Corey Whitely - Ethan Allen Interiors, Inc. M. Farooq Kathwari - Ethan Allen Interiors, Inc..

Cristina Fernández - Telsey Advisory Group LLC Justin Laurence Bergner - Gabelli & Company Beryl Bugatch - Raymond James & Associates, Inc. Jeremy Hamblin - Dougherty & Co. LLC.

Good afternoon, and welcome to the Ethan Allen's Earning Release Conference Call. It is now my pleasure to introduce your host, Mr. Corey Whitely, Executive Vice President, Administration and CFO. Thank you. You may begin..

Yeah, thank you, Anna. Good afternoon, and welcome to Ethan Allen's conference call for our fiscal third quarter ended March 31, 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, and good to have you all on our earnings call. As we discussed in our April 10 investor meeting, we are positioned well to grow and service our business.

We have strengthened many initiatives, including expanding our presence as a premier interior design destination, multiplying our fashionable and relevant offerings, leveraging our vertically integrated manufacturing and logistics and most importantly increasing our marketing.

We're also pleased that we have continued to increase the cash dividends this year by 64.7%. We've also repurchased about 2% of our outstanding shares this month, and the Board of Directors increased share repurchases to 3 million shares.

After Corey provides a brief financial overview, I will provide further information and open for questions and comments.

Corey?.

Yeah. Thank you, Farooq. Consolidated net sales for the third quarter of fiscal 2018 increased 0.5% to $181.4 million. Our manufacturing made good progress during the quarter and working through the production challenges from the first half, which helped to drive the 7.3% increase in wholesale sales.

Retail sales decreased 3.6%, primarily due to delayed shipments from wholesale. The retail backlog increased 15% compared to prior year, and now with our manufacturing moving past the earlier production challenges, we expect the retail order backlogs to come back down over the next several months.

Our consolidated gross margin for the quarter was 53.3%. The mix of retail sales as a percent of consolidated sales was 75.5% for the quarter, compared to 78.6% in the prior year. Strong wholesale shipments, including shipments to retail and for the government contract drove the change in mix, which was a primary impact to gross margin.

Higher raw material costs also impacted our gross margins. Our adjusted operating expenses were $92.3 million, and our advertising expense increased by approximately 20% during the quarter. Turning to the balance sheet, our cash and securities totaled $52.1 million.

During the quarter, we paid out dividends of $13.8 million, including the special dividend. And fiscal year-to-date, we have paid $24.3 million in dividends, a 65% increase over the prior year period. We ended the quarter with no debt outstanding under our credit facility.

Our effective tax rate was 31.2% for the quarter and 24.4% for the fiscal year-to-date period as a result of the Tax Cut and Jobs Act (sic) [Tax Cuts and Jobs Act]. We expect our effective rate for the full fiscal year will be approximately 26% and for fiscal 2019, we expect the effective rate to be approximately 25%.

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

in May, as we introduced the timeless, attainable elegance of Uptown; and in September, with the introduction of Artisan, a modern projection of mid-century style with all the attention to detail and quality that Ethan Allen is known for. We have increased our marketing by 20% from last year quarter, including a strong national television presence.

We continued to increase our advertising in the fourth quarter by about 11%. In addition, due to a larger wholesale business, we expect the gross margin to be in the third quarter range.

We have expanded our vertically integrated structure of manufacturing and logistics to be in a better position to service our North American Retail, international and U.S. government business. Adding technology on all areas is a priority.

Last quarter, we shipped out more than 1,000 newer tablets to our interior designers to enable them to be productive and provide personal service with the technology clients expect. We also continue to invest in state of the art machinery and software to refine and improve our manufacturing business.

Conducting our business in a socially responsible manner continues to be a priority, both within our organization and in all our relationships with outside suppliers. As we mentioned in our April 24 press release, the company will pay a regular dividend of $0.09 (sic) [$0.19] with a record date of July 10, and a payment date of July 25.

We also advised that in April, the company repurchased approximately 2% of our outstanding shares and the board authorized a repurchase of up to 3 million additional shares. We plan to repurchase in keeping with our policy of prudence and the goal of maintaining a strong position of liquidity.

I am now pleased to open the discussion for any questions and comments.

Anna, are we ready for question and answers?.

And we have a question from Cristina Fernández..

Yes. Hello, Cristina..

Oh, hi, good afternoon. Farooq, I wanted to clarify your comment on the gross margin for the fourth quarter, that it would be similar to the third quarter. I wanted to make sure that that's what you meant, the 53.3%.

And also, can you help us break down when we look at the gross margin compression for the third quarter, how much was it due to the manufacturing inefficiencies and how much is really through like a true sales mix with the normalized wholesale margin?.

