Earnings Call Transcript - ETD Q3 2023

Operator, Operator

Good afternoon, and 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. 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, CFO

Thank you, operator. Good afternoon and 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 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 under the News and Events tab on the Investor Relations page of our ethanallen.com website. There you will 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 am pleased to now turn the call over to Mr. Kathwari.

Farooq Kathwari, CEO

Thank you, Matt. We are pleased with our strong financial performance for the quarter ended March 31, 2023, especially compared to the strong results for the previous period. Matt will review in detail our financials for the quarter ended 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 remains strong and importantly, we ended the quarter with cash of $156.2 million and no debt. Also pleased yesterday we announced that our regular cash dividend has been increased by 13% to $0.36. Last week, we had an 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 while 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, CFO

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 gross and 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 in lower inventory. 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 backlog, pricing actions taken, and the positive effects of product mix, partially offset by lower delivered unit volume. Sales in fiscal 2022 set a new 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. However, 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. However, our wholesale backlog remained 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. When 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 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. Now 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 '23, and 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 restored 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, and 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 five years. In summary, we produced strong gross and 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, CEO

Thank you, Matt. As I mentioned last week, we had an in-person convention at our Danbury, Connecticut headquarters with about 300 of our leadership from retail, manufacturing, logistics, and corporate. We revealed many areas of our enterprise, including the 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 an 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 it will help us in driving traffic to our design centers during the time of a softening economy. Our manufacturing is in great position to service our clients. During the last few years, we 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 backlogs are 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, but 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 absorbed very high freight costs. Currently, we see the freight rates coming down. Now, very importantly, we have also continued to invest in technology in all areas of our enterprise. The combination of strategic locations of our manufacturing, talented motivated associates, and technology has resulted in many initiatives. Especially since fiscal 2019, we have made major efficiencies in getting stronger talent, reducing overall headcount, while achieving major increases in sales. For example, since fiscal 2019, we have reduced our headcounts both in our retail network and our manufacturing logistics by 12%, while increasing sales substantially. We 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 am very happy to open it up for any questions or comments that you might have.

Operator, Operator

Our first question comes from Cristina Fernández with Telsey Advisory Group. Please go ahead with your question.

Farooq Kathwari, CEO

Yeah. Hello, Cristina.

Cristina Fernández, Analyst

Hello, Farooq and Matt. Good results on the operating side. I wanted to start with the SG&A expenses being very well controlled. Where are those reductions coming from? And do you think you can manage this from quarter to quarter, or as we look at an environment of softening sales, will there need to be more structural changes to your expense levels?

Farooq Kathwari, CEO

Yeah, Cristina, it’s interesting. When you look at the figures from 2019, pre-COVID, we have reduced our inventories. We have reduced operating expenses while our sales have gone up. A lot of it is due to several factors. First, on the retail side, technology and stronger interior designers have played a very important role. We have today fewer people in our retail, bringing more business. Today, our designers are able to work virtually with clients. Of course, with COVID, that was tremendously important. That resulted in a reduction of personnel, but stronger interior designers were produced, and I think that will continue. Our designers are doing well. Similarly, in manufacturing, if you take a look at our manufacturing and our logistics, we have fewer people today than we had in 2019 with higher sales. And as we go forward, that will continue and will provide benefits as we continue to become more efficient. Therefore, ensuring efficient operations has been a very important part of our initiatives, and I think that will continue.

Cristina Fernández, Analyst

Thank you. I also wanted to ask about demand; the down 9% in wholesale for the quarter, 12% in retail. How has the demand progressed during the quarter? Is that consistent, or are you seeing a lot of volatility? Any insights by regions that you can share? Are there any major differences in how demand is trending so far in April? Any insights would be helpful.

Farooq Kathwari, CEO

Well, we are, of course, comparing to very high numbers from the previous years. So, obviously, we are looking at our business and even compared to 2019, our backlogs are still higher, as Matt mentioned. But we do know that we were operating at very high demand levels. That is softening, and we saw that throughout the quarter, and in April, also I think that people are being more cautious. And obviously, it's still early. As you know, we look at the whole quarter before we make any determinations, but we are prepared to understand that people are being more cautious. We need to be more effective and efficient, both in marketing and in terms of our operating expenses, and we are looking at both very carefully.

Cristina Fernández, Analyst

And as a follow-up to the backlog comment, you mentioned backlog being up about 30% versus pre-pandemic, and orders for the quarter are down approximately 3%. So, do you expect that backlog to normalize versus the pre-pandemic level, or has anything changed indicating that backlog should remain elevated?

Farooq Kathwari, CEO

No, only to keep in mind that our backlog, just from the prior year, is down almost 40%. They're still high compared to the pre-pandemic level. As we continue to go forward, our backlogs will continue to come down because we are able to produce the products. We experienced tremendous high business in the first two years of COVID. We've ramped up effectively, and by this quarter, we will have completely caught up, which is good news as we will have even faster deliveries.

Cristina Fernández, Analyst

And one last question I had was on the dividend increase. As you considered increasing the dividend, is there a payout target you're working towards in relation to the level at which you increased the dividend?

Farooq Kathwari, CEO

Well, you know, as you know, we have been providing over the last few years, as Matt mentioned, a regular dividend, and we have also issued special dividends. Before the recent increase in dividend, I think our yield on the regular dividend was close to around 4.7%, 4.8%, right, Matt?

