Earnings Call Transcript - ETD Q3 2020

Operator, Operator

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

Corey Whitely, CFO

Thank you, Lee. Good afternoon and welcome to Ethan Allen’s conference call for our third quarter ended March 31, 2020. 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, all 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, our Vice President of Finance. After Farooq 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.

Farooq Kathwari, CEO

Thank you, Corey. As we mentioned in our press release, our third quarter results were negatively impacted as a result of lower order backlog entering the quarter from our transition to the membership model combined with the disruptions due to COVID-19. In the March quarter, we saw strong growth for the first two months of our fiscal third quarter until the significant disruption in March due to COVID-19. We are pleased that even with almost all our design centers closed, we were able to generate about 35% of written orders in April compared to April 2019. Our unique vertically integrated structure, where we produce about 75% of our products in North American manufacturing, enabled us to maintain our sourcing. In addition, all our logistics are delivering products to our clients and have continued to operate. We’re also pleased that as of today, over 60% of our approximately 190 design centers in North America are opened or about to open. We’re also pleased that during the quarter, we have maintained strong liquidity while also purchasing 3.8% of our outstanding shares for $14 million and paying $5.5 million of our quarterly regular dividend. After Corey provides a brief overview of our financial results for the quarter, I will discuss in greater detail our initiatives as we move forward.

Corey Whitely, CFO

Thank you, Farooq. During the third quarter of fiscal 2020, our consolidated net sales were $149.8 million compared with $177.8 million in the prior year quarter. Net sales were negatively impacted as a result of lower order backlogs going into the quarter from our transition to the Ethan Allen Member Program along with the emerging impact of the COVID-19 health crisis that rapidly intensified during the latter half of the quarter. Wholesale segment net sales were $93.1 million compared with $108.4 million in the prior year quarter. There are 180 North American design centers this year compared to 184 in the prior year period as we continue opening new design centers while closing older locations. We saw continued growth in our contract sales, primarily with the GSA contract. However, the growth rate slowed this quarter as the COVID-19 health crisis began delaying some GSA orders and shipments. Our total wholesale orders decreased 21.9% in the third quarter compared with the same quarter last fiscal year. Orders from our North American retail network declined 32%, while wholesale orders from China declined 25.7%, mainly due to local quarantines in place for most of the fiscal third quarter. The closing of our retail design centers and manufacturing operations during March negatively impacted our results, as evidenced by a 37.3% decrease in March wholesale orders compared to a year ago. Retail segment net sales were $115.7 million compared with $138.9 million in the prior year quarter. Our retail segment orders grew during the first two months of the quarter; in fact, our February retail orders increased by 13.6% thanks to a very strong Presidents Day period. Business conditions then began to deteriorate as concerns over COVID-19 increased leading up to the March 11 announcement by the World Health Organization of COVID-19 being declared a pandemic and the subsequent closures of our design centers. By March 19, all our design centers were closed along with most of our North American manufacturing. Despite the disruptions and resulting lower net sales, our consolidated adjusted gross margin for the quarter of 56% remained strong. Adjusted operating expenses for the quarter decreased by 4.4% to $83.6 million, which included $8.3 million of advertising costs, impacted primarily by the lower sales. Adjusted operating income was $0.4 million. Adjustments netted tax totaled $0.8 million and represented restructuring and asset impairment charges during the quarter. Adjusted EPS was $0.02 compared to $0.31 in the prior year. In the fiscal third quarter, the decrease in wholesale net sales along with the decline in our stock price and the significant adverse changes in the business climate from the COVID-19 health crisis led to determining that an impairment triggering event occurred. This required an interim quantitative impairment assessment of goodwill and intangible assets. While our preliminary results released on April 22 included the effect of an impairment to our goodwill, based on the company's interim assessment performed, the fair value of our wholesale reporting unit exceeded its related carrying value by approximately 25%, thus no impairment of goodwill as of March 31. We also performed the interim trade name impairment test and concluded that its fair value substantially exceeded the carrying value as of March 31. So there was no impairment of the trade name either. Turning to the balance sheet, we ended the quarter in a strengthened position. Inventory of $138.8 million compared to $164.6 million in the prior year. Cash increased to $116.9 million, with $100 million in borrowings on our credit facility. As Farooq mentioned, we returned value to shareholders during the quarter by paying regular quarterly cash dividends of $5.5 million and repurchased 3.8% of the company's outstanding shares. As part of the company's COVID-19 action plan, we have temporarily suspended the regular quarterly cash dividend and share repurchase program. As we announced on April 1, we are taking many steps under our COVID-19 action plan to ensure liquidity, including the furlough of approximately 70% of our global workforce, the decision by Farooq Kathwari 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, elimination of our nonessential operating expenses, negotiating with our landlords to receive temporary rent deferrals or abatements for our lease design centers, delaying nonessential capital expenditures, and taking other steps to reduce disbursements. We are fortunate to own all of our wholesale properties and about 35% of our retail properties. We continue to monitor cash on hand through a detailed cash burn analysis and believe the fundamentals of the company remain strong. As of March 31, 2020, we had total cash on hand of $117 million and remaining borrowing availability of $24 million under our credit facility. In addition, there are no debt maturities until December 21, 2023. Based on our current cash burn analysis, we believe our liquidity will be sufficient to fund our operations for at least the next 12 months. With that, I'll turn the call back over to Farooq.

