Earnings Call Transcript - ETD Q1 2023

Operator, Operator

Good afternoon, and welcome to the Ethan Allen Fiscal 2023 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 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. Good afternoon, and thank you for joining us today to discuss Ethan Allen's fiscal 2023 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 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 under the News & 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. 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 am pleased to now turn the call over to Mr. Kathwari.

Farooq Kathwari, Chairman, President, CEO

Thank you, Matt, and we are pleased and gratified with very strong results. Our teams and our vertically integrated enterprise have done a good job in helping develop strong programs in our various areas from strengthening our interior design network, to strengthening our product programs and marketing, and the effective use of technology in all areas, including our marketing, manufacturing, and logistics. After Matt provides an overview of our financial results, I will review our focus to continue to grow our enterprise.

Matt McNulty, CFO

Thank you, Mr. Kathwari. As a reminder, we present our results on both a GAAP and non-GAAP basis. Non-GAAP results include restructuring initiatives, asset 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. For the quarter, consolidated net sales increased 17.7% as a result of strong order backlog, along with improved manufacturing production and efficiency and higher receipt of offshore products. Previous constraints, including COVID-related shutdowns, labor disruptions, supply chain challenges, shipping delays, and raw material availability have eased in recent quarters, which helps us reduce the time to convert written orders to delivered shipments. Beginning about two quarters ago, we increased our manufacturing productivity as well as saw an uptick in the receipt of imports and raw materials from a higher volume of shipping container receipts, which led to strong sales growth during the first quarter. Our wholesale backlog as of September 30, 2022, was $106 million, down 24.4% from a year ago, but up 62.1% from September 2019. In the near-term, our teams are effectively managing the business to work through this high order backlog and to service our clients. Our retail written orders were down 8.6% due to a strong prior year comparable. However, when compared to the pre-pandemic first quarter of fiscal 2020, retail written orders were up 7.4%. Wholesale segment written orders were down 7.2% last year but nearly flat to Q1 of 2020. Consolidated gross margin was 60.4% for the first quarter, primarily due to a change in sales mix with our retail segment becoming a larger portion of favorable product mix, previous product pricing actions that are now working their way through delivered sales, and higher manufacturing productivity and efficiency partially offset by higher input costs. Retail sales growth of 18.5% increased our retail sales mix from 85% of consolidated sales last year to 85.6% in this year's first quarter, improving our consolidated gross margin. We expect a higher percentage of retail sales to consolidated sales to moderate towards normalized levels as we increase delivery of the high wholesale order backlog. Our adjusted consolidated operating margin increased from 15.2% last year to 17.6% in the current year first quarter. Adjusted operating margin expansion was primarily from higher consolidated net sales, retail and wholesale gross margin expansion, and strong cost containment measures, partially offset by higher selling expenses, including increased delivery and freight costs combined with higher marketing spend. Our ability to maintain disciplined cost and expense controls, including strong cost containment measures and tight expense management within our G&A expenses continued to help drive operating income growth. Our SG&A expenses when expressed as a percent of net sales decreased from 44.7% last year to 42.9% in this year's first quarter, reflecting our strong operating leverage. This operating margin expansion combined with double-digit delivered sales growth helped generate another quarter of strong profits with diluted EPS of $1.17, up 48.1% from last year. Our effective tax rate for the quarter was 25.3% compared to 26.3% a year ago. Now turning to liquidity and capital resources. We remain committed to maintaining a strong balance sheet and continue to monitor our liquidity closely. Our sources of liquidity include cash and cash equivalents, short-term investments, and amounts available under our credit facility. As of September 30, we had cash and investments of $142.4 million and no debt outstanding. Our investments at quarter end were within short-term U.S. treasury bills designed to enhance returns on cash while ensuring capital preservation and liquidity. We generated $38.4 million in cash from operating activities during the quarter, an increase from $17 million in the prior year period primarily due to higher net income and an improvement in working capital. Capital expenditures were $3.2 million for the quarter and included further investments in various areas, including manufacturing, retail design centers, and technology. We continue to pay quarterly special cash dividends. In August, our Board declared a special cash dividend of $0.50 per share, in addition to our regular quarterly dividend of $0.32 per share, both paid on August 30. Since our IPO in March of '93, we have paid over $595 million in cash dividends to shareholders, repurchased $625 million of our stock, and invested over $856 million back into the business in the form of CapEx and retail acquisitions. To sum up our quarterly financial results, we delivered excellent results despite challenging trends within the global economy. Net delivered sales, operating income, and diluted EPS were all above expectations, and our teams executed effectively.

