Ethan Allen Interiors Inc (ETD) 2018 Q4 法說會逐字稿

Good afternoon. My name is Terry, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ethan Allen's Earnings Release Call. (Operator Instructions)

I will now turn the call over to Mr. Corey Whitely, Executive Vice President and Chief Financial Officer of Ethan Allen. Sir, you may begin.

Thank you, Terry. Good afternoon, and welcome to Ethan Allen's conference call for our full fiscal year and fourth quarter ended June 30, 2018. 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. As we mentioned in our press release, we are well positioned to grow our sales and earnings. In fiscal 2018, we accelerated our focus on many initiatives, including strengthening our leadership in our vertically integrated business, undertaking major product innovation, continuing our retail transformation and increasing spending in advertising, which reduced our EPS by about $0.09 over the third and fourth quarters. We also made infrastructure investments. We incorporated all of these efforts under the umbrella of a socially responsible approach to business.

After Corey provides a brief overview of our financials, I will discuss our initiatives in greater detail. Corey?

Thank you, Farooq. Consolidated net sales for the fourth quarter increased 5.5% to $205.6 million and increased 0.4% for the full fiscal year. Our manufacturing production levels further increased during the quarter, which helped drive the 11.4% increase in wholesale sales and a 1.9% increase in retail sales.

The wholesale increase reflected a strong international shipments, which increased 8.7% and increased shipments to our retail network. With our strengthened manufacturing capacity and production levels in place, our retail order backlogs are caught up and back to normalized levels. GSA government contract orders continued strong during the quarter, and for the full fiscal year, GSA orders totaled $24 million.

Our consolidated gross margin for the quarter was 54.1%, primarily reflecting the 75.9% mix of retail sales as a percent of consolidated sales. We expect our retail mix will stay in the 75% to 76% range for fiscal 2019 as our wholesale business continues to benefit from strong contract and international sales. We continued to monitor the potential impact on gross margins related to current or potential tariffs. We currently make approximately 75% of what we sell in our North American workshops and about 50% is produced in the U.S. The balance of our product assortment is sourced throughout the world. Approximately 6% of our consolidated sales represent product source from China.

In regards to Canada, some of our upholstery products that we export to Canada became subject to a 10% surge tax that went into effect July 1st. We expect this will have a minor impact to our retail margins.

Our fourth quarter adjusted operating expenses were $95 million, an increase of 5.8%. The increase was primarily driven by our advertising expense, which increased 15.8% during the quarter, as we continued our brand building campaign, which started in Q3. Our full fiscal year advertising was $43.3 million, an increase of 9%.

For the quarter, the adjusted operating margin was 7.9%, adjusted net income of $11.6 million, with adjusted EPS of $0.43. For the full fiscal year, adjusted EPS was $1.35.

Turning to the balance sheet, we generated $42.5 million of cash from operating activities during the fiscal year and returned it to shareholders through the repayment of $29.5 million of dividends, a 47.3% increase and repurchased $22 million worth of the company's stock.

We ended the year with cash and securities of $22.4 million and had no debt outstanding under our credit facility. Our capital expenditures for the fiscal year were $18.8 million, and we expect about $20 million in capital expenditures for fiscal 2019.

Our effective tax rate was 29% for the fourth quarter and 25.9% for the full fiscal year as a result of the Tax Cuts and Jobs Act. We expect our effective rate for the 2019 fiscal year will be in the range of 24.5% to 25.5%.

With that, I will turn it back over to Farooq.

Thank you, Corey. Our many initiatives in 2018 should help us grow sales and profitability in fiscal 2019. They include strengthening our leadership in all areas, particularly in marketing, manufacturing, logistics and the retail network. We have continued to reposition our interior design network of 200 design centers in North America and about 100 internationally. twenty percent of our design centers have been relocated within 5 years and 69% within the past 15 years.

During the past year, we opened several new design centers and relocated other than key markets, including the Buckhead area of Atlanta, Downtown Chicago and Calgary in Alberta, Canada. Design centers in Albany, New York; Denver, Colorado; and Rancho Mirage, California are currently under construction.