Farooq Kathwari, CEO

Yeah, thank you. Corey. As I mentioned, in April 2020, we were able to generate 35% of written orders compared to April 2019 with practically all our design centers closed. This was due to our interior design associates working remotely, utilizing technology we deployed over the past few years, including the Ethan Allen inHome augmented reality, 3D room planner tool, Live Chat on ethanallen.com, and communications tools including Skype and FaceTime. As we move forward, we have a strong combination of personal service from our interior designers and technology. We have started to open design centers. And as of now, as I mentioned, about 60% of our 190 design centers in North America are open or about to open. We continue to bring back furloughed associates. Our vertically integrated structure is an advantage, including making about 75% of our products in our North American manufacturing. Most of our North American manufacturing is now operating, and we continue to bring back our associates. Our national and regional logistics are also fully operational. We are also pleased that our licensee in China has opened up most of their 100 locations, and we continue to do business with the US Government. In April and May, we have maintained strong marketing initiatives, including distributing about 2.5 million copies of our spring magazine. The magazine projects fashion, service, accessibility, and a strong offer of savings of up to 25%, free premium home delivery, a 48-month interest-free offer, and very importantly, complementary design service. Our objective is to continue our strong advertising to bring clients to our design centers and let them know of our strengths at a time when many retailers are in trouble, creating consumer concerns. Crisis creates an opportunity, and I feel strongly that we are positioned well to grow. With this brief overview, we would like to open for any questions or comments.

Operator, Operator

Your first question is from John Baugh from Stifel. Your line is now open.

Farooq Kathwari, CEO

Yeah, hi there.

John Baugh, Analyst

Good afternoon Farooq, Corey. I was curious, first of all, could you perhaps tell us where your lease negotiations are going and what you think ultimately may happen there? And then secondly, I'm curious, when did you open the first, I don't know, handful or tranche of stores, and is there any sense – is there enough time there to get a sense of how that's ramping versus full closure?

Farooq Kathwari, CEO

We are talking about our discussions on our current lease stores.

John Baugh, Analyst

Yeah, lease abatements on the 65%. Yeah, lease stores.

Farooq Kathwari, CEO

Right. Yes, we are having good discussions with the various landlords and like in most other businesses, there are some abatements taking place, some reductions taking place. And I think we're making good progress; it's important. But as also, as Corey mentioned, the good thing is that we own most of our properties. If that was not the case, as you know, I've always said, it's good to own these properties because the next recession is going to make a difference. And fortunately, we are in a better position.

John Baugh, Analyst

And then stores. Did you open – when did you open your first, I don't know, 10, 15, 20 stores? And is there any color on the ramp since you did that?

Farooq Kathwari, CEO

Well, you're talking about, I mean, we have not opened too many stores in the last couple of years, very, very few, actually. If you take a look at it about a year and half ago, we opened Downtown, Chicago. I'm talking – you're talking about new stores. Our focus…

John Baugh, Analyst

No, no, I'm sorry. I was talking of close the stores all the stores yet to close.