Yes. Cristina, gross margin in the fourth quarter will be close to what we had in the third quarter. Now, the third quarter gross margin was impacted by a number of factors. The first main one was the retail, total retail business to total business; it was about 75.5% versus about close to 79% in the previous year quarter.

That mix is a very important factor, as you know the retail has a higher gross margin, and of course, the positive news was – news is that it was due to the fact that we increased our wholesale business mostly to the government contract.

The second factor on the gross margin was impacted, I would say about 1% or so of it was impacted due to increase in raw material costs in the third quarter and those costs are still going to be there even though we've taken a price increase as of April 1st, some of that will show in the later months..

Okay. Thanks.

And then, on the SG&A side, the increase was a little bit less than what we had expected, given how much you increase marketing, what were the offsets to that higher marketing spend that allow you to control expenses better?.

Well, one of the things was, which I had mention at the investor meeting, was that we decided especially, myself included that we would – that I would not take some of the restrictive stock that had been given to me. I decided not to take it and that became a credit and reduced our expenses in the third quarter.

In addition to this, also some of the restricted stock that was – that would have been given based upon performance was also went back to reduction of our expenses, it was about $1.6 million credit that we had in expenses in the quarter..

Thanks.

But we should think about this being just specific to this third quarter and not recurring going forward?.

That's right. It was specifically in third quarter..

Yeah. Thank you..

And your next question comes from Justin Bergner..

Yeah. Hello, Justin..

Hi. Good afternoon, Farooq.

How are you?.

Thanks very much.

Now, Justin, we are buying our shares, you see that, right?.

Yes..

All right. Go ahead..

Okay. Just I wanted to ask question about that, but just a couple of quick clarifiers, for the last question.

Is the $1.6 million credit to restricted stock inclusive of you're not taking the restricted stock that you would normally take or is that on top of the $1.6 million?.

No, it was. Actually what it had happened was, Justin, last year, fiscal 2017, I told our board that I would not, should not be considered for any cash bonus and what they did was, they decided to give me about $0.5 million in restricted stock.

And I, but it was given in fiscal 2018 even though it was a fiscal 2017 and this quarter I decided not to take it..

Okay, but that's within the $1.6 million, so $1.6 million doesn't become $2.1 million?.

No, it is $1.6 million. (00:12:22).

Okay.

And then secondly, in regards to the comment about the gross margin being similar to Q3 and Q4, the small add back to adjusted wholesale operating margin, that $500,000, does that add back to the gross margin or does it affect the SG&A?.

No, it's an SG&A..

Okay. So, the gross margin is sort of as reported for purposes of modeling..

Yeah. Yeah..

Okay. And then on the repurchase, clearly you've gone from a slow rate of repurchases to a pretty dramatic rate in April.

I mean what is sort of the timeframe that's anticipated for this $3 million share repurchase and I assume that is beyond what you'd purchased in April, the $3 million?.

Yeah, it is beyond what we purchased, that's right. As I mentioned in my comments, we'll use some good judgment.

As we have done in the past, I want to make sure that we'll continue to buy, repurchase our shares back in keeping in view liquidity, see how business conditions and the stock price, and we have purchased now close to 42% of our company back since we went public. So we have been doing that and will continue to do that.

I don't think that – the prices are relatively low. We'll buy it, but I also want to make sure that we don't put too much pressure on our cash flow..

Okay.

And then, lastly, any comment on sort of April month-to-date trends?.

We get about 50%, 60% of our business in the last five, six days of the month, so we will see. We have a very, very strong national television campaign. We have seen in the last week or 10 days, increase in traffic. The first week or two are somewhat slow because Easter Passover fell in that time period this year versus last year it was in March.

But in the last week, 10 days, we have seen an increase in traffic. And we expect it to have a positive impact in the next seven, eight days..

Okay. Thank you..

All right. Justin..

And your next question comes from Budd....

Bugatch..

Bugatch. Yes.

Yeah, Bugatch. Hello, Budd.

How are you?.

I'm all right, Farooq.

How are you?.

Your name is as – my name is easier than yours, Budd..

Well, that's good, Farooq. Talk a bit about advertising. I think it....

Yeah..

...came in a little bit more in terms of expense than you initially told us, and can you talk about the fourth quarter and where you think it will come in for the year?.

Budd, I think it came in pretty close to what we had said. We had said that we would be spending about close to 20%, and that's what we did. In this quarter, we're continuing to run national advertising. We ran it in April. We'll run it in May. And then, after that instead of national, we'll look at perhaps some national cable and things of that nature.

