Earnings Call Transcript - ETD Q2 2022

Operator, Operator

Good afternoon and welcome to the Ethan Allen Fiscal 2022, Second Quarter analyst conference call. At this time, all participants are in a listen-only mode, a question-and-answer session will follow the presentation. Please note that 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, Diego. Good afternoon. And welcome to Ethan Allen's Analyst Conference Call for our fiscal 2022. Second quarter ended December 31, 2021. Joining me today is Farooq Kathwari, our Chairman, President and CEO. Mr. Kathwari will open and close our prepared remarks, while I will speak 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 will 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 Mr. Kathwari.

Farooq Kathwari, Chairman, President and CEO

Thank you, Matt. And good afternoon. I'm pleased that you've joined. I'm happy to provide a brief overview of our results and focus as we move forward. As reported, we had strong results. Sales increased 16.4% to $208.1 million. Gross margins increased to 58.8% from 56.7%, and adjusted operating margin rose to 15.7%, resulting in adjusted earnings per share of $0.95, a 37.7% increase. We also maintained a strong cash position of $105.2 million and no debt. Also, as conveyed in our various communications, we are very pleased to celebrate 90 years of innovation and profitability. Off to Matt, who will provide a brief overview of our financial results. I will review our initiatives to continue our growth in sales and earnings and maintain strong dividends as we have done. As you know, Matt was recently promoted to CFO after serving as VP of Finance and Treasurer. Matt has a strong public and private accounting and finance background, and I'm very pleased to have him as part of the team. With that, Matt.

Matt McNulty, CFO

Thank you, Mr. Kathwari. As we celebrate 90 years of innovation throughout fiscal 2022, we saw acceleration in our net sales, with both wholesale and retail net sales reporting double-digit growth, as well as an operating margin and diluted EPS during the quarter. While our retail written orders were flat for the second quarter last year, orders were up 45% from two years ago. Similarly, wholesale segment written orders were up 1.7% compared to last year, but up 30% compared to the second quarter of fiscal 2020. Our order backlog at December 31 is approximately 50% higher than a year ago, but becoming more current, and we expect to get caught up during calendar 2022. Retail net sales were up 24%, and wholesale net sales increased 14.2%. Consolidated net sales were up 16% from increased manufacturing production that led to higher deliveries combined with the prior year being negatively impacted by COVID-19 production delays. The increased production was partially offset by continued supply chain disruptions that negatively impacted raw material receipts and imported finished products. Consolidated gross margin increased 210 basis points to 58.8%, primarily due to a change in the sales mix, benefits realized from the ongoing manufacturing and logistics optimization project, and a favorable product mix, partially offset by higher import and raw material costs. The retail sales mix grew to 86.3% of consolidated sales compared to 81% a year ago, which positively impacted our consolidated gross margin. While we were pleased with our consolidated gross margin of 58.8%, we expect our margins to return to approximately 57.5% in the near term due to the impact of rising raw material, labor, and freight costs, combined with the return of our sales mix to more historical norms. Adjusted operating expenses were 43% of sales for the quarter, down from 43.8% last year due to our operational leverage, along with reductions in certain selling expenses, including advertising costs. We reduced our advertising across various mediums, including national TV and regional radio markets, thereby reducing our overall spend to 2% of net sales compared to 2.8% last year. For the rest of fiscal 2022, we expect advertising to be approximately 3% to 4%. Adjusted operating margin, which excludes restructuring initiatives and other corporate actions, increased from 13.1% last year to 15.7% in the current year, primarily due to the strong gross margins and cost containment measures. Adjusted diluted EPS was $0.95, an increase of 37.7% due to net sales growth, expanded retail, and consolidated gross margins, our ability to minimize operating expense growth, and improved production and delivery of products, partially offset by higher raw material and freight costs. Now, turning to our liquidity and capital resources. We ended the quarter with $105 million of cash on hand, an increase of $11.5 million in the last three months, primarily from $5.5 million of cash from operating activities and the sale of two properties for total cash proceeds of $8 million. Our board also increased our regular quarterly cash dividend by 16% in November 2021, reflecting the strength of our balance sheet and strong history of returning capital to shareholders. In addition, just yesterday, we amended our existing credit agreement to provide a revolving credit line of $125 million and extended the maturity of the facility to January 2027. The amended facility also provides the company with the transition of improved pricing on borrowings and enhanced future flexibility over the next five years. With that, I will turn the call back over to Mr. Kathwari.

