next question comes from the line of Jeremy Hamblin with Dougherty & Company.

I wanted to follow up and just ask a follow-up on your comment about, part -- some of the reasons why you had a little tougher results or lower reported results. And one of the reasons you gave was the strong results from last year. And as I look back at fiscal '16, total sales growth was like 5.25%, which was very solid. But as I think about the organic growth of this company moving forward, is there may be a range that you would think about in terms of -- is this kind of a 2% to 3% grower on a typical basis, and that something like 5% growth on an annual basis is more of an outlier? Or is it -- or is there a broader range of potential sales growth?

I would say that, Jeremy, it is broader. And I think that -- when you take a look at it, you're right. This last -- this quarter our sales were down. The previous year, they were up 6.3% on a consolidated basis. And when you take a look at our -- what we're going to be comparing it with, this next -- this first quarter, our sales were up about 1.5%, even though our written orders were up. And I'm not talking of this first -- the fiscal first quarter of this fiscal year. Last year, our written were up, approximately in the Retail Division, about 8%, and Wholesale was up about 6%. And so we had a strong written in the first quarter. Our delivered was up only 1.5%. So I would say that it is a broader range. And I would say that -- I mean, again, this is just a perspective that I'm giving, that I would say anywhere from 2% to 10% should be the range that we should be using.

2% to 10%. Okay. And in terms of the key drivers this year, from your perspective, you've got -- you have the State Department contract. You have the Amazon partnership, which is new and just launched. And then you do have, it sounds like there are some product launches planned for the fall. I'm sure you know more about what might be launched over the winter and next spring. In terms of relative impact, how should we be thinking about which of these programs is most likely to have the most significant impact? Is it the State Department? Is it Amazon? Is it the new products?

No. I would say that the biggest impact for us is within our own control. That's our Retail Division. Our Retail Division is -- provides most of the business and that we have 148 locations. We have 1,500 interior designers. We have built a strong network. That is really, to me, one of the strongest assets we have and the opportunities for us to grow. In this last -- this fiscal year, it did not, because again, comparisons and other factors came into being. But I believe that our biggest opportunity is, number one, the growth through our Retail Division; second is the growth through our Wholesale, whether it's internationally or North America; third is through some of these special collaborations, whether it's U.S. government or as -- also as you know, our involvement with contract. And then, we also have the opportunity of doing more business with, as I said, Disney or even Amazon. I mean, we don't know how that -- we expect that to do well, but the drivers are going to be areas that are within our own control right now.

Understood. And then one additional question as a follow-up from last week's event. You mentioned discounting from competitors as pretty severe, I think, over the last 6 months, really probably over the last year. And that you weaned your customers off of those discounts, and I think you said there's an opportunity to mix them in a bit more maybe in fiscal '18 versus '17. What are you seeing from your competitors in terms of their discounting? Are you starting to see it pull back at all? And does that provide you a better opportunity to have more effective promotions when you target them because competitors maybe aren't discounting as much? How would you characterize it?

Jeremy, I don't see any change in our competitors. If anything, people are becoming more discount oriented. Last week, I saw in The New York Times some big store saying Black Friday is in July, 60%, 70% off. I mean, that's what people are talking about as sales. So for us, to have 15% off, 20% off, it is -- it can only be done because the credibility of our brand and because of the fact that we start with a credible price. We don't increase them just to raise -- to lower them. We went -- if you go to 50%, 60% off, you'll have nothing left. So we start with a credible pricing, and we will continue with that. And for us, the messages you're going to see us get across is why Ethan Allen is not only a known brand, it's a desired brand because of our quality, because of our values and because of the service we provide. That's going to be the focus of our -- that will continue to be the focus of our advertising. In fact, we're going to accelerate that and not fall into the trap of increasing our discounts.

And your next question comes from the line of John Baugh with Stifel.

The -- normally, when you run a promotion of the month, it's stacked to the end of the month. So when we ask you how the quarter started or the first month, you are always able to say, "Well, we run our promotion at the end, so we won't know because all the orders come in at the end of the month." Was that different with the July Fourth promotion? And therefore, I guess the question simply is do you really know how July came in at this point? And are you willing to give us any kind of numeric direction, other than it was quite strong?

John, I mean, it's a good question. This time, and we said it, we will not have said that July is, so far, strong because of the fact that, in July, for 4 days, we ran a very special celebration of our 85th year event. It also coordinated with the Prime Day of Amazon, so we coordinated all of that, with Disney, too, and it ended with a very strong 4 days. However, having said this, our end of the month is still strong, and this is now coming this week. That will determine, to a great degree, how the overall month will end. But comparing up -- this period up to now to July of last period, it is strong because of -- with the event of those 4 days.

