Good afternoon, and welcome to the Ethan Allen 2019 Fiscal Third Quarter Analyst Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Corey Whitely, Executive Vice President, Administration and CFO. Thank you. You may begin..

Thank you. Good afternoon and welcome to Ethan Allen's conference call for our third quarter ended March 31, 2019.

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 I provide some brief details on the financial results, our Chairman and CEO, Farooq Kathwari, will provide updates on the business and on our ongoing growth initiatives. We'll then open up the telephone lines for questions.

During the third quarter improved gross margin cost containment within our expenses and a lower effective tax rate help drive a 233% increase in our diluted earnings per share, taking diluted EPS to $0.30 up from $0.09 in the prior year third quarter. Adjusted EPS increased to $0.31 up 182% from $0.11 per share.

Consolidated net sales were $177.8 million compared to $181.4 million an increase of 1.5% for retail net sales was offset by a decrease of 8.9% for wholesale net sales.

The lower wholesale net sales were primarily due to a reduction in sales to the North American retail network the prior year wholesale sales benefited from the late shipments during the first half that were getting caught up during the third quarter.

Contract sales was a source of strength during the current year quarter while international sales weakened. Consolidated international net sales for the quarter decreased 30.2% primarily due to lower sales in China. Our retail division return orders reflected 1.4% increase for the third quarter.

Gross profit grew by $1.7 million in the current year of third quarter driven by 200 basis point expansion in our gross margin. For the three months ended March 31, 2019 gross margin was 55.3% up from 53.3% a year ago due to improved retail and wholesale gross margins together with the change in the retail sales mix relative to total sales.

Retail sales were 78.1% of consolidated sales compared with 75.5% in the comparable prior year period. Operating income was $10.7 million or 0.6% of net sales compared to $3.9 million or 2.1% of net sales in the prior year period.

Adjusted operating income was $11 million or 6.2% of net sales compared to $4.4 million or 2.4% of net sales for the same prior year period. Significant growth in operating income was primarily due to reduction in national television advertising cost and the benefit of higher gross profit.

The effective income tax rate was 24.8% in the current year quarter compared with 31.2% in the prior year due to tax law changes from the Tax Cuts and Jobs Act. During the quarter, we paid $31.8 million cash dividends including a special dividend of $1 per share.

Nine months year to date total dividends paid of $41.9 million reflected 73% increase compared to the comparable prior year period. Turning to the balance sheet, we ended the quarter with inventory of $164.6 million, cash and securities of $25.7 million and $8 million of bank debt outstanding. With that I'll turn the call over to Farooq..

Thank you, Corey and thank you all for participating in our third quarter conference call. I'm also pleased that we are also joined by Mac McNulty [ph] has joined us as the Vice President of Corporate Controller. John Bedford was in this position for many, many years retired.

The positive impact for vertical integration and operating at more normalized advertising expenditures resulted in the strong earnings growth that Corey just mentioned.

Despite lower consolidated delivered sales of 2% gross margins increased to 55.3% from 53.3% and adjusted operating income increased by 150.6% and adjusted earnings per share increased by 181.8%.

We have continued to return cash to stockholders as Corey mentioned our cash dividends of $31.8 million were paid during the quarter, 130% increase over last year.

As mentioned in our press release we continue to strengthen our vertically integrated enterprise with many strategic initiatives including investing in talents, introducing relevant new products, repositioning our retail and our manufacturing and logistics network, investing in technology and operating our enterprise in a socially responsible manner.

On April 17, we announced plans to further improve our vertically integrated operations with a number of initiatives including converting our 550,000 square foot casegoods manufacturing plant in Old Fort, North Carolina to a state-of-the-art distribution center and consolidating casegoods manufacturing to our Vermont and other plants.

Also announced addition of 80,000 square foot to our 714,000 square foot upholstery plants Maiden, North Carolina and moving our distribution operations from [indiscernible] New Jersey to North Carolina.

So we expect to have consolidation cost of $7 million to $8 million, 40% non-cash, invest about $5 million in Maiden, North Carolina, in our upholstery operations and additional about $3 million in conversion of the Old Fort, North Carolina location.

We expect these changes to provide benefit to gross margins by $5 million to $6 million during fiscal 2020 and beginning in fiscal 2021 after the completion of the initiatives provide the opportunity for 100 to 200 basis point improvement to gross margin.

