Ethan Allen Interiors Inc. (ETD) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ethan Allen Earnings Release Call. At this time, all participants are in a listen-only mode. [Operator Instructions] And I will now introduce your host for today's conference, Corey Whitely. Please begin.

Thank you, Tyron, and good morning everyone. Welcome to Ethan Allen's earnings conference call for our second quarter and first half ended December 31, 2014. This call is being 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. Also joining the call today is John Bedford, our Vice President, Corporate Controller after our Chairman and CEO, Farooq Kathwari, provides his opening remarks, I will follow-up with details on the financial results. Farooq will then provide further updates on our ongoing business initiatives before opening up the telephone lines for questions. With that, here is Farooq Kathwari.

Yes, thank you, Corey, and thank you for participating in our earnings conference call. Our results reflects our being in transition of making major changes to continue our growth in sales and earnings. As many of you know, during the last 26 years, we have gone through number of major reinventions to remain relevant. Today the need is all the more important due to many changes including changes in consumer attitudes, impact of globalization and rapid changes in technology. As we have discussed previously, we are in such a change today. Before I comment on our various initiatives, I will give a brief overview of the quarter and six months ended December 31, 2014. Our net sales of $197.1 million increased 2.1%, gross margin of 53.8% compared to 54.9% in previous year quarter. During the quarter ended December 31, 2014, our clearance sales were about 35% higher than the previous year quarter with average discount of about 60% from our regular prices. We needed to make room for new products as though clearance impacts our total sales and also reduces gross margins. In addition, we are continuing to focus on making most of our furniture products in our North American facilities. The new products, start-up costs impact negatively on wholesale margins. We estimate that our gross margins were impacted negatively due to floor inventory sell-off and manufacturing variances by about $2 million. Without this impact, the gross margin would be about 55%. While an adjusted operating income of 9.5% of sales was lower than last year of 10.7%, it is still healthy, especially in lieu of the impacts on gross margins. We have increased our operating expenses by increased advertising of $1.1 million and other increased operating expenses at both wholesale and retail to position us to grow our business. Comparable written sales for the retail division increased 8.4% for the quarter. We also believe the written sales were also negatively impacted by sale of floor samples and discontinued products. We estimate the lower retail selling prices impacted our written sales by about 4%. For six months, sales of $387.8 million shows an increase of 3.5%, again impacted by floor sample sales. Gross margin was a healthy 54.4% and adjusted operating income of $40.6 million which is 10% of sale and an increase of 8.6% from previous year. Our focus on North American manufacturing and over 70% of our products sold as custom products has a positive impact on inventories and cash. Cash and securities of $129.8 million increased $17.1 million or 15.2% from December 31, 2013. After Corey provides more details on the financial information, I will discuss our various initiatives. Corey?