New design centers in China, Taipei, Bangkok, the Philippines and Cambodia are among our 110 international design centers. We have continued to refresh our products with an attitude that is modern, but classic. In the 3 years from fall 2015 to fall 2018, we will have revitalized about 70% of our product line. In fiscal 2018, we expanded our marketing initiatives. In the second and third quarters, we spent more than $15 million on national television. While the message helped our brand, it lacked the urgency to build traffic. Hindsight is 20/20. We should not have invested as heavily in national television at expense of other mediums. Starting this quarter, we are returning to a balanced advertising menu that will include direct mail, print and digital initiatives. Our digital marketing gains, momentum and reach via a refreshed websites, e-mail blasts, banner ads and Live Chat, which combines technology with personal service, with more than 600 of our most enthusiastic interior designers participating.

We have also introduced Ethan Allen InHome, an augmented reality app that lets client see Ethan Allen products in their homes and an all new 3D room planner designed specifically for us, which our designers are using to enhance customer experience.

We continued to invest in our infrastructure in manufacturing and logistics at the wholesale and retail levels. We operate eight manufacturing plants and two major national distribution centers, 29 service centers are operated by the company retail division. We continue to have a strong environmental and social governance program. Respect for associates, the law and the land is fundamental to our business and guides many important decisions.

Now I'm pleased to open the call for questions and comments.

(Operator Instructions) Our first question comes from the line of Buddy Bugatch with Raymond James.

I guess, the number -- the number that strikes me and just hits me in the face is the comparable and total written orders at retail. And I don't understand how those jive with what you say is your being well positioned for growth in the upcoming year and quarters. Please help me connect those dots because those are big numbers being down 11.4% and 10.8% from the quarter?

Yes, Budd, and that is a big number. And that is a reason, as I said that in the second -- in the third -- in our third and the fourth quarters, we did spend a lot of money on national television. And as I said, the impact of it has been good for our brand, but it lacked the urgency to bring traffic, and our traffic was down resulting in this lower traffic. Now the good news is, we started back in June in terms of a more balanced and a very strong balanced advertising program this quarter. So we expect that, yes, we have to make up the difference that you say, but we have an opportunity of making it up with a much stronger balanced advertising program that we have started now and it's like slightly spending less money. But we believe we have an opportunity to get more traffic and that should help us rebuild the written sales.

Okay. Are we starting to see that now as you've gone -- started in June. I don't know if you started early June or late June to do that. But we're now at least much through July. What can you tell us about the impact so far?

It's a little bit early in the sense that as you know, we do most of our business -- lot of our business comes in the last few days of July, but so far, the prospects look better, they look stronger. And we are looking for a stronger August and September. And of course, time will tell, but I think we are getting positive news. And that's why I say that we are back, hindsight is 20/20. We shouldn't have spend as much as we did on that TV campaign. It was well -- people liked it, but it did not create urgency. And we were back to a more balanced advertising program. And I think we're already seeing some benefits of it in July. But we'll see a lot more in August and September, and going forward too.

Okay. And you talk about increased backlogs. Can you kind of parse the backlog for us as to how much of that is backlog associated with the GSA over the State Department program? And how much is associated with normal business from dealers or from others?

Well, Corey can give you more details. However, at this stage, we are talking about a major backlog as you -- as I said, is in the wholesale side. And that to a great degree represented -- represents business from the contract, which is GSA and international.

Okay. And 2 last questions from me. One is kind of a housekeeping question. Can you give us actually the advertising dollars spent in the quarter? You said, I think $15 million. I think 15% above what I had -- got me to about $13.5 million in the quarter. So I obviously don't have a number right somewhere.

Yes, go ahead, Corey. We have the...

Yes, the advertising in the quarter was $13.5 million.

Was $13.5 million. Okay. So it is right. And you closed 10 design centers, I think internationally? Where were they closed?

Budd, a lot of those was small studios that have been experimenting in Germany. And most of them were in Germany.