I would say that at this stage we are looking at the spending in the next quarter close to I think the fourth quarter, most probably we'll spend close to $13 million in advertising..

$13 million, did you say?.

Yes, $13 million. Yeah..

Okay. Okay..

Which is about an 11% increase..

Okay. And your backlog is up substantially, particularly in wholesale.

Will you be able to deliver most of that in the fourth quarter?.

I would not say most of it, but I think that, yes, we will make a big impact on it in the fourth quarter and some of it will go into the first quarter of next fiscal year..

And can you characterize how the State Department orders have come in for the quarter and how much of the backlog is state?.

Well, in our wholesale, maybe we have – Corey mentioned we have about a 67% increase in wholesale..

Right..

67% in wholesale. I would say a fair amount of that is the government contract and we've continued to receive new orders, Budd, from the government..

Okay. And talk a little bit about the foreign business for the quarter, overseas business.

How was that?.

Overseas business has also been positive, especially in China. We have also opened up, with our licensees, we have just opened up an Ethan Allen in Cambodia. We have opened up a small one, an Ethan Allen in Indonesia, opened in a few months back in Taipei. So we're making progress. But China, of course, is a major one.

And I was recently there, as you know as I mentioned at our investor conference, major design center they opened in Chengdu, which is the capital of Sichuan province. So China has continued to grow..

Okay. And you had originally said that you would be probably spending in SG&A for this quarter $94 million to $95 million, I think as Cristina had expected. And of course, the offset for your earn-back of the restricted stock and the incentive comp took that down.

Where do you think we come in at the fourth quarter? Is there a number you're comfortable in talking about for operating expense?.

Well, I would say that I think Corey and John are here, but I would – it is, it also depends upon our deliveries, especially in the retail because as you know, our retail expenses go up, based upon deliveries and also depends upon number of business we do this quarter.

So I would say that, that it we expect – again, it all depends on the top line, but really we expect it to be in the range of 44%, 45% of our total sales..

Okay. All right. Thank you very, very much..

Thanks, Budd..

And your next question comes from Jeremy Hamblin..

Yeah. Hello, Jeremy..

Hi. Good evening. Thanks for taking the questions. I want to come back to the gross margins for a second here. I think it sounds like about 100 basis points of the year-over-year impact is due to raw material costs. Some of that's kind of hard to control.

How much of it would you attribute to kind of execution inefficiencies on your end versus the competitive pressures that you're seeing out there, more discounting from some of your peers on a year-over-year basis?.

Yeah. Jeremy, that's an important challenge and a question because we are. There is a pressure. Lots of discounting going on and we are meeting that to some degree, not to the level of what we see out there. So, I would say that if I had to characterize it, I would say that most probably 50% of our gross – 50% plus is due to this mix.

Then we have a prior raw material increases. And then also the impact of some inefficiencies due to the making of these new products that we have done that we are making in our plants. So, I would say it's a mixture of all those factors..

Okay. And then in terms of – you know it's always a tough call on incentive compensation. When you look back in the year, I think it probably – profitability hasn't been quite where I think you guys had envisioned at the start of the year.

And just again, kind of a similar question of – you know you have seen compression, primarily on the gross margin line item, but your overall operating margins are on track to be down likely over 100 basis points for the year.

How much of that again is related to the competitive set versus prior expectations? I mean, I think any time if you're not taking the kind of incentive compensation that's really an indication that you're maybe disappointed with the overall performance for the year? Could you just speak to that in terms of what do we do moving forward? Do we get more aggressive potentially on some of the promotions yourselves, and you've done that in the past and had some success, but can you speak to that?.

Jeremy, I should tell you this.

I take this very, very unusual steps of making the decision of not taking something that is due to me, sometimes I contract, sometimes I decide what the board gave me, but I – the reason I did it, because I felt that our – many of our associates will not get too much of our – or any incentive, and even though this was what I decided to take, give back was for last year, but I decided to give that back.

Overall, I think that, that was probably relatively just smaller impact on our earnings. On our gross margin, I would say that it's a – the maximum or maybe 70% or so I said earlier is due to the mix and the rest is due to price, due to duty increases in raw material cost and maybe 15%, 20% impact of somewhat higher as you say discounting..

Okay. And just that's a honorable thing, certainly to turn that down. Just coming back to the point that you're making about mix.

So, historically, your wholesale margins have been significantly better and as you've seen the percentage of wholesale businesses is up quite a bit this year and your retail segment is going to be down I think $10 million to $15 million. I would have thought that might have had a positive impact on your overall mix.

Is there any conclusion we can draw at this point on the State Department contract, is that may be relative to the rest of your wholesale businesses that are negative from a margin standpoint versus the rest of your wholesale business?.

