Corey Whitely - EVP and CFO Farooq Kathwari - Chairman and CEO.

Budd Bugatch - Raymond James Jeremy Hamblin - Dougherty & Co Cristina Fernández - Telsey Advisory Group Justin Bergner - Gabelli Group.

Good afternoon. My name is Carey and I will be your conference operator today. At this time, I would like to welcome everyone to the Ethan Allen's Earning Release Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. 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, Carey. 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% percent increase in wholesale sales and the 1.9% increase in retail sales.

The wholesale increase reflected 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 continue 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 US. The balance of our product assortment is sourced throughout the world. Approximately 6% of our consolidated sales represent products sources from china.

In regards to Canada, some of our upholstery products that we export to Canada became subject to a 10% surtax that went into effect July 1. 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 Cut and Jobs Act. We expect our effective rate for the 2019 fiscal year will be in a range of 24.5% to 25.5%. With that, I would 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 incurious design network of 200 design centers in North America and about 100 internationally. 20% of our design centers have been relocated within five years and 69% within the past 15 years.

During the past year, we opened several new design centers and relocated others in 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 three 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 2020. We should not have invested as heavily in national television at the 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 refresh website, 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 act that lets clients 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 continue 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 our 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 Budd Bugatch with Raymond James..

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 as you're 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% in the quarter..

Yes. Budd. And that is a big number and that is a reason, as I said, that in the second -- 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 in fact slightly sending less money, but we believe we have an opportunity to get more traffic and that should help us rebuild the written sales..

And are we starting to see that now, if you've gone -- it started in June, 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 – a lot of our business comes in the last few days of July, but so far, the prospects look better, they look stronger and we're looking for a stronger August and September and of course time will tell, but I think we’re getting positive news and that's why I say that we are back, hindsight is 2020.

We shouldn’t have spent 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 or with the State Department program and how much is associated with normal business from dealers or from others?.

Well, Corey can give more details, however, at this stage, we're 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 two last questions from me. One's 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 obviously don't have a number right somewhere..

Yeah. The advertising in the quarter was 13.5 million..

It was 13.5 million. Okay. That is right. And you closed 10 design centers, I think, internationally.

Where were they closed?.

But a lot of those were small studios that had been experimenting in Germany and most of them were in Germany. Now, also if we’re talking 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 have spent $7.4 million. So, we have 13.5 and now, we’ve 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?.

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?.

No. I don't think so..

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

So I want to just come back to the advertising for a second and 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 --.

Wasn’t 5.4% of sales?.

It was 7.4, 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, it will be approximately in the same range, Jeremy..

Okay. So 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 a word balanced.

In terms of -- is there other things that you think you need to do to really drive sales and 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 when we spend as much as we did on national television, Jeremy, we did not spend much or we spend much less on direct mail. And we could see the difference. Our customers not receiving our direct mail, again, hindsight is 2020, 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 it 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, but 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 strong digital advertising to go with it..

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 has gotten through all that first production challenges of making that new product for the State Department. So I 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 for our state department as well as internationally, because when the region -- overall retail divisions sales, as a percentage of the total are lower, that does impact the gross margin.

Despite that, Corey said, our improvements in our manufacturing in the fourth quarter reflected 54.1% gross margin from 53.3% in the previous quarter. So [indiscernible] 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, 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, our products are not more expensive or higher priced.

So I think at the best, we sort of come close to breaking even..

As I look ahead at your SG&A, clearly, you're expressing some regret on the ineffectiveness of the advertising, the additional dollars 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 spend.

When you look at your business now and it’s hard to project any significant kinds of sales acceleration, do you feel comfortable with the level of SG&A spend? Do you think that there is a need to maybe tighten that down a little bit? Are there opportunities to tighten that down?.

Well, Jeremy, we always look, every year, all our budgets are based on zero based budgets, always. We take a look at what we need to do, the last quarter four, we spent $95 million of our SG&A, it was $95 million and again, you’re right. Advertising increased it. In the first quarter of last fiscal year, our SG&A was $88 million.

And this was a fairly important increase to face. So I think that if you take a look at the $90 million and $95 million somewhere, we have that opportunity..

Okay.

So, but nothing meaningful?.

Yeah..

Okay.

And then I just want 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%..

Oh, 24.5..

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, is 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 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 the 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 the opportunity, of course, we have a tremendous leverage. When sales increased, we had operating leverage at all levels from retail to manufacturing. So, we have an opportunity, it would be an – around 8% or so is an opportunity that we have..

Okay. And then just going back to the sales and how the quarter progress, 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..

Well, first, Uptown has been extremely well received all across the country and continue -- the passport has also been very 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, launch in direct mail and digital. As far as, the question was on –.

On the promotion, the promotional, you're doing –.