I see. Okay.

Now also let's talk about advertising, Budd. As Corey mentioned, we spent $13.5 million as against $11.7 million in the previous year. And keep in mind also in the first quarter of last fiscal, this is what we're going to compare with this, we spent $7.4 million. So we have $13.5 million, and now we spent $7.4 million in the first quarter of last year.

Do you think you're going to spend that much in the first quarter of this year again? Or is it going to be less than the $7.4 million?

No, no, it's going to be about that level. It's going to be much less than what we were running in the third and the fourth quarter.

But not less than what you ran last year in the first?

No. I don't think so.

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

So I wanted to just come back to the advertising for a second. And just -- I think I had like $9.8 million that you spent in Q1 of 2018. Corey, can you confirm?

No. That's Q1 of '18, no.

Wasn't 5.4% of sales?

It was $7.4 million, 4.1% of sales.

Okay. And I'm sorry, the number that you're expecting now for this year is going to be or the range?

Corey, I mean, approximately the same range, Jeremy.

Okay. So it maybe $7.5 million, $8 million. And just in terms of thinking about how to drive your orders. So you're -- you weren't happy with the results from national TV, which was expensive, excuse me, and not that effective. So you're going to go back to more digital spend, you're going to go back to more targeted spending. I think you used the word balanced. In terms of -- is there other things that you think you need to do to really drive sales in written order traction? Do you need to crank out more new products? Because it seems to be that when you have products that resonate, that's been when you've seen an acceleration in orders.

Yes. In terms of our advertising, we have -- the balanced -- what we did was we spend as much as we did on national television, Jeremy. We did not spend much or we spent much less on direct mail. And we could see the difference. Our customers not receiving our direct mail, again, hindsight is 20/20, there -- we could see the difference. We could see the fact of not sending our direct mail to prospects. So we immediately went back, and that's what we did some in June, but we're doing more aggressively in July, August, September and going forward. In September, we will be introducing our newest product line, which is under that umbrella of artisans, which is more than that. This is a very strong product program that will be getting into our design centers next month. And then, we start our marketing in September with a very strong marketing program including a 116-page direct mail beautifully done. It shows the new Ethan Allen, a more eclectic, it's more modern and classic. And that will be sent out in September and October and also with a strong digital advertising to go with it.

Okay. Turning to your gross margins. I believe that there was a comment Corey made that your retail mix of business, you expect it to continue to be a little bit lower because of the strength of the GSA contract among others. I think you said, 75% to 76%. Now when you've been seen sales down at those levels, your gross margins have been more in the, let's call it, 53.5% to 54.5% range. Is that kind of what we should be expecting in 2019, Corey?

Well, what we'll see this year is a little bit of a benefit in that, our manufacturing have gotten through all of that first production challenges of making that new product for the State Department. So I'll have a little bit of a gain on the efficiency side. So that 54.5% is still probably the neighborhood of where we'll see the margins, 54% to 54.5%.

And Jeremy, if you take a look at our third quarter this fiscal '18, we had a 53.3% gross margin, and we ended up the fourth quarter with 54.1%. And despite the fact that we did have a strong presence -- and shipments in for our State Department as well as internationally, because when the retail -- overall retail division sales as a percentage of the total are lower, that does impact the gross margin. Despite that, as Corey said, our improvements in our manufacturing in the fourth quarter reflected 54.1% in gross margin from a 53.3% in the previous quarter. So that range approximately is something that we should be looking at.

And then also in the fourth quarter, Jeremy, we didn't get the full benefit of the price increase that we took in April. It took a little while to work that through this system.

Did that have any negative impact on your orders, the price increase?

No.

No, not really. I mean, even though, Corey, talks of our price increase, the fact is, Jeremy, as you know, on one hand, we take price increases on the other hand, we do give even much better values and sales to the customers. So the net-net, it is -- our products are not more expensive or higher priced. So I think at the best, we sort of come close to breaking even.

Okay. Fair enough. As I look ahead at your SG&A. Clearly, you're expressing some regret on the ineffectiveness of the advertising, the additional dollar spent. And that was certainly, a decent chunk of your overall increase for the year. I think it was about $6 million or $5.5 million, $6 million of incremental SG&A spent. When you look at your business now and it's hard to project any significant kind of sales acceleration. Do you feel comfortable with the level of SG&A spend? Do you think that there are -- is a need to maybe tighten that down a little bit? Are there opportunities to tighten that down, any comments?

Yes, Jeremy, we always look. Every year, we follow -- all our budgets are based on a zero-based budgets, always. We take a look at what we need to do. The last quarter 4, we had -- we spent $95 million -- of our SG&A was $95 million. And again, you're right, advertising increased it. In the first quarter of last fiscal year, there were -- our SG&A was of $88 million. So -- and this wasn't a fairly important increase that took place. So I think that if you take a look at between $90 million and $95 million some where we had that opportunity.

Okay. So but nothing meaningful?

Closer to $90 million.

Nothing on advertising.

Nothing on advertising, yes.

Okay. Fair enough. And then, I just wanted to clarify. Corey, did you say the tax rate to expect for next year, was it 23.5% to 25%. Is that the number you said?

24.5% to 25.5%.

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

So following up on Jeremy's question, with all the puts and takes, I mean, it's your expectation that the operating margin would be flattish for fiscal year '19? Or could you see some expansion and where would that come from?

Well, our fiscal -- our operating margins in fiscal -- if you take a look at our fiscal '18, our operating margins, excluding any special items was 6.5%. And in that last -- in the fourth quarter, it was 7.9%. And so I would say that we already made improvements in terms of taking it to almost 8%. So I would say that opportunity -- of course, it -- we have a tremendous leverage. When sales increased, we had operating leverage at all levels from retail to manufacturing. So we have an opportunity within 8%, 8.5% -- around 8%-or-so is an opportunity that we have.

Okay. And then just going back to the sales and how the quarter progressed. You stayed high on promotions with a fair amount of free delivery offers. How is the customer responding to those? And also can you talk about the reception to the Uptown collection that was launched in May?

I'll first -- Uptown has been extremely well received all across the country, and continue -- the passport has also been well received, which was done before that. And I believe that the reaction by our own teams to the new artisan has been extremely strong, and we're going to start getting it into our design centers next month. And as I said, September, we start launching the national -- our major advertising campaign nationally, launching direct mail and digital. As far as the question was on...?

On the promotion. The promotional, I mean you're doing...

It's hard to tell that from time to time, but for instance, we just gave last -- about 2 weeks back, we had a 4-day special celebration. Basically, it was like prime days with no delivery. It does, it does help. What it does -- to help in that sense, it takes people who are on the -- who are holding back, perhaps they would -- close end of the month or next month, it helps them close. So that's what happened. And we want to use it very selectively, because once you give it up, we make it available all the time, that it loses its effectiveness.

And one last one. The inventory was up about just $13.5 million year-over-year. And you talked on the press release about supporting the backlog and an expanded stocking program. Can you clarify what that's about?

Well, the inventory was up, again, yes. First with this -- the GSA created an inventory increase both at the manufacturing level and in the finished goods. And good news is, we have to consolidate it. We have to keep it in our distribution centers. So half of that increase really reflected the increase of the State Department contract. And now as we move forward, our objective is to have somewhat lower inventories than what you see.

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

My first question just relates to the various partnerships that you have in progress. As we look sort of on a go-forward basis. Is the $15 million run rate for Disney still meaningful? And are other partnerships excelling through Amazon, some of your hotel deals or real estate agency deals. Are those contributing meaningfully or does it sort of drop down materially after that $15 million or so from Disney?

No, I think the main -- it's a good question, where main -- of course, major has been the State Department contract. The second is our contract in programs that we are launching something like the Margaritaville program that we have in Orlando, where we are furnishing about 1,000 homes and a hotel. That are important components of our outside business. Third one is, we've had a fairly -- we have a good increase in our international business. So international business, our GSA business, our contract business. Disney, we have got -- we have started getting some good business on contract for Disney. The Disney product line that we introduced is holding up a little bit lower than the number that you have mentioned, which has not grown up significantly. Our Amazon business also is above the same as last year. And in both cases, we have really not given it a tremendous amount of advertising push.