We've strengthened our talent by adding several leaders to our retail network and business development. Continuing to develop the strong 1,500 professional interior design management and interior designers, we continue to strengthen our marketing initiatives with addition of relevant products and strong advertising initiatives.

In June, we plan to introduce our new modern relaxed product programs and a very strong new consumer finance program. We continue to position the design center network with relocations and renovations at both North America and internationally. While our business in internationally were somewhat down as Corey just mentioned.

We continue to be very proactive in opening new design centers with our partners in China as well as Southeast Asia. We continue to focus on technology in all areas of our enterprise including emphasis on customer experience. We have expanded our 3D digital capabilities and are also implementing salesforce, CRM platform.

During the quarter we were impacted by lower orders and shipments through China as we've just mentioned. We have strong marketing programs and expect the orders to improve in this quarter. We're also pleased with the growth of the US Government and contract business. With this brief introduction, happy to open for any questions or comments..

[Operator Instructions] our first question comes from the line of Bobby Griffin from Raymond James. Bobby your line is now open..

On the first I wanted to talk on was just the - in orders. I'm just trying to connect the dots between the 1.4% for the quarter and then the 5% number that we were told through the first two months of the quarter.

Can you help me understand what happened in March and did the business slow down or was there any timing impacts, with shipments that impacted the 1.4% growth..

In March, the incoming return business was lower and that impacted it..

Was there any changes in marketing message or anything or Farooq guessing in your high level view and opinion, what do you think drove the change in trajectory?.

It's hard from month to month I think that there is so many factors that people are concerned about what is taking place in the economy, was taken place internationally all the news. So I think it was nothing particular it was just that, I would think that some of that business just went to April..

Okay, did you see a bounce back in April? Can you give us any color on what April orders look like so far?.

Well its still - as you know yesterday and tomorrow we should get about between 20% and 35% of the business is done in the last two days of the month. So we'll see but rarely I think that we have strong programs in place and I think that we should continue to grow our business as we move into this quarter..

Okay and secondly I wanted to talk on the retail segment and maybe just a little further out view on how or what the pathway is for that profitability in that segment.

Is there some structural changes that need to be done there from a cost perspective or is it just all sales growth driven aspect?.

Well our business is sort of unique in the sense that you have to take a look at our overall margins because our retail margins, retail sales impact our wholesale margin.

So we have lots of program to place and we expect our retail business to growth and that will have a positive impact on the retail profitability and especially in the wholesale profitability. If you were just only the retail business, the chances are some of the retail that we have, we may not have kept them.

But they do have a positive impact on our wholesale. End of the day I want both retail - I want all retail to make - but our retail does provide an opportunity of improving margins at our wholesale level.

And if you take a look at for instance at operating margin of our wholesale was what Corey, about 10% for the quarter?.

Actually it's about 12%..

12% on the quarter. Despite somewhat of a lower delivered sales from the wholesale we increased our gross margins, part of that is of course efficiency and also the impact of the retail is very positive on our wholesale. So it's not we got to combine the two together that's the nature of our business..

Okay and then I guess lastly from me, it's just on advertising spends. You did mention you're now kind of going to run at more normalized levels here in the third quarter. Is that something we can run, run forward in our model as we expect the introduction of relaxed modern coming on.

Is there going to be any big uptick in advertising spend for that introduction?.

No, we see our advertising expense has run anyway between 4% and 6% if you take a look at the last. So I would say at this stage between 4% and 6% is of a normalized rate in the last year, this two quarters were just extraordinary. We didn't get the benefit we thought we would..

Okay, I appreciate all the detail and thank you again for answering my questions and best of luck going forward..

Your next question comes from the line of Brad Thomas from KeyBanc Capital Markets. Brad your line is now open..

I wanted to first ask about trends that you're seeing in China obviously in your press release you referenced some softer trends there.

What are you seeing in that market and what's your outlook there?.

We have number of factors impacted. First was that they had I mean overall our business in China has been weak, in China for our partner as well as others. Secondly, last year they purchased at somewhat of an excess inventory so they had to get out of that inventory. And third was, this whole tariff situation did create issue.

People were concerned and about the fact of as you know, whether how much of the duties are going to be and still are concerned to some degree. All those factors impacted us. Now as we move into our fourth quarter, things are somewhat stable in the sense that they're almost out of the excess inventories they had.