Farooq Kathwari, Chairman, President, CEO

With that, I will turn the call back over to Mr. Kathwari. All right. Thanks, Matt, and good overview. So we are pleased with the progress. And as you have heard me in the past, we are just getting started. Crisis creates an opportunity. For over 90 years of our history, every major crisis has given us an opportunity to examine what we do and take steps to innovate and position us for growth in the next chapter of our long history. Our focus going forward is on the following areas. First, continued transitioning from a furniture store to an interior design destination. This involves a number of key areas, most importantly having qualified and motivated interior design talent. Today we have about 1,200 interior design associates in our North American network compared to about 2,400 ten years ago while doing more business. The quality of talent is extremely important and most critical has been adding technology to enable the interior designers to work effectively with clients in our design centers and remotely. Adding effective technology to our talented interior designers will remain a major focus. Secondly, the repositioning of our design centers. Today over 70% of the 170 design centers in North America have been relocated in the last 25 years, of which 48% have been relocated in the last 10 years, and the process continues. Currently, many design centers are being relocated, including in Manhattan, Chicago, San Jose, northern Florida, and New Hampshire. We will also continue to refresh our current locations to make them even more effective as an interior design destination. Third is continued strengthening of our product offerings. While during the pandemic, we had to slow down our new product introductions, we are now in a position to accelerate and introduce new products. In addition, we have substantially increased our digital marketing, which has expanded our reach and has been very cost-effective. During COVID, we did lower our advertising expense as there was strong interest by consumers to redecorate. This past quarter, we increased our advertising spend, including on national television. We will continue to strategically invest in marketing and utilize the new digital mediums available to us today. Investing in technology will continue to be a priority. This involves effective technology for our interior design network, manufacturing, logistics, and marketing. Our continued focus on manufacturing and logistics is crucial. About 75% of our products are made in our North American workshops. We have continued to make major investments in our manufacturing and logistics, thereby providing a significant competitive advantage. Our logistics is a major advantage in providing good service to our clients while managing overall costs. Delivering products at one cost throughout North America to our network was a challenge during the pandemic with major increases in freight costs, both internationally and domestically. However, it remains a great competitive advantage. Our continued focus on social responsibility is very important. This includes providing many benefits to our associates, including a safe working environment, healthcare, and other benefits. Environmental responsibility is a key part of our focus and ensuring we have proper compliance programs in place. Finally, we will continue to maintain strong cash and returns to stockholders. As Matt mentioned, we ended the quarter with $142.4 million in cash and investments. During the last quarter, we paid $20.9 million in regular and special dividends. Since our IPO in March 1993, we have paid $595 million in cash dividends to our shareholders and invested over $876 million in capital expenditures to strengthen various areas of our vertically integrated enterprise. With that brief overview, I am pleased to answer any questions.

Operator, Operator

Our first question comes from Cristina Fernandez with Telsey. Please state your question.

Cristina Fernandez, Analyst

Hey, good afternoon. Hi, Farooq and Matt, and congratulations on a good result. I wanted to get your thoughts on the demand environment and how the demand progressed through the quarter. What is your outlook going forward, considering that some of the housing metrics seem to be softer?

Farooq Kathwari, Chairman, President, CEO

Yes, Cristina. We are coming to the next stage after having gone through very high demand for all products, especially in custom products, we see that there is obviously just leveling off. However, as Matt said, we are still doing better than our business prior to COVID. I would see that we continue to do well because of the various programs we have. Although our written business has moderated and is not as high as it was two years ago, it is still present. Thus, we will continue to see some growth going forward.

Cristina Fernandez, Analyst

My last question was on the gross margin, which was very high this quarter at 60.4, at a peak versus historical levels. Can you comment on the other drivers, how structural they are, and should we see the gross margins stay in the high 50s level? Is that a reasonable assumption?

Farooq Kathwari, Chairman, President, CEO

Yes. If you take a look at our gross margins in the last year or so, we have been able to keep them at the high 50s levels. That is our intention.

Cristina Fernandez, Analyst

Thank you. One last question on the supply chain. Can you comment on the order to delivery times? Where are those now? And how long will it take to get back to pre-pandemic levels if they're not there yet?

Farooq Kathwari, Chairman, President, CEO

Yes, Cristina, our advantage has been that 75% of our products are made in our North American workshops. About 75% of our total products are custom when we receive the orders. Our lead times have improved significantly, currently at close to 8 weeks or less for upholstered products. Our wood products, which are mostly made in North America, are now at close to 10 to 12 weeks, which for custom is still a reasonable delivery period.

Cristina Fernandez, Analyst

Thank you.

Farooq Kathwari, Chairman, President, CEO

Thank you, Cristina.

Operator, Operator

Thank you. Our next question comes from Zachary Donnelly with KeyBanc. Please state your question.

Zachary Donnelly, Analyst

Thank you. Congratulations on the strong quarter. I was just wondering about your wholesale backlog, which was $106 million as of September 30. Last quarter, you had stated the backlog was about $102 million. This indicates a slight uptick in backlog. Despite strong delivered sales within the wholesale segment and written orders declining year-over-year, how did we get to an elevated backlog?

Farooq Kathwari, Chairman, President, CEO

Yes, a good question. Our wholesale backlog still is at about $106 million as of September 30, down from $192 million, which was at very, very high levels, but still at a good level. The reason is based on our ongoing business deliverables from our regional network, and our contract business has been strong, which has resulted in the higher wholesale backlogs.

Zachary Donnelly, Analyst

Understood, thank you. My follow-up question is regarding some of the margin inputs. You mentioned heightened freight and raw material prices remain elevated this quarter. However, there seems to be some price relief on inbound freight and containers. Are you experiencing any benefit from that year-over-year? Do you anticipate this relief will serve as a tailwind moving forward regarding margins?

Farooq Kathwari, Chairman, President, CEO

Yes, indeed. For instance, ocean freight coming from East Asia has seen a significant decrease from $567,000 to $30,000, now down to about $16,000. Domestic transportation costs are still on the higher side, but the trend shows lower. Despite these increases in freight costs, we have managed to maintain high gross margins, reflecting significant efficiencies and higher volume. We do see domestic freight moderating as overall business levels decrease.

Zachary Donnelly, Analyst

Thank you.

Farooq Kathwari, Chairman, President, CEO

All right. Zachary, take care.

Operator, Operator

Thank you. We see no further questions at this time. I'll hand the floor back over to Mr. Farooq Kathwari for closing remarks.

Farooq Kathwari, Chairman, President, CEO

Well, thanks very much. We're very pleased and gratified with the work of our associates; they've done an amazing job in terms of positioning. But we're just getting started. As I mentioned earlier, our focus on becoming an interior design destination is going to have a tremendous impact and benefit as we move forward. You will hear a lot about it in the coming quarters. Thank you all for attending, and I look forward to talking to you again next quarter.

Operator, Operator

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