Okay. So should I assume then -- I mean just the sequence of relationships you mentioned there after Disney it drops off pretty materially? Or is the Amazon contribution material display?

No, I think the material one as I said, is the government then other contracts, hotel business. No, in fact, the first is, international,. second is -- and especially China, and the second is the State Department's contracts, then GSA. And then third is our other contract business like Margaritaville and even in Disney.

And how did that -- in the State Department contracts, how did the orders of $24 million, I think compared to the revenue? And sort of now that the operation is running a little bit more smoothly. Sort of what uptick to margin can we expect from a smooth GSA operation?

Justin, this is done on a competitive bidding. This is almost like eBay. So we have almost -- to get this contract, we really have to be very, very aggressive, which we have been. And that does have an impact on margins. It has a double impact on margins because most of these products to win, we had to be very competitive. Second, we had to make these products in our plants, the first time. So it affected the plant margins. But as Corey said in the fourth quarter, our plant margins went up, our overall gross margins went up. And we are now in the process of -- I mean, we've gotten it through the system and it will -- it is going to make positive contributions. But as I said, we have $24 million but it's very competitively bid.

Okay. So is the fourth quarter than representative of normal operating conditions with the exception of sort of the seasonality that tends to make fourth quarter higher revenue quarter?

Yes, I would say that if you're looking from a gross margin and operating margin level more or less, I think those are -- those are numbers that you can utilize.

Okay. And then finally, and this is sort of an open ended question/comment. Given the difficulty in the retail environment with sort of the consumer dollars seemingly moving a little bit away from the furniture category versus prior years. Are there sort of out-of-the-box things that Ethan Allen can consider partnerships, mergers above and beyond sort of out-of-the-box organic initiatives. I mean, are there things that are -- you're thinking about may be you haven't discussed that fit that bill that might be able to sort of take the company estimate as trapped that we're seeing in the retail and furniture space?

Justin, we're always looking at options, because we all must. So yes, you're right to the retail, there have been so much of change that has taken place in retail at all levels. And so we have a great opportunity of leveraging what we have done. We do need, which as you see even in our fourth quarter that we did have an increase in sales, we had increase in gross margins, our operating margins were good, but it would have been much, much better if it didn't have this big advertising expenditures that we have. So we are positioned well, and our leverage is that we need to increase the top line, we have to increase our written sales not go down as we did last quarter. So we have that opportunity and our biggest opportunity is taking the retail network of 200 design centers and leveraging that and doing more business. Having said this, we are always looking at opportunities that will be consistent with our business, with our philosophy and all of that we're always open to look at.

And we do have a follow-up question from the line of Buddy Bugatch with Raymond James.

I've got a few more questions. You talked about the fact that the State and GSA was a $24 million number for the year. If I remember the State Department contract, it's like about $60 million a year. If that's true because it was a $300 million 5-year contract. Did they under spend on that? Or did you -- was your penetration around 40% of the government spending?

That's a good question, Budd. I'd tell you, it did start at $60 million, but that was when it was not on a competitive bid. When they put it on a competitive bid, the government really benefited because that reduced it by a certain amount. The second is possible that the government -- the State Department, as the rest of the government is spending less money this year than they did in the past. From information we have, we got a very substantial portion of the orders. And yet of course, the most of the orders do come at the end of the fiscal year, which is going to be October of this year. That's just in the last 6 weeks or so the government does give a fairly large orders. And that's -- we will see what then happened, but a lot of this -- the $60 million was impacted by this competitive bidding and the discounts everybody were giving.

And how much was the state or a government business during the fourth quarter? What percentage -- what was the number of business up to $24 million? How much was in the fourth quarter?