It's hard to tell that from time to time, but for instance, we just gave last, about two weeks back, we had a four day special celebration, basically, it was like prime days with no delivery. It does help.

What it does to help in the sense is, it takes people who are holding back, perhaps, it would close in the 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 out, make it available all the time that it loses its effectiveness..

And one last one, the inventory was up about 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 the good news is, we have consolidated, we have given 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. Our main -- of course, the major has been the State Department contract. The second is our contracts in programs that we are launching something like the Margaritaville program that we have in Orlando, where we are furnishing 1100, about 1000 homes and a hotel.

Those are important components of our outside business. Third one is, we’ve had a fairly – we had a good increase in our international business. So international business, our GSA business, our contract business. Disney, we have started getting some good business on contract logistics.

The Disney product line that we introduced is holding up a little bit lower than the numbers that you have mentioned. It has not grown up significantly. Our Amazon business also is about the same as last year and in both cases, we have really not given it a tremendous amount of advertising push..

So should I assume then that, I mean just the sequence of relationships you mentioned after Disney, it drops off pretty materially or is the Amazon contribution material at this point?.

No. I think the material one, as I said, is the government and other contract hotel business. No. In fact, the first is international. Second is -- and especially China and the second is the state department contacts, the GSA and then third is our contract business like Margaritaville and even in Disney..

In the State Department contracts, how did the orders of 24 million I think compare to the revenue and sort of now that that 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 in a competitive bidding. This is almost like eBay. So we are 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 this product, to win, we had to be very competitive.

Second, we had to make this product in our plants 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 – we’ve gotten it through the system and 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 then representative of normal operating conditions with the exception of sort of the seasonality that tends to make fourth quarter a higher revenue quarter?.

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

Okay.

And then finally and this is just sort of an open ended question/comment, I mean given the difficulty in the retail environment, with sort of the consumer dollar seemingly moving a little bit away from the furniture category versus prior years, I mean 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 -- you're thinking about maybe haven't discussed that fit that bill that might be able to sort of take the company, some of the trap that we're seeing in the retail and furniture space..

Justin, we’re always looking at options and we’re always open to options, because we all must. So yes, you are right. The retail, there has 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 an increase in gross margins, our operating margins were good, but it could have been much, much better, if you didn't have this big advertising expenditures that we have.

So we are positioned well and our leverages 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’re 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 Budd 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 a year.

If that’s true, because it was a $300 million five year contract, die they underspend on that or did you – was your penetration around 40% of government spending..

It’s a good question, Budd. I’ll tell you it did start with 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’ve got a very substantial portion of the orders and yet, of course, 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 six weeks or so, the government does give fairly large orders and that's -- we will see what 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 the government business during the fourth quarter? What percentage -- what was the number of the business -- of the 24 million, how much was in the fourth quarter?.

Corey, I mean, we 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, 4 million normally, we don't say. But he had already said that we have. Didn’t really look at that..

It’s been hard to put that toothpaste back in the tube I guess?.

[indiscernible]..

And so then the next question I have is, do you expect that retail sales, I think the comparable retail sale delivered retail sales for the quarter was 2.3%, if I did the math right, when 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 will be a recovery. So I don't think you would see up retail revenues in quarter one.

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 things 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’re 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're looking forward to July and August to see how much we are able to make up..

Well, nothing happens bad by running the business on a more efficient way. So I think positive, but I'm just trying to -- we have a job to do to try to come up with estimates and we wanted to have rational basis, so I’m trying to make sure that at least –.

Budd, your comments are fair that I think that, as I said and I know that, you had also look at that advertising and you're a smart fellow, you had given me your comments. So this, beautifully done, very well received by all our network, we got standing ovation, but there is 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 and fourth quarter, somewhat extraordinary. We’re going to be back to where we need to be, but we've 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..

And my last question is, when will the K be issued?.

Expected in the next week or so..

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

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 advantages is the fact that we manufacture 75% of our products in North America ourselves. It’s a challenge also, challenges that if we're not keeping them busy, we have an impact on margins, it’s positive when we have leverage.

It’s also negative when we're not keeping our manufacturing busy, if you're buying products from overseas and we don't have to worry about the manufacturing and variances and all that stuff.

Having said all of this, we do have an advantage, relative to folks who are buying a lot of product from, at this stage, it is China, but as you know, product doesn't just come from China also, it comes from 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 this is something that is proposed and is going through some review and then they will -- based on review, they will then make the final determination as I understand it..

And then there was a small adjustment, I think, in one of the segments in add back, what did that relate to? A couple of hundred thousand?.

Yeah. That was related to the cost associated with the purchase of assets in 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 said, we had a good quarter in terms of deliveries, in terms of earnings.

The challenge was the return and I know we do understand it and that's why we've been working hard to make sure we put into place programs that we can increase our return 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. And Carey, thank you very much..

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