Ethan Allen Interiors Inc (ETD) Q4 2021 Earnings Call Transcript

Good afternoon. Welcome to the Ethan Allen Fiscal 2021 Fourth Quarter Analyst Conference Call and Webcast. As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Matt McNulty, Vice President of Finance. Thank you. You may begin.

Thank you, Kevin. Good afternoon, and welcome to Ethan Allen's Analyst Conference Call for our Fourth Quarter and Fiscal Year ended June 30, 2021. Joining me today is Farooq Kathwari, our Chairman and CEO; and Corey Whitely, our Chief Financial Officer. Mr. Kathwari will open and close the call, while Corey will speak to the financials midway through. After our prepared remarks, we will then open the call to questions. Before we begin, I'd like to remind the audience that this call is being recorded and webcast live on ethanallen.com, where you'll find a copy of our press release, which contains reconciliations of non-GAAP financial information referred to in the release and on this call. A replay of today's call will also be made available via phone in our website. As a reminder, our comments today will include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a complete review of those risks. The company assumes no obligation to update or revise any forward-looking matters discussed during the call. With that, I'm pleased to now turn the call over to Farooq Kathwari.

Thank you, Matt, and thank you all for participating in our earnings call. While fiscal 2021 began with heightened levels of uncertainty, we were able to have strong performance for the fourth quarter and fiscal year ended June 30, 2021. After Corey provides a brief overview of the financial results, I will discuss our plans to grow sales, profits and cash. We believe we have a great opportunity to continue our growth and increase sales, profitability and cash flow and continue the strong returns to our stockholders. Corey?

Thank you, Farooq. Our fiscal year ended June 30 was challenging, yet we performed well. Our retail segment written order demand continued to accelerate during the fourth quarter, achieving 105% growth compared to the prior year fourth quarter and 40.2% growth compared to the fiscal 2019 fourth quarter. We are pleased that our July retail written orders are holding positive to the prior year's high order demand when our retail was reopening and are also positive to our strong July 2019 order demand. Wholesale segment written orders increased 82.3%. Excluding GSA and other government orders, wholesale segment orders grew 87%. Consolidated net sales for the fourth quarter were $178.3 million, a 94.7% increase to the prior year quarter. Our retail sales increased 113% for the quarter and wholesale sales increased 106.2%. Our international sales increased 4.1%, while contract sales had a 7.1% decrease. Contract or demand has recently started to rebound, especially for our government GSA contract. Total contract order demand increased 49.1% during the fourth quarter, and we expect this trend to positively impact wholesale net sales in the upcoming quarters as we produce and ship these orders. At the end of the fiscal fourth quarter, both our retail and wholesale segments had high order backlogs that we expect to get caught up during fiscal 2022. Our GAAP gross margin for the quarter was 58.7%, while our adjusted gross margin increased to 58.8%. The growth in consolidated gross margin was due to a shift in the retail to wholesale sales mix, improved operating leverage within our manufacturing due to higher production levels and benefits from our optimization of manufacturing and logistic initiatives over the past years. Retail sales grew to 84.5% of consolidated sales compared with 77.2% a year ago, which positively impacted our consolidated gross margin. We expect this higher percentage of retail sales to consolidated sales mix to continue in the near term as a result of the strong retail written order performance and related high retail order backlogs. Operating margin was 13.5%. Adjusted operating margin, which excludes the impact of pretax charges from restructuring initiatives, asset impairments and other corporate actions, increased to 14.1%, primarily due to net sales growth, improvement in gross margin and controlling costs by leveraging cost reductions from measures taken as part of our previously announced COVID-19 action plan. Adjusted operating expenses were $7.2 million or 8.2% less than they were in the fiscal 2019 fourth quarter. Adjusted operating expenses for the quarter were lower despite the strong sales growth due to reductions in certain selling expenses, including advertising costs and reduced G&A compensation expense as we are operating more efficiently with less headcount in our retail segment and at the corporate level than in the prior year period. Advertising costs were approximately 2% of net sales in the fourth quarter compared to our historical run rate of 4%. We expect advertising costs to return to the 3% to 4% range in fiscal 2022. Our GAAP earnings per share for the quarter was $0.71 compared to a $0.48 loss per share in the prior year quarter. Fourth quarter adjusted diluted EPS increased to $0.74 compared with a loss per share of $0.15. For the full fiscal year, adjusted EPS of $2.37 compared to $0.52 in fiscal 2020 and compared to $1.56 for fiscal 2019. As of June 30, our balance sheet remains strong with cash on hand of $105 million and no outstanding borrowings. Inventory sequentially increased 6.1% from our third quarter, reflecting our focus on increasing production and stock levels to service our backlogs. Customer deposits from written orders for our retail segment more than doubled during fiscal '21 and totaled $130.6 million at June 30. Strong retail order growth of 47.7% outpaced net delivered sales growth of 19.9% and led to high customer deposits. During the fourth quarter, we generated $27.8 million of cash from operating activities. And for the full fiscal year, we generated $129.9 million. For fiscal 2022, we expect capital expenditures to range between $16 million and $18 million as we reaccelerate our spend to further invest in technology, increase manufacturing capacity and open new or relocated design centers while also continuing to improve all our design centers projection. We paid a total of $31.7 million in regular and special dividends during the quarter. And for the full fiscal 2021, we returned $43.3 million to shareholders in regular and special cash dividends. We are also pleased to announce on August 3 that our Board of Directors declared a $0.75 special cash dividend, along with the $0.25 regular cash dividend, both payable on August 31 to shareholders of record on August 17. We intend to continue with the shortened time period between the regular dividend declaration date and the payment date as we've done for the past 2 dividends. With that, I'll turn the call back over to Farooq.

Thank you, Corey. We are positioned as a vertically integrated enterprise that develops relevant offerings, manufactures about 75% of our products in North America, and focuses on interior design services, increasingly paired with technology and a robust logistics network, providing in-home services we refer to as white cloud service to our clients. We maintain strong cash flow and deliver substantial cash dividends to our shareholders. As many of you know, I was part of the team that took our company public in 1993 at an adjusted share price of $3.51. Since then, we have consistently generated strong cash flow, disbursing $526 million in dividends, reducing debt by $585 million, and repurchasing $625 million of our stock. We also invested in our enterprise with $839 million in capital expenditures and acquisitions, strengthening our manufacturing, retail, logistics, and technology sectors. Over the past 10 years, our adjusted share price has risen from $14.76 to $27.60 as of June 30, 2021. During this time, we have used around $100 million to buy back shares, paid cash dividends totaling $233 million, and invested $183 million in capital expenditures and acquisitions. I mention this to highlight our commitment to managing our business and delivering strong returns to our shareholders. Our main focuses for fiscal 2022 and beyond are continued growth in sales, profitability, and cash generation. Notably, we saw a 6% increase in our July written orders at retail compared to a strong July last year. Wholesale written orders were up 13% in July year-over-year and 16% compared to two years ago, driven by robust orders from the U.S. government contract business, as Corey highlighted. Our second goal is to enhance our supply chain, as we have significant backlogs that need to be fulfilled. Though we manufacture 75% of our products in North America, we have faced challenges due to raw material shortages and the 25% of products sourced from overseas being affected by COVID-19 and rising transportation costs. However, our considerable investments in North American manufacturing and logistics have positioned us well for growth. We are also monitoring the delta variant closely in North America and internationally, though it has not had a significant negative impact so far. Additionally, we reported a strong fourth quarter adjusted gross margin of 58.8%, supported by a higher percentage of retail business in our total operations, and we aim to maintain a gross margin around 58%. Lastly, we believe we are well positioned with our product offerings and plans to introduce exciting new products by early 2022. At this point, we are happy to address any questions.

Our first question is from Bradley Thomas from KeyBanc Capital Markets.

This is Andrew on for Brad. I wanted to start by talking about these raw material delays. You gave some helpful detail on the state of your supply chain. But could you talk more specifically on the raw material delays you're facing, including which particular raw materials you're seeing the most delays from? And how has that situation evolved into July and August?

Yes. So the raw materials are as we are in both the upholstery business, in manufacturing and wood products or case goods. As it relates to upholstery, the raw material issues like we heard, of course, from the industry, have related, for instance, to foam, springs, and other items. We have, of course, operations also in Mexico, which have been less impacted than the one in the United States. As we know, a lot of this happened because of the problems in the Texas area, where a lot of these foam factories are. It's improving. It's still not where it needs to be, but we see gradual improvement every week. That is really on the upholstery side. In our wood products, there has not been a major issue. We had initially some issues on the lumber procurement, but that has sort of caught up, and I think it is more a question about catching up to high orders.

Great. And it's great to see the strong gross margin this quarter despite the higher product and freight costs you're seeing. But could you talk about how these rising costs may impact the next few quarters? And then how are you thinking about ways to mitigate those costs? I know you talked about price increases and changes to your discount or promotional strategy in the past. But could you talk about how you're thinking about it as we go into the next few quarters here?

Yes, Andrew, as I mentioned, we will also consider that having about a 58% gross margin reflects improvements in our sales efficiencies, as well as a higher percentage of retail to total sales. Moving forward, I think the gross margins indicate our business ratio of wholesale versus retail, which will have some effect. However, this doesn't necessarily mean a significant impact on the operating margins. For instance, if we see an increase in our overall business from the contract sector, our gross margin might be slightly lower, but the operating margin could be higher. That's why I suggested that aiming for approximately 58% is a reasonable target.

Okay. That's helpful. Shifting to the revenue outlook, given the ongoing strength in your order trends and increasing capacity in light of a substantial backlog, I'd like to explore the financial possibilities for the upcoming quarters. I understand that over the past three quarters, you've reached nearly $180 million in revenue each quarter. With the raw material delays easing week by week, do you believe you can exceed the $180 million revenue threshold in the next quarter or in the upcoming quarters?

Yes, Andrew, I believe that is indeed an opportunity. If we were to increase our revenue, we need to consider the ongoing issues with raw materials and other factors. However, I think a good target would be an increase of about $5 million to $7 million or $8 million.

Next question today is coming from Cristina Fernández from Telsey Advisory Group.

A couple of questions following up on the previous one. I wanted to see if you can update us on sort of what are the time frames now from customer orders to delivery? Have those compressed over the past couple of months as you've been able to increase capacity? Or are they still pretty meaningfully above like the pre-COVID time frame?

No, Cristina, our time frames are still significantly longer than they were before COVID. As you know, 75% of our products are produced in North America, and most of them are custom-made. This sets us apart from many others who typically buy inventory and have an average time frame between selling out of stock and what is custom. In our situation, everything is custom, which is why our time frames are affected. Although they are gradually decreasing, it is a slow process. On the positive side, this allows us to operate more efficiently and boost sales. Additionally, we have very little excess inventory to manage.

Okay. That's helpful. Another question we had was, can you talk about why you're seeing in traffic at your interior design centers? It seems like trends are normalizing. Obviously, July orders were still above last year. But how did the quarter progress? What do you expect to see here over the next couple of months?

Yes, Cristina, one of the key factors is that we were fortunate to have invested in technology like 3D and virtual reality over the past four to five years. If we hadn't made those investments, I'm not sure how our custom business would have managed. We didn't have a lot of inventory for customers to see and buy, so our designers have had to engage with clients both physically and virtually. It's remarkable that I receive updates about numerous events involving customers each week, with at least 50 just yesterday. I'm both surprised and pleased by the extent to which our business operates through a combination of personal service and technology. This sets us apart from those who rely on selling from existing inventory. As we build our business, we are focusing on having fewer interior designers, but ensuring they are more qualified. We will continue to invest in technology to equip them with tools that enhance their personal service. This will be a crucial factor moving forward, and I see it as an advantage for us.

And then the last one I had. Can you talk about marketing? How are you thinking about marketing spend this upcoming year? And also, I guess, I mean, as you've seen new customers over the past few quarters, are you doing anything differently to try to retain those customers and bring them back in the next year or 2?

Yes, Cristina, that's an important factor. As Corey mentioned, we reduced our overall advertising spend last quarter primarily because we had a significant number of people coming in and spending. Additionally, we have shifted our advertising strategy to focus more on digital platforms rather than print and, to some extent, television. This change has allowed us to lower our costs while increasing our reach. If 2% feels a bit low, for budgeting purposes, we will plan for around 3% to 4%, but I'll continue to monitor it to ensure we utilize our budget effectively. The change in our advertising mediums is crucial as we are actually reaching more people by spending 2% on advertising compared to the previous 4%. Therefore, a budget around 3% to 4% seems reasonable.

As there are no more questions in the queue, I'll turn the floor back over to Farooq for any further or closing comments.

Thank you very much. We are pleased with the progress we have made, but there is still much work ahead of us. We need to ensure that we continue to serve our customers effectively. Our backlogs are quite high, which requires our focus. Thank you to everyone, and I look forward to our next conversation.

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

All right. Thanks very much. Take care.