Okay. And then I'm curious on Amazon, how are you and/or we going to understand the pluses and minuses of that relationship? And then I guess I'm getting at things like cannibalization versus truly incremental sales. I mean, what kind of -- what are you looking for internally? And what, if anything, will you share with us externally about Amazon going forward?

John, it's a little bit early to understand how -- where it will end up. We have started in the right manner. We have established an Ethan Allen Design, of course, in collaboration with them, a Design Studio on Amazon which reflects, as I said, our website. We're also going to have the ability, which we are starting actually this week, of having live chat of our designers through this website. We will -- we are servicing the products, we are -- through our network. And so we look upon it as, number one, as an opportunity to reach more people. That's the main thing. And now we will see how many people we reach. There will be somewhat more of an acceleration of our visibility of our website right now. We just want to make sure it's working right. A lot of work has gone through it. It is -- we're projecting well. But starting in the next few weeks, we'll have -- they will accelerate, and we will also do some advertising to make our design studio known. And our main objective is to expand our reach to a very large base of customers that Amazon gets. How much of that will then go and buy through Amazon? How much of them will come directly to Ethan Allen? We don't know, but it's all right. We look upon it at this stage as incremental business, and we look upon the fact that this partnership with Amazon is important. I think it will benefit us, and it should benefit them also. But it's too early to tell, so we are not attributing, at this stage, counting a lot of this business coming in. We don't know.

And, Farooq, I apologize if you commented about this before. I missed it if you did. But if you commented on any margin implications of Amazon, I assume you're paying them some sort of a fee. Maybe you'll help them with ad spend, maybe not. I would assume it would be less because they've already got all the customers. And then of course you're not paying a sales commission. I assume you control the pricing, the wholesale pricing on there. But anything you've given out or could share about the margin structure?

Well, the margin structure is -- keep in mind that we do obviously -- we will compensate Amazon. Keep in mind that the product that we are selling is at our retail prices, and so there is a margin between a wholesale and retail. So a small portion will go to them. The rest will come to us. And what we will do is, we will share a portion of that with our retail network because they will be doing the work of logistics, servicing and even providing some interior design help. So it is -- it works well. Now as you initially said, if all of this business is cannibalization, then obviously it is going to be lower margins, but we don't think so. We believe a lot of it is going to be incremental business, so that we have the opportunity of sharing the margins and doing reasonably well.

And you do have a follow-up question from Budd with Raymond James.

Well, I've -- they -- I don't think we got the answer to the -- for the planned advertising for the year. That was the question that I had, and if you've given it since I missed it.

No, no. I basically said that we're going to do it by quarter by quarter. Now just to give you a perspective, Budd, this last -- in fiscal 2017, our advertising spend was 5.2% of our total sales versus 4.3% in fiscal 2016. So that is what -- we created also the spending. I'm looking at advertising expenses for fiscal -- yes, right. For fiscal 2017, it was 5.2% of sales. Interestingly, the total dollar amount was -- what is this? 30 point...

$39 million.

$39.7 million, yes. It's too small to read. And the previous year, in 2016, we spent $34.1 million. So we spent 5.2%. And I will say, Budd, that for purposes of your -- you need to see how much we're going to spend, but I will say you can use your judgment between 5% and 5.5% for the whole year. That might -- that will give you sort of an understanding of how much we might spend.

Okay. And I guess my other question is what are you seeing in the way of costs? And what is -- any thoughts of -- any need for a price increase? Or have you taken a price increase?

We are taking a pricing increase on selected products, actually, effective August 1. So -- now it's a small -- it will most probably, it will -- it may average less -- about 3% or less, and to reflect to a great degree increase in compensation, medical costs. And then of course, having said that, then we see, when we give some discounts, how much of that is lost. So it's -- all of this price increase is fine, but the net-net is what's important. And the net-net, as you know, is not -- is a challenge always. So keep that in mind that price increases are there, but really what matters is how much of that really is maintained and how much is given away when we give discounts.

And your next question comes from the line of Cristina Fernández with the Telsey Advisory Group.

I wanted to ask about the mix of wholesale versus retail here in fiscal year '18. How should we think about that given the initiatives you have like Amazon and the Department of State? Would that benefit more wholesale? Or would retail also see a lift from those?

Well, that's a good question. There are 2 elements to it. First is the retail, as I said, when the question was asked about our opportunities, and I said we have an opportunity to build our retail business. In fiscal '17, our Retail Division had net sales of about $604 million. That is an opportunity for us. And of course, it was down from the previous year by $626 million. So our objective is to grow our retail business because we have a strong network out there. Wholesale also has an opportunity of growth. In fact, wholesale, because of all this business we are talking about, the State Department, our international contract will go into wholesale. But overall, Cristina, I would think that our objective is to grow both and we have an opportunity of growing both wholesale and retail.

And then as a follow-up, looking at the order intake in May and June and July so far, which has been a lot better than what you saw earlier in the year. Do you think the consumer is feeling better or you attribute that mostly to the promotional events picking up?

I think it's a combination of both. I think that we did feel, right after the elections or around that time, that people's concern, especially in the coastal areas, where we have a strong presence, on the West Coast, the East Coast, I think to some degree, we see that Manhattan still had an issue interestingly. But we see, for instance, even Long Island is doing extremely well. So it is picking up. So I believe that consumer attitudes are better. And after a while, listening to all this crazy news, people get -- people now -- people are starting not to listen to it. And I don't listen to it too much. But anyway, I think a lot of people are not listening to it, which is important. So I think it is -- that impact. And also, discounting is still taking place. That is not abating.

(Operator Instructions) The next question comes from the line of Justin Bergner with Gabelli.

First question relates to just Amazon and recapping maybe some of the comments you delivered at your investor event. Could you highlight what is different about your relationship with Amazon versus the relationship that other furniture retailers that might choose to sell through their website have, just what features are unique to the Ethan Allen-Amazon relationship?

Well, Justin, I'm sure that there are a lot of different variations depending upon who one talks to, so I cannot say about -- I can't give any examples of how others operate. What I think is important for our relationship is this, that we don't sell our products to the general market. So we only sell our products through Ethan Allen, through our own network. So our products are available only through Ethan Allen network. Like, for instance, if we were to sell our products with some large furniture store or department stores, that would be different. That might create some complications. So our products are sold directly by us. And the products that are being sold through the -- keep in mind, we are the seller of record. Amazon is acting as an agent. So when they sell the product, they sell it at the price -- at our stated prices. And we then deliver their products. We service the products. And that is a big difference and a big opportunity, so that -- because as you know, delivering furniture is not an easy thing. Our competitive advantage is that we have a national logistics network which delivers white-glove service across the country, and that's what we are using with -- through the sales on Amazon.

Okay. And the chat feature, I mean, is that going to be unique to Ethan Allen? Or will -- in the future, will we find other retailers that are selling directly, having that chat feature as well?

Well, at this stage, it is somewhat unique to us, but I can't speak -- we don't have any exclusivity arrangement with Amazon. The chances are, most probably, others will, too. But again, in our case, it is being done with our 1,500 interior designers. In fact, we just started today with 50 of them to start working on it, and we will then get more people to chat on the Amazon site.

Okay. Great. And then switching to another business opportunity. On the State Department side, I guess maybe I'm a little bit confused as to why you're not going to start shipping until next year. I mean, is this a sort of setback or delay that's facing you and other participants in the program? Or is it something that's uniquely affecting Ethan Allen?

No, no. It is everybody. What the State Department did was after they awarded the contracts, they then went through an entirely different process of what's called a FedBid process. So if there's a multiple source, like this is, each participant have given their products and offerings, and they are sort of classified, all of them, in -- by numbers. And they spend a lot of time allocating those numbers, and those numbers are to be used. Like for instance, if they want a traditional bed, a traditional bed which has been approved by all these folks has a certain number. And that number -- when they order a bed, they order that number, and that bid is sent to all the 4 participants. And then you bid on it, and that bid -- it's almost like eBay. And the bid keeps on -- you keep on having to keep on -- changing it based on how far you want to go in winning the bid. I mean -- and it's a crazy system, but that's what it is. And that's what took them a lot of time but now is operating. And the bids are out, and we are bidding and winning.

Okay. That's a good perspective. And then I guess the third thing I want to address is the international side of the business. I think Corey said it was a little bit over 10% of sales this year. I'm not sure I got the exact number there. But why can't this international business sort of grow to be a much larger part of Ethan Allen's business than it is today? I mean, clearly, you have a brand that has global recognition. Even if one kind of considers a lot of the international sales are wholesale, the end retail value is still just a small fraction of what it would be in the U.S. Sort of -- can Ethan Allen take international to the next level? And what's needed to do that?

It is growing. Look, it's now this -- as what Corey said, was 10% of our total sales versus 9.2% in the previous year. So it is increasing, and I believe it has an opportunity of increasing. But, Justin, it's -- our business model is a model based on service. A lot of the furniture sold internationally, let's say, in Germany, for instance, and other European countries, is sold as a commodity. And so you really have to compete only on price, and that is not our business. Our business model has been -- that's why we are expanding. We're just opening, for instance, an Ethan Allen Design Center in Cambodia. We just opened in Taiwan. We are opening one in Indonesia. So that is our model, and I believe it will continue to grow.

Okay. Are there partnerships and other sort of relationships that can kind of accelerate the international opportunity? Or are you sort of continuing with the model you have?

At this stage, the model we have, we have great partners or licensees, but we are not partners.

And there are no further questions in queue.

All right. Well, thanks very much. If there're any more questions and comments, please let us know. Thanks very much.

This does conclude today's presentation. You may now disconnect.