Ethan Allen Interiors Inc.

Good afternoon and welcome to the Ethan Allen Fiscal 2024 First Quarter Analyst Conference Call. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

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. Cathwari. 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 maintain 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 are impacted due to 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 36 cents of regular and 50 cents of special dividend. And we also yesterday announced a regular dividend of 36 cents 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? Thank you, Mr. Katwari. 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 plant, 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 impacts of the Vermont flooding. which resulted in a temporary work stoppage and lowered net sales by approximately $15 million in the quarter. Our Orleans plan 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 backlogs, 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 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 improvements seen within upholstery and home access. 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 backlogs, 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 in delay of shipments. The gross financial loss incurred from the disposal of inventory, inoperable machinery equipment from water damage, facility cleanup and restoration amounts 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 pre-tax loss was $2.1 million and was reported within restructuring and other charges and is excluded from our adjusted earnings. Adjusted EPS was 63 cents compared with $1.11 last year. For historical context, Our adjusted diluted EPS for the three months ended September 30, 2019, was 35 cents. 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 restore 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 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 a strong expense management. We will continue to carefully manage our expense structure. With that, I will now turn the call back over to Mr. Kethlard.

Well, thanks, Matt. As you know, we have had our interior design focus for decades. However, the recent focus Our initiative under the umbrella of interior design destination takes our business to an entirely different level. This includes the following impacts. Repositioning of the interior 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 in our design centers across North America and internationally. Recently, we have ribbon cuttings in 16 locations. Just to give you a perspective, including having this enhanced projection in Manhattan, New York, in Albany, New York, in Cordova, Tennessee, Placetown, New Hampshire, Malta, New Jersey, Lancaster, Pennsylvania, Garden City, Long Island, Westchester, New York, Mount Pleasant, South Carolina, Green Bay, Wisconsin, Peach 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, 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. 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 the 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 growth in operating margins. After the 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 reduction of costs such as in raw materials, energy and transportation. While we had developed very strong new products during the last two to three years, we decided to hold off introducing 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 continue to strengthen and streamline our operations, including strengthening our interior design teams in our design centers. Today, we have about 30% less interior design professionals who are about to do the same business. In fact, from 2019, our total headcount in our company is less by 21%. By using technology, whether it is in our manufacturing, whether it's in our retail, especially in retail, and in our logistics, has helped us make our interior designers more proficient and, as they say, is the game-changer. We have strengthened our talent and unfortunate recent bankruptcies of furniture retailers has brought us also new and experienced talent. Our manufacturing also has 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. We are stronger both in terms of people, in terms of our offerings, and in our facilities. And with that, I'd like to open it up for any questions and comments.

Thank you. Ladies and gentlemen, we are now ready to take your questions. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Bud Butuch with Water Power Research. Please proceed with your question.

Good afternoon, Farouk.

It's Bud Bugach. And Bud Bugach, you have been covering us since I've been 15 years old. So how are you, Bud?

Probably since I was 15 too, Farouk. But I'm fine, thank you. Congratulations on the margin performance and what has got to be a very challenging environment. And I do have a few questions and I'm trying to just project forward um as you uh as you look at the at the volume uh and going forward um you you noted that your uh deposits are down about 29 percent year over year at the at the customer deposit that that would be at retail so i'm thinking you and you did a pretty good job of uh less uh uh you were less down in orders for the retail than you were an actual net sale so I suspected for the second quarter retail sales will be down year over year, but probably somewhat lower than what we saw in the first quarter, lower than the 20, less than the 24%. 27% for retail, pardon me.

Yeah, it's a little bit early, Bud, but I think that your comments are good comments in the sense that while we have reduced our backlogs to a great degree, but still, you know, keep in mind, as I said, our backlog is now down. And it's down because we delivered. We're down by about 27%, and 28% or so at our wholesale, 27% at retail. So we delivered a lot of backlog. We still have reasonably good backlog. We are still, backlog is, when you go back to pre-COVID, when, for instance, our backlog is still about 20% higher than it was in 2019. So we have a decent backlog, not as what we had last year. But that backlog still gives us an opportunity to continue to ship products. And we are also expecting, hopefully, I hope it's not a method, but we're expecting that consumers' attitudes, as I mentioned, are going to somewhat go back into the home In the last three or four months, they've spent a tremendous amount of time in travel and other areas.

I understand that. And you did note that the retail orders were down 13% year over year. And I'll ask the obligatory, how did that proceed during the quarter? What did those comparisons look like as the quarter progressed?

You're talking of this last, the first quarter?

Yes, sir. Yeah, and it was 13% was for the entire quarter for a little trend.

It was about consistently more or less the same.

Okay. And for me too, just one thing on the margin performance, which is notable at that 61%. Can you kind of give us, and I know you don't disclose that, but give us a flavor of how that compared retail versus wholesale. I know you had the... the issue in the audience plan. So I'm just curious as to how that proceeded.

Matt, do we give those margins or what?

We do not break out gross margins on a retail and wholesale perspective. We do on an operating margin.

You know, but generally I would say this, that if you take out this question of what happened in Orleans, but again, what happens in Orleans was considered as extraordinary. I think that on a basis of our operations, we've been consistent both in our wholesale margins and the retail margins.

Okay. And last for 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?

Well, It's approximately, let me just see.

Matt, you have that information? Inventory is down 11% from last year.

No, he says inventory is down.

