Ethan Allen Interiors Inc. (NYSE:ETD) Q3 2023 Earnings Call Transcript

Ethan Allen Interiors Inc. (NYSE:ETD) Q3 2023 Earnings Call Transcript April 26, 2023

Ethan Allen Interiors Inc. beats earnings expectations. Reported EPS is $0.86, expectations were $0.79.

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: 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: Thank you, Matt. We are pleased with our strong financial performance for the quarter ended March 31 2023, especially compared to strong results for the previous period. Matt will review in detail our financials for 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 dividend – 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 keeping an view in 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: 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 and 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 taking 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 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 out 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 cost, 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 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 restore 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, also 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 : Thank you, Matt. As I mentioned last week, we had 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 following: 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 and our plan is to have this projection reflected in over 172 design centers across North America during the next nine months. This is 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 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 had 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, combination of strategic locations of our manufacturing, talented motivated associates, and technology has resulted with our many initiatives, especially some from fiscal ‘29 we have made major efficiencies in getting stronger talent, reducing overall headcount, while major increases in sales. For example, since fiscal 2019, we have reduced our headcounts both in retailer 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 ‘29, 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.

Q&A Session

Operator: Our first question comes from the line of Cristina Fernández with Telsey Advisory Group. Please proceed with your question.

Farooq Kathwari: Yeah. Hello, Christina.

Cristina Fernández : Hello. Farooq, and Matt. Good results on the operating side. I wanted to start with the SG&A expenses are being very well controlled. Where 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, there need to be more structural changes to your expense levels?

Farooq Kathwari: Yeah, Christina, our – it’s interesting since when you look at from 2019, that at thepre-COVID we have reduced our inventories. We have reduced operating expenses while our sales have gone up. A lot of it is due to the fact of – there are a number of factors. First is, on the retail side, technology and stronger interior designers have played a very important role. We have today less people in our retail, bring more business. Today our designers are able to work virtually with clients. Of course, with the COVID, that was tremendously important. That resulted in reduction of people, but more stronger interior designers 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 less people today’s than we had 2019 with higher sales.

And as we go forward, that will continue and will give us benefit and will continue to become – continue to become more efficient. So this question of making sure their operation is more efficient has been a very important part of our initiatives and I think that will continue.

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

Farooq Kathwari: Well, we are of course, comparing to high – very high numbers in the previous years. So, obviously, we are looking at, when you take a look at our business, even compared to 2019, our backlogs are still higher as Matt just mentioned compared to even 2019. But we do know that we were operating at very high demands. That is softening. And we saw that most of it really during the quarter and in April also I think that people are more cautious. And obviously, it’s still early. We – as you know, we look at the whole quarter before we make any determination, but we are prepared to – we need to understand that people are more cautious. And that we have to be more effective, efficient, both in marketing and in terms of our operating expenses. And we are looking at both very carefully.

Cristina Fernández : And as a follow-up to the backlog comment, you mentioned backlog is up about 30% versus pre-pandemic in orders for the quarter, I think are down like 3%. So do you expect that backlog to normalize versus the pre-pandemic level or anything has changed with that backlog should stay higher?

Farooq Kathwari: No, only to keep in mind, just our backlog, just from prior year, they’re down almost 40%. They’re still high, compared to the pre-pandemic level, no, as we continue to go forward, our backlogs are going to continue to come down, because we are able to make the products. We had just tremendously high business in the first two years of the COVID. We’ve got up and got up very, very well. And I think by this quarter, we will have completely got up and which is good news that we will have even faster deliveries.

Cristina Fernández : And one last question I had was on that on the dividend increase. As you thought about increasing the dividend, is there a payout target you’re working towards that you wanted to, to head with the level of where you took the dividend?

Farooq Kathwari: Well, you know, as you know, we have been giving over the last, as Matt just mentioned, we have continuously have had our regular dividend then we also have had special dividends. And when I take a look at it, just before the increase of dividend now, I think our yield on the regular dividend was close to I think 4.7%, 4.8%, right, Matt?

Matt McNulty : It’s correct.

Farooq Kathwari: It will now go over 5%. But then if you include, which I do and the financial markets don’t include our special dividends that would also – that makes it close to 5.5% to 6%. So I think having a dividend between 5% and 6% yield is a pretty good and that’s our intention.

Cristina Fernández : Thank you.

Farooq Kathwari: All right, Christina. Thanks very much.

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

Farooq Kathwari: All right. This is not Brad. Is it?

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

Farooq Kathwari: Thanks. Very good. Good to hear your voice. Go ahead please.

Zach Donnelly: Sure. So, I want to touch on the backlog, as well. I know you had 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 puts and takes associated with the contract versus non-contract portion of the backlog.

Farooq Kathwari: By contract, you mean our business with the government?

Zach Donnelly: Exactly.