Farooq Kathwari, CEO

Oh! I’m so sorry…

John Baugh, Analyst

No, no, I'm sorry.

Farooq Kathwari, CEO

But you know we closed most of them towards the end of March and early April.

Corey Whitely, CFO

Yeah, we opened probably – most of them have reopened in the last two weeks…

Farooq Kathwari, CEO

Right, yeah.

Corey Whitely, CFO

...and some may have opened even a couple of weeks before that and some of the states that have more relaxed rules in place.

Farooq Kathwari, CEO

Yes. I'm sorry. I was wondering, but no, no, I understand that. Yes, we closed almost all of them by the first – towards the end of March almost all of them were closed. And now we are starting to open them up, in fact, even today. But every day, we are hearing of states which are allowing stores to open up as long as they're done safely and distance is maintained. What we have done also is we have spent a great deal of time in making sure that we put the right kind of safety procedures in place. In fact, we have also been able to obtain and are just kind of receiving a fair amount of masks and gloves from our partner in China, who were able to arrange these for us so that we are able to distribute them at our manufacturing locations and our retail. So as I said, about as of now 60%, but just in the last hour, Wisconsin, for instance, decided that we could open up the design centers. Now what we are doing is this: we are bringing people in selectively. As Corey said, 70% of our folks were furloughed in our retail and in manufacturing. The good news is we're starting to bring them back. But on a basis that – as this is going to ramp up, it's not going to do it quickly. We are also opening most of the stores now on a Monday to Saturday or Tuesday to Saturday schedule, so that we are not open 7 days a week in most locations.

John Baugh, Analyst

Okay. And my last question is you mentioned, Corey, that you've enough cash to run for 12 months. Any parameters around the scenarios you ran that make you comfortable? I mean, is there a percentage of sales decline, for example, worst case that you could share that you still have the cash to operate for 12 months? Thank you very much and good luck.

Corey Whitely, CFO

Yeah, John, we used very conservative numbers. And we've actually ran a few different scenarios with very, very low based upon a worst-case scenario, considering the immediate drop-off in business that we saw after March 19, when we closed all our locations. So it was a very slow ramp-up to business going forward. So it was very conservative. We felt very comfortable that that would be a worst-case scenario. And of course, our outside auditors were also comfortable with it as well. So we feel comfortable making that statement concerning our liquidity.

Farooq Kathwari, CEO

You see, I'd like to also add a couple of factors. One of the advantages of our business is that it's mostly custom. As of March 31, we had $86 million of order backlog in the retail division. Now that's important. We don't have a cash-and-carry business. So it's $86 million of backlog on which we did have about 55% deposits by our customers, which also helped us maintain cash flow during this period in April. Also, when we take a look at our business in April, 35% of our orders by our retail division were written without any of the stores being open. So it was – these are very positive factors here.

John Baugh, Analyst

And Farooq, I'm sorry, you did all the April, where you were 35% of last year's business. Was there – did you get better towards the end of the month, adjusting to the virtual world and working online with the stores closed? Was there any improvement in that downtrend through the month?

Farooq Kathwari, CEO

It did improve towards the end. Because of the fact, our e-commerce, for instance, increased by 215%. But the reason we don't give a lot of – put a lot of emphasis on that is, all the business of this 35% was done through technology. At the end of the day, these were our folks meeting our designers. So yes, there was an increase as people became more comfortable, but not like the normal towards the end of the month; we usually get very large business from that time, not that, but it was somewhat better as the month progressed.

John Baugh, Analyst

Okay. Thanks for that color, good luck.

Farooq Kathwari, CEO

All right. Good to talk to you.

Operator, Operator

Your next question comes from Bradley Thomas from KeyBanc Capital Markets. Your line is now open.

Unidentified Analyst, Analyst

Hi. Good afternoon.

Farooq Kathwari, CEO

Yeah. Hello, Bradley. How are you?

Unidentified Analyst, Analyst

Hey, I wanted to ask, given this changing environment we're in, has your strategy behind the membership model changed at all? And we were wondering if you could give us a sense for how you're thinking about non-membership model promotions during this time as well?

