Good afternoon and welcome to the Ethan Allen's Fiscal 2020 Second Quarter Analyst Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Corey Whitely, Executive Vice President, Administration and Chief Financial Officer. Thank you. You may begin..

Thank you, Jeff. Good afternoon and welcome to Ethan Allen's conference call for our fiscal second quarter ended December 31, 2019.

This conference call is being recorded and webcast live on ethanallen.com where you will also find a copy of 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 that 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.

Joining me on the call is our Chairman and CEO, Farooq Kathwari; and Matt McNulty, who we have recently promoted to Vice President of Finance. Matt had been serving as our Vice President of Corporate Controller and in his new role. Matt will also be involved in Investor Relations together with me.

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 some closing comments before opening up the telephone lines for questions. With that, here's Farooq Kathwari..

Thank you, Corey, and thank you all for participating in this conference call. As Corey mentioned, I'm also pleased that Matt McNulty is making good contributions and taking on more responsibility and he says he's going to keep on working very hard.

As we mentioned in our press release, we continue to strengthen our marketing, including the introduction of the Member Program, and continued enhancing of this program. Our sales and profitability were impacted in our second quarter due to the introduction of this program.

We will see continued impact in our third quarter primarily due to low backlogs at the end of the second quarter. We expect stronger order growth in our third and fourth quarter, positively impacting fourth quarter sales and profitability.

We are pleased that our unique vertical structure continues to provide strong operating leverage to allow us to return value to shareholders through quarterly dividends, periodic cash dividends and share repurchases. During the second quarter, we paid $5.6 million in cash dividends.

We repurchased 546,000 shares representing 2.1% of our outstanding shares. After this purchase the board authorized further repurchases up to 3 million shares.

Just for information since our taking the company public, we have generated strong cash flow, refocusing $611 million of our stock, paying $472 million in cash dividends and investing $819 million in capital expenditures. After Corey provides a brief financial overview, I will discuss our initiatives to grow sales and profits.

Corey?.

Thank you, Farooq. During the second quarter of fiscal 2020, our consolidated net sales were $174.6 million, compared with $197.2 million in the prior year quarter.

Net sales were negatively impacted due to the transition to the Ethan Allen Member Program, along with the decrease in consolidated international net sales, which was primarily related to lower sales to China and in Canada due to the economic uncertainty surrounding international trade disputes and the challenging global economy.

Net sales to China decreased 45.1%, and we expect continued headwinds there with the emerging concerns around the coronavirus. As we had previously stated, the implementation of the Ethan Allen Member Program was expected to negatively impact our sales and profitability during the initial year as we transition to the membership model.

Our second quarter results reflected this and we expect a similar impact in net sales and profitability for the third quarter ending March 31, 2020. Wholesale segment net sales were $91.9 million, compared with $107.7 million in the prior year quarter.

There were 180 North American design centers this year, compared to 188 in the prior year period as we continue to reposition our retail footprint, opening new design centers and closing on relocating older legacy locations.

The company has experienced continued growth in contract sales, which grew 66.9% primarily due to higher sales in the GSA contract and hospitality sales. Our total wholesale orders decreased 21.8% in the second quarter, compared with the same quarter last fiscal year. International wholesale orders declined 53.6%.

Retail segment net sales were $139.1 million, compared with $158.5 million in the prior year quarter. There were 144 company operated design centers at the end of the second quarter compared to 146 in the prior year period.

Our consolidated adjusted gross margin, which excludes $0.4 million in restructuring activities was 56.1% reflecting improvement from our optimization initiatives. Retail sales as a percentage of total consolidated net sales was 79.7%, compared with 80.4% in the prior year second quarter.

Adjusted operating income, which excludes $0.3 million in restructuring was $9.5 million with an adjusted operating margin of 5.4% compared to 8.3% in the prior year, our adjusted EPS of $0.27 compared with $0.46 a year ago. The effective income tax rate was 23.5% for the quarter, compared to 25.1% in the prior year.

Turning to the balance sheet, we ended the quarter with inventory of $139 million, compared to $159.2 million in the prior year. Cash of $28.3 million and no debt. As Farooq mentioned, during the quarter, we paid regular quarterly dividends of $5.6 million, repurchased 545,727 shares representing 2.1% of the company's outstanding shares.