Yes, thank you, Farooq. As Farooq mentioned, the major product rollout and renovation of our design centers did create disruption during the first half ending December 31, 2014. Even with this disruption, we are performing relatively well at the midpoint of the fiscal year with adjusted earnings per diluted share for the first half increased by 9.6% to $0.80 compared to $0.73 in the prior year period. This improvement benefited from the very strong first quarter tampered by the second quarter adjusted earnings per diluted share of $0.37 compared to the $0.41 in the prior year second quarter. For the second quarter of fiscal 2015, consolidated net sales of $197.1 million increased 2.1% compared to the second quarter of fiscal 2014, the fiscal year 2015 first half consolidated net sales were $387.8 million, an increase of 3.5% compared to $374.8 million in the first half fiscal 2014. The consolidated gross margin of 53.8% for the second quarter of fiscal 2015 was down from the 54.9% gross margin in the prior year second quarter. The retail segment net sales for the second quarter were 77.7% of consolidated net sales. That compared to 78.5% during the fiscal 2014 second quarter. Stronger discounts on clearance sales at retail together with the manufacturing inefficiencies and ramping up with the new products negatively impacted gross margins. Clearance sales at retail were 34.6% higher than the prior year. Fiscal 2015’s first half gross margin was 54.4%, compared to 54.6% in the prior year. At current sales levels, a 55% gross margin run rate is attainable, however we expect some disruption to continue in the second half due to the additional new product launches. Operating income for the second quarter was $17.7 million with an operating margin of 9.0% compared to $19.9 million in the prior year second quarter with an operating margin of 10.3%. The first half operating income was $38.1 million with an operating margin of 9.8% compared with operating income of $35.8 million with an operating margin of 9.6% in the prior year first half. Consolidated adjusted operating income for the second quarter was $18.7 million with an adjusted operating margin of 9.5% compared to $20.6 million in the prior year’s second quarter with an adjusted operating margin of 10.7%. The first half adjusted operating income was $40.6 million with an adjusted operating margin of 10.5%, compared with adjusted operating income of $37.4 million with an adjusted operating margin of 10.0% in the prior year first half. Wholesale division net sales for the second quarter increased 2.7% and generated adjusting operating income of $14.1 million for an adjusted operating margin of 12.1% that compared to an adjusted operating margin of 12.7% for the second quarter of fiscal 2014. For the first half, wholesale division net sales increased 6.4% and generated adjusted operating income of $36.1 million for an adjusted operating margin of 15% compared to an adjusted operating margin of 13.5% in the prior year period. Retail division net sales for the second quarter increased 1.1% and generated adjusted operating income of $3.1 million for an adjusted operating margin of 2% compared to an adjusted operating margin of 3.3% for the second quarter of fiscal 2014. For the first half, retail division net sales increased 1.7% and generated adjusted operating income of $5.8 million for an adjusted operating margin of 1.9%, which was even compared to the 1.9% adjusted operating margin in the prior year first half. Total comparable written orders by the retail segment for the second quarter of fiscal 2015 increased 8.4% compared to the second quarter’s fiscal 2014, while total written orders increased 7.8%. For the first half fiscal 2015 period, the comparable retail segment written orders are up 4.1% and total written orders are up 3.0% compared to the first half fiscal 2014. The retail segment’s undelivered backlog at December 31, 2014 is up 0.7% compared to December 31, 2013. Retail had four less design centers than the prior year period. Our global retail network included 297 design centers at December 31, 2014 compared to 295 in the prior year. Independent retailers operated 153 design centers including 95 international locations. This compares with 148 independently operated last year including 87 international locations. Our global retail network had a total of 104 international locations at December 31, 2014 as compared to 95 international locations in the prior year. For the second quarter, international sales accounted for 10.7% of our consolidated net sales compared to 9.9% in the prior year second quarter. Our adjusted results in the second quarter of fiscal 2015 excludes $0.9 million in losses on the sale of real estate and a $0.1 million restructuring charge. The prior year second quarter adjusted results excludes $0.8 million of international start-up losses. Our normalized income tax rate for both the current and prior year was approximately 36.5%. Please refer to our press release information and reconciliation tables showing all the adjustments made to our results for that period. GAAP net income for the quarter ended December 31, 2014 was $10.0 million or $0.34 per diluted share compared with $11.6 million or $0.39 per diluted share in the prior year quarter. GAAP net income for the first half was $21.9 million or $0.75 per diluted share compared with $20.6 million or $0.70 per diluted share in the prior year first half. Our effective tax rate for fiscal 2015 was 36.7% for the second quarter and 36.6% for the first half. We continue to maintain a healthy balance sheet and liquidity. Our total cash and securities at December 31, 2014 totaled $129.8 million, an increase of $17.1 million or 15.2% over December 31, 2013. Approximately, $129 million of our senior notes remain outstanding which become due in October 2015. On October 21, 2014, the company entered into a new five-year $150 million senior secured revolving credit and term loan facility. The new facility provides a term loan of up to $50 million and a revolving credit line of up to $100 million. The reclassification of current and long-term debt on our December 31 balance sheet reflects our intention and ability to use $75 million of the new $150 million facility together with working capital to fully redeem and retire the company’s outstanding senior notes prior to April 21, 2015. At December 31, 2014, there was $0.3 million of standby letters of credit outstanding under the facility and total availability under the facility of $149.7 million. Our year-to-date capital expenditures for fiscal 2015 totaled $15.1 million, compared to $8.6 million in the prior year. We expect total year capital expenditures of $28 million to $29 million as we continue to invest in new technology in the retail and wholesale segments, as well as incur capital expenditures relating to improving and growing our design centers. We expect total year depreciation and amortization for fiscal 2015 of $19 million to $20 million. Inventory of $151.7 million increased as planned by $11.8 million from December 31, 2013. With that, I’ll pass it back over to Farooq.

Thank you, Corey. As I stated earlier, we are in the midst of many important initiatives to reposition our enterprise. These include, repositioning our offerings, Ethan Allen is America’s classic brand for the home. For 82 years we have continued to reinvent our offerings and our structure to remain relevant. Under the umbrella of America’s classic brand, we are developing and introducing products under two broad categories which are inter-related and provide an eclectic attitude which is becoming more important. In phase 1, the first phase is what we refer to as modern classics which we introduced last fall and by December 2014 is in our design centers and being well received. The product programs are being developed in all categories from case good to upholstery, to hard and soft accents. These products also reflect what we describe as being fashionable and relaxed. The Phase 2, the second important category we refer to as romance classics. These are being introduced in two stages. The design inspiration is classic, primarily with American, English and European design attitudes. In two weeks, the first part with American and English design inspirations is being introduced to our retail network, in mid-February with a consumer launch in spring of 2015. In the Phase 3, we are introducing the next product program under the romantic classics and concerns to our network in spring of 2015 with consumer launch in fall of 2015. We are excited about these major changes to our offerings. However, we will continue to be in transition for sale of lock inventory during the next few quarters. Our next initiative has been improving the projection of our design centers. Last fall, we started to improve the projection of our design centers to reflect the attitude of being fashionable and relaxed. The changes include improving the exterior of our design centers and interior design projection focused on flooring, lighting and paints. While we have made much progress, we will continue the process in the second half of this fiscal year. Our next initiative has been opening of new design centers. These include new markets and relocating for existing design centers. During the last six months, we have opened design centers in many markets including in Marlton, New Jersey, in Summerlin, Las Vegas, in the Shenandoah area of Houston, recently in Watchung, New Jersey, in Redding, California, and also in November the second design center in Dubai, the United Arab Emirates and in Doha Qatar. And last, this past Sunday, I returned from China, where we celebrated the opening of a new flagship design center in Haikou, in the Henan Province. This is the 75th location. We also celebrated the 25th anniversary of the founding of our partner and our 15th year association with them. In the next six months, under construction, we have a number of design centers in large markets and also we are now concentrating on smaller markets where we used to have design centers. The next six under construction are design centers in Chattanooga Tennessee. Two locations in Pittsburg Pennsylvania, in Wichita Kansas, in Hunt Valley Maryland, in Lancaster Pennsylvania, Victor, New York. In Dubai, our mall location is completely being renovated. We are opening in international markets in Vilnius in Lithuania, in Bangkok, our location in Manila and in China another flagship design center in Beijing. The next initiative is acceleration of our marketing. We continue to accelerate our marketing including larger distribution of direct mail, advertising and national shelter magazines, including Architectural Digest, Traditional Home, Veranda, Coastal Living and our dream home partnership with HDTV. We are also increasing our local advertising efforts, tailored to each market. In our quarter ended December 31st, we increased our advertising by 15%, compared to the previous year quarter and plan to continue to increase and in fact accelerate our increase in advertising as we move forward. Our next initiative has been to focus on technology. Technology is an important initiative. We launched our new website on October 15, 2014 with enhanced navigation for easy browsing adding elements to improve search, major site to mobile and tablet responsive and also enhance our design center search and designer portfolio. In addition, upgraded the touch screen in our design centers and the tablets used by our designers. The improvements in technology is a work in progress and we will continue with this focus. Our next initiative has been focus on North American manufacturing. This is an important initiative. We have gone counter to most people in our industry in giving up manufacturing. This focus represents a challenge and an opportunity. In the short-term, we have presence - we have pressure on our margins due to increasing production capacities in the US manufacturing to open new plants in Mexico and Honduras and then to have major new product introductions. Despite all these challenges, we still maintain industry-high margins. We believe in the long-term provides a major differentiation including control of quality, inventories, ability to customize and build international business. We are also pleased that our seven manufacturing facilities meet high environmental standards, having EFAC certification in all facilities including our national distribution centers and retail service centers. For example, in Vermont, due to our producing alternate source of energy including generating electricity, we are burning zero oil. During the last six months, we have equipped and installed high efficiency machinery in our manufacturing operations and the process continues. With this brief overview, I would like to open it up for questions or comments.

