Earnings Call Transcript - ETD Q1 2024

Operator, Operator

Good afternoon. And welcome to the Ethan Allen Fiscal 2024 First Quarter Analyst Conference Call. 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, Doug. Good afternoon. And thank you for joining us today to discuss Ethan Allen's fiscal 2024 first 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 website. There, you will find a copy of our press release, which contains reconciliations of non-GAAP financial measures referred to on this call and in this press release. A replay of today’s call will also be made available on our Investor Relations website. Our comments today may include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. The most significant risk factors that could affect our future results are described in our annual report on Form 10-K. 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 am pleased to now turn the call over to Mr. Kathwari.

Farooq Kathwari, Chairman, President and CEO

Thank you, Matt, and good to have you join our call to review our first fiscal 2024 results and our initiatives. As we reported, we maintained strong operating margins, gross margin of 61.1% and operating margin of 12.1% despite a decline of delivered sales of 23.6%. Our sales were impacted due to the softening of the economy and the impact of a major flood in our Vermont manufacturing operations. We are positioned well. We have continued to strengthen our vertically integrated enterprise. We have also continued to maintain a strong cash balance. During the quarter, we distributed $0.36 of regular and $0.50 of special dividend, and we also yesterday announced a regular dividend of $0.36 in addition to these two. After Matt provides a brief overview of our financial results, I will discuss our various initiatives in growing and growing our business by positioning us as an interior design destination, strengthening our talent, marketing, manufacturing, logistics, and our unique retail network providing interior design service increasingly combined with technology.

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 exclude restructuring initiatives, impairments, unusual or infrequently occurring events such as the Vermont flood and other corporate actions. We believe the non-GAAP presentation better reflects underlying operating trends and performance of the business. Our financial results in the just completed first quarter are highlighted by strong margins, sales being impacted by July flooding at our Vermont case goods plants, positive operating cash flow, the payment of a special cash dividend, and a robust balance sheet. Despite operating in a softening economy, our operations produced positive financial results, which I will now discuss. Our consolidated net sales totaled $163.9 million, a decrease of 23.6% due to lower delivered unit volume from softening order demand, reduced manufacturing production from lower backlog, a strong comparable prior year, and the impact from the Vermont flooding, which resulted in a temporary work stoppage and lowered net sales by approximately $15 million in the quarter. Our Orleans plant has since resumed operations and we expect to recover from the delayed shipments during the upcoming second and third quarters. Sales in the first quarter a year ago set a near record pace as we worked through historically high backlog, leading to a difficult comparison. From a demand perspective, we are back to more normal conditions, down from the high demand we experienced during the height of the pandemic. Wholesale segment written orders decreased 15.6% compared to last year, while retail segment written orders were down 13.2%. We ended the quarter with a wholesale backlog of $75.4 million, down 28.6% from a year ago but up $1.4 million since June 30, 2023 due to the timing of contract business orders combined with production levels being impacted by the Vermont flood. The number of weeks of backlog as of September 30, 2023, was down compared to last year with notable improvement seen within upholstery and home accent. Our wholesale backlog is approaching pre-pandemic levels as our teams are managing the business to service our customers. Consolidated gross margin was 61.1%, our 10th consecutive quarter that consolidated gross margin exceeded 58%. When compared to last year, our consolidated gross margin was up 70 basis points due to favorable product mix, lower input costs, investments in technology, and reduced headcount, partially offset by lower delivered unit volume and a change in sales mix. Retail sales were 81.5% of consolidated sales, down from 85.6% last year as we delivered out more wholesale backlog, including a greater percentage of contract business. Adjusted operating margin was 12.1%, down from 17.6% last year, primarily from lower sales. These costs were partially offset by gross margin expansion, lower headcount, and the company’s ability to maintain a disciplined approach to cost savings and expense control. Our SG&A expenses decreased 12.7% and equaled 49% of sales, up from 42.9% last year from fixed cost deleveraging. As previously stated, in July 2023, our wood furniture manufacturing operations located in Orleans, Vermont sustained damage from flooding. In addition to losses related to inventory and state-of-the-art manufacturing equipment, the flooding also resulted in a temporary work stoppage for many associates and a disruption and delay of shipments. The growth financial loss incurred from the disposal of inventory, inoperable machinery, and equipment from water damage, facility cleanup and restoration amounted to $3.6 million and after insurance proceeds of $1 million and a grant from the State of Vermont of $500,000, the net amount of the pretax loss was $2.1 million and was reported within restructuring and other charges and excluded from our adjusted earnings. Adjusted EPS was $0.63, compared with $1.11 last year. For historical context, our adjusted diluted EPS for the three months ended September 30, 2019, was $0.35. Our effective tax rate was 25.6%, which is comparable to 25.3% a year ago. Now turning to our liquidity and capital resources. We ended the quarter with a strong balance sheet, including cash and investments of $163.2 million and no outstanding debt. We generated $16.7 million of cash from operating activities during the quarter, which was driven by strong profits. Our inventory levels decreased $18 million from a year ago as we restored our operating inventory levels to more historical norms as backlog decreases. We continued our practice of returning capital to shareholders in the form of cash dividends. In August, our Board declared a special cash dividend of $0.50 per share in addition to our regular quarterly cash dividend of $0.36 per share, both of which were paid on August 31st. We have now paid a special dividend in each of the past three years. Also, as just announced yesterday, our Board declared a regular quarterly cash dividend of $0.36 per share, which will be paid in November. In summary, our vertically integrated business was able to produce a double-digit operating margin during a period marked by industry-wide softer demand and a temporary work stoppage at our Vermont plant that led to lower sales. We generated $16.7 million in positive cash flow and protected our margins through disciplined investments and strong expense management. We will continue to carefully manage our expense structure. With that, I will now turn the call back over to Mr. Kathwari.