Farooq Kathwari, CEO

Well, it's a very important question. This crisis has had significant implications. When we saw it happening in China, we saw signs of it happening overseas. So we decided that we would, for the time being, hold up the membership program. In March, we took it out so that people would be able to purchase our products without being a member, and they would be able to get premium free delivery. So at this stage, with the way the conditions are, we really are giving everybody the benefit of a member.

Unidentified Analyst, Analyst

Understood. And then it's also good to hear that the contract sales continue to grow throughout the quarter. But going forward, how do you expect the pandemic and the changing environment to potentially impact your contract business?

Farooq Kathwari, CEO

Well, our government contract business at this stage is holding up. I think that there is always some slowdown everywhere, but people are still placing orders, albeit a little more slowly. Generally speaking, this last quarter and the next quarter are usually very strong for the government business.

Unidentified Analyst, Analyst

Got you. And then I guess the last question for me. I wanted to ask, given the changing consumer environment, have you noticed any changes in average selling price lately? And if so, how do you expect this to impact margins?

Farooq Kathwari, CEO

Well, as you know, even this quarter, we improved our gross margins despite the fact that our volumes were low. Even if you look at our operating margins, they held up pretty well. It was mainly due to the retail not being able to deliver that had most of the major impact. We have continuously made improvements in our operations. We didn't wait for this crisis to consolidate some of our manufacturing; we had already done it. We are operating very efficiently and I think that we can maintain our gross margins despite the very tough conditions. We have an opportunity to improve our operating margins as we move forward.

Unidentified Analyst, Analyst

Okay. That's good to hear. Thank you. That's all for me.

Farooq Kathwari, CEO

All right, Andrew. Thanks.

Operator, Operator

Your next question is from Cristina Fernández from Telsey Advisory Group. Your line is now open.

Farooq Kathwari, CEO

Hello, Cristina.

Cristina Fernández, Analyst

Hi. Good evening, and hope you are all well. I wanted to ask about the expense reductions that you're making. Is there any way you can size for us in aggregate with all the efforts, including the furloughs, and how much should we expect overall expenses to go down in the second quarter maybe on either expenses or cash? So we have a sense of where business could be from a profit standpoint?

Farooq Kathwari, CEO

Yeah, it's a good question; I think that will let us study, because it's changing every day. We've already opened up close to 60% of our stores and we've brought a lot of people in. Certainly, our expenses are going to be lower; there is no question about it. And how much lower? I think that might be better for us to discuss at the end of this quarter, because overall, we're going to all operate more efficiently. We are learning how to do business with Zoom and Skype, etc. Our traveling is going to be much less. Our focus on making sure that our operating expenses across the board are not going to be reduced only now, but as we go forward. So I think Cristina, it would be better for us to give that kind of insight at the end of this quarter; it would be a better time.

Cristina Fernández, Analyst

Okay, understood. And in that light, I wanted to get your thoughts, obviously, a lot of change in the industry and perhaps some more permanent changes to how consumers shop more digitally. I guess, how you're thinking about the furniture and home furnishing business, how that can evolve over the next 1 to 2 years. And perhaps how the way you conduct your business will evolve as a result of this pandemic?

Farooq Kathwari, CEO

Well, I think that there's no question that there will be a great opportunity, and I'm talking for us and most probably our industry, too. But certainly for us, which is a combination of personal service and technology. When I mentioned that we did 35% of our business in April under very tough conditions, all of it was done, almost all of it was done with our designers working with consumers remotely. In some cases, in some states, they were able to go by appointment to meet. So I believe the combination of personal service and technology is going to be very, very important. I think those businesses that sell a product as a commodity, like for instance, we are seeing that in apparel, we are seeing this in other toys, are being bought online. They don't need much personal service, so the chances are they are not going to go to stores. You've got to have stores that can create opportunities for people to buy offline, but with personal service. And I think that is especially important for products and services like ours because we are not selling commodity items. So I think that's where the difference will be Cristina.

Cristina Fernández, Analyst

Good. And last one, any trends you're seeing differently by region across the US, for example, urban versus more suburban and then the type of items consumers are buying?