[Operator Instructions] Our first question is from Brad Thomas of KeyBanc Capital Markets. Your line is open.

Yes, hi. Good morning, Brad.

Hi, Farooq. This is actually Jason Campbell in for Brad.

Yes.

My first question is, you have a relatively large delta between your written comps and your delivered comps. I was wondering if you can talk about the cadence through the quarter and how much of that delta was just demand, maybe strong at the end of the quarter versus some other factors such as like, manufacturing inefficiencies or something like that?

Yes, and actually, you have referred to the areas. When we look at the quarter, our increases took place in October and December. November was slower. Second, most of this product that is being ordered reflects our new products and we are also going through the phase of manufacturing and in fact the learning curve is taking place which resulted in somewhat of a lower delivered sales, our delivered sales also reflect the fact that in our first quarter, the written business reflected also products sold on clearance. Clearance product was some of it was delivered in our first quarter, but a lot of it was also delivered in the second quarter, what you might say at lower retail prices reflecting the lower delivered sales that you refer to. So I think all of those factors reflected and now the good news is that we did have higher written sales and, but on the other hand as has been noted previously, that our business in this quarter that we are in the third quarter will depend to some degree, as we are starting with somewhat of a higher - slightly higher backlog, but lot of it will also depend upon what we write this quarter.

Okay. And then the $2 million of gross margin when you call out, was that just from the clearance activity or is that clearance activity as well as the disruptions?

It is a combination of both, but most of it is on the clearance.

And then, I assume that’s mainly dealing with the phase 1, you also talked about phase 2 and 3 that are coming up. Can you talk about the magnitude of phases 2 and 3 versus 1? Is it kind of moderate, because these are smaller launches or we are going to see the kind of $2 million head on per quarter to next two or three quarters?

They are of the same, they are all for major launches and we will see that kind of an impact in the second and third - in our third and fourth quarters.

All right. Thank you very much.

All right.

Thank you. The next question is from Budd Bugatch of Raymond James. Your line is open.

Hi, hello Budd

Good morning, Farooq and Corey, this is Bobby Griffins filling in for Budd. Thank you for taking my question.

Yes, please go ahead.

Can you talk about how the backlog increased sequentially this quarter versus last quarter?

Corey, do you have the numbers?

On the, I don’t have that number in front of me, I just have change from the year as 0.7%, Farooq.

All right. So, I think that’s the backlog as he said is 0.7% from the previous year.

Okay, I can circle back to Corey when I get the chance. But maybe can you give a little bit more color on the managed sales for clearance in Q1 about 9.6% of sales for the quarter were - I’m sorry, not Q1, last quarter, where clearance, how did that percentage of sales look this quarter for a comparison quarter-over-quarter?

Are you talking of the third quarter or the second quarter?

Yes, I am talking about last quarter, I am sorry. Yes, fiscal first quarter one of 2015, I am sorry.

Yes, you are talking our first quarter of fiscal to the second quarter of fiscal?

Yes sir, I apologize.

Yes. As I mentioned about - in the second quarter we had a substantially higher percentage of clearance as compared to the first quarter. And I think that the numbers, Corey, do you have the numbers approximately?

Yes, it’s approximately about 11% of sales in the second quarter.

All right, thank you and then for - can you - is it possible to quantify the total dollar value of ad spending and should we expect that same level in terms of a percentage of sales to the carry forward?