Farooq Kathwari, Chairman, President and CEO

Well, thanks, Matt. As you know, we have had our interior design focus for decades. However, our recent initiative under the umbrella of the interior design destination takes our business to an entirely different level. This includes the following impacts: repositioning the interiors of our design centers with strong and consistent programs across the entire network. We launched this concept in our Danbury Design Center in April of this year and have recently started launching it in our design centers across North America and internationally. Recently, we had ribbon cuttings in 16 locations, just to give you perspective, including having this enhanced projection in Manhattan, New York; Albany, New York; Cordova, Tennessee; Plaistow, New Hampshire; Marlton, New Jersey; Lancaster, Pennsylvania; Garden City, Long Island; Westchester, New York; Mount Pleasant, South Carolina; Green Bay, Wisconsin; Peachtree City, Georgia; Knoxville, Tennessee; Princeton, New Jersey; and Setauket, Long Island. This week, actually just now, we are in the process of having grand openings in Kennesaw, Georgia that is near Atlanta; San Francisco, California; Oklahoma City, Oklahoma; Birmingham, Alabama. Our objective is to continue implementing this in our 174 design center locations in North America. In the next 30 days, 67 are scheduled and in December 27, and by the end of December, 114 of the design centers will have been repositioned with these products and the attitude. The initiative has many benefits, including consistent projections across North America, continued strengthening of our Interior Design associates, consistent marketing across North America, strengthened and motivated interior designers and clients; consistency in offering across North America helps improve service and gross and operating margins. After amazing focus of consumers in their homes during the COVID pandemic, we see consumers have spent more time and focus in other areas such as travel. We expect to see that moderate and more focus on home, although not at the level we saw during the COVID period. We continue to see a reduction of costs such as in raw materials, energy, and transportation. While we have developed very strong new products during the last two to three years, we decided to hold off on introducing them during the COVID period. We have now started introducing new products and will continue to do so in the next 12 months. During the last three years, despite high demand, we continued to strengthen and streamline our operations, including strengthening our Interior Design teams and our design centers. Today, we have about 30% less interior design professionals who are doing the same business. In fact, from 2019, our total headcount in our company is down by 21%. By using technology, whether it is in our manufacturing, our retail, especially in retail, and in our logistics, has helped us make our interior designers more proficient, as they say, is a game changer. Now we have strengthened our talent, and unfortunately, recent bankruptcies of furniture retailers have brought us also new and experienced talent. Our manufacturing has also continued to benefit from strong teams and use of technology. Keep in mind that 75% of all our products are made in our North American operations and 75% of the products are made custom when we receive the order. So we are in a good position, and I know that we have some challenges because of the economy, but we are positioned well, and we are stronger both in terms of people and our offerings and our facilities. And with that, I’d like to open it up for any questions and comments.

Operator, Operator

Thank you. Our first question comes from the line of Budd Bugatch with Water Tower Research. Please proceed with your question.