Farooq Kathwari, Chairman, President and CEO

Thank you, Matt. Our unique vertically integrated structure, very focused on one brand, from concept to design, to manufacture, to retail and logistics, has provided us with strong returns even in a very challenging environment. Our focus continues on five areas: talent, service, marketing, technology, and social responsibility. In the area of talent, I'm pleased we have continued to make great progress. Importantly, we have strengthened our Board of Directors. Our newest member, Gina Casar, was elected early this week and joined us with our directors on this call. I welcome Gina. She has a strong background in management, finance, and ESG. During the last quarter, we strengthened our goals, and in addition to director John Duda, who is our lead director, and Taras Taken, we were joined by a number of new directors with backgrounds in entrepreneurship and finance, Jon Clark, background in management and finance, and the President of our University here. David Sable has a background as a CEO with a strong marketing background. About John Dooner has had a distinguished career, including as CEO of a leading marketing advertising company, and Tara Stacom manages in a leading real estate enterprise. We're very pleased to have a strong board of directors. During the quarter, we also promoted a number of our executives. I'd like to mention Amy Franks, a veteran of 33 years in our enterprise as Executive Vice President of Retail and Business Development. I also mentioned Matt McNulty being promoted to CFO. Corey Whitely, after 33 years of dedicated service, has decided to work for us as an advisor consultant. We thank him for his work throughout this period. The second area of service: maintaining about 75% of manufacturing in North America is an important part of our strategy for service, and almost all of the 75% is custom-made when orders are received from clients. We continue to invest in our manufacturing, including a strong workforce and investment in technology. Our national and retail logistics deliver our products with white glove service at one cost nationally. This is a great advantage, which we started close to 30 years back. While we have been impacted by major freight increases internationally and domestically, we have been able to provide good service to our clients. The third area is strong and relevant marketing, which continues to convey our differences. We have utilized strong digital, print, and other mediums to help us reach a larger consumer base at lower costs. The fourth area is technology. Technology enhancements during the last 12 years or so have been critical to help our sales and improve efficiency throughout our enterprise. Finally, we continue with a strong focus on social responsibility that includes taking care of our associates, especially in these challenging times, while maintaining a strong focus on environmental programs. Now with this, I'm very pleased to open for any questions or comments.

Operator, Operator

Thank you. Ladies and gentlemen, at this time, we will be conducting our question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. One moment, please, while we poll for questions. Our first question comes from Brad Thomas with KeyBanc, please go ahead.

Farooq Kathwari, Chairman, President and CEO

Hello, Brad.

Bradley Thomas, Analyst

Hi, Farooq. Hi, Matt, how are you two doing?

Farooq Kathwari, Chairman, President and CEO

Very good, Brad, and yourself?

Bradley Thomas, Analyst

I'm doing well, and let me add my congratulations, Matt, for the record year on your promotions. Congratulations.

Matt McNulty, CFO

Thank you very much.

Bradley Thomas, Analyst

Well, I've had a couple of questions I wanted to first ask a bit more about the cadence of the business. Still running from an order standpoint at really, really exciting levels from a company perspective and a historic perspective. But I was just curious, Farooq, what you've been seeing lately in orders? And how you plan the business for the quarters ahead and think about the outlook for the furniture industry.

Farooq Kathwari, Chairman, President and CEO

Yes, last year was remarkable, Brad. This created various opportunities and challenges due to a significant increase in backlogs. It also led to a notable rise in our written sales, as we've reported, which had a considerable effect on our profitability. While we experienced strong retail orders, the main challenges were on the delivery and cost structure sides, which affected everyone in our industry and beyond. We managed to navigate these issues thanks to high sales that helped offset some of the considerable increases we observed in the wholesale segment. Our wholesale margins have been significantly affected. If not for our robust retail performance, we would have faced severe impacts had our business been solely wholesale. Last year and in the most recent quarter, our order levels were relatively flat compared to the previous year. However, if we look back two years, how much growth did we see there, Matt?

Matt McNulty, CFO

45%.

Farooq Kathwari, Chairman, President and CEO

45% from the quarter of the previous year. So flat is good because we had very, very strong orders. I see as we move forward from an orders point of view, I think if we maintain flat or even a little bit lower, we still have a very substantial orders coming in, Brad.

Bradley Thomas, Analyst

That's great. Just on the question of capacity, you were able to deliver more than we would have expected to this quarter, some very encouraging execution on your part. Can you just share with us what the outlook is for capacity and how much do you think you could generate in the quarters ahead?

Farooq Kathwari, Chairman, President and CEO

Yes. The fact that 75% of our products are manufactured in our North American plants has been very beneficial. Although we've faced challenges due to COVID, including employee absences and some cost increases, we recognized the need to bolster our workforce. Last fall, I visited our plants in Vermont and we decided to raise base wages and ramp up recruitment. Despite these challenges, our manufacturing has performed well, although COVID has still had an impact. Looking ahead, I believe we have the potential to further increase our manufacturing capacities, thanks to our significant investments in technology, particularly in our wood and upholstery manufacturing. This has been a key advantage. While the future of COVID remains uncertain, we currently have the opportunity to boost our capacities and production levels. Only 25% of our products are sourced from overseas, which has also been affected by COVID and rising transportation costs. Fortunately, we have strong partnerships in place. It's worth mentioning that we have a considerable number of containers arriving, which means our overseas situation is manageable since only 25% of our production comes from that area. If that percentage were higher, like 80% or 90%, we would likely face significant challenges.

Bradley Thomas, Analyst

Very helpful. Congrats on the great quarter and thanks for taking my question.

Farooq Kathwari, Chairman, President and CEO

All right. Thanks, Brad.

Operator, Operator

Thank you. And our next question comes from Andrew Appoma with KeyBanc. Please say your question.

Farooq Kathwari, Chairman, President and CEO

Hello, Andrew.

Andrew Appoma, Analyst

Hi. Good afternoon, Farooq and Matt, thank you for taking my questions. I wanted to start by following up on Brad's capacity question. You mentioned that you are planning for significant capacity increases in the upcoming quarters. However, this quarter marked the first time that delivered revenue surpassed written revenue. I'm seeking some clarity on this. Do you anticipate slowing down the pace of capacity increases, or how should we view this for the next quarter? Additionally, how does this translate to delivered revenue? For instance, in this last quarter, there was a notable $26 million increase in delivered revenue sequentially. Do you expect to maintain that level of growth in the future, or do you think it will decline?

Farooq Kathwari, Chairman, President and CEO

There's two factors. First, Andrew, is that we do have still a strong backlog. So that backlog is going to enable us that way in this quarter and maybe into the following quarter to be able to maintain strong shipments, provided of course, that we don't have any major issues on the supply side. I don't think so, but we always have to keep that perspective in mind. The capacities that we have increased and we plan to increase will cover the backlogs we have, and then of course, we also have very strong programs in products and in marketing to continue to grow our business, so that any increase in capacities should be there for us to grow our business.

Andrew Appoma, Analyst

Understood. You mentioned experiencing a bit more disruption from COVID on the labor front, which makes sense given the current surge in the Omicron variant. I would like to know how this increased disruption might affect our revenue in the upcoming quarter.

Farooq Kathwari, Chairman, President and CEO

Yes, it's a good question, Andrew. Right now, we do see some impact. However, I think that in some areas it's impacting more than others. It looks like they will be able to maintain fairly close to the production levels that we had in the second quarter.

Andrew Appoma, Analyst

Okay. That's very helpful. On written sales, I know that you gave some commentary, but I just wanted to follow up here. While written sales were flattish for the quarter, it was good to see the acceleration on a two-year basis, at least for the retail written orders. Could you talk about what drove that acceleration? Or if that was more because of the timing of the membership-model action you had about a few years ago? Just any color there would be great.

Farooq Kathwari, Chairman, President and CEO

You're talking about the increase from not the last quarter, but the previous year. And yes, it had a number of factors. Of course, first is that consumer interest in the home has continued to be strong. That, to me, is the main factor. The second is that our competitive advantage of having about close to 1500 interior designers in our network who have been empowered with technology. I would tell you, Andrew, that if we had not in the last eight and 12 years invested in technology with our designers, training them to be able to work virtually from home, from the design center, working with clients, we would not have the business we have today. Combining the professional work of our designers with technology has been critical to not only what we have done, but critical to the future. I think that will be very important as we move forward.

Andrew Appoma, Analyst

Understood. And I guess for my last question here. In your prepared remarks, you noted that you plan to take some additional selective price increases to counter the rising costs you are seeing. I know that you have already implemented some price increases and some reduced discounts to offset the higher prices previously. But I was wondering if you could share, if you have it, how much higher your average prices are currently tracking versus pre-pandemic levels. And going forward, how much more do you expect to increase that to fully offset the cost inflation impact?