There is a less of tension on the whole issue of these duties and I would say - and they were really aggressive. In fact they just opened up two months back major design center 15,000 square foot in [indiscernible] China and they're continuing to also develop some strong advertising and marketing programs as we move forward in the next quarter.

So I would think that, I would appear to me that the worst is over and we're moving towards more positive direction..

That's helpful. And then, within the wholesale segment, can you give us some more color on, on where the state department came in, in terms of its contribution to 3Q and how you're thinking about the trajectory of that business in your fourth quarter..

Right we don't give the numbers but I would say that, it is positive both in terms of sales and also margins because as you know last year we were committing against a business that was in bankruptcy and it really impacted our margins. So we're back to normalized margins and then also the business is increasing, it's positive developments..

Great and then just lastly for me. I guess as we think about the consumer backdrop proof, a lot of questions about tax refunds and salt [ph] taxes and such.

I guess as you go back and look at your sales in your fiscal third quarter, do you think there was any particular noise or pressure that you experienced because of how tax rates have changed for your customers?.

There is an impact especially if you're living especially let's say in the well to do East Coast communities - people have been impacted with a fact that, we can't deduct the taxes and the taxes, real estate taxes are pretty high. So we have seen some, but overall I think that even though there is a lot of competitions out there as you know.

We have people selling a product - pretty major discounts. But I see overall things are somewhat positive as we go into the fourth quarter..

That's helpful. Thank you so much Farooq..

Your next question comes from the line of Jeremy Hamblin from Dougherty & Company. Jeremy your line is now open..

I wanted to come back to the commentary on China for a second. You've seen pretty significant expansion of the number of retail centers that you have in that geography I think from 88 a year ago up to 102. Given your comments, that it's been sluggish for you and your partner there.

Is there risk, is there concern that we potentially have a closure of the number of centers there? Can you give us a kind of state of affairs in terms of how your third party partner there is looking at the business going forward?.

Well we have seen them being very proactive, aggressive and I would say that also being, so they've not slowed down. But on the other hand, they have been impacted by the slower consumer attitude, more competition over there.

But I've really not seen any slowdown from them as yet in fact of anything they're growing and they're also making major renovations and in fact introducing our newer products in the next six months or somewhat of an aggressive manner. They have more competition but so far they're holding strong..

Okay. And then I wanted to come back to another point that was made.

You talked about your wholesale segment which your sales were down about $10 million in that segment year-over-year, but you saw 500 basis point improvement in the operating margins and I don't know if that's entirely tied to like allocation of advertising expense or but I wanted to see if you could just walk us through that change in profitability dynamic.

Either you or Corey, just and how we're arriving at that 500 basis point higher op margin despite sales being down in $10 million..

I think Corey can add to it. But I would say it's a combination of lower advertising expenses and our manufacturing operating at more efficiently including this question of the state government, the government contract with higher margins. So it would say it's a combination of the two factors that has resulted in this increase in gross margins.

Right Corey?.

Just primarily yet - we have the advertising benefit that helped us well, that really is our manufacturing efficiency in improved production efficiency..

And now as you know, our objective we have one of the few ones which are still manufacturing as much as manufacturing as we have in North America especially in United States.

This changes that we have made will help us to increase our production in Vermont in casegoods and continue to be very strong in upholstery in North Carolina supported by our operation in Mexico.

Our casegoods is also supported by our operations in Honduras and keep in mind, we bought those plants in the last 12 years, Honduras six years back and Mexico about 12 or 13 years back and those are very vibrant, but combination of our United States and the rest of its - North American plant gives us a competitive advantage and as we go forward should further help our operating margins, gross margins and wholesaler [indiscernible]..

Okay, that's helpful. And then I just want to, your backlog looks like it's down about 12% in your retail segment. It's down 22% in your wholesale segment at the end of Q3 and you had a pretty strong Q4 last year with total sales were up 5.5%.

I wanted to just get a sense of I know you don't provide quarter-to-quarter guidance, but with those kind of starting points on your backlog and lapping some pretty tough compares from last year.

how should we be thinking about June quarter, is this kind of assumption that sales will be down given that starting points on your backlog as well as return orders that were, there wasn't significant growth in the Q3..

Well I think, yes Corey can also add to this, but I'm just saying there are two perspectives on this.

In the last year, our delivered sales then got benefit from this high backlogs we ended up in the third quarter due to number of factors including that we've got a fair amount of state department orders that we had, that we delivered those in the fourth quarter.