Yes, we have spent $8.3 million, which represents approximately 4.2% versus $7.2 million which is 3.7% in the previous year quarter.

Okay, and should we expect that percentage of sales to increase going forward, or is that’s something that you feel comfortable with that and the total dollar value would trend up the sales trend up?

Well, at this stage in this quarter our objective is to increase and it will be in excess of 20% increase from the previous year and then we will see as we go forward what that increase would be.

All right, thank you and thank you for taking my questions again and best of luck going forward.

All right. Thanks very much.

Thank you. Our next question is from Jessica Mace of Nomura Securities. Your line is open.

Yes, hi, good morning, Jessica.

Hi, good morning. My first question is just a follow-up on the point about marketing. Just, you communicated some plans earlier in the year about how much you plan to spend incremental on the marketing and does that outlook still look the same or has there been any change in your planned spending cadence?

Jessica, we had said that, in this second quarter, we could most probably spend in excess of 20%. We spent 15%, keeping in view the fact that we also are managing our production, managing sales, both floor sales as well as new sales. So we determined that about 15% was appropriate and we watch it very carefully and as I said, as we move forward in this quarter that we are in, we will most probably increase it about 20%, it could be even higher. Then as we go forward, we will see - also what is working and what’s not working where we should be putting the money in. So we watch it very carefully.

Understood, and then on the clearance volumes that you are talking about, just, if you could provide a little bit more color on the plans for phase 2 in the romance classics, I’m just following up on the earlier question, is this a similar volume that’s planned as we go through the rest of the year on the clearance side specifically?

Yes, Jessica, I think that you should assume that, because, we are - this is an unprecedented change that we are taking place. We haven’t done this kind of a change. Even the last major change we made was in the early 90’s when we changed our projection from early American colonial to a more classic style. That’s when we made major changes and even at that time, it was 40%, 50% change in the two year period. This is a major undertaking, but we thought it is best to do it as rapidly as possible. Take all these challenges and I think in the next two quarters and even a little bit in the summer, we will be selling off inventory and bringing in new products in. The good news is that we don’t have too much excess inventory overall.

Understood, and then, just finally, any comments on the health of the underlying environment and kind of the outlook you see for the rest of this fiscal year on the furniture environment overall?

Jessica, you know it’s there are mix signals. Consumer confidence is up, home sales are up, but the consumer attitude also we see towards disposable products is somewhat limited. I think the consumer is cautious. I think that, we have to really work very, very hard to get the consumer excited and interested throughout offerings and even these impacts in the margins also reflects to some degree higher, you might say, promotional activity. We are going to moderate our promotional activity also as we go forward, but we still have to continue with that because consumers are looking for also good values, good deals whether we like it or not. So, I think that, I would say, as I said in my press release, we are cautiously optimistic about the consumers’ attitude. We just have to make sure, we do it - we do things right.

Great, thanks so much for taking the questions.

Thanks, Jessica.

Thank you. Next question is from Jeremy Hamblin of Dougherty & Company

Yes, hi, Jeremy. Good morning.

Good morning to you. Thanks for taking my questions. Wanted to just - as you talk about the significance of this change and thinking about moving forward even not just a quarter or two, but Ethan Allen’s strategy overall, should we be thinking that the company is - the product cycles are overall moving forward are going to compress to some extent versus what you had been doing before I think, typically you have about 10% to 15% of your product turnover on the floors each year. This is obviously five times greater than that. But should we be thinking that the company is now positioned based on the manufacturing improvements you made and so forth to in general turnover your floor product on a faster cycle basis moving forward?

Jeremy, that is right. First as you rightly pointed out, this is a major, major undertaking and at the time when we are also increasing our capacities after having brought them down after the great recession. And expanding into new plants, for instance our plant in Honduras is just getting started and it is under tremendous amount of pressure to produce some of that new product. The phase 2 and 3 actually are even more important than phase 1 because they represent product programs which have - we believe are going to have a great resonance in North America and internationally. Now I would have like to have that product program introduced first before we did phase 1, but this product line takes a longer time and it also required us to make sure that our manufacturing was geared up in the United States. So we have been very busy getting products ready and in fact we are now producing the phase 2 products, which is going to be introduced to our network in two weeks and for the launch in the consumer in the spring. As we do all of these things, we have a lot of - would you might call costs associated with this kind of a major initiative. But as I believe that by the summer, early first quarter of next year, we would have gone through a lot of this in terms of producing these products as well as the learning curve that goes in making new products. So after this is over, I would think that we will go back into some lower introductions, it may not be 5% or 10%, maybe slightly higher and the second part that you said is absolutely right, that is to reduce the delivery time. In our case, as I said, about 75%, 80% of all our product is custom made, which means we got all the capacities to make it and to deliver it, which also means that we got to keep the products coming in. We don’t build inventories if there is a slow time, if the order, when we compress our time, which we are doing now to four to five weeks, if orders are little slow down in a week, we got to take downtime. In the olden days, we’ll build inventories. So all of those things, Jeremy, have to be taken into consideration that is, it gives us with somewhat of a, you might say, great opportunity of managing our assets, our cash flow, but, we could have variances from quarter-to-quarter.

Okay, and then, just a question on the wholesale segment. You saw a slowdown in Q2 on sales growth in that segment. You’ve been doing 9% to 10% in the last two prior quarters and saw that slow down to little less than 3%. In terms of thinking about that particular segment, you have seen some growth in the total number of independently owned stores, should we be thinking that the growth rate in that segment is likely to move back higher as you ship out some of these new phase 2, phase 3 products?