Budd Bugatch, Analyst

Good afternoon, Farooq and Matt.

Farooq Kathwari, Chairman, President and CEO

Budd, just a second. It’s Budd Bugatch, and you have been covering us since I was 15 years old. So how are you, Budd?

Budd Bugatch, Analyst

I probably have been following you since I was 15 too, Farooq, but that’s fine. Thank you, and congratulations on the margin performance in such a challenging environment. I have a few questions as I look ahead. You mentioned that your deposits have declined about 29% year-over-year in customer deposits, particularly in retail. I'm considering that you performed better in terms of retail orders compared to actual net sales. Therefore, I anticipate that retail sales will decrease year-over-year in the second quarter, although likely by a smaller margin than the 24% to 27% drop we saw in the first quarter.

Farooq Kathwari, Chairman, President and CEO

It's a bit early to say, Budd, but I appreciate your comments. We have significantly reduced our backlogs; however, it's important to note that our backlog is down by about 27% and 28% at wholesale and 27% at retail because we have delivered a lot. We still maintain a reasonably good backlog, which currently remains about 20% higher than it was in 2019, despite being lower than last year. This backlog allows us to continue shipping products. We are also hopeful that consumer attitudes will shift back toward home after spending a considerable amount of time traveling and engaging in other activities.

Budd Bugatch, Analyst

I understand that. And you did note that the retail orders were down 13% year-over-year, and I will ask the obligatory, how that proceeds during the quarter, what were those comparisons looks like as the quarter progressed?

Farooq Kathwari, Chairman, President and CEO

You are talking about the first quarter?

Budd Bugatch, Analyst

Yes, sir. Yeah.

Farooq Kathwari, Chairman, President and CEO

Okay.

Budd Bugatch, Analyst

It was 13% for the entire quarter for…

Farooq Kathwari, Chairman, President and CEO

Yeah. I’d say, it was about consistently more or less the same.

Budd Bugatch, Analyst

Okay. And for me just one thing on the margin performance, which is notable that 61%. Can you kind of give us any, I know you don’t disclose that, but give us a flavor of how that compared retail versus wholesale? I know you had the issue in the Orleans plant. So I am just curious as to how that proceeded?

Farooq Kathwari, Chairman, President and CEO

Matt, do we give those margins or what our gross?

Matt McNulty, CFO

In our breakout, gross margins on our retail and wholesale perspective, we do on an operating margin.

Farooq Kathwari, Chairman, President and CEO

Budd, generally, I would say this: if you take out this question of what happened in Orleans, again, what happens in Orleans was considered extraordinary. I think, on the basis of our operations, we have been consistent both in our wholesale margins and retail margins.

Budd Bugatch, Analyst

Okay. And last from me on the inventory, it’s down, I think, what was it, about 11% year-over-year? How does that compare retail, again, retail versus wholesale?

Farooq Kathwari, Chairman, President and CEO

It’s approximately, let me just see. Matt, do you have that information?

Matt McNulty, CFO

Inventory is down 11% from last year.

Farooq Kathwari, Chairman, President and CEO

Yeah. No. He says inventory is down.

Matt McNulty, CFO

I think, it would be more down on the wholesale side versus the retail side. As Mr. Kathwari pointed out, we do have new product that’s coming out on the floor of our design centers. So the retail inventory was a little bit higher compared to a year ago versus the bigger decrease in wholesale.

Farooq Kathwari, Chairman, President and CEO

Yeah. About 11% or so down, Budd.

Budd Bugatch, Analyst

Okay. Thank you and good luck for the balance of this year and on to next.

Farooq Kathwari, Chairman, President and CEO

Thanks. Thanks, Budd.

Operator, Operator

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

Farooq Kathwari, Chairman, President and CEO

Hello, Cristina.

Cristina Fernandez, Analyst

Hi, good afternoon, Farooq and Matt. I wanted to ask about the SG&A expenses for the quarter. I know they declined by 13%, but there was a significant deleverage due to the sales decline. I wanted to know if there were any one-time costs or anything related to the store refresh initiatives that were additional this quarter. Is the 12% operating margin a new level we should anticipate for the next few quarters given the macro conditions and the store refreshes, or can it possibly return to a slightly higher level similar to what we experienced in the previous quarters?