Farooq Kathwari: As you know, most of our business comes from our own retail network. Retail network which is operated by our own retail division and then our independents. So we have what we call retail backlog and wholesale backlog. And I think at this stage, Matt could give you perhaps a little bit more information, but our – if you compare it, for instance to, let us say the pre – let’s say, 6/30/ 2020 going back to three years. Our backlog is still approximately at the retail level is still higher by about close to 30% to 40%, right, Matt?

Matt McNulty : That is correct. It is up 41%.

Farooq Kathwari: Okay, 41% percent and our wholesale backlog is up even with all the business – all what the business we’ve done, we’ve delivered is approximately up about 12% to 15%. Correct Matt?

Matt McNulty : The wholesale backlog is up 30%.

Farooq Kathwari: Well, it’s between retail and …

Matt McNulty : And up about 40%

Farooq Kathwari: Oh, I see. From 6/30/2020 to now?

Matt McNulty : Yeah, from pre-pandemic levels, actually I was looking at, yes.

Farooq Kathwari: $10 million over $63 million is what? Yeah, that’s okay.

Matt McNulty : From June, 30, yes, you are correct. It’s down about 15%.

Farooq Kathwari: 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: 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 kind of seeing have been negatively impacting gross, margins. We’ve been hearing from different industry participants that 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: No, I understand. As we just – those are gross margin for this quarter just ending was about almost 60% and 59.9%. And if you take a look at going back to our pre-pandemic levels, it was about 56%. So we have maintained a high gross margin. And now as we go forward, always – we have to take a look at economies, we have got to take a look at whether we have to be more aggressive in our marketing, but we have these gross margins are – they are a result of a number of factors. First is the fact that volumes are very important factor in terms of having an impact of gross margins, especially at our manufacturing level because our manufacturing is impacted by volumes that have a tremendous impact on our gross margins.

So I think, at this stage, we operated at a very high level of 59.9%, and at the pre-pandemic level was 55%. So I think within 55% and 60% that is something in between the two, I think we will continue to have that – we expect that to be our gross margins.

Zach Donnelly: Understood. Sounds good. And just one last question for me, I think the last time we spoke, you had reminded me and our team that the last set of pricing actions you had taken or past maybe in 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: Maybe Matt can give perhaps, give you somewhat more details. But our objective has not – we have not had – we have not taken price increase across the board. We, our focus has been in the last few years to be very selective in our price increases depending upon where the product is coming from. And 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, is coming from offshore, in east Asia, the cost of a container went from $3,000 to $30,000. Now it’s coming back to close to $3,000. Similarly, our – for instance, our foreigner container from East Coast to the West Coast also increased by almost doubled. And now it’s come down. So, our price increases reflected to a great degree the impact of freight. And that’s why we have not taken many price increases because the freights is coming down.

Matt McNulty : And just to clarify – we – the last price increases worked on in January, February of last year of 2022, but do you remember though, due to the backlog and the nature of our business, those prices increases do not impact our P&L until it actually gets delivered. So there is a lag of anywhere between two to four months on that.

Farooq Kathwari: Yeah, and that’s important, but also, as I said, the freight factor was a very important factor. It’s still not completely down, but a major factor. Look at this, as I said from East Asia, from $30,000 – $3,000 to $30,000, now it’s down to $3,000 or $4,000. So we just take price increases. Other price increases that came in having absorbed because by the reduction of freight, the national and domestic.

Zach Donnelly: Got it. Got it. Yes, that’s really helpful. And just to kind of clarify as a last point with the kind of lagged impact of those pricing actions, I guess, it sounds like we won’t really or truly kind of lap those pricing actions until maybe the end of next quarter. Is that kind of generally correct in that thinking?

Farooq Kathwari: At this stage, we don’t have any any plans of increasing prices at this stage.

Zach Donnelly: Got it. Thank you. That’s it for me.

Farooq Kathwari: All right. Thanks very much. And any other questions?

Operator: We reached the end of the question-and-answer session. So, therefore, I’ll hand it back over to you Farooq for closing remarks.

Farooq Kathwari: Thanks very much. Well, as I said, we are pleased with the performance. We are also of course cautiously optimistic as I said in our press release that we have to watch what is taking place in the economy. We got to take a place and we’ve got to take a look at manufacture the sofa, we are positioned extremely well. Keep in mind, as I said, our operating expenses are lower. Our inventories are lower. We have managed our costs quite well. And we have strengthened our teams and this launch of the Interior Design destination is a very important initiative. We were going to do that too, but it just so happens the softening of the economy gives us an opportunity of having a strong marketing to get a message across. Thanks for everybody for joining and I look forward to continuing our progress and talking in the next quarter.

Operator: And this concludes today’s conference and you may disconnect your line at this time. Thank you for your participation.