So our consolidated deliveries - I mean [indiscernible] sales were $2 million and $5 million, but when you take a look at last year on our return orders. Our return orders in our retail division were down 10.8%. Our wholesale was down 5.9%.

So if you take a look at that, we have the opportunity on one hand yes, they delivered the challenge, the return gives us an opportunity because last date was soft..

And then with lower backlogs you got the benefit now of being able to ship product much more timely this year without those heavy backlogs that we were fighting in the prior fiscal year..

I mean we had highest sales, but this time it's much more efficient..

Understood, last question from me. I also, I noted - that you did access some long-term debt for the first in a while. My assumption is that maybe part of that was being used to fund the special dividend and it's not a significant amount, but I think just understand $9 million.

Wanted to just see if you can give some color on thinking about capital structure and use of debt going forward, is that something where you feel comfortable in your cash flow and you make access a little bit more debt, have - buybacks or other things.

Any color that you might be able to provide on that would be helpful?.

First is, we wanted to please all the handlers [ph] we're taking debt because everybody says you folks are [indiscernible]. So I hope the analysts are happy. But having said this, we gave - over $30 million of dividends and that was.

We needed some cash in the short-term to some degree to use our cash on hand and the debt as we go forward we're going to take a look at what makes good sense. I mean you know I'm not interested as you know I've gone through all kinds of bit of 90% debt and we had all kinds of struggle, have gone through all of those things you know that.

So I don't mind taking debt but it makes but as we go forward we'll continue to return money to the stockholders. In the past we've done it. In the repurchase of our company stock.

We purchased, we spent nearly over $600 million of stock we have purchased and so when you take a look at this as we go forward we'll see whether we need to have some debt, but I'm not going to have too much. I've gone through that period..

Got you. Thanks for taking the questions, good luck..

[Operator Instructions] your next question comes from the line of Cristina Fernandez from Telsey Advisory Group. Cristina your line is now open..

I have a couple of questions on the gross margin, so to start on this quarter.

how should we think about off the 200 basis points improvement just the natural sort of help from the mix between retail and wholesale versus sort of lapping with those manufacturing inefficiencies you had last year because it seems like that could have been sort of the biggest component of the benefit this year..

There was a number of factors. We did take a price increase last September, October which also contributed to increase in gross margins. But on the other hand, we're also given bigger savings. So yes, we can have one hand higher margin, but then we give it away on savings so we got a balance out of these factors.

So we got higher - we've got a price increase but then we have higher savings. We have better manufacturing margins and as you can see our retail margins and wholesale margins both improved. The wholesale improved the gross margin level and obviously it improved at the operating level because of this question of this advertising.

So as you go forward it's hard to say but I think the levels that you see, there's an opportunity of maintaining those levels..

And then looking to fiscal year 2020 and beyond, with the plan consolidation you're doing, you quantify $5 million to $6 million next year beyond that another 120 basis points.

Can you help us understand is the initial part of just cost savings and what needs to happen to be able to capture that next leg, the 100, 220 basis points longer term from the specific plan consolidation you're doing..

By producing, by increasing our volumes in Vermont that has an opportunity of increasing our gross margin in Vermont. Second, it will also to some degree add products in our Honduras plant, which has higher margins. Thirdly, some of the product will be outsourced that also increases margins.

So those are three factors that will help us increase our gross margins at the wholesale level and that we see going forward..

And when should we expect this to start contributing next year?.

Well as we said in our press release that we're going to have some benefits in our next fiscal year and then and we'll continue, we should see some benefit next year because we will be consolidating this product.

We're already doing it and into Vermont and to other plants and you also give us an opportunity of certainly there's some start-up cost and things of that nature but I think we should start seeing the benefit of it starting in the next fiscal year..

Mostly in the second half..

Of next fiscal year..

Okay, thank you. And then one last question of marketing, if my math is correct. I estimate about 3.5% of sales was spent on marketing this quarter.

I think in prior calls you talked about 5% spend for the year, is that still the target or should that come in below that 5%?.

No, we spent advertising this year. If you take that is about 4.1%. This is what you - if you take a look at it that is what we spent, this third quarter and as we go forward it's going to be between 4% and 5%..

Okay, thank you..

[Operator Instructions] at this time there are no questions on queue. Presenters you may continue..

All right well thank you very much and thanks everybody any questions or comments, anything else. Please let us know. Thanks very much..