Farooq Kathwari, Chairman, President and CEO

It’s a good question, Cristina that at this stage, it’s very hard to say, because the good news is that we are operating much more efficiently both at the manufacturing level and at the retail level. When I talked about the decrease in our associates, it has taken place at all levels, and especially, with the use of technology. It’s amazing how the technology has helped us, especially at retail where our interior designers today are about 30% less than what we had just a few years back, writing more business because of the combination of technology and their personal skills. And of course, this was also tremendously important during COVID, where many people worked from their homes. So I think that from our perspective, it is more or less, I would say, consistent between the two major areas of our business, wholesale and retail.

Cristina Fernandez, Analyst

Maybe ask another way, is there room to cut expenses more or is that kind of $80 million you saw this quarter sort of like a slow, if you can go on the expense side?

Farooq Kathwari, Chairman, President and CEO

Well, it’s a good question, because when we went from $92 million that we had in the previous year quarter to $80 million, that’s a pretty major decline year-over-year. I think we always keep looking at what needs to be done, but there is always a possibility. We are always looking at the opportunities. And again, as I said, the combination of technology and personal service in our manufacturing, retail, and logistics is tremendously important. So there is a possibility, but I think we have cut down quite a bit.

Cristina Fernandez, Analyst

Okay. Can you provide more information on the demand side? What feedback are you receiving from your design centers? It seems that consumer sentiment has declined this quarter. Can you share any insights into the changes in consumer behavior compared to two, three, or four months ago, or even earlier this year?

Farooq Kathwari, Chairman, President and CEO

I think that consumers, if you take a look at it right now, they are still somewhat very conservative. I think that we are expecting that will remain so for the next few months, and again it is the question of what we are comparing it to. Comparing it to last year was a very tough comparison, but if you compare it to, for instance, going back to pre-COVID, you can see the differences that we are starting to recover. We are actually higher than the pre-COVID in both our retail business and our wholesale business, and I would think this: that consumers are looking to see some interest in furnishing their homes. They have already done a lot of it. I think they have spent a fair amount of time in travel and other areas, and so we would say that certainly coming into this quarter and the next quarter, we should have more consumers and more interest in the home.

Cristina Fernandez, Analyst

Thank you and good luck this quarter.

Farooq Kathwari, Chairman, President and CEO

Okay. Thanks very much.

Operator, Operator

Our next question comes from the line of Zach Donnelly with KeyBanc. Please proceed with your questions.

Farooq Kathwari, Chairman, President and CEO

Hello, Zach.

Zach Donnelly, Analyst

Thank you, Farooq and Matt, for addressing our questions. Matt mentioned earlier that you don’t provide gross margin details by retail or wholesale segment, but I noticed in the quarterly report that you stated gross margins remained the same year-over-year for the retail segment. I'm assuming there's some favorable product mix and input costs contributing to this, but I also observed that clearance sales increased. Could you clarify how elevated clearance sales have affected gross margins in the retail segment?

Farooq Kathwari, Chairman, President and CEO

Yeah. That’s a good question because of the fact that we did a number of initiatives. One was, of course, after we did the Danbury Design Center with great projection. Of course, I think you saw that we also had it in Manhattan and now we are launching it all over the country. What it has done is this, it has done a great job of having very strong projections in all our design centers, but it also created some products that had to be sold at clearance. So that is and that clearance as we sold at a lower margin, so that affected our gross margins. The other thing we did, which I think we haven’t mentioned too much is that the size of our design centers is going to change. It’s already changing. Keep in mind, Manhattan for instance, we for 30 years or so were in a 30,000-square-foot location and we went to 7,000 square feet. In many areas of the country, we are going to 7,000 square feet, 8,000 square feet, 10,000 square feet, and what we also did starting in Danbury when we repositioned Danbury, which was a 20,000 square-foot design center, we said anything over 12,000 square feet will not be part of a regular design center. So we created space so products have to be sold and that product was sold at lower margins. They are all good products. It did two things that certainly gave us business, brought in customers, but it also in the short term sold products at a lower margin. But as we get out of those, we will have a greater benefit of having fewer products on the floors because today, I also mentioned that almost 75% of the products we sell is a combination of interior design and technology. Twenty-five years back, we sold whatever we showed on the floors. That’s why we are 20,000 square-foot and 30,000 square-foot design centers. All of that has had a tremendous impact, but as we go forward, I think it will take us another six months or so to sell off excess products that we had in all these design centers in the country. The good news is as we move forward, we will have smaller design centers and be much more efficient.