Also, as we announced on January 13, the Board of Directors increased the share repurchase authorization to 3 million shares. With that, I’ll turn the call back over to Farooq.

Thank you, Corey. We continue to strengthen our vertically integrated structure of our retail network, manufacturing and logistics by strengthening our product offerings, projection in our design centers, enhanced marketing, and continued investments in technology.

Our key areas of focus include the strengthening challenge, developing strong entrepreneurial leaders in retail continues a major focus and we have made good progress. In corporate, Rodney Hutton joined a Chief Marketing Officer on January 1, after a three month consultancy arrangement.

Matt McNulty as you heard with a strong financial and accounting background was promoted to Vice President and Finance and he'll be reporting to Corey Whitely. The second area is our marketing. This month, we have enhanced the marketing program.

In October the Membership Program was launched and for all practical purposes, customers had to become a member to purchase our products, which did impact our traffic and sales. As of now, we have made a change. We have expanded our program, so that non-members can also purchase products at special savings in effect of that time.

The members will continue to secure enhance benefits including 20% savings on all our products from our everyday best price, free in-home delivery and 24-month financing. We have also expanded our marketing and advertising to include radio, television, and increasing presence in digital mediums.

On our service, our manufacturing in North America and our unique logistics network is an excellent position to service our growth. We completed the consolidating initiatives in manufacturing and logistics started last year. About 75% of our products are made in our North American facilities. The next focus has always been on technology.

And this is a major focus to implement new technologies in all areas of our enterprise. And finally, social responsibility continues to be a major focus to maintain our leadership in this very important area. With this, we are ready for any comments or questions..

Jeff, go ahead and give the instructions for people to ask questions..

[Operator Instructions] We have one question from Bobby Griffin. Sir Griffin, your line is now open..

My first question, I just want to see if we can, can you help us understand a little bit more what happened during the quarter? How did consumers react to the Membership Program? How much of the sales decline would you attribute to just a little bit of the learnings of the new program versus the overall environment? And then what do you seen kind of as the progression of the business, are you starting to see sales get better as more people get used to the program, anything like that to help us frame up what exactly took place during the quarter?.

Bobby this is a good question, this is something that we are constantly working on.

We introduced the program where we decided that because of the structure that we have, we had about 1,500 interior designers that it makes sense for them to work and provide their service to their clients without having to - you might say I have to worry about constant sales. So we decided that the Member Program will give certain benefits.

The benefits of special savings for everyday best price, special financing, complimentary interior design service, complimentary in home delivery, all great things and our interior designers love it. Our clients love it.

However, the issue that was that it did not create urgency, whereby we used to have end of month sales and that did create an urgency, that's number one. The second thing was that the way we introduced the Member Program was that in all practical purposes, everybody had to become a member to take advantage of the benefits.

As of February, we made some changes. We just now have implemented a program that non-members can also purchase based upon whatever the special savings are at that time, things right now we're running a special savings on our living room products.

Now what that will do is, that will enhance people coming in and because the way we started it, it did impact our traffic and traffic impact sales. So I think that in addition to the learning curve, in addition to not having the sense of urgency, all those factors, contributed to lower sales. So we have now taken some steps.

First is people are learning. Our designers love it. Our customers love it because they want to do - to have great homes. They don't want to have to wait till new sales come in. But in the real world, people do wait for sales, their customers that are not members. So we have Bobby taken steps to improve it.

And I believe that we're going to start seeing benefits of that while maintaining the membership program..

Okay, I guess two follow-ups real quickly on that, when you took the steps to add some benefits for the non-members, have you seen anything in the traffic results yet or is it still too early to tell?.

It is too early because just started this month, and I think that it also reflected the way we are marketing. See we are marketing in - our second quarter basically was to get members. Now our marketing reflects to get members but also expand it to all others who come in. So we have made some changes, hindsight is always 2020..

Okay.

And then the way the program still work now though the members would still get the absolute lowest price, is that price is even better than the special savings going on at the time?.

Yes, they will get because for them, it is a special savings. In addition to that, they will get complimentary in home delivery because those are two important benefits, they will continue to get. They'll get the best price plus complimentary in home delivery..

Okay, and then I guess lastly….