Corey, I mean if you want to take a look at it and maybe get back to Budd. I don't have it here, Budd. Corey will look at it and also we'll see how much of information we can give this out. Even I'm surprised that Corey gave this number out of $24 million. Normally, we don't say, but he had already said it that we had that. So to look at it.

It's hard to put that toothpaste back in the tube, I guess.

I know, I know.

I thought it was our first year, I'd give you just an idea.

Now he used the toothpaste, Budd, okay.

And so then the next question I have is. Do you expect that retail sales, I think the comparable retail sales delivered retail sales for the quarter was 2.3% if I did the math right and you gave the comparable numbers. Do you expect retail to be up in the first quarter, it doesn't look like with a negative order number that you can do that, it kind of will be a Yoeman recovery. So I don't think you would see up retail revenues in quarter 1. Is that a fair commentary?

Budd, it is fair. It also depends upon our July business, our August business, because today one of the other thing that we have done, which is positive and also challenging, we have reduced our delivery times, which creates an opportunity for us to deliver faster. But on the negative side, it also creates an issue in our manufacturing and running it on a consistent basis. A few years back when we delivered our products in 12 or 14 weeks, our manufacturing was always running consistently. Now when we do it the way we are doing and orders don't come consistently, we have to reduce our work in our manufacturing. So a lot of factors have to be taken into account, but it is going to be somewhat of a challenge this quarter. But we are looking forward to July and August to see how much of that we are able to make up.

Well nothing happens bad by running the business on a more efficient way. So I think that's in all positive. But I'm just trying to -- we have a job to do to try to come up with estimates and we want them to have rational basis. So trying to make sure that at least.

Budd, your comments are fair, but I think that, as I said, and you know I know that you had also looked at that advertising and you had a smart fellow you had given me your comments ahead in what was March or so. This beautifully done, very well received by all our network, we got a standing ovation. But there's something missing, which was, it did not drive traffic. So we have changed it. We've seen the impact of it. I would take what happened in our second and third -- I mean third and fourth quarter somewhat extraordinary because we're back to where we need to be but we got to build the business as you rightly said. I believe that we'll be able to do a fair amount of it. Now can we deliver it in the quarter? That will be somewhat of a challenge because as you also saw that we have caught up in the deliveries on the retail side.

Okay. And my last question is when will the 10K issued?

Expect it in the next week or so.

And you have a follow-up question from the line of Justin Bergner with Gabelli Group & Company.

The tariffs, sorry the 6% that you import from China, will that be subject to tariffs such that you'll have a leg up on competitors that import more from China?

Well, one of our competitive advantage is the fact that we manufacture 75% of our products in North America ourselves. It's a challenge also. The challenge is that if we are not keeping them busy, we have an impact on margins, it's positive when we have leverage, it's also negative when we are not keeping our manufacturing busy, if we're buying products from overseas and we're going to worry about manufacturing and variances and all that stuff. Having said all of this, we do have an advantage relative to folks who are buying lots of products from, at this stage, it is China. But as you know, product does not come from China also, it comes from the Vietnam, it comes from other countries as well. So we do have an advantage from that perspective.

But are tariffs actually in effect on that 6% or part of that 6%?

No, it's not. I think is something that is proposed and it is going through some review. And then they will -- based on review they will then make the final determination, as I understand it.

Okay got it. That's what I thought, but just wanted to clarify. And then there was a small adjustment I think in one of the segments and add back. What did that relate to couple of hundred thousand?

Yes, that was related to the costs associated with the purchase of assets by our retail.

There are no further questions at this time. Do you have any closing remarks?

No, well good. I know these are good questions. As you all folks heard, we had a good quarter in terms of deliveries, in terms of earnings. The challenge was the written and I know even you understand it and that's why we've been working hard to make sure we put into place programs that we can increase our written, and that will help us use our operating leverage on the retail side as well as on the manufacturing side, and we have that opportunity. So thank you for participating. And any other questions, please let us know.

Thank you for participating...

And Terry, Thank you very much.

You're very welcome. Thank you for participating. This does conclude today's call. You may now disconnect.