Zach Donnelly, Analyst

Got it. That’s really helpful. Thank you, Farooq. And kind of piggybacking off of that just really honing in on retail segment gross margins, something we have been tracking closely over the past month or so is just credit delinquencies and financing for big-ticket discretionary items?

Farooq Kathwari, Chairman, President and CEO

Yeah.

Zach Donnelly, Analyst

We have noticed over the past two quarters, you have kind of called out increased financing costs as an impact to retail gross margins. I was just wondering, do you have any sense of what percent of your retail sales are financed versus non-financed? And then on that end, can you provide any color on what you are seeing in terms of interest rates associated with that?

Farooq Kathwari, Chairman, President and CEO

Yeah. That’s a good question because interest rates on financing have gone up quite a bit and we were offering until two months back 24 months free interest, I mean, loans with free interest for 12 months to 24 months... 24 months and we said, no, that was too much. And even though we realize that was probably close to 15% to 20% of our business was done with those loans, we took it down to 12 months instead of 24 months because I think the interest rates went up from 3% to close to about 5% or 6%. So I think as we go forward, what we feel is that still there are people who need financing, but we believe that 12 months is sufficient. Now, we have to be careful that we don’t want to lose business, so we are going to watch very, very carefully, but at this stage, we have taken it down from 24 months to 12 months, which has an impact of about, as I said, the impact on the margins, that the interest has gone from 5% to 3% or so.

Zach Donnelly, Analyst

Got it. Okay. Yeah. Thank you. That makes sense to us. And then, I guess my last question just kind of on wholesale and order trends and just breaking those out. We kind of noticed that in terms of contract orders, you were down about 18% year-over-year this quarter. I was just wondering if you could maybe touch on what sort of impact that had or if there is any sort of timing shift that’s impacted that where maybe the GSA is pushing out orders later potentially into fiscal 2Q for you and just how to think about that maybe moving into the next quarter, that would be really helpful.

Farooq Kathwari, Chairman, President and CEO

You have actually answered most of the question yourself. It is. The GSA used to have a cut-off at the end of the government’s fiscal year that is September 30th, that all orders had to be put in. But this year, I don’t know if they will do it next year, they have allowed them to enter orders after the end of the fiscal year. So that way what it has done is it has created lower orders in September because not everybody didn’t have to put it in. So they are now going to put this in this quarter. So we believe from what we hear is that the orders that didn’t come in September, they will come in this quarter and that’s been the one major factor. The other is, if we talk about wholesale, obviously, when our retail business is lower, it does affect our wholesale orders and the majority of our wholesale is from our own retail division. But when you asked about the government, yes, the government business has been lower and that outside business that you referred to that’s non-retail was impacted by this decision by the State Department and the GSA to not enter all the orders in September.

Zach Donnelly, Analyst

Got it. Got it. That’s really helpful. And then, I guess, just a follow-up on that as a final point maybe. So with that being the case moving into fiscal 2Q as we kind of see that timing shift maybe benefit written orders in 2Q. I also believe that fiscal 2Q of the prior year, your contract orders were down maybe around 88%, so just easier comparisons moving into the next quarter, the benefit of the timing shift. Would it be fair to assume that we should see some sort of sequential improvement in written order trends on the contract side moving into the next quarter?

Farooq Kathwari, Chairman, President and CEO

I believe we can assume that, although the government has a different perspective. Our retail performance will largely depend on how our retail network operates and the state of the economy. Our team is highly motivated, and the Interior Design Destination initiative is making a significant impact. Launching this initiative during a soft economy was the right choice, as it provides us with an opportunity to convey our message amidst widespread deep discounts and business closures. We're successfully communicating that we are thriving and have a strong product lineup, which I believe will benefit us moving forward.

Zach Donnelly, Analyst

Got it. Yeah. That’s it for us. Thank you, Farooq. Good luck on the refresh and congrats on the strong margins this quarter. Thank you.

Farooq Kathwari, Chairman, President and CEO

Thanks very much. Any other questions or comments?

Operator, Operator

There are no further questions in the queue. I’d like to hand it back to Mr. Kathwari for closing remarks.

Farooq Kathwari, Chairman, President and CEO

Well, thank you very much and thank you for participating and attending. And as Budd knows, this is most likely, I think, over the 120th, 125th consecutive quarterly call and we are just getting started. So stay with us and we got a lot of good things happening. So thanks very much for participating.

Operator, Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.