Farooq Kathwari, Chairman, President and CEO

First of all, the value of our products is excellent because we really haven't taken the price increases to account for all the increases, especially from transportation to raw materials, to everything else. I would say that we have done it selectively, in the sense that many of our product programs coming in from offshore had to be increased first, and that's what we did. Those increases were fairly large, anywhere from 15% to 25% based upon the cost of a container, which has gone from $2,000 to $24,000. I also mentioned, which is a very unique setup that we have, which really helps our retailers, both our company operated shops and especially our independents. We deliver our product at one cost to them, whether you are in Seattle, Texas, or wherever. We have also had to absorb domestic cost increases in transportation, which while not being at the level of the international, is still a bit high, maybe 8% to 10%. So we've absorbed that. That is why retail margins, in addition to us having very high sales, did not increase like any other retailer in the country. So going forward, I think we'll be able to maintain this advantage we have with our vertical integration. We will take some more selective price increases. But I would say that if you average it out, it's about a 10% price increase.

Andrew Appoma, Analyst

Understood. That's helpful and great to hear. Thank you.

Farooq Kathwari, Chairman, President and CEO

All right, Andrew.

Operator, Operator

Thank you. Our next question comes from Cristina Fernandez with Telsey Advisory Group. Please go ahead.

Farooq Kathwari, Chairman, President and CEO

Hello, Cristina.

Cristina Fernandez, Analyst

Hi. Good afternoon, Farooq and Matt, and congratulations on a good quarter as well. I have a couple of questions. I wanted to see if you could talk about whether customers are experiencing shorter order-to-delivery times as you've managed to increase manufacturing and deliver more goods, or if it's too early to tell.

Farooq Kathwari, Chairman, President and CEO

Not for us. That's a really good comment because our advantage is the fact that our upholstery, which represents about 50% of our total business, has an average upholstery delivery time of about eight to 10 weeks. I would think now because again, it might be a little bit larger if it goes to Seattle or it goes to some other bases because our upholstery is made in North Carolina and in Mexico, Silao Mexico. I would think that most folks have a much larger lead time. The same thing in our wood products, it's a little bit larger because of the backlog that we have. And keep in mind, almost 100% of the products we make in North America are custom made when we receive the order. I would say that our delivery time in our wood products ranges from anywhere from 12 to 15 weeks, which is still much lower than what the industry has.

Cristina Fernandez, Analyst

That's helpful. Then, with the supply chain going on, delays, and your manufacturing capacity, are there any other product categories that you might consider bringing back to North America?

Farooq Kathwari, Chairman, President and CEO

Well, yes. It's a good question. We're looking at it, but keep in mind, we, against all odds, have maintained manufacturing in North America, both in the United States and Mexico. That was a very important move for us. We've invested a great deal, and I would say over $100 million in those facilities because otherwise, we would not be where we are. So we have the opportunity certainly in furniture, but we're also looking at opportunities for non-furniture products being manufactured more in North America.

Cristina Fernandez, Analyst

Then the last question I had, the SG&A had a step-up this quarter, maybe this is more for Matt, to about $90 million. They have been trending lower. Is this more structural driven by higher wages and costs, or is it just due to the higher sales? Maybe you can help us think about SG&A going forward.

Farooq Kathwari, Chairman, President and CEO

I will say that Matt can follow up, because he is quite astute on this. But I'll tell you this: most of it is good news and is based upon the written sales in our retail. Our designers have done an excellent job and they have been rewarded with a fair amount of money. That's most of it, along with some in transportation. Come on, Matt, go ahead.

Matt McNulty, CFO

You're making my job a lot easier. By as a percentage of overall sales, our SG&A is actually down a little bit, from 43.8% to 43%. Most of the overall dollar increase is what Mr. Kathwari stated: driven by increased sales and higher freight costs. So delivery fees are included in there, as well as compensation to our interior designers. So we want to see that designer compensation going up; it means there's more written and more sales going on. So that is why you saw that come up to about $90 million.

Cristina Fernandez, Analyst

Thank you.

Operator, Operator

Thank you. There are no further questions at this time. I will turn the floor back to Mr. Kathwari for closing remarks.

Farooq Kathwari, Chairman, President and CEO

Well, thank you. I'm very gratified by the work that our people have done. Our teams have done an amazing job. We continue to maintain our focus, ensuring that we provide great quality and great service, while also improving our net retail network and our manufacturing in North America. So again, thanks very much.

Operator, Operator

Thank you. This concludes today's conference. All parties may disconnect. Have a great evening.