Earnings Call Transcript - ETD Q1 2022

Operator, Operator

Good afternoon, and welcome to the Ethan Allen Fiscal 2022 First 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. Please note, 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.

Matt McNulty, Vice President of Finance

Thank you, Alex. Good afternoon, and welcome to Ethan Allen's analyst conference call for our fiscal first quarter ended September 30, 2021. Joining me today is Farooq Kathwari, our Chairman and CEO; and Corey Whiteley, 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 for your 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 measures referred to in this release and on this call. A replay of today's call will also be made available via phone and on 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 this call. With that, I'm pleased to now turn the call over to Farooq Kathwari.

Farooq Kathwari, Chairman and CEO

Thank you, Matt, and thank you all for participating in our earnings call today. We are pleased with the continued strengthening of many aspects of our enterprise, including our financial results, our talent, our manufacturing, our service, marketing, technology, and social responsibility. We have continued to strengthen our talent in our vertically integrated enterprise by adding to our workforce in manufacturing, logistics, and retail. Our headcount of 4,212 has increased 18.5% from the previous year's first quarter. Continuing personal service of our interior design teams with technology has been a game changer and will continue to provide a major competitive opportunity to grow. Servicing our large backlog of orders is of critical importance. At September 30, 2021, our retail backlog was up 73% from a year ago, which provides us the continued opportunity to increase delivered sales. Seventy-five percent of our products are made, and most of them custom, in our North American manufacturing workshops, providing us a good opportunity to serve our clients. We have taken steps to strengthen the business, including additional work shifts within our North American workshops, building a new addition to our Maiden, North Carolina plant, continuing our investments in Vermont plants in Honduras, Mexico, and also in our various logistics centers. We have also grown our manufacturing headcount by double digits over the last several months. Through these actions, we have increased capacity and are focused on servicing our large backlog of written orders. We continue to strengthen our product offerings, the projection of our design centers, and the various elements of marketing. For the quarter ended September 30, 2021, we substantially increased our digital marketing, reaching over 15 million households with our 36-page digital magazine. We reduced our advertising in other traditional mediums, thereby reducing our overall advertising spend to 2% of sales compared to 4.1% in the previous year's quarter. Going forward, we expect to increase our advertising to about 3% to 4% of sales. We had strong financial results during our first quarter of fiscal 2022, which Corey Whiteley will now briefly walk you through.

Corey Whiteley, Chief Financial Officer

Thank you, Farooq. We had a strong performance for our fiscal 2022 first quarter ended September 30. Retail segment written order demand continued to accelerate during the quarter, achieving 6.1% growth compared to the strong prior year period and 17.6% growth compared to the first quarter ending September 2019. Wholesale segment written orders increased 8.1%. Strong retail demand and contract sales growth, which increased 51.1% due to a rebound in government orders, helped drive the strong wholesale performance. Consolidated net sales for the first quarter were $182.3 million, a 20.7% increase from the prior year quarter. Our retail sales increased 31.3% and wholesale sales increased 12.4%. At the end of the quarter, both our retail and wholesale segments had record high order backlogs that we expect to catch up on during this fiscal year. We were able to achieve a strong gross margin of 59.9% despite ongoing supply chain challenges. This growth was due to a shift in the ratio of retail sales to wholesale sales, improved operating leverage within our manufacturing from higher production levels, and benefits from our optimization of manufacturing and logistics initiatives. The retail sales mix grew to 85% of consolidated sales compared with 78.2% a year ago, which positively impacted our consolidated gross margin. We expect this higher percentage of retail sales to consolidated sales to moderate towards normalized levels as we ramp up delivery of the high wholesale order backlogs. Our merchandising and supply chain teams continue to work through the current environment of rapidly escalating commodity and freight costs, product shortages, price increases, and shipping delays. While we were pleased with the strong gross margin of 59.9%, we expect our gross margin to return to a more normal range of approximately 58% to 58.5% in the near term as the sales mix returns to more historical norms. Our operating margin was 15% for the quarter. Adjusted operating margin increased to 15.2%, primarily due to net sales growth, the improvement in gross margin, and controlling costs. Adjusted operating expenses of 44.7% of sales for the quarter reflected operational leverage under our vertical structure, along with reductions in certain selling expenses, including advertising costs. Our GAAP earnings per share for the quarter increased to $0.79 compared to $0.37 per share in the prior year's quarter. First-quarter adjusted diluted EPS increased to $0.80 compared to $0.36 in the prior year. As of September 30, our balance sheet remains strong with cash on hand of $93.7 million and no outstanding borrowings. During the first quarter, we generated $17 million of cash from operating activities and paid a total of $25.4 million in regular and special dividends. With that, I'll turn the call back over to Farooq.

Farooq Kathwari, Chairman and CEO

Yes, Corey, thanks. And just to again focus on some of these important financial metrics. We had strong sales and profitability in this quarter. Sales of $182.3 million increased 20.7%. Gross margin increased to 59.9%, and operating income increased 134.2%, and operating margin was 15%, and the diluted EPS was 113.5%, also showing the impact of our vertical business and the leverage that we have on both our margins, gross margins, and profitability. Our retail segment operating margin increased to 9.3% from 2.3% last year. Again, a very important element, just shows the impact of sales and its impact on our margins because we are able to manage a lot of our costs, which are fixed. On the balance sheet, we ended with cash of $93.7 million and no debt. We distributed $25.4 million of regular and special dividends. Our inventory grew to $158.7 million due mostly to sold orders that have to be delivered and improving our manufacturing position to better service our backlog. We remain committed to our sustainability practices, including both corporate social responsibility and ESG practices as they have been a fundamental part of our operation for the last 90 years. We understand that our approach to managing the business must be aligned with our commitment to sustainability. Many of our decisions are based upon factors such as energy consumption, reduction of waste and emissions, the effects of our operations on climate change, equality, equity, and inclusion in the workforce, employee safety and security in the workplace—all the more important in this last year, and compliance with national and international legal standards for the conduct of business and enforcing the most rigorous social standards in every jurisdiction in which we conduct business. We are pleased with what we have accomplished in the first 10 years of the major sustainability initiatives that we undertook and are setting our new 10-year goals through 2030. As part of those goals, we have established a commitment to achieving net-zero emissions by 2050 and developing methods, plans, and resources to meet this commitment. Now, as we look ahead, our focus remains on long-term growth. We acknowledge the support of our shareholder base with a focus on longer-term returns, especially cash dividends. As I previously mentioned, we paid $25.4 million in regular special dividends, and our objective is to continue strong shareholder returns. And now, I'm pleased to open for any questions or comments.

Operator, Operator

At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Bradley Thomas with KeyBanc Capital Markets.

Farooq Kathwari, Chairman and CEO

Yeah, hello there. Is that Brad?

Andrew Efimoff, Analyst

This is Andrew. Good afternoon, Farooq and Corey. This is Andrew on for Brad. Thanks for taking our questions here.

Farooq Kathwari, Chairman and CEO

Hi, Andrew.

Andrew Efimoff, Analyst

Hi, Farooq. I wanted to start out by talking about capacity and delivered revenue. We know that in this quarter, you saw about a $4 million increase in delivered revenue sequentially versus fiscal 4Q. But as your capacity continues to ramp, how should we think about the improvement in delivered revenue over the next few quarters? Do you expect to continue to grow delivered revenue by a similar amount of $4 million sequentially in the quarters ahead? Or do you expect to achieve a different pace?

Farooq Kathwari, Chairman and CEO

Andrew, I would think that it would be somewhat higher than what we have done because, as I mentioned, we have continued to invest in our North American manufacturing. Some issues that we have had and some raw material supplies have improved. So I would say that it will be somewhat of an increase from what you have seen.

Andrew Efimoff, Analyst

Understood. And speaking of raw materials, I know in the past few quarters, the foam supply was a significant bottleneck for you all. What are you seeing on the foam supply? And are you seeing continued improvement in that area of your supply chain?

Farooq Kathwari, Chairman and CEO

Yes, we are almost back to normal.

Andrew Efimoff, Analyst

Okay. Great. And so—

Farooq Kathwari, Chairman and CEO

Yes, I'm sorry, go ahead.

Andrew Efimoff, Analyst

So, as it looks like foam has recovered back to normal, what are some of the remaining bottlenecks you have to work through on the supply chain to meet this higher level of demand that you're seeing?

Farooq Kathwari, Chairman and CEO

Well, as we have mentioned, about 75% of our products are made in our North American facilities. You might have read, a couple of months back, I was hiking in Vermont and said I better visit our plants. They were having a tough time in terms of getting labor. We have a tremendous amount of capacity and investments. So we discussed with our team and then increased the base rate from $13 to $16 and increased other wages. Getting labor was a big factor. The good news is, since we did that, we are starting to get good, strong labor not only in North Carolina but we, of course, implemented it throughout North America, these new wages, especially in the United States. So labor was a big factor and is in a much better position. We are better positioned. And then, of course, in the 25% or so of the products that are coming from offshore, we are having challenges. We are in a better position than most, but still face challenges in terms of getting containers. And the cost of the containers has gone from about $2,000 to $2,500 to $20,000 to $25,000. So it's not only the question of cost but availability. However, as I said, the 75% coming from North America has given us an opportunity to increase our production and our deliveries.

Andrew Efimoff, Analyst

Understood. That's good to hear. Shifting to written trends, it was good to see continued positive written sales growth through the quarter despite the long delivery times. However, it's difficult to assess how written trends compared to the strength you saw in recent quarters, given the lumpiness of the pandemic comparisons. So I was wondering if you could share how written trends are faring on a two-year basis and how that strength compares to what you've seen earlier this year.

Farooq Kathwari, Chairman and CEO

Corey?

Corey Whiteley, Chief Financial Officer

Yeah. For the quarter just ended, while we were up 6.1% to that really strong prior year when we saw the recoveries just start after the lockdowns. If we go back all the way to September 2019, that was a 17.6% growth. So it's still a good trend from either direction, and that’s been good to see. We're also seeing the growth on the contract sales as the GSA business has rebounded as well. We are just at the end of the government fiscal year. So that helped on the order growth side and then they'll turn, of course, into wholesale shipments as we then start delivering that product out.

Farooq Kathwari, Chairman and CEO

Yeah. Brad, having said this, the way we have had strength has been in the state department where the weaknesses we have seen have been in our international business because there's still a lot of issues, whether it's in China, other Southeast countries, or in the Middle East. That has been somewhat slow. But fortunately, most of the business is in North America, and the state department is a big part of our business. So they're doing well.

Andrew Efimoff, Analyst

Understood. Thanks for the detail there. I will pass it on to others, and I'll jump back in the queue. Thank you.

Farooq Kathwari, Chairman and CEO

All right, Brad. Thanks.

Operator, Operator

Thank you. Our next question comes from the line of Cristina Fernández with Telsey Advisory Group. Please proceed with your question.

Farooq Kathwari, Chairman and CEO

Hello, Cristina.

Cristina Fernández, Analyst

Hi, good afternoon, Farooq and Corey. And congratulations on a good quarter. I had a couple of questions. I wanted to follow up on that order question. Maybe if you can talk more broadly about demand trends. How do you feel about continuing to generate positive orders over the next couple of quarters? And as you look at the health of the consumer, what gives you confidence that the strong demand we've seen for home furnishings can continue as we go into 2022?

Farooq Kathwari, Chairman and CEO

Yeah, Cristina, that's a very important question. When we take a look at it in the last year, we have done extremely well. Corey just mentioned that in the September quarter, we were up 6.1% and written against a very strong order that we had in the previous year. I believe that the consumer interest in the home has been very strong in the last 1.5 years. I would think that the consumer interest will not be as strong going forward, so we've got to work harder. We need to be in a much better position. I would say that the easier days for our industry are over. Now having said this, we are in a better position because we have strengthened our offerings. We have strengthened our retail teams. We have a very strong interior design network combined with technology because 75% of the products that the order that they take is custom designed. If we didn't have the technology and the ability of our interior designers to work from their home or wherever else, or consumers working at home, we would not be doing this business. I think we have an opportunity to continue our growth, and we have an opportunity to continue to expand our reach to more people. As we will be introducing very strong product offerings early next year, which we held back due to the supply situation, I think that also is going to make an impact. So we are positive, but I think we are also cautious.

Cristina Fernández, Analyst

Okay. That makes sense. Then my second question, I wanted to delve a little more into the gross margin. I know it was very high this quarter, and it seems like some of it was due to the retail mix. But as you look forward, 58% to 58.5% is a little bit higher than what you talked about before. So I wanted to see if you could talk more about how you are offsetting some of the supply chain pressures? And what are the drivers of that higher gross margin?

Farooq Kathwari, Chairman and CEO

Well, Corey also mentioned that our gross margin of 59.9% that we have this quarter is higher, reflecting a number of factors. One was that we had a higher total retail sales to total sales. As we increase the shipments, let's say, for the state department contract, that gross margin may slightly go down, but it has a positive impact on the operating income. So keep that perspective in mind because you have to look at gross margin and operating margins. If you can maintain the rate more closely to the rates we have, that's a very strong gross margin. It also reflects the fact that we have been able to offer great savings to our clients and absorb some of these costs that we've talked about. Some of the raw material costs, we've had to absorb on about 30% of our products coming from offshore—very high freight factors. Now we have passed on some increases, but we have not been able to pass all because I hope those crazy increases in container costs are temporary. We have taken some price increases, but we don't want to overdo it. This gross margin of close to 58% is very good for us.

Cristina Fernández, Analyst

Okay. And another question I had was on marketing. You mentioned today that the goal is to get to 3% to 4%, up from 2% this quarter. Back a spread, it was more like 4% to 5%, if I recall correctly. So has anything changed in how you're thinking about marketing and how much you want to spend in one way or how you want to spend it?

Farooq Kathwari, Chairman and CEO

Yes, Cristina, that's a very good question. Our marketing people, I said we're going to control it rather than leave it to others. I don't want to give you all the names of these companies that are taking a lot of our money on the digital medium. So we decided we're going to control it ourselves. We have the ability to reach consumers and prospective clients through digital mediums that we didn't have before. That's why we are now mailing close to 15 million copies of our digital magazine every month. We’re buying the prospects. They are much less expensive than the traditional mediums. We're going to continue with that. That was one very important factor. The other one was we felt that with this high demand for consumers' interest in the home, there was no need for us to spend a lot more money. But as we go forward, we'll spend some more, but the medium that we will spend on will continue to be different than what we did in the past.

Cristina Fernández, Analyst

Okay. Very helpful. And one last one, which is just more of a modeling question. The increases that you've made on wages, particularly in manufacturing, how material are those to SG&A? Or I'm not sure whether those are included in cost of goods sold going forward over the next couple of quarters?

Farooq Kathwari, Chairman and CEO

Yeah, that's a good question. I think that both Corey and Matt are trying to figure that out. These two elements, because on one hand, it does increase the cost of goods. But on the other hand, it reduces costs because we can produce more. If you're not able to produce more, you may have lower labor costs, but you don't have the profits and products. Overall, I think the benefit is going to be more beneficial for us as we increase our production. If we don't increase our production, then, of course, it goes the other way.

Cristina Fernández, Analyst

Okay. Got it. Yes. So higher labor costs, but you're going to manufacture more, and you should get more leverage on those costs. Okay. That makes sense.

Farooq Kathwari, Chairman and CEO

Exactly. Yeah, that's the main thing. If, on the other hand, we increased all of this and don't increase production, then that's going to be an issue, Cristina.

Cristina Fernández, Analyst

Okay. Thank you. Very helpful. Appreciate it.

Farooq Kathwari, Chairman and CEO

All right.

Operator, Operator

Our next question is a follow-up from the line of Bradley Thomas with KeyBanc Capital Markets. Please proceed with your question.

Farooq Kathwari, Chairman and CEO

Yeah.

Andrew Efimoff, Analyst

Hi. Thanks again for letting me in here. This is Andrew on for Brad. Just wanted to follow up on some of the written trend commentary. I was wondering if you could talk about the cadence and what you saw on a monthly basis throughout the quarter and if those trends have continued thus far into fiscal 2Q?

Farooq Kathwari, Chairman and CEO

Are you talking of the first quarter that we just ended?

Andrew Efimoff, Analyst

Yes.

Farooq Kathwari, Chairman and CEO

Yeah. I think that what we saw were usual trends, that we had a strong end of the month, which happens every month, and that continued every month. Now in October, we haven't closed the month; it's always in the last week, we are able to do 30% of the business. However, we are now comparing to very high numbers last year. So we've got to always keep that in perspective. So our comparisons are going to be tougher, most likely. I mean, not pleasantly surprised that we have very high numbers. But I think we are going to have lower increases or as we move into the quarter than we had in the last previous year. That's what we are taking at this stage because we are comparing to very high numbers.

Andrew Efimoff, Analyst

Understood.

Corey Whiteley, Chief Financial Officer

Andrew, I would just add that Labor Day was also a strong period for us.

Andrew Efimoff, Analyst

Okay. Got it. Thanks for that. And just wanted to follow up, I know that earlier in the call, Corey, you mentioned that retail segment written order growth was up 17.6% on a two-year basis, if I heard that correctly. And so that compared—I mean that's very strong. But that compares to last quarter where you saw around a 42% increase in retail segment written order growth, if my notes are correct. What do you think drove the deceleration there? And do you think it has anything to do with these extended lead times?

Farooq Kathwari, Chairman and CEO

Corey, you look at the numbers. But Andrew, we are comparing with numbers from when many offices were closed you're talking last year, right?

Corey Whiteley, Chief Financial Officer

You got the two-year stack. Yeah. I think part of it, though, is also just the timing of the quarter being the September quarter versus the June quarter comparison. So it's a little harder to compare from period to period, but still positive growth as we moved along and also the marketing programs that we had running at the time had an impact in that as well.

Andrew Efimoff, Analyst

Okay. Got it. I appreciate the detail. That's all for me. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, there are no further questions in the queue. I will now turn the call over to Farooq Kathwari for closing remarks.

Farooq Kathwari, Chairman and CEO

All right. Thank you, Alex, and thank you for participating. As usual, if you have any comments or questions, please let us know. Matt is available, and I'm sure he will take your questions. But we look forward to continuing this journey. We have lots of opportunities and, of course, challenges too. But I think we are well positioned. So we are in a good position to continue the positive growth that we have had. So thanks very much.

Operator, Operator

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