Ethan Allen Interiors - Q3 2023

Transcript

Operator (participant)

Good afternoon, welcome to the Ethan Allen Fiscal 2023 Third Quarter Analyst Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. It is now my pleasure to introduce your host, Matt McNulty, Senior Vice President, Chief Financial Officer, and Treasurer. Thank you. You may begin.

Matt McNulty (SVP, CFO, and Treasurer)

Thank you, operator. Good afternoon. Thank you for joining us today to discuss Ethan Allen's fiscal 2023 third quarter results. With me today is Farooq Kathwari, our Chairman, President, and CEO. Mr. Kathwari will open and close our prepared remarks while I will speak to our financial performance midway through. After our prepared remarks, we will open the call for your questions. Before we begin, I'd like to remind the audience that this call is being recorded and webcast live under the News and Events tab on the Investor Relations page of our ethanallen.com website. There, you'll also find a copy of our press release, which contains reconciliations of non-GAAP financial measures 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.

Our comments today may 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 the call. With that, I'm pleased to now turn the call over to Mr. Kathwari.

Farooq Kathwari (Chairman, President, and CEO)

Thank you, Matt. We are pleased with our strong financial performance for the quarter ending March 31, 2023, especially compared to strong results for the previous period. Matt will review in detail our financials for quarter ending March 31. We had sales of $186.3 million, strong gross and operating margins of 59.9% and 15.5%, respectively. Our diluted earnings of $0.86 remained strong. Importantly, we ended the quarter with cash of $156.2 million and no debt. Also pleased, yesterday we announced that our regular dividend, cash dividend has been increased by 13% to $0.36. Last week, we had a in-person convention with 300 of our leaders from retail, manufacturing, logistics, and our corporate teams.

We launched with a grand opening of our Interior Design Destination initiative at our flagship Danbury Design Center. We discussed many initiatives to continue to operate our business, also keeping in view the softening of the economy. After Matt provides the detailed financial overview, I will review our initiatives to maintain a strong operational and financial position. Matt?

Matt McNulty (SVP, CFO, and Treasurer)

Thank you, Mr. Kathwari. As a reminder, we present our financial results on both a GAAP and non-GAAP basis. Non-GAAP results include restructuring initiatives, impairments, and other corporate actions and are further detailed in our press release. We believe the non-GAAP presentation better reflects underlying operating trends and performance of the business. Our financial results in the just completed third quarter were highlighted by strong growth in operating margins, shorter lead times from decreasing backlog, disciplined cost and expense controls, and a robust balance sheet, including $156.2 million in cash and investments and lower inventories. As we began to revert back to pre-pandemic conditions, our operations produced strong financial results, which I will now discuss.

Our consolidated net sales totaled $186.3 million and were helped by high backlogs, pricing actions taking, and the positive effects of product mix, partially offset by lower delivered unit volume. Sales in fiscal 2022 set a near record pace, leading to a difficult comparison. Compared to the third quarter of fiscal 2019, which is pre-pandemic and more reflective of historical norms, our consolidated net sales were up 4.8%. Wholesale segment written orders decreased 9.3% compared with last year and were down 5.9% to the pre-pandemic third quarter of 2019. Our retail written orders declined 12.3% due to a strong prior year comparable. When compared to the third quarter of 2019, our retail orders were up 3.6%.

We ended the quarter with wholesale backlog of $73.3 million, down 42.2% from a year ago, as we were able to reduce the number of weeks of backlog by over 30%, bringing it more current. Our wholesale backlog remains approximately 30% higher than pre-pandemic levels. Consolidated gross margin was 59.9%, which marked our eighth consecutive quarter that our consolidated gross margin exceeded 58%, a metric previously not seen before the onset of the COVID-19 pandemic. Compared to last year, our consolidated gross margin was down 50 basis points due to a change in the sales mix, partially offset by lower input costs such as inbound freight and raw materials. We had expected the percentage of retail sales to consolidated sales to moderate towards normalized levels, and this materialized in Q3.

Retail sales were 81% of consolidated sales, down from 84.4% last year, as we delivered out more of our wholesale backlog, including a greater percentage of contract business backlog. Adjusted operating margin was 15.2%, down from 15.8% last year due to lower consolidated net sales, a gross margin reduction and higher retail delivery costs, partially offset by our ability to maintain a disciplined approach to cost savings and expense controls. Our SG&A expenses decreased 5.7% and equaled 44.7% of net sales, the same as last year as we carefully managed expenses in a declining net sales environment. Adjusted diluted EPS was $0.86 per share compared to $0.93 last year. Our effective tax rate for the quarter was 25.1%, up from 24.2% last year.

Turning to our liquidity and capital resources. As of March 31, 2023, we had cash and investments of $156.2 million with no outstanding debt. We generated $33.4 million in cash from operating activities during the quarter, bringing our total year to date amount up to $74.4 million in fiscal 2023, an 85.9% increase over last year due to higher net income and an improvement in working capital. Our inventory levels decreased $24.8 million since the start of the fiscal year as we restore our operating inventory levels to more historical norms as backlog decreases, while also ensuring appropriate amounts of inventory are on hand to service our customers. Capital expenditures were $2.2 million for the quarter and included investments in various areas within manufacturing, technology and retail.

We continued our practice of returning capital to shareholders as our board declared a regular quarterly cash dividend of $0.32 per share in January, which was subsequently paid in February. Our total year-to-date dividends paid were $37.2 million. As just announced in our earnings release, our board increased the regular quarterly cash dividend by 13% to $0.36 per share, which will be paid in May. We have paid a cash dividend every year since 1996 and have now increased our regular quarterly cash dividend in each of the past 5 years. In summary, we produced strong growth in operating margins while managing our expenses in a challenging environment. As we move through 2023, we are carefully managing our expense structure while investing in growth initiatives that we believe will further our business.

With that, I will now turn the call back over to Mr. Kathwari.

Farooq Kathwari (Chairman, President, and CEO)

Thank you, Matt. As I mentioned last week, we had in-person convention at our Danbury, Connecticut headquarters with about 300 of our leadership from retail, manufacturing, logistics and corporate. We reviewed many areas of our enterprise, including the following: Introduction of the Interior Design Destination Initiative. The Danbury, Connecticut Design Center reflected our strengthened offerings and projection of classic designs with a modern perspective. The projection and our new offerings were extremely well received, and our plan is to have this projection reflected in over 172 design centers across North America during the next nine months. This is extremely important initiative for several reasons, including our design centers across North America will project the perspective, creating excitement with our interior design teams and also our clients. We believe will help us in driving traffic to our design centers during the time of softening economy.

Our manufacturing is in great position to service our clients. During the last few years, had to manage very strong backlogs of orders. As you know, about 75% of our products are made on receipt of orders in our North American workshops. While we had developed new products, we decided to hold introductions until most of the backlog was delivered and we were in a better position to service our clients. We started to introduce some new products during the last year or two. Now we have continued to invest in strong product introductions. We also continued to improve and invest in our manufacturing. Keep in mind, 20 years back, we operated about 30 manufacturing plants in the United States. Today, we operate 10 very strong plants in North America, making, as I said, about 75% of our products.

We have strengthened our logistics both at the national level and at the retail level. We deliver our products at one cost nationally. During COVID, we had to absorb very high freight costs. Currently, we see the freight rates coming down. Very importantly, we have also continued to invest in technology in all areas of our enterprise. Combination of strategic locations of our manufacturing, talented, motivated associates and technology has resulted with our many initiatives, especially some from fiscal 2019, we have made major efficiencies in getting stronger talent, reducing overall headcount, while major increases in sales. For example, since fiscal 2019, we have reduced our headcounts, both in retail and network and our manufacturing logistics by 12% while increasing sales substantially. We have also reduced our overall inventory.

As Matt mentioned, we have worked hard to service our clients, and while our backlog is down substantially from fiscal 2019, it still remains at healthy levels. With that, I'm very happy to open it up for any questions or comments that you might have.