Yes, Jeremy, it’s a good question, because our wholesale business also is impacted by these floor sales. Then our network is selling products from the floor, they are not ordering new products. And that has - and they are selling it at a lower price. So what it does is, it’s a sort of a multiple impact. We sell the products at lower price which has an impact on lower margins. They are also not ordering the products because they are selling it from the floor and they are waiting for the new product to come in. Yes, as we move forward and we get out of this transitional period, there will be a much closer balance between the retail and wholesale.

Great, thanks. I’ll jump back into the queue.

All right, Jeremy. Thanks.

Thank you. Your next question is from John Baugh of Stifel. Your line is open.

Hi, John. Good morning.

Hi, Farooq. You actually got me. I wanted to follow-up on that last question on just - so when we complete all three phases, we will have changed over, what percentage of the products roughly and that’s going to dropped into something like more like 10% to 20% in the future?

Yes, John, as we have said last year, our objective is to change over 70% of all our offerings. Now keep in mind, this is case goods, this upholstery is accents, it is accessories, lighting, soft goods, we have also in the last year or two added merchants to our - and designers to our team. So, yes, I think that - when we are done with this, I would say that the maximum. It will range anywhere between 10% to 20% - 20% on the higher side.

And you’ve mixed back more to US produce although you’ve got the Honduras plant coming up as well. Could you talk about the implications and I don’t know what your starting point might be a year or two ago. So margins, cash flows, inventories from sort of where you started from and where do you think you’ll end up in terms of domestic versus importing?

John, as I said, we are taking up major, major challenge. It would have been easier for us to just buy the products overseas, I’ve got to tell you this. Our margins, domestically are lower than overseas, especially right now. And if we had to impress everybody with higher margins, we would close everything up, buy the products from overseas, operate at higher margins. Short-term great, but I think longer term, it is better for us, to depreciate, to have better control. So we are operating at 15%, we could operate at higher 15%, higher margin if you buy the same product overseas right now because of the learning curve and getting it going. But as we move forward, it will help us improve our margins and as importantly it helps us also maintain better control on inventories and cash flow and that’s what we see after the next one year or so, I think, we will have an opportunity of stabilizing it and improving our margins at the manufacturing wholesale level also.

And two other sort of non-related questions, one, is there any update on the government potential government business that you may or may not be bidding for? And then secondly, I think you brought in a new position of brand - an overall brand manager, I am curious as to what has come out of that personnel to-date? Thank you.

Yes, on the first question, yes, the government solicitation is, we understand above to be distributed in the next - they’ll tell us in a couple of weeks and this is you are talking the state department contract, I presume?

Yes.

And, yes, so that is coming out, we understand. And as far as our talent is concerned, our objective has really been to add a lot of talent, whether it is in our merchandizing, or whether it is in our advertising and you are referring to our advertising associates. So we have strengthened those teams and of course we are working in terms of - working in conjunction with all of our teams whether it is our digital advertising or whether it is our online or whether it is our direct mail. So, we have added a lot of talent including the brand manager you refer to.

And Farooq, sort of a higher level question, but, as you think about Ethan Allen and you are sort of close to it, maybe you are not the best judgment as you solicit feedbacks from people, your biggest challenge maybe to increasing revenues would be what, the brand still being identified in a narrow style, which of course you’ve shifted that long time ago, but the consumer may still think that, is it the fact that most of your stores are in furniture retailer as opposed to more lifestyle retail areas? Are the size of the stores still too large? Just curious as to what you get it into feedback as to what maybe the biggest challenges you face and then how you are addressing them? Thank you.

All right, well, that’s a big question there, John. But let me tell you this, there is certainly a change in our competition and today our competition consists of as I - as we see it, first you got this mass merchants who have benefited from globalization and commoditization. These are mostly regional mass merchants and they are able to today sell a lot of products at a pretty good decent prices level of quality and service varies. Second is all these lifestyle companies, which is from Pottery Barn to Crate and Restoration and Our House and others, so they have come in. The traditional furniture stores of the past more or less, they’ve had somewhat of a decline. And the fourth one is the internet. They have taken a lot of business too. So, online business has been an important factor. So we have to contend with all these factors when we look at our business and our competition. What our focus has been to differentiate by providing great products and of course, we are now changing a lot of that by also having - in North America, we have 1500 interior designers which is a great competitive advantage, because we have 1500 entrepreneurs who work for Ethan Allen and provide services to our clients. And then, we have also now added technology, so that, in our business sort of somewhat seamless whether the consumer buys it from our interior designers or they use the interior designer and the technology more and more is taking place and we will see that you are going to see us increase our business online, but in conjunction with our interior designers. Our traffic overall has declined as has been noted by many others, but in a way, for us in some ways it has been positive, because, today the internet is the windows that people shop. Before that, lot of folks would come to our design centers, take a lot of our interior designer’s time just to get information. Today they come better prepared, so while the traffic is lower, it’s more qualified and our interior designers’ performance has substantially increased which means, we can have less designers do more work. So all of those factors are what we look at are competitive advantages and to see how do we position ourselves, so that technology becomes an important part, where we had - the new products are very, very important for us to be become more relevant. And then you mentioned our locations, but I think, we have in the last 15 years changed almost 60% of our locations and even the ones I mentioned, half of them are relocations. So we are really locating our design centers from destination to areas with higher traffic. So you are going to continue for us to see improvement in that regard and those are the challenges that we have faced with and the ways we are meeting them John.

That’s a great answer Farooq. Are you in a position to give us any metrics around, and I am not a big fan of website hits, but anything around the internet feels free to our traffic, particularly since you revised the website? Thank you.

John, it’s too early, but certainly our traffic has increased. Our online business has increased by 40%, 50% but that’s still on a very small base. So, it’s too early, but we are going in the right direction.

Great, good luck. Thank you.

Okay.

Thank you. The next question is from Todd Schwartzman of Sidoti & Company. Your line is open.

Hi, Todd. Good morning.

Good morning Farooq. Good morning, Corey. Just - first off, a couple of points of clarification in my part if I could. Farooq, you talked about consumer attitude as cautious. I just want to be clear, were you referring to the Ethan Allen consumer or is that a broader economic assessment you are making?

Todd, I am - this is broader assessment I am making.

Okay. And Corey, you had given us the number, the percentage of clearance sales in Q2 at 11%, I think you were going to compare that to Q1 of fiscal 2015. I didn't get that number for comparison purposes.

The comparison between Q1 and Q2, Q2 was 36% higher than it was in the prior year. Sequentially, let me see if I have it on a sequential basis, Q1 over Q2.

The number that I thought I heard you mentioned was the 11% of consolidated sales in Q2. Just wondering if that - what the apples-to-apples number would be for first quarter. If I am accurate in my - what I heard.

Let me see here. Todd, let me pull those numbers and let me circle back with you on that. I don’t have those calculated from a sequential basis.

Okay, also in terms of numbers, can you maybe quantify January's traffic and written business?

It’s a little bit early, especially, as you know the last four five days is - are critical in making January and so, we will see how - we have had some setback in the Northeast. Fortunately, it wasn’t too bad in the New York and Connecticut areas. Somewhat more of an impact in Boston and Northeast, but it’s a bit early, but I think that we have very, very strong programs and everybody is focused on these last four days of closing business, Todd.

And if you can remind us, Farooq, what your exposure is in terms of number of design centers from Maine or from New England on down to the tri-state area?

Approximately, about 25 to 30, Todd.

Okay. With - looking at the second quarter, what was the delta in average ticket, both for delivered and written sales in Q2?

Approximately, in the United States, approximately 18 - you are talking of ticket price?

Yes.

About $1800, about the same - about, stayed about the same. \

Okay and that was on delivered sales?

On written sales and in the second quarter about 2% or 3% lower than the first quarter, sort of reflecting this the floor samples.

So, the $1,800, is that delivered or written?

It’s written.

And that was about flat year-over-year, correct?

Yes, approximately, I would say, 3% or so lower.

And what was the average delivered ticket?

Corey, it should really correspond to the written, Todd, because we more or less deliver what we write.

Okay. During normal times, if there is anything, what kind of bump in written business would you normally expect to see, Farooq, with a major product rollout and is there any extra incentive for the designers to sell the newly launched items?

We had on comparable stores an 8.6% increase in written and keep in mind that also reflect the fact that lot of product was sold at a discount. So most probably if it was not this discount stuff, it would been a higher written. As far as our designers are concerned, they get the same compensation, I mean, their compensation of course increases the more they sell and in fact the more they sell, their percentage increases, but we do not change the percentage based upon new products or old products.

And there are no limited time contests or anything of that sort, correct?

No, not larger than incentives.

Okay, now what’s the turnover been like, what’s the annual churn, if you will, in designers?

Corey, do we give that information out?

Yes, we don’t have our turnover rates, we give out, but I will tell you that it’s relatively low from a retail perspective. We don’t really follow the retail average turnover rates, really because of professionalism of our interior designers. So it’s…

It’s relatively low, Todd.

And you haven't seen really any meaningful increase in that as the economy has picked up, I am guessing?

There is some in some areas, there has been some pressures, but overall no and in fact, we have been adding interior designers that’s one of the increase in our costs. We have also been adding management to our designing centers and the great decision came, we used to be, we took people out. We took some of our project managers in our design centers and put them back as designers. Now we are adding project managers. We are adding district managers. So we are preparing for doing more business. So, that’s all those investments are being made right now. Our turnover is - turnover rate is low, if that was your question?

Yes, yes, sounds good, thanks. Last question, you’ve got some bonds maturing in the next twelve months. What are the plans for redeployment there?

Well, as Corey had mentioned the fact that by April, our objective is to utilize our new credit facilities, also to use some of our own cash and redeem those notes and at the end of the day, we will end up with much lower interest costs. Although we have to pay the interest on the notes to its maturity to October.

Got it. Thank you gentlemen.

All right, Todd.

Todd, just one thing, I’d just circle back on that clearance. Just I can clarify where that ended up. For Q1, our clearance sales were 24.8% higher than in the prior year and they were 9.4% of our retail net sales.

And in the second quarter - what, Corey, you said 36%, 35%?

Yes, so 35% higher.

35%.

And then they represented to about 7% of the net sales for retail because of the lower selling price. As Farooq mentioned, it was average about 60 some percent off of the regular price, so therefore you saw the lower percentage of the total sales because of the lower selling price in the second quarter.

And in the back half of the year, Corey, relative to that 60% number for Q2, is that about the same expected to be?

I don’t think so, Todd. When we come out with the new reductions, the first round of clearance is usually a lower mark down and it’s only then in the back half of the round of clearance that you take the steeper discount. So, we’ll have to see how it falls between the quarters. Now that is always going to be a little bit of flux between when you first put something on clearance when you are selling it off and lot of it goes initially at lower discounts and then what you are left with, then we take the larger markdown, so that we can get it off the floors and get the new product out and move on.

Thanks, Corey.

All right, Todd. Thanks.

Thank you. The next question is from Cristina Fernandez of Telsey Advisory Group. Your line is open.

Good morning, Christina.

Hi, good morning. I wanted to ask about the outlook for operating expenses here over the next couple of quarters. Should we assume that this quarter was the high watermark, just given you did all the remodels, had the manufacturing inefficiencies and increased marketing, and then it gets better from here or is this stay - going to stay - are they going to stay elevated so you get through phases 2 and 3 of the product launches?

Christina, as I said, we are gearing up. Our objective is, of course to increase sales, but to increase sales, we also have to increase our structure. So, we are going to increase advertising as we have discussed earlier. We are also going to increase some people in our management and even designers in our retail. We are increasing our expenses in our manufacturing, from the operating expenses perspective. So you are going to see increases - continued increases, we will of course keep them under control. But I believe that relative to last year, you are going to start seeing increases as we move forward in the rest of this fiscal year.

Okay, thanks. And then my second question, last year when you did the introduction or the expanded assortment of home accessories you talked about, that category potentially reaching 25% to 30% or 20%, 30% of sales, would phases 2 and 3, do those still have a high component of home accessories so that you still see that being a long-term goal or has the thinking changed?

No, absolutely, in fact, we have accelerated the development and the introduction of our accent programs, and for instance, in two weeks’ time, we are introducing the second phase of the romance classics and it’s really had a very, very strong accent programs as well and we’ll continue to do that and we’ve already seen a spike and somewhat of an increase in our accent business relative to the total business by about 2% and you are going to start seeing it as we move forward.

Okay, thank you.

Okay, Christina, thanks. Tyron, any other questions?

We have a question from Kristine Koerber. Your line is open. Yes, Kristine, good morning.

Good morning, Farooq and Corey. A couple of questions. First, when we look at the design centers, are you - where do you stand with renovations? Are the renovations done at this point, any major renovations needed for the next two phases?

I would say that about close to 70%, 75% is done. So we’ve got about 25% to 30% still to do.

Okay, but the - for the next two phases, is there anything major or is it just a continuation?

It is continuation, what we are doing also is taking a closer look as what we call our suburban or our urban and suburban flagship design centers. Like centers as you know in Manhattan, we did a complete renovation, similarly, we have taken some of the major design centers in Boston, in Chicago, and Atlanta, Los Angeles. We are giving them a much stronger renovation than we are doing with the rest, because they are positioned very well. So we’ll continue to do that, I would say, 70%, 75% is done, we got another 30% or so to go.

Okay, great. And then, when you look at the advertising and what you are spending on advertising are you seeing that what you are doing on the advertising front is driving new customers to the brand? I know you are going after the younger customer. What are you seeing so far?

We are - but it’s - certainly, or if you have seen our direct mail in the last few months, it sort of gets the message across about the attitude of this what I call the modern classics is getting across. We have increased our exposure to newer people we are increasing it. But I think, it’s going to take us the next year or so to really get that message across in all the different mediums and we will continue to do that and accelerate it.

Okay. And then, I am sure you have learned a lot from phase 1 and as we look at the next two phases, based on what you have learned from phase 1, are you going to do anything different for the next two product launches?

Not really, other than the fact that the Phase 2 and 3 as I said earlier, very, very strong programs, they are more of the classic romantic programs, but designed to be more, I’d say fashionable and more relaxed for today’s lifestyle. That I believe as very, very important category for us. So, I believe that you are going to see us with similar marketing campaigns on direct mail. We are also using more and more shelter magazines and also digital marketing. So I believe that we will continue with the strong advertising programs and the marketing programs that we have and we - but it will take us again the next few months to get it into the system and then to get it market it nationally and internationally.

Okay and then just lastly on the clearance, I believe it was $18 million to $20 million floor samples that you needed to sell-off in phase 1. What type of dollar amount are we looking at for the next two phases?

It would be approximately in that range too Kristine.

It's the same, okay, great. Thank you and good luck.

All right. Thank you.

The next question is from Justin Bergner of Gabelli & Company. Your line is open

Hi, good morning.

Good morning, Farooq, good morning Corey. My first question, just wanted to clarify a comment that you made earlier about written sales, if I heard correctly, potentially being 400 basis points higher without the negative impact of floor sales and clearance sales. Could you maybe let me know if I heard that correctly and maybe provide a little more perspective on that?

You did hear it correctly because as we said the 35% of our sales during the quarter were in clearance as margins, almost no margins, because these were towards the end of that Corey was explaining is this has towards the second half is when we really take mark downs. So, what we said was that if this product has been sold at our regular margins, it would have increased our sales by 4%.

Okay and did that apply to written sales as well as delivered sales or mainly written sales?

This is mainly written but our delivered also are impacted because of the fact that the products we are delivering are also delivered at a lower price. So, it may not be 4%, it maybe 4% but it’s pretty close to that.

Okay, so that means that without these impacts the written sales would have looked like plus 12%, am I,,,

No, you are right.

Okay.

Delivered would have been about 3% to 4% higher too.

Okay. And as I think about sort of Ethan Allen's comparable sales and written sales versus the numbers that some of your other peers in the furniture space have reported, are there any other differences that I should be thinking about in terms of the higher-end of the market perhaps not growing as quickly as the middle-end of the market or case goods versus upholstery mix and how that might have impacted your sales cadence?

Our upholstery business in the last few years as a proportion to total has continued to increase, which I believe is what is happening in the marketplace also. Certainly, there has been, as you see the numbers, we see from the industry are sort of all across the board whether it is, sort of medium priced or higher priced where some we have done well and some we haven’t done well. But I would say that, generally speaking, more mass merchants have had an opportunity of having higher sales than folks who are at more of the middle to higher-end part of the business.

Okay, that makes sense. My final question just relates to two of your initiatives over the last 6 to 12 months, the on-demand and the Modern Classics. Maybe you could just help us understand sort of what data points in regards to those two initiatives sort of give you confidence that they’re really moving the chains forward as opposed to just allowing you to keep your current rate of sales growth intact?

The new products have - first of all, we’ve got 1500 internal critics or interior designers. They play an important role in reviewing what we do. If they don’t like things the chances are, we’ll have a tough time selling them to the customers. But they are excited about it. And again, most of these products got into our design center at the end of November, December. In the next six months we are going to see the benefit of those product lines. These product lines that we have introduced reflects good design. They are more relevant for today in terms of their finishes. They are relax, they are fashionable, because that’s what’s consumers are looking for. So I think that, it is a little bit too early, but we are just now in a position this quarter to really start marketing those strongly. Then you’ll see that and then as we go into our fourth quarter, we will start marketing the first phase of the new classics. And then the second phase and by next fall, we would have a full complement of both the classics in the modern classics and the romantic classics in our programs which I think will give us a very strong product offerings.

Okay, thank you for taking all my questions, Farooq.

Thanks very much Justin.

Our next question is from Seria Benites of Cooper Capital. Your line is open.

Yes, hi, good morning.

Good morning. Thank you for squeezing me in. I understand that these are the new products you are talking about and obviously they should have a higher price point. But as you talk about some of the clearance that you sort of still need to move through, how do you mean that customer to go from clearance which is some of the higher price points? Is it’s all just products? How are you getting - how are you going to get there?

You know, the good thing about the clearance is, it has negatives that we are selling it at a lower margin. But it is bringing us a lot not only our current customers, it’s also bringing us new folks to see what at Ethan Allen has to offer. So, it gives an opportunity to expand our reach to more people and we are going to continue to see the benefit of that to our current clients as well as to new clients. Now, you know, in our business, we don’t have any outlet stores. It’s positive and negative. If we had outlet stores, lot of these products would have gone to those outlet stores and we would have maintained our - all our design centers to run the newer products and not the used to sell clearance. Now, if long-term we had lots of returns and lots of products that were to be sold in clearance, then we would have outlet stores. We have managed our inventories well. We don’t have a lot of products to sell other than in the normal course of business. This is an extraordinary period of time and I would say, in a year from now we will go back into normal operations.

Got it, thank you, and then just appreciate all the color on the phases and as well as the color of the environment in some of the newer entrants. Just sort of bigger picture, how do you think about your margin profile? I mean, if some of these competitors have operated significantly well, particularly the online guys, particularly in lower margin than you do, obviously, you have been in the industry a lot longer than they have. But, just, sort of bigger picture, how do you think about the sustainability of your growth and EBITDA margins please?

Yes, it’s a good question. Keep in mind, our retail margins are pretty close to what others have. If you take a look at the way the people - for instance, some of these lifestyle companies show their occupancy expenses as part of their gross margins, others show it as operating expenses, we show it as part of operating expenses as not part of gross margin. If we took our retail gross margins and took off the occupancy cost, our gross margins would be pretty competitive or pretty close to or perhaps even lower at retail than on these - most of these folks have. Then the other element is we are a manufacturing company. So our gross margins are also impacted positively by the gross margin of our manufacturing operations. That is the advantage that we have. So our gross margins reflects the retail gross margins and also reflect the wholesale gross margins because as a manufacturing company and as a combination of the two, we are pretty competitive.

Right and you expect them to stay there for the sustainable future?

We think so, of course, on the one hand, as you rightly noted, we have to remain competitive. We got to keep on what’s happening in the world, but even today our prices are very competitive, our margins are very competitive and it is because of the fact of a vertical integration structure, which gives us an opportunity to have the 54%, 55% gross margins. Otherwise, if we were operating like any other company, the chances are that our margins would be, you’ll see our margins pretty comparable to others.

Right, thank you.

All right. Thank you.

Thank you. And we have a follow-up question from Budd Bugatch of Raymond James. Your line is open.

Yes, hi there. Go ahead.

Thank you for taking my one quick follow-up. Corey, if you have it on you, can you please just give us what ad spending was as a percentage of sales for 3Q of last year where we have a reference point for the expected increase?

Sorry, I was on mute there. Advertising for Q3 of last year, well it was pretty close to what we ran for the year is at 5%.

Perfect, I appreciate you filling me back in and best of luck going forward.

All right, thanks very much.

Thank you.

All right. Tyron, I think that should do it, correct?

And I am showing no further questions at this time.

Well, thank you very much. If any other questions or comments, please let us know. Thanks very much.