Farooq Kathwari, CEO

Well, obviously, when we look at urban areas like, for instance, New York, obviously, it's almost shut down; I'm talking about Manhattan. Suburbs are a little bit better. And I think that certainly, there has been some increase in home office, because people are using their homes, and we have also been advertising it too. But overall, people are paying more attention to their homes. If you take a look at our advertising, we've gone back to advertising that we've done many, many years ago. We said, 'Home is a haven.' Our whole advertising is on that concept. Home is a haven. People are spending more time; they're learning how to operate. So it has to be functional, utilitarian, and people have got to be able to combine great design with function, and that's what we see.

Cristina Fernández, Analyst

Thank you, and best of luck this quarter.

Farooq Kathwari, CEO

Thank you, Cristina.

Operator, Operator

Your next question is from Bobby Griffin from Raymond James. Your line is now open.

Farooq Kathwari, CEO

Hello, Bobby. How are you?

Bobby Griffin, Analyst

Good afternoon. Good, Farooq. Good afternoon. How are you? Thanks for taking the questions. I jumped on the call late; I was having some technical difficulties, so I apologize if this was already addressed. But the first question I wanted to ask was mainly about the health of the independent network, the non-company owned stores?

Farooq Kathwari, CEO

Well, I tell you this; the good news is they are in very good shape for a number of reasons. The average association of our independent family is about 40 years, second generation, or third generation. Over the years, the ones who retired, we took over those. So the ones we have are really fairly strong. I have an opportunity of talking to them every week because they want to know how things are. So they're maintaining their business so far. We have not heard of anybody going out of business, which is great news.

Bobby Griffin, Analyst

Okay. And then, how have they adapted to the membership model? What's the feedback they're getting from them on the membership model?

Farooq Kathwari, CEO

Yeah, this is a question that was asked. Basically, we decided, I saw in February that things were going to get bad because we saw what was happening in China and what was happening in other countries. So we, in March, even before a lot of this emergency was taking place, said we are going to give the opportunity to every customer to become a member. So every customer is getting the benefits of the membership without having to pay a $100 fee. We believe…

Bobby Griffin, Analyst

Okay.

Farooq Kathwari, CEO

...in the meantime, and that's what we're going to do.

Bobby Griffin, Analyst

And is that just temporary? I did hear your answer to the prior question on that. Is that temporary or is it…

Farooq Kathwari, CEO

We'll see – at this stage, we'll continue. It's a great opportunity, a great benefit, because what it means really is, giving an opportunity of delivering products free to their homes, which we have done from time to time. We'll continue. We'll see how this crisis leads us, but for the time being, we will give everybody an honorary membership, and that's what we are doing.

Bobby Griffin, Analyst

Okay. And then I guess lastly for me, I saw in the release the commentary about the China orders, wholesale orders during the quarter. But how have those trended in April and early May? Are you seeing a recovery in our China wholesale order business?

Farooq Kathwari, CEO

Yes. They had gone down quite a bit, not only because of this crisis but also because of all the other issues faced in China. The good news is, that actually, just starting in the last month, it was a pleasant surprise to us, they decided to utilize our television commercial, which really focuses on Ethan Allen, 'We Make the American Home.' With all the conflicts and problems, faced and we hear about with China, they decided to use that commercial. Based on that, they are doing some decent business. So we're starting to get back orders after a few months of really low business.

Bobby Griffin, Analyst

Okay. That was it for my questions. I appreciate the time and best of luck here in this tough environment.

Farooq Kathwari, CEO

No, all right Bobby, thanks very much.

Operator, Operator

And there are no further questions at this time. Presenters you may continue.

Farooq Kathwari, CEO

Well, thank you very much. If there are any questions or comments, please feel free to contact Matt McNulty, who is here too, and Corey, I and myself want to, but both Matt and Corey are available for any questions or comments. So thank you very much for participating, and thank you very much, Lee.

Corey Whitely, CFO

Thanks, Lee.

Farooq Kathwari, CEO

Lee, take care.

Operator, Operator

You're most welcome. Thank you everyone for participating. This concludes today's conference call. You may now disconnect.