Plus financing and our complimentary interior design service, everybody else will also get complimentary design service. But everybody will not get the free in home delivery..

And then I guess lastly - can you disclose whether or not kind of what you're seeing in terms of total members - a number or you continuing to see them grow month-over-month, anything to help us get a sense of how the program is going from an adoption standpoint?.

Bobby, all our business now is members. So we have a great increase in members, but now with what we have just done, it will also expand it to non-members and the fact remains that non-members, most of them will become members, but they have got to come in first.

The reason is this that for a $100 they become a member and get a benefit of our free delivery, it costs about $190 for them for delivery, if they are buying furniture..

Okay, that makes sense. That's it from me for now. I’ll jump back in the queue. And if I have anything also I'll buzz back in. Thank you for the time and thank you for answering the questions..

All right Bobby..

Next question from the line of Sanjay Bhatt of Stony Point Capital. Sir, your line is now open..

Just to drill in on the membership model again. Can you help us understand how much of the retail business specifically was impacted by the shift in membership model in the quarter since I think you called out both the membership model transition and some cautious consumer headwind.

So I guess one, if you could help us bifurcate the two that will be great. And maybe ask another way, I think on the last call you guys previously suggested a 3% to 4% net revenue headwind for the full year from the membership program, but clearly, you're making some changes to the savings offer around the members and non-members, et cetera.

So, is that 3% to 4% number still your belief or how should we kind of think about that mathematically?.

Yes, on the 3% to 4% just to clarify that that was on the piece of the deferred revenue for the membership fee..

Yes Corey let me you explain that. Sanjay, it is - Corey will go to discuss that because it was not 3% to 4% on total sales. Your question is a good one, which is the impact on sales due to the membership and also due to perhaps, the issues in the economy and everything else. I would say that 90% of our decline was due to the membership program.

There were some external factors in terms of what's taking place in the world was taking place in for instance, unfortunately in China. That impacted of course, our international business, it has some impact in the United States because we do have a lot of Chinese customers in the United States, especially on the West Coast.

But I would say that - at least 90% plus was due to the fact we implemented the membership program which is great. As I said, our designers love it. And just to give you a perspective Sanjay that before the Great Recession, we used to have an everyday best price, no sales.

It was like it was like a membership program, without people without being members. But then with the Great Recession, we first started with a 10% saving, then 15% saving, then 20% saving and on and on. So I believe that the impact of the membership because people had to get used to it.

And secondly, was the fact of while we're giving great savings, but we did not have the end of the month urgency for people to close and quarter end is generally very, very important. So it's a learning process. All our team members believe they tell me again and again, they love it. Their clients love it.

But again, for practical reasons, we also have to make sure we create urgency and bring people in and that's why we made the changes we have..

Right, that's helpful, and I remember the deferred revenue, that makes sense. Thanks..

Next question from the line of John Baugh of Stifel. Sir, your line is now open..

I just wanted a point of clarification on the change for the non-members versus the members.

So you’re still - are you running, sort of give or take depending on the time 20%, 30% of your product at a like 20%, 25% off type sale and they're going to get access to that or is that different because here before they not been a member, they wouldn't have gotten that or is there a savings across the board of some 20%, 25% for all the members?.

All right John I understand, let me just go back a little bit before the membership program. Before the membership program, we had some savings every month, every quarter, and those savings range from anywhere from say 15%, 20%, even 25%. So those savings we gave to everybody and once in a while, we would also give free delivery.

So when a membership program started, we said the members are going to get 20% savings from our retail prices. We call them our everyday best prices. The members will also get 24 month financing and they will also get complimentary interior design service and delivery that was the plan.

And now what we have done is we have added a savings - which would also not only be for our members, but will also be utilized by non-members. Like for instance in December, we did have a special savings, which was only really meant for our members.

But now starting in February, we have - and just announced if you see our marketing you'll see we have a special 25% savings on all living rooms. That products - those savings are - can be utilized by our members because the members will get 20% savings on everything. Non-members will get - I’m sorry the members will get 20% savings on everything.

And they will now also get 25% savings on the living room while non-members will get savings of 25%. Members also get a benefit of free delivery. So - that's the change we have made. What it does is it expands our reach to more people. What we found was John that - people felt that they had to become a member to come in.