No. It is not. I think that we had in this quarter, we had the impact of expanding, increasing our capacities in – especially in North Carolina and because of the government contract. And there is lot of inefficiencies, when you hire a lot of new people and you put a lot of new product in, but most of that I think is behind us..

Okay, great. Last question, I wanted to just come back to the Amazon relationship. I think that was kind of an exploratory deal from last summer.

I don't know that it's gained significant traction at this point, but any learnings that you've had from that, that partnership, that's helping you to drive or change the way that you're doing your own e-commerce business?.

Our e-commerce is increasing from a relatively smaller base; 40%, 50% increase we have seen in the last few years, still relatively small. And what's happening is this that at Amazon, we got a great relationship with them. We have great looking designs, Ethan Allen Design Studio on their site.

What we are not doing is really spending a lot of money in advertising on their site, which makes it possible for you to have your products go up. People are coming in if they want to look at Ethan Allen, it is there. They can live chat with our designers through the Amazon site or they come to us.

So, as you know, our objective is to bring more people to our digital sites because 60%, 70% of the folks do their window shopping on our digital mediums, so any mediums where they are able to get to our digital mediums and help us bring traffic into our stores is important and that's what we are doing with Amazon..

Great. Thanks for taking my questions. Good luck the rest of the year..

All right, Jeremy. Thanks..

And your next question comes from Justin Bergner with Gabelli & Company..

Hi, Justin..

Thanks. Thanks for taking my follow-up.

With respect to the fourth quarter gross margin, are you expecting the retail sales as a percentage of overall sales to also be consistent with the third quarter?.

Yes.

Corey, is that right?.

Yes..

Yeah, it will be in that range about 75% or so. We had 75.5% and in that range is what is going to be. And that's okay as long as the reason it is at 75.5%, not 78% is because we've got higher business in the wholesale. Objective really is as we move forward is to improve our operating margin..

Sure.

And then the raw material headwinds, which I think you said were about half of the year-on-year gross margin – sorry, about 100 basis points of the year-on-year gross margin decline, when and how do you sort of catch up to those raw material headwinds?.

Well, we did take a price increase of about 3% or 4% in April 1 this month. However, as you had also indicated or mentioned earlier, that we have to not only take into account the price raw material increases, we have to also consider the competitive environment of what kind of a discounting we are giving.

So, all of those factors impact the gross margin. Also our ability in terms of improving our efficiencies in our manufacturing is important, so I would say that we'll – in terms of catching up, any business we do in April generally, it is within 45 to 60 days is when we start seeing the benefit of that..

Okay. I guess what I'm trying to figure out is, you mentioned that the residual impact beyond mix and beyond cost pressure was a small amount of sort of I guess pricing impact on gross margin.

I'm just trying to figure out, is the pricing impact really larger than that residual impact because you're not going to be able to catch up on that full 100 basis points of raw material inflation?.

Well, as I said, this last quarter, it was 1%. The chances are, without a price increase, the impact would be greater this fourth quarter. Our price increases will help, but then also, there are a lot of other variable factors. The question of discounting, how much do we discount our products.

The question about the overall volume increase, but that also has an impact on our overall margins in terms of efficiency, both at the manufacturing level and at our regional level. As you know we're vertically integrated company. So we do get leverage on both sides.

That is an sales increase, it is positive in terms of our manufacturing, it is positive impacts on our logistics, positive impacts on our retail. If on the other hand, they go down, it's negative on all – all of those..

That's very helpful. I mean is there something that changed though to sort of accelerate the competitiveness of the underlying environment versus, call it, a year ago. It just seems like things are getting a little more challenging.

I was just curious if you could put your finger on anything in the competitive environment?.

For us as I said – for us, I do not say there was a big impact from if you're talking about our sales, our margins. On the margin side I mentioned the factors, as far as overall environment is concerned, of course, it is very competitive. As most folks in retail are giving all kinds of discounts at every level. So it is certainly competitive.

But if it wasn't the fact that we have 1,500 interior designers that we are a interior design company and that we are – that we have a great history of quality and great service. The chances are that we would not be in a position that we are today, so we're in a much better position than a lot of folks in this industry..

Okay. Good luck in the rest of the year..

All right..

And we have no questions at this time..

All right. Anna, thanks very much and thank you for being on the call. I know we just had an opportunity of talking and seeing most of you at our Investor Conference. Any other questions, please feel free to let us know. Thanks very much, and thank you, Anna..

Thank you. Ladies and gentlemen, this concludes today's conference call, you may now disconnect. Thank you for your participation..