Operator (participant)

At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Cristina Fernandez with Telsey Advisory Group. Please proceed with your question.

Farooq Kathwari (Chairman, President, and CEO)

Yeah. Hello, Cristina.

Cristina Fernandez (Managing Director and Senior Research Analyst)

Hello, Farooq and Matt. You know, good result on the operating side. I wanted to start with the SG&A expenses are being, you know, very well controlled. You know, where are those reductions coming from? Do you think you can manage this from quarter to quarter? Or as we look at an environment of softening sales, there need to be more, you know, more structural changes to your expense levels.

Farooq Kathwari (Chairman, President, and CEO)

Yeah, Cristina, you know, it's interesting since when you look at from 2019, that is pre-COVID-19, we have reduced our inventories, we have reduced our operating expenses while our sales have gone up. A lot of it is due to a number of factors. First is, on the retail side, technology and stronger interior designers have played a very important role. We have today less people in our retail bring more business. Today, our designers are able to work virtually with clients. Of course, you know, with the COVID-19, that was tremendously important. That resulted in reduction of people, but more stronger interior designers, and I think that will continue. Our designers are doing well. Similarly, manufacturing. If you take a look at our manufacturing and our logistics, we have less people today than we had 2019 with higher sales.

As we go forward, that will continue and will give us benefit and will continue to become more efficient. This question of, making sure that our operation is more efficient, has been a very important part of our initiatives, and I think that will continue.

Cristina Fernandez (Managing Director and Senior Research Analyst)

Thank you. I also wanted to ask about demand, they're down 9% in wholesale for the quarter, 12% in retail. How did demand progress during the quarter? Is it even or are you seeing a lot of volatility? Any color by regions that you can share? Are there any, you know, major differences? And how is demand trending so far in April? Any color there would be helpful.

Farooq Kathwari (Chairman, President, and CEO)

Well, we are of course comparing to high, very high numbers in the previous years. Obviously, we are looking at, you know, when we take a look at our business even compared to 2019, our backlogs are still higher, as Matt just mentioned, compared to even 2019. We do know that we were operating at very high demands. That is softening. We saw that most of it really during the quarter and in April also, I think that people are more cautious. Obviously, it's still early. We, as you know, we look at the whole quarter before we make any determination. We are prepared to... We need to understand that people are more cautious and that we have to be more effective, efficient, both in marketing and in terms of our operating expenses.

We are looking at both very carefully.

Cristina Fernandez (Managing Director and Senior Research Analyst)

As a follow-up to the backlog comment, you mentioned backlog is up about 30% versus pre-pandemic, and orders for the quarter, I think are down like 3%. Do you expect that backlog to normalize versus the pre-pandemic level or anything has, you know, changed where that backlog should, you know, stay higher?

Farooq Kathwari (Chairman, President, and CEO)

No. Well, if you keep in mind just our backlogs, just to take a look at it just from prior year, they're down almost 40%. They're still high compared to the pre-pandemic levels, no. As we continue to go forward, our backlogs are going to continue to come down because we are able to make the products. We had just tremendously high business in the first two years of the COVID. We've caught up, and we've caught up very well. I think by this quarter, we'll have completely caught up, and which is good news that we will have even faster deliveries.

Cristina Fernandez (Managing Director and Senior Research Analyst)

One last question I had was on the, on the dividend increase. As you thought about increasing the dividend, is there a payout target you're working towards that you wanted to, you know, to hit, you know, with the level of where you took the dividend?

Farooq Kathwari (Chairman, President, and CEO)

Well, you know, as you know, we have been giving over the last, as Matt just mentioned, we have continuously had our regular dividend, and we've also had special dividends. When I take a look at it, just before we increase this dividend now, I think our yield on the regular dividend was close to, I think, 4.7%, 4.8%. Right, Matt?

Matt McNulty (SVP, CFO, and Treasurer)

That is correct.