And that sort of restricted people coming into - it had an impact on traffic. We have now changed it and I believe it has been very well received by our teams, and our marketing is taking care of it. So, we don't increase traffic both on our website and to our design centers. And as I said, most of these folks are going to come in.

The chances are they will become members, but they've to got to come in first and that's what this program does..

So the members were getting 20% off of everything. And now when you decide to run say 25% savings on living room, they're getting 25% additional savings. And of course the non-members had nothing percent off and now when you run a special in this case 25% on living rooms they're getting back.

Is that correct?.

No what the members will not get additional 25%, they will get 25% on the living rooms and anything else they’ll get 20% they're not going to get additional 25%..

Okay 20% on everything else. Okay..

Yes. .

And the non-member is paying full price on everything except the special?.

That's right. Yes..

As it relates to China and sourcing.

Could you update us again on your rough percentage of product you're bringing in from there and/or maybe Asia in general and whether or not you fear supply disruptions from what's going on there?.

John 75% of our furniture is made in our North American facilities, and other vast majority of our furniture, they now come to Accents because what represents at this stage approximately 20% of our business. Now the other 5% or 10% of our furniture is coming from countries such as Indonesia, and we had already moved most of our production.

We didn't have much business in China anyway, as you know we sell to China. So from a perspective of our sourcing, we are in very, very good shape. Now, there are some products that come from China, they're like lighting and accessories. And they're - so far we've not seen a problem.

But it's possible that there might be some disruptions depending upon how they handle this issue of this unfortunate situation that's taking place in China. So our main issue in China has been the fact that we've been shipping - we sell and ship more products than we buy. So we were first impacted by the tariffs of 25%.

And now we are impacted by the fact that most of the locations. Our partner there is 100 locations most of them are closed now. So our visit is already down, I think close to 60%. So it's going to go down further, but we're already down 60% due to the tariffs and to some degree softening of the economy in China..

That was going to be my follow-up question on that. It's been down for a while now so the magnitude of what's remaining must be pretty, pretty small..

Yes, it still is somewhat it is smaller. It's not in fact this quarter I think was more or less pretty close to what it was down from the previous quarter. So good news is as Corey said, we have made - very good inroads in the business we do with the GSA, the government and also some contract. So that has that has been good for us..

Okay. And then you use the word enhanced marketing programs - what would be the dollars either in gross dollars or percentage of revenue? And you know, I'm thinking maybe more calendar 2020.

What should we expect from Ethan Allen in terms of either gross dollars of marketing your ads been year-over-year or as a percent of sales flat, down, up?.

Well, you know John if you take a look at this second quarter, we spent $8.5 million which represented 4.8% of our sales. In the last year, in the same quarter we spent $7.6 million, which represented 3.8% of sales. Now in the next quarter that we're looking at, that is our third quarter that we're in now.

Last year we spent $7.4 million, which represented about 4.1%. I think we're going to spend anywhere between $7.5 million to $8 million in our third quarter, and again the percentage of course is impacted with overall sales. So our percentage has gone up because of lower sales.

So, I would say John that approximately utilizing around 4.5% would be a good number..

And then sort of - and that’s very helpful, but as we go sort of June through December quarters, and just stick to dollar since we don't know exactly what sales are going to do.

Although you indicated you would hope June quarter will be better to see kind of gross dollars you spend on marketing when you add up four quarters in calendar 2020 match or exceed likely what you did in 2019 or you just don't know?.

Well I think and we most probably spent close to $30 million last year and we’ll most probably spend close to that this year..

Next question from the line of Cristina Fernández of Telsey Advisory Group. Ma'am, your line is now open..

I also wanted to follow up on the Member Program and understand the impact its having on the SG&A line items. So of the - I guess 300 and of 800 basis points deleverage this quarter, it seems from your comments on the last call that about 100 of it was marketing.

How much of the rest was due to the Member Program and I assume it's mostly the impact of the free delivery up to the members?.

Corey?.

Yes, most of them was, really that reduction in sales and the deleveraging that is being a vertically structured company we really benefit when sales increase, but when sales go down we do get the reverse of that. The advertising was about 1 million more than where we were last year. So that was probably the biggest impact on the SG&A side.

Otherwise, it was relative to sales, it was fairly well controlled..

Yes, Cristina I'll give you - I mean, if you take a look at our total sales, which of course you will see that in the quarter. We had $175 million versus $197 million and last year, our - again it's a question of - now if you compare our selling, which is last year we had $52 million and this year with $51 million.

But - overall our expenses this quarter were at $88 million versus $93 million last year. So, we did reduce our expenses as total, while obviously as a percentage of total sales, our expenses were higher, because - of lower sales.

Our total dollars went from $93 million to $88 million as a percentage it was 50.6% versus 47% last year, again because of sales..

And then I wanted to - I guess follow-up on Corey, your commentary about this next quarter, this third quarter being an impact similar to what we just saw in the December quarter.

Wouldn't some of the changes that you're making like the additional discounts be able to drive although a little bit better sales or I guess what are you contemplating in that outlook?.

Well, we do have an opportunity to see our stronger order growth as a result of our enhanced marketing plans that we have in place. However, there is a little bit of a lag time between ordering it and then delivering it out.

Therefore we expect to see our sales benefit beginning in the fourth quarter from the stronger orders this third and fourth quarter..

Yes, I think that's - as Corey said we are entering our third quarter with lower backlogs because of lower sales in the second quarter. Now as we become very efficient, we don't have a lot of backlogs we do deliver fast.

So this quarter, third quarter we expect that - we expect with all the changes we have made and all the marketing we are doing to have improvements in our orders, which will reflect then more in the deliveries in the fourth quarter.

So on order side we see positive, but the delivery side obviously shipments, this quarter is going to be lower because of the lower backlogs entering the quarter..

And then lastly a different topic.

Can you remind us of - new products that you have coming up in the next couple of quarters as we geared towards the bigger spring summer selling season?.

Yes, it's a very important initiative that we're going right now. In fact Corey is most probably going to talk to all of you - we like to have an investor meeting in May in Manhattan. Then we will be a little bit early - I mean earlier we can do it but I think in Manhattan more people will come.

We are in the process of also making more improvements in the projection of our design centers and the products. As you know, we have very strong product categories of, you might say classic products with a modern perspective we are strengthening it.

And we're going to be marketing that because those products to - some customers want that product back. There has been too much focus on casual contemporary including us to some degree. The second important category for us is what we call country, but again with a modern perspective.

So you're going to see products introduced in that, you'll also see products introduced in the first category that's classics. In the olden days, we call them formal, but today they are more classics and livable with a modern perspective.

And the third is our version of the model, which is you’re going to be pleasantly surprised at the new products, including what we have called Lucy which is great program in upholstery. In fact it's going to be in our design center starting next month and we'll be starting marketing it.

So these three categories classics with the more modern perspective, country with a modern perspective and our modern is products that we're going to be doing a lot of marketing, starting some this quarter, and then some and also in the next quarter..

[Operator Instructions] Next question from the line of Bradley Thomas of KeyBanc Capital Market. Sir, your line is now open..

This is Andrew on for Brad. I had a question on the contract side of the business.

I wonder if you could tell us how the State Department contract performed during the quarter and how you are thinking about the contract side of the business going forward?.

Yes as Corey said, we had a substantial increase or 50% Corey, right..

Right..

Or 50% of business in the State Department during the quarter, and also with better margins. Then we've also gotten business I think we discussed it, we have had a good partnership with the Margaritaville Group, where we been furnishing a number of hotels. We furnished one in Orlando. We're doing one in Houston. We're doing in few other places.

We also continue to do some more business with the Disney program and contract. So that is growing that's a bright spot..

And then I wanted to follow up on the promotions you are doing in addition to the membership model.

Could you give us a sense for how often you plan trying to run these additional promotions going forward?.

We're going to see how it works, but certainly at this time - we plan to have in addition to the savings for our members, we will continue to have some special savings which the non-members can use come in and I believe that most of them will become members, and I believe those programs will most likely have monthly..

[Operator Instructions] There are no further questions at this time. Please continue..

Well thank you very much. And if any questions, comments, please let us know and Corey and Matt team are going to be ready to talk to you. So take care..

That concludes today's conference. Thank you everyone for participating. You may now disconnect..