Matt McNulty, CFO

It’s correct.

Farooq Kathwari, CEO

It will now exceed 5%. But then if you include, which I do and the financial markets don’t, our special dividends, that would also bring the yield closer to 5.5% to 6%. So, I think having a dividend between 5% and 6% yield is quite good, and that's our intention.

Cristina Fernández, Analyst

Thank you.

Farooq Kathwari, CEO

All right, Cristina. Thanks very much.

Operator, Operator

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

Farooq Kathwari, CEO

All right. This is not Brad, is it?

Zach Donnelly, Analyst

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

Farooq Kathwari, CEO

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

Zach Donnelly, Analyst

Sure. I want to touch on the backlog as well. I know you mentioned that you were working down that portion of the backlog, specifically for this quarter. So 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 dynamics associated with the contract versus non-contract portion of the backlog.

Farooq Kathwari, CEO

By contract, do you mean our business with the government?

Zach Donnelly, Analyst

Exactly.

Farooq Kathwari, CEO

As you know, most of our business comes from our own retail network. The retail network is operated by our own retail division and then our independents. So we have what we call retail backlog and wholesale backlog. At this stage, Matt could provide perhaps a little bit more information, but if you compare it, for instance, let's say from June 30, 2020, going back three years, our backlog is still approximately at the retail level, approximately 30% to 40% higher, right, Matt?

Matt McNulty, CFO

That is correct. It is up 41%.

Farooq Kathwari, CEO

Okay, 41%. And our wholesale backlog is up even with all the business we've done, we've delivered, it's approximately up about 12% to 15%. Correct, Matt?

Matt McNulty, CFO

The wholesale backlog is up 30%.

Farooq Kathwari, CEO

Well, it’s between retail and…

Matt McNulty, CFO

And up about 40%.

Farooq Kathwari, CEO

Oh, I see. From June 30, yes, you are correct. It's down about 15%. All right. Yes, so our backlogs are still high, but again both at the contract level, which is our government contract and at the retail. But retail is higher.

Zach Donnelly, Analyst

Understood. Thank you. And then, I also wanted to touch on unit volume trends. So I know that the negative unit volume trends you’ve been seeing have been negatively impacting gross margins. 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. But I was wondering if you could provide any additional detail on that. And then maybe touch on whether or not you think Ethan needs to become perhaps more promotional in order to drive unit volumes in the next couple of quarters?

Farooq Kathwari, CEO

No, I understand. The gross margin for the just-ending quarter was almost 60%, at 59.9%. If you look back to our pre-pandemic levels, it was about 56%. So we have maintained a high gross margin. Now, as we go forward, we always have to take into account the economy; we need to assess whether we have to be more aggressive in our marketing, but our gross margins are the result of several factors. First, volumes are a very important factor in terms of impacting gross margins, especially at our manufacturing level because our manufacturing is greatly affected by volumes. So, at this stage, we are operating at a very high level of 59.9%, and at the pre-pandemic level, it was 55%. I think we will continue to expect margins to stay between 55% and 60%.

Zach Donnelly, Analyst

Understood. Sounds good. And just one last question for me, I think the last time we spoke, you reminded me and our team that the last set of pricing actions you had taken were passed around January to March of the previous year. Can you just remind us if that's correct? Or if you passed along any additional pricing actions since then? And 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, CEO

Maybe Matt can give you some more details. But our objective has not – we have not taken price increases across the board. Our focus has been in the last few years to be very selective with our price increases depending on 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 products, for instance, are coming from offshore, in East Asia, where the cost of a container went from $3,000 to $30,000. Now it's coming back to close to $3,000. Similarly, the freight from the East Coast to the West Coast had also increased by almost double. And now it’s coming down. So, our price increases were largely reflective of freight impacts. Consequently, we have not made many price increases because freight is coming down.

Matt McNulty, CFO

And just to clarify, the last price increases were implemented in January, February of last year, but remember, due to the backlog and the nature of our business, those price increases do not impact our P&L until they are actually delivered. So, there is a lag of anywhere between two to four months on that.

Farooq Kathwari, CEO

Yeah, and that’s important, but as I said, the freight factor was a major consideration. It's still not completely down, but has significantly impacted our pricing strategy. As I mentioned, from East Asia, the costs dramatically dropped from $30,000 to $3,000.

Zach Donnelly, Analyst

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

Farooq Kathwari, CEO

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

Zach Donnelly, Analyst

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

Farooq Kathwari, CEO

All right. Thanks very much. Are there any other questions?

Operator, Operator

We reached the end of the question-and-answer session. Therefore, I'll hand it back over to you, Farooq, for closing remarks.

Farooq Kathwari, CEO

Thanks very much. Well, as I said, we are pleased with the performance. We are also, of course, cautiously optimistic, as I indicated in our press release, that we have to monitor the economy. We need to consider the manufacturing aspect as we are positioned extremely well. Keep in mind, our operating expenses are lower. Our inventories are lower. We have managed our costs quite well. Additionally, we have strengthened our teams, and the launch of the Interior Design Destination is a very important initiative. It just so happens that the softening economy provides us with an opportunity for strong marketing. Thanks to everyone for joining, and I look forward to our continued progress in the next quarter.

Operator, Operator

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