Farooq Kathwari (Chairman, President, and CEO)

It'll now go over 5%. If you include, which I do not, and the financial markets don't include our special dividends, that would also, you know, that makes it closer to 5.5%-6%. I think having a dividend between 5% and 6% yield is pretty good, and that's our intention.

Cristina Fernandez (Managing Director and Senior Research Analyst)

Thank you.

Farooq Kathwari (Chairman, President, and CEO)

All right, Cristina. Thanks very much.

Operator (participant)

Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets Inc. Please proceed with your question.

Farooq Kathwari (Chairman, President, and CEO)

All right. No, this is not Brad, is it?

Zach Donnelly (Equity Research Associate Analyst)

This is Zach Donnelly on for Brad. How are you, Farooq?

Farooq Kathwari (Chairman, President, and CEO)

Very good. Good to hear your voice. Go ahead, please.

Zach Donnelly (Equity Research Associate Analyst)

Sure. I want to touch on the backlog as well. I know you had mentioned that you were working down the contract portion of the backlog specifically for this quarter. I was wondering if you could provide us with details on what portion is contract versus not contract, and maybe some of the different margin puts and takes associated with the contract versus non-contract portion of the backlog.

Farooq Kathwari (Chairman, President, and CEO)

By contract, you mean our business with the government?

Zach Donnelly (Equity Research Associate Analyst)

Exactly.

Farooq Kathwari (Chairman, President, and CEO)

Yeah, yeah. As you know, most of our business comes from our own retail network. Retail network, which is operated by our own retail division and then our independents. So we have what we call retail backlog and wholesale backlog. I think at this stage, Matt could give you perhaps a little bit more information, but If you compare it, for instance, to, let us say, let's say even 06/30/2020, going back to three years, our backlog is still approximately at the retail level, is still higher by about close to 30%-40%. Right, Matt?

Matt McNulty (SVP, CFO, and Treasurer)

That is correct. It is up 41%.

Farooq Kathwari (Chairman, President, and CEO)

Okay, 41%. Our wholesale backlog is up even with all what the business we've done, we've delivered, is approximately up about 12%-15%. Correct, Matt?

Matt McNulty (SVP, CFO, and Treasurer)

The wholesale backlog is up a 30%.

Farooq Kathwari (Chairman, President, and CEO)

Oh.

Matt McNulty (SVP, CFO, and Treasurer)

Retail is up about 40%.

Farooq Kathwari (Chairman, President, and CEO)

Oh, I see. From 6/30/2020 to now.

Matt McNulty (SVP, CFO, and Treasurer)

Yeah. From pre-pandemic levels, actually, I was looking at.

Farooq Kathwari (Chairman, President, and CEO)

Pandemic.

Matt McNulty (SVP, CFO, and Treasurer)

Yeah.

Farooq Kathwari (Chairman, President, and CEO)

Yeah. $10 million over $63 million is what? Yeah, that's. Okay. Yeah.

Matt McNulty (SVP, CFO, and Treasurer)

From June thirty, yes, you are correct. It's down about 15%.

Farooq Kathwari (Chairman, President, and CEO)

All right. Yeah. Our backlogs are still high, but again, both at the contract level, which is our government contract and at the retail. Our retail is higher.

Zach Donnelly (Equity Research Associate Analyst)

Understood. Thank you. I also wanted to touch on unit volume trends. I know that the negative unit volume trends you've been kind of seeing, have been negatively impacting gross margins. You know, we've been hearing from different industry participants that unit volume trends might be down somewhere in the mid-single digit to high single digit range for this quarter. I was wondering if you could provide any additional detail on that, and then maybe, you know, touch on whether or not, you know, you think Ethan Allen needs to become perhaps more promotional in order to drive unit volumes in the next couple of quarters.

Farooq Kathwari (Chairman, President, and CEO)

No, I understand. As we just closed, our gross margin for this quarter just ending was about almost 60% and 59.9%. If you take a look at going back to our pre-pandemic levels, it was about 56%. We have maintained a high gross margin. Now as we go forward, you know, obviously, we have to take a look at the economy. We've got to take a look at whether we have to be more aggressive in our marketing. We, we have. These gross margins are a result of a number of factors.

First is, the fact that volumes are a very important factor in terms of having an impact of gross margins, especially at our manufacturing level, because our manufacturing is impacted by, volumes that have a tremendous impact on our gross margins. I think at this stage, we operated at a very high level of 59.9%, and our pre-pandemic level was 55%. I think between 55 and 60, that is something in between the two, I think we'll continue to have our. We expect that to be our gross margins.

Zach Donnelly (Equity Research Associate Analyst)

Understood. Sounds good. Just one last question from me. I think the last time we spoke, you had reminded me and our team that the last set of pricing actions you had taken were passed maybe in January to March of the previous year. Can you just remind us if that's correct or if you've passed along any additional pricing actions since then? Then if not, how do you expect the fact that we're now lapping those pricing actions to impact revenue and margins moving forward?

Farooq Kathwari (Chairman, President, and CEO)

maybe Matt can perhaps give you somewhat more details, but our objective has not taken price increases across the board. Our focus has been, in the last few years, to be very selective in our price increases depending upon where the product is coming from. In fact, some of the price increases that we took in the last two years also reflected extremely high freight costs. 25% of our product, for instance, is coming from offshore in East Asia. The cost of a container went from $3,000 to $30,000. Now it's coming back to close to $3,000. Similarly, for instance, our forwarding a container from East Coast to the West Coast, also increased by almost doubled.

To seven-- Now it's come down, so our price increases reflected, to a great degree, the impact of freight. That's why we have not taken many price increases because the freight is coming down.

Matt McNulty (SVP, CFO, and Treasurer)

Just to clarify, the last price increases were done in January, February of last year, of 2022. Do remember, though, due to the backlog and the nature of our business, those price increases do not impact our P&L until it actually gets delivered. There is a lag of anywhere between 2 to 4 months on that.

Farooq Kathwari (Chairman, President, and CEO)

That's important. Also, as I said, the freight factor was a very important factor. It's still not completely down, but major factor. Look at this. As I said, from East Asia from $3,000 to $30, now it's down to $3,000 or $4,000. We did take price increases. Other price increases that came in have been absorbed because by the reduction of freight, the national and domestic.

Zach Donnelly (Equity Research Associate Analyst)

Got it. Got it. Yeah, that's really helpful. And just to kind of clarify as a last point with the kind of lagged impact of those pricing actions, I guess it sounds like we won't really or truly kind of lap those pricing actions until maybe the end of next quarter. Is that kind of generally correct in that thinking?

Farooq Kathwari (Chairman, President, and CEO)

At this stage, we don't have any plans of increasing prices at this stage.

Zach Donnelly (Equity Research Associate Analyst)

Got it. Thank you. That's good for me.

Farooq Kathwari (Chairman, President, and CEO)

All right. Thanks very much. Any other questions?

Operator (participant)

And-

Farooq Kathwari (Chairman, President, and CEO)

John?

Operator (participant)

Yep.

Farooq Kathwari (Chairman, President, and CEO)

Yeah.

Operator (participant)

Yeah, we've reached the end of the question and answer session. Therefore I'll hand it back over to you for closing remarks.

Farooq Kathwari (Chairman, President, and CEO)

Thanks very much. Well, we're very... As I said, we are pleased with the performance. We are also, of course, cautiously optimistic, as I've said in our press release, that we have to watch what is taking place in the economy. We've got to take a place, we've got to take a look at the trend factors. So far, we are positioned extremely well. Keep in mind, as I said, our operating expense are lower, our inventories are lower, we have managed our costs quite well, and we have strengthened our teams. This launch of the Interior Design Destination is a very important initiative. We were going to do that too, but it just so happens that the softening of the economy gives us an opportunity of having a strong marketing to get our message across.

Thanks for everybody for joining and look forward to continuing our progress and talking next quarter.

Operator (participant)

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.

Farooq Kathwari (Chairman, President, and CEO)

Thank you.