It would be more down on the wholesale side versus the retail side. As Mr. Cassewary pointed out, we do have a new product that's coming out on the floor of our design center, so the retail inventory was a little bit higher. compared to a year ago versus the bigger decrease with that wholesale.

Yeah, about 11% or so down, Bud.

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

Thanks, Bud.

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

Hi, good afternoon. For Luke and Matt, I wanted to ask about the SG&A expenses in the quarter. I know they declined 13%, but obviously significant leverage on the sales decline. So I guess what I wanted to know, was there anything one time or related to the store refreshes and the initiative that was incremental this quarter? And it's the 12% operating margin, like a new level, that we should think about the next couple of quarters, given the macro and the refreshes in the stores, or can it get back to a little bit higher level, like what you've seen in the past couple of quarters?

That's a good question, Christina. At this stage, it's really 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 in 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, riding more business because of the combination of technology and their personal self. And of course, this was also tremendously important in the COVID when many, many people were working with them from their homes. So I think that from a perspective, it is more or less, I would say, consistent between the two major areas of our business, wholesale and retail.

Maybe ask another way. Is there room to cut expenses more Or is the kind of 80 million you saw this quarter sort of like as low as you can go on the expense side?

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

Okay. And then I wanted to see if you can share more color on the demand side What you're seeing from their design centers, the feedback you're getting, it seems like the consumer took another step down this quarter. Maybe any more color in the behavior you're seeing, how is it changing relative to three, four months ago or earlier this year?

I think that consumers, if you take a look at it right now, they're still somewhat very conservative. I think that we are expecting that will remain for the next few months. And again, it is a 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. We are actually higher than the pre-COVID in both at our our retail business, our wholesale business. And I would think this, that consumers are, we are looking to see the consumers somewhat get back into furnishing their homes. They've already done a lot of it. I think they've 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.

Thank you, and good luck this quarter.

Okay, thanks very much.

Our next question comes from the line of Zach Donnelly with KeyBank. Please proceed with your question. Hello, Zach.

Hey Farouk. Hey Matt. Thank you for, uh, for taking our questions. Um, I know Matt had mentioned earlier that you don't break out gross margins based on retail or wholesale segment. Um, but in the, in the queue just kind of noticed that, that you had mentioned that gross margins were unchanged year over year for the retail segment. And so I was wondering, I'm assuming you're seeing some, some form of favorable product mix on that end. Uh, favorable input costs, but noticed that clearance sales were higher. So I was wondering if you could kind of bridge that for us, or maybe help us understand what impact elevated clearance has had on gross margins on the retail segment.

That's a good question because of the fact that we did a number of initiatives. One was, of course, that After we did the Danbury Design Center, the 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 projection in all our design centers, but it also created some products that had to be sold, clearance. And that clearance has to be sold at a lower margin. So that affected our gross margins. The other thing we did, which I think we may not have 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, many areas of the country, we are going to 7,000, 8,000, 10,000, 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 foot will not be part of a regular design center. So we created space so products had to be sold, and that product was sold at lower margins. They're all good products. They did two things. They certainly gave us business, brought in customers, but it also in the short term did sell products at a lower margin. But as we get out of those, we will have a greater benefit of having less products on the floors because today I also mentioned that almost 75% of the products that we sell is a combination of interior design and technology. 25 years back, we sold whatever we showed on the floors. That's why we had 20,000, 30,000 square foot design centers. All of that has a tremendous impact, but as we go forward, I think it will take us another six months or so to sell off this excess products that we had in all these design centers in the country. The good news is, as we move forward, we'll have smaller design centers and much more efficient.

Got it. That's really helpful. Thank you, Farouk. And kind of piggybacking off of that, just really honing in on retail segment gross margins, something we've been kind of tracking really closely, maybe over the past month or so, is just credit delinquencies and kind of financing for big ticket or discretionary items. We've noticed over the past two quarters, you've 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're seeing in terms of interest rates associated with that?

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

Got it. Okay. Yeah, thank you. That makes sense to us. And then I guess my last question is kind of just on wholesale written 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 can maybe touch on what sort of impacted that or if there's 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.

You actually answered most of the question yourself. It is. The GSA used to have a cutoff 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'll do it the next year, they have allowed them to enter orders after the end of the fiscal year. So that way, what is done is it's created sort of 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. We believe, or what we hear is, that the orders that didn't come in in September, they'll come in this quarter. And that's been one major factor. The other is, if you talk of wholesale, obviously, when our retail business is lower, it does affect our wholesale orders. And, you know, the majority of our wholesale is from our own retail division. But when you ask about the question of 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.

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. You know, 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?

Yeah, I think that we can make that assumption because unless the government does something different, but we are expecting that. And the retail, of course, will depend upon how our retail network works, how the economy is. We are, you know, I think we are, our people are very motivated. This initiative of interior design destination is creating a lot of impact because at this time, you know, we didn't do it because of the fact that we're going to end into this We did it. It was the right thing to do. But this has given us a great opportunity to get a message around at a time when the only message that is being given out is that of deep discounts and going out of business. So we are getting the message across that we are alive, well, and very strong in our offerings. I think that is going to help us.

Got it. Yeah, that's it for us. Thank you, Farouk. Good luck on the refresh, and congrats on the strong margin this quarter. Thank you.

Thanks very much. Any other questions?

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

Thank you very much, and thank you for participating and attending. You know, as Bud knows, this is most likely, I think, over 120th or 125th consecutive quarterly call. And we're just getting started. So stay with us, and we've got a lot of good things happening. So thanks very much for participating.

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.