Ethan Allen Interiors Inc.

Good afternoon and welcome to the Ethan Allen fiscal 2026 second quarter analyst conference call. At this time, all participants are in a listen only mode. Question and answer session will follow the formal presentation. 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's now my pleasure to introduce you to our host, Matt McNulty, Senior Vice President, Chief Financial Officer, and Treasurer. Thank you. You may begin.

Thank you, Operator. Good afternoon, and thank you all for joining us today to discuss Ethan Allen's fiscal 2026 second quarter results. With me today, Pru Kefwari, our Chairman, President, and CEO. Mr. Kefwari 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 up for your questions. Before I begin, I'd like to remind the audience that this call is being webcast live under the News and Events tab within our Investor Relations website. A replay and transcript of today's call will also be made available on our Investor Relations website. There you'll find a copy of today's press release, which contains reconciliations of the non-GAAP financial measures referred to on this call and in the press release. 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 most recent quarterly report on Form 10Q. 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. Kefwaris.

Well, thank you, Matt. And thank you for joining our second quarter ending December 31, 2025 earnings call, and our initiative to grow our business. The second quarter results were strongly impacted by the government shutdown, resulting in lower consumer confidence, lower traffic to our design centers, and lower orders at retail, and especially from the U.S. government contract, also impacted by a very strong previous year comparison. The good news is that we have started the third quarter with stronger traffic and positive written sales in January, as we mentioned in our press release. During the last few years, we have made major changes to our vertically integrated structure including our retail network, manufacturing, marketing, logistics, and are positioned well. After Matt provides a brief overview of our second quarter financial results, I will provide more details of our business, of our initiatives to grow our business, and then we'll open up for any questions or comments. Matt, please proceed.

Thank you, Mr. Kefwari. Our financial performance in the just-completed second quarter was highlighted by a robust balance sheet and strong margins despite a challenging environment. Our consolidated net sales of $149.9 million benefited from a higher starting retail backlog, a higher average ticket price, incremental clearance sales, and fewer returns. These increases were offset by fewer contract sales and lower demand. Retail written orders declined 17.9% while wholesaler orders were 19.3% lower than a year ago, with both metrics declining sequentially throughout the quarter as our prior year comparables got tougher. Our demand trends reflect a combination of macroeconomic challenges and a difficult prior year comparison, as well as an 11% decline in design center traffic. With that said, we are pleased to see positive written order growth in January. We ended the quarter with wholesale backlog of $49.8 million, A lower volume of contract orders combined with improved customer lead times help reduce our backlog. Our consolidated gross margin was 60.9%, up 60 basis points from a year ago due to a change in sales next, reduced headcount, a higher average ticket price, and lower inbound freight, partially offset by increased promotional activity, incremental tariffs, and elevated clearance sales. Our adjusted operating income was $13.5 million, with an operating margin of 9%. For historical context, adjusted operating margins during the pre-pandemic 2019 second quarter was 5.4%, or 360 points lower than it is today. Our current year operating margin was impacted by fixed cost deleveraging from lower sales combined with delivering out orders with higher promotions, additional marketing, higher occupancy costs from new design centers, increased employee benefit costs, as well as incremental tariffs. These increases were partially offset by disciplined approach to controlling operating expenses, including reduced headcount. At quarter end, we had 3,149 total associates, a decrease of 5.1% from a year ago. Adjusted diluted EPS was 44 cents. Our effective tax rate was 25.3%, which varies from the 21% federal statutory rate, primarily due to state taxes. Now turning to our liquidities. We ended the quarter with a robust balance sheet, including total cash and investments of $179.3 million with no debt. Our liquidity position remained strong, although we generated an operating cash flow deficit of $1.8 million during the quarter due to changes in working capital, including lower customer deposits and the timing of our biweekly payroll. In November, we paid a regular quarterly cash dividend of $10 million, or $0.39 per share. Also, as just announced in our earnings release, our board declared a regular quarterly cash dividend of 39 cents per share, which will be paid in February. We are pleased to continue to pay cash dividends while maintaining a strong cash position. Before closing, I'd like to spend a few moments on tariffs. We are exposed to tariffs assessed on raw materials and finished goods we import into the U.S. Recently enacted Section 232 tariffs made effective in mid-October have resulted in manufactured upholstered wood products being subject to a 25% tariff. Our non-U.S. manufactured case goods are currently subject to a 10% tariff that is partially reduced based on the consumption of U.S. source materials. With regards to imports, our exposure is primarily concentrated on imported case goods from Indonesia, black fabrics from Asia, and imported accents consisting of lighting and area rugs. To help offset some of this tariff impact, We worked with our vendors on cost sharing, performed additional sourcing diversification, and recently pushed through selective retail price increases, which averaged 5%. These carefully measured price increases were applied strategically across select SKUs rather than broadly. We will continue to review pricing and will respond quickly and thoughtfully as conditions evolve. We believe our North American manufacturing, which represents approximately 75% of the furniture we sell, provides us with a strategic advantage By controlling more aspects of the production process within North America, we believe we can mitigate some of our tariff exposure. As I conclude my prepared remarks, we are pleased that our disciplined investments and strong expense management are helping to build a fundamentally stronger company. We delivered another strong quarter and enter the 2026 calendar year with a debt-free balance sheet, strong liquidity, and a proven ability to provide clients with custom furniture and complementary design services. With that, I will now turn the call back over to Mr. Kethwari.

Thank you, Matt. I'm pleased to share our initiatives to help us to grow our business as we move forward. Our key focus remains to continue to strengthen our unique vertically integrated structure, including continued strengthening of product programs, Our design centers have started to receive our new products introduced in the fall of last year. Our products continue to be developed under the umbrella of classics with a modern perspective. About 75% of our furniture is made in our manufacturing workshops in North America. And all products are custom made. All products made in North America, I'm talking of furniture, are custom made on receipt of orders. This is possible because of our North American manufacturing and provides a strong competitive advantage. Strengthening our marketing programs, in our second quarter, we continue to utilize various mediums, including direct mail and digital advertising. We increase our advertising by 25%, mostly in digital mediums. While we did not get the full benefit in our second quarter of this increased marketing spend due to economic slowdown, we feel it will benefit us in the future. Our retail network, today we operate 172 design centers in North America and reflects our current projection under the umbrella of, we say, classics with a modern projection. The design centers reflect the reduction of the size due to strong interior design talent and digital technology. Continued strengthening of manufacturing. As I mentioned, about 75% of our furniture is made in our North American facilities. Combination of strong talent and technology is key to our productivity. Again, I repeat that all our manufacturing in North America is based on custom-made furniture. You know, 20 years back, 80% was in stock that we sold furniture, especially what we call case goods. Strengthening our national and retail logistics continues to be a very important initiative. We deliver our products to our clients all across North America at one delivered price with what we call white glove service. Very unique. If a customer is in Seattle or in Florida, Our in Texas, it's exactly the same delivered price, and it took us a long time to do this, and it reflects the investments we have made to have a very strong logistics network. And again, very, very important, the focus on continued strengthening of talent combined with technology. Combined with technology is key to future. With this, happy to take any questions.

Thank you. With that, we'll now be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. Confirmation tones indicate that your line is in the question queue. You may press star 2 to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. One moment while we poll for questions. And our first question comes from the line of Taylor Zick with KeyBank Capital Markets. Please proceed with your question.

Yeah. Hello, Taylor. How are you? Hi, Farouk. I'm doing well. How are you doing? Good. I just wanted to ask about the retail written orders during the quarter. You know, you noted that the monthly trends decelerated during the quarter just due to difficult comparisons. But as you kind of look through that, do you have any sense of what the underlying trends were during the second quarter?

Yes, I think Matt can give you the exact numbers of the retail. Our retail business in the quarter was somewhat impacted, but Matt, what are the numbers?

Yes, each sequential month during Q2 decreased by a higher percentage. We don't typically disclose the breakdown on a month-to-month basis, but it did blend to an average decrease of 18%. But we started out stronger in October, and it decelerated more so. For the government shutdown combined with the prior year comparison, if you recall, November, December last year were very strong. So it was a difficult prior year comparison. If we go back two years, fiscal 24, that calendar year 23, we were only down very low single digits compared to this past year ago, it was much higher written.

Got it. Yeah, it's certainly good to see the positive rent comps here in January. That's great. And Farouk, maybe for my second question, can you touch a bit on the contract side of the business? You have obviously cited the government shutdown as sort of a headwind here, but since the government has reopened, have you seen any improvement in the orders, or does those remain relatively soft?

Well, during the last quarter, the orders stopped. That, of course, had a major impact on our results last quarter because of the fact that the The government's been closed. They were not sending any orders. The good news is the orders are coming in, and they are coming in reasonably high but not as strong as, you know, we had last year because it is now taking the government, all the embassies all over the world a little time to get back on. So, yes, we are seeing new orders. It's a little bit lower than last year, but every week it's growing.

Understood. And then maybe one last question for me before I turn it over to others. You know, the company continues to put up, you know, very strong gross margins here despite, you know, the difficult environment and tariffs and all that. So how should we think about the sustainability of these margins as we, you know, look to 3Q and 4Q ahead?

I think we have a good opportunity of maintaining them because of the fact that a lot of work has been done at all levels, in terms of combining great talent and technology. That has really impacted all elements, especially our retail network, our manufacturing, our logistics. So I believe that obviously the volumes have an important factor, but we have an opportunity of maintaining them.

Great. Thanks so much. All right. Thanks.

Thank you. And our next question comes from the line of Christina Fernandez with Telsey Advisory Group. Please proceed with your question.

Hello, Christina.

Hi, good afternoon. Hi, Farouk. Hi, Matt. I appreciate all the color on the tariffs, Matt, that you gave. I wanted to see if you could give more detail as far as I guess what the total impact is. And you mentioned that you were mitigating some of it. So I wanna see if you can give some color on what the mitigated amount is and how should we think about that impact as we move forward? Do you think with the price increase and some of the changes you've made, you can mitigate the cost or we're gonna see some impact flowing through the cost base?

Yeah, go ahead, Matt.

Yeah, I'm happy to answer that one. So there's a couple strategies we took. It's really a three-pronged approach to trying to mitigate some of the tariff impact. One is vendor cost sharing or partner cost sharing, reaching out to partners to help negotiate and share in some of the costs. That we did over the last several months and was very successful. Another strategy that we've employed is supplier sourcing diversification, trying to source from other countries, which We've done to some extent. And then the third prong is really the retail price increases, which I mentioned we pushed through about a blended average of 5% in October of this past quarter increase. Those did help mitigate some of the tariff impact. It did not do all of it. Now price increases were late in the beginning of October. October, but late from a delivered perspective, a lot of those orders did not get delivered out fully in the quarter. So we'll see a little bit more of a benefit from price increases moving forward. With that said, there will still be some more headwinds. I mentioned the Section 232 tariffs that came into play mid-October. So we hadn't really experienced a full quarter worth of those. That's probably the largest. That's about 40% of our overall tariff exposure is there. And then the IEPA tariffs, which are currently under review by the Supreme Court, it's about 40%, and the remainder is Section 301 tariffs. I would say all in, we're still seeing a headwind. We don't disclose the actual percentage of the headwind overall, but I think the steps we've taken will help mitigate a significant amount of that, plus our current structure of being 75% in North America does help mitigate it naturally that way.

Yes, and also, of course, we're not counting on it, but the U.S. Supