Earnings Call Transcript - ETD Q4 2020

Matthew McNulty, Vice President of Finance

Thank you, Kevin. Good afternoon, and welcome to Ethan Allen's conference call for our fiscal fourth quarter ended June 30, 2020. This conference call is being recorded and webcast live on ethanallen.com, where you will find a copy of our press release, which contains reconciliations of non-GAAP financial information referred to in the release and on this call. A replay of today's call will also be made available via phone and on our website. After our prepared remarks, we will open the call to questions. 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 today is our Chairman and CEO, Farooq Kathwari; and our Chief Financial Officer, Corey Whitely. I am pleased to now turn the call over to Farooq Kathwari.

Farooq Kathwari, Chairman and CEO

Thank you, Matt. And thank you all for participating in our fourth quarter and fiscal year ending June 30, 2020 call. As we all know, the last few months have been very challenging. The COVID-19 pandemic, according to a recent economic study, has wiped out the last five years of economic growth. We are pleased and gratified that we have been able to generate business despite the major closure of our retail network for the most part of the fourth quarter. We have been able to maintain business due to a number of factors, including strong talent in our vertically integrated structure, trust in our brand, great quality, value and service, combining the personal service of our interior designers with technology. Adding technology for client interaction was a major focus in the last few years, maintaining strong marketing initiatives during the quarter; and emphasizing safety and social responsibility. Due to many initiatives, we were able to generate a positive $14 million cash during the fourth quarter. We also decided to pay back $50 million of the $100 million we had drawn from our line of credit for precautionary purposes. We are especially pleased that our written orders for the three months ending June were strong when most of our design centers were closed. Our wholesale orders as compared to the previous year were for April, 35%; May, 70%; June, 117%; and July, 103%. These numbers also reflect the doubling of sales online during the quarter ended June 30 from the previous year's quarter. We are pleased to announce that the Board has reinstated the quarterly dividend of $0.21 per share. After Corey provides a financial overview, I will be happy to give more detail and information, and then we'll be able to open for any comments and questions.

Corey Whitely, CFO

Thank you, Farooq. The COVID-19 crisis challenged our operations during the fourth quarter. As Farooq mentioned, our teams did well in persevering through these challenges. Our primary focus was operating in a safe manner for our associates and our clients. As our design centers began to reopen, we implemented the CDC guidelines for operating businesses safely. We established logistics for the supply of hand sanitizer and related dispensers, disinfectant cleaning supplies, masks, and nitro gloves, and we increased the cleaning frequency of our design centers and other facilities. For the safety of our associates and our design centers, we require all associates and clients to wear masks. So far, we have been fortunate with very few cases of COVID-19 throughout our enterprise. As we previously announced on March 19, we temporarily closed all our company-operated design centers in the U.S. and Canada due to COVID-19 and the various governmental stay-at-home orders. Each of our North American manufacturing operations was also impacted by governmental orders requiring temporary shutdowns for various periods during April, May, and June. Our logistics operations, while continuing to operate throughout the quarter, were operating in a limited fashion, especially with restrictions on our in-home white glove deliveries. As a result, our consolidated net sales for the quarter of $91.6 million were about half of the prior year's net sales of $183.9 million for the quarter. Wholesale segment net sales were $51.6 million compared with $107.5 million in the prior year quarter, primarily due to lower sales to our North American retail network and shutdowns at manufacturing related to the COVID-19 crisis. Retail segment net sales were $70.7 million compared with $147.2 million in the prior period. There were 144 company-operated North American design centers in both the current and prior year periods. COVID-19-related manufacturing shutdowns and logistics disruption negatively impacted the net sales and the consolidated adjusted gross margin, which decreased to 53.3%. For the full fiscal year, gross margin on an adjusted basis was 55.7% compared to 55.1% in the prior year. As we announced on April 1, we took many steps under our COVID-19 action plan including the furlough of approximately 70% of our global workforce. The decision by our CEO to forgo his salary through June 30, 2020, and the salary reduction of up to 40% for all senior management and up to 20% for other salaried employees through June 30. Our Board of Directors reduced their cash compensation by 50% through June 30. We eliminated all our nonessential operating expenses, negotiated with our landlords to receive rent deferrals or abatements for our lease design centers, delayed nonessential capital expenditures, and took other steps to reduce cash disbursements. With these expense controls, our adjusted operating expenses for the fourth quarter, which included $5.3 million of advertising costs, decreased 38.2% from the prior year to $53.7 million. We incurred some incremental costs associated with the additional supplies and cleaning regimes based on the CDC safe business protocols. These costs, which were less than $1 million, are reflected within our fourth quarter SG&A expenses. Impacted primarily by lower net sales and a decline in wholesale gross margin, the adjusted operating loss for the fourth quarter was $5 million. For the full year, adjusted operating income was $17.1 million. Adjustments to GAAP operating income for the quarter totaled $7.5 million and primarily represented restructuring and asset impairment charges during the quarter, of which $4.7 million were noncash charges. Adjusted EPS for the quarter was a loss of $0.15 compared with adjusted earnings of $0.46 in the prior year fourth quarter. For the full fiscal year, adjusted EPS was $0.52 compared with $1.56 last year. A key element of our COVID-19 action plan was to reduce expenses and conserve cash. We were pleased to have generated cash from operating activities of $14 million during the quarter and $53 million for the full fiscal year. For precautionary purposes, we drew $100 million from our credit facility in March. By June 30, we paid back $50 million while still ending the quarter with total cash of $72.3 million. We carefully managed our inventories and ended the fiscal 2020 year with $126.1 million of inventory compared with $162.4 million a year ago. We believe the fundamentals of the company remain strong, with orders improving sequentially each month. As our businesses started to rebound, we are pleased to have called back 56% of our furloughed workers as of June 30. With that, I will turn the call back over to Farooq.

Farooq Kathwari, Chairman and CEO

Yes. Thank you, Corey. While facing many external challenges, we were pleased with the results of the quarter. Despite many unknowns, we still believe that we are positioned well to grow. The main areas of focus, as I stated earlier, one is maintaining strong talent in our vertically integrated structure. Our teams really have done a great job in the quarter amidst the changes we had to make, while still maintaining business, in fact, increasing business in June and July from the previous year. Today, combining technology with personal service will help us increase productivity as we saw in the fourth quarter. Our ability to service our clients is critical. With 75% of our products made in our North American workshops, we have the ability to service our clients well and increase efficiency in our manufacturing and logistics. Like others, we have had to get back into manufacturing. We have had to ensure that we are also able to obtain supplies of raw materials on a timely basis, but our production is increasing. With increased backlogs, we have an opportunity in the next few months to address this backlog. Initiatives to strengthen and expand our design center network are extremely important. Currently, we have 200 design centers in North America and over 100 internationally. We are also planning to launch a campaign to attract retail entrepreneurs to join our network in many markets where we are not currently present. Our government and contract business remains promising, and we look forward to continued growth. Enhancing our marketing and product development programs is critical. Our focus remains on three important attitudes in our product program that we define as classics with a modern perspective, country coastal, and modern. Our recent introduction of custom bedroom products made in our North American facilities and the recent introduction of a program called farmhouse-inspired products has been extremely well received by clients. We have maintained strong marketing in various mediums, including national and regional television, direct mail, digital mediums, and grassroots at the retail level. Finally, our focus always remains on managing our business with safety and social responsibility across our enterprise. With this, I would like to open for any questions or comments.

Robert Griffin, Analyst

The first thing I want to ask about, Farooq, is the cost base. A lot of cuts during the quarter to conserve cash. As you've seen demand return here in June and July, what's coming back in terms of cost? Is it all coming back? Or are there some costs that are going to be permanent reductions?

Farooq Kathwari, Chairman and CEO

It's a good question, Bobby, because crises create opportunities to rethink our enterprise, reconsider how we can operate. We have been able to operate during the last three months of this last quarter with approximately at the retail level, with about 30% fewer people, while still doing more business. Some of this is pent-up demand, but most of it is due to the fact that we brought in the best of our best people. The clients that came in were motivated and interested in buying, so the best of our design centers interacted with them, some in person as well as online. Going forward, we believe that we can do the same amount of business or much more with approximately 30% fewer associates in our retail network. We have brought back most of the manufacturing staff due to this focus on products made in North America, which is good news. Our North American operations in Mexico, Honduras, and Vermont are almost back to where we had them previously. In other areas, we are learning how technology will help us. I believe we can operate with about 20% to 30% fewer associates while doing more business.

Robert Griffin, Analyst

Okay. That's very helpful. And I guess, secondly for me, I know this time of the year is usually an important time for the state department contract as the fiscal year ends for the government. Can you maybe talk about what you're seeing from that side of the business as things have returned a little more towards normal?

Farooq Kathwari, Chairman and CEO

Yes. As you said, August and September are our two important months. The government's fiscal year ends September 30. So we expect strong business in the next two months based on indicated trends, and we believe that will take place.

Brad Thomas, Analyst

My first question was going to be around recent trends. The press release talks about wholesale orders versus prior year. You indicated that it was up, and then July had gone up year-over-year. I was hoping you could talk a little bit about the retail side of things, and what you've been seeing in recent months on the retail side.

Farooq Kathwari, Chairman and CEO

Brad, the retail represents a very vast majority of our business. The numbers you see are a direct result of what is happening at retail.

Brad Thomas, Analyst

Got you. So directionally, Farooq, would you prefer to say that the retail numbers have tracked that pattern you outlined in the press about the trends in wholesale?

Farooq Kathwari, Chairman and CEO

Yes. Almost. Not 100%, but pretty close because the retail business is almost 85% to 90% of our total business.

Brad Thomas, Analyst

Okay, great. As you've reopened the business, could you talk about where the backlog is today? What the timing is to fulfill orders and any nuances we should keep in mind as we think about modeling sales in this current quarter as demand starts to come back?

Farooq Kathwari, Chairman and CEO

Well, Brad, we've already done surprisingly well, including in July. Our teams have done exceedingly well to do more business this July than last. While some is due to pent-up demand, partly due to decent savings provided to our clients, we are cautiously optimistic that we can maintain this. We also have to keep in mind external factors, especially COVID. In states where COVID has increased, like Florida, Texas, Georgia, and the Carolinas, we have to be cautious. However, our designers have done well, and our clients have trusted us, allowing us to perform house calls. We do have a backlog and are currently increasing our capacities. Some of that is impacted by raw material challenges, but overall, we will be able to meet the increase in business that we've received this quarter.

Brad Thomas, Analyst

That's very helpful, Farooq. If I can squeeze one last one in. Clearly, the backdrop from COVID has accelerated our market share on the B2C side of the business. Can you discuss what opportunities you're seeing to enhance B2C presence on Ethan's website, and how do you plan to make further investments in this area?

Farooq Kathwari, Chairman and CEO

Brad, I wasn't completely able to understand everything due to a big storm affecting my internet connection. Corey, could you please respond?

Corey Whitely, CFO

Yes. I think you were questioning our online presence and how we plan to continue to grow it. As Farooq mentioned, we more than doubled the business online. In July, it was over 100% of what it was the prior year. We have also been effectively driving business into our design centers. Right when the crisis started, we added a 'make an appointment' feature to our website, which was very well received. People can make virtual appointments or private in-store appointments with our design consultants. We're continuing to see great use of that tool, even today. The live chat also generates sales and often processes sales through the design center's point-of-sale system. Overall, the website has done very well at driving business and presenting the brand, and we will continue to see that grow.

Farooq Kathwari, Chairman and CEO

Yes. Brad, I would also mention that fortunately in the last few years, we focused a lot on adding technology to enhance the personal service of our interior designers. It's amazing how much business they've been able to do by utilizing technology. This is also beneficial going forward, as we need to become more efficient. We have added a lot of tech in manufacturing, which has also helped us make our products better while increasing efficiency.

Cristina Fernández, Analyst

I wanted to follow up on Brad's question about the backlog. Can you help us understand how much of the May and June orders were already delivered in the quarter? Just want to get a better sense of how that's going to flow through? Also, what is the time delay today between when an order is placed and when it's delivered to the customer, and how has that changed compared to early this year?

Farooq Kathwari, Chairman and CEO

Yes. The retail backlog has increased by over 30% in this last quarter, which is encouraging. However, we need to produce the products. Our total backlog in wholesale has also increased by over 30%. That backlog is going to be delivered in this quarter and some in the following quarter.

Cristina Fernández, Analyst

Can you talk about the time to delivery, how long it's taking for deliveries to be made from when the customer places an order?

Farooq Kathwari, Chairman and CEO

It varies because, for instance, all our upholstery is custom and is now taking about 8 to 10 weeks. We do have a quick ship option for upholstery, which used to be 30 days but is now about 45 days. Regarding our wood products, those in stock are delivered immediately, while custom wood manufacturing takes about 6 to 8 weeks.

Cristina Fernández, Analyst

That's helpful. Any color you can share about traffic trends and ticket trends, along with any shifts in the types of products customers are buying?

Farooq Kathwari, Chairman and CEO

Yes. Nationally, traffic is down about 30%, but our business is higher than last year due to more qualified traffic. This is very important. The clients coming in are more knowledgeable and motivated, having done their homework. In terms of products, we are seeing a demand for great design, classic yet livable products. Our country design, coastal design, and modified classic designs are doing well. We recently introduced Lucy, which is a modern perspective that has also performed well. Additionally, we have seen an increase in demand for mattresses and home office products, which we are developing more options for.

Cristina Fernández, Analyst

I wanted to inquire about the number of employees. You mentioned bringing back 56%. Is that low compared to all stores being open and manufacturing being back up? Is that a function of operating the stores with less employees as you said, or are you having some trouble bringing employees back?

Farooq Kathwari, Chairman and CEO

There are some employees who have chosen to stay home, but most want to return. We haven't had any major issues. It's just that our retail teams are determining how many people are needed. More qualified staff are accomplishing more business, and we've adjusted our hours. My executives have discretion about Sunday openings and appointment times. Employees are working fewer hours but focusing on appointments, which is working well. We're monitoring closely and will adjust as needed, aiming for an effective model with fewer associates handling more business. All right. Well, thank you very much, and thank you for being on the call. These are challenging times, but we are pleased with the results we've had. What our people have done has been remarkable. We'll continue to monitor our positive cash situation carefully, and our inventories will reduce significantly. We'll also be aggressive in maintaining our marketing presence, which accounted for about 5% of sales during this last quarter. Thank you again. Any further questions can be directed to Matt or Corey.

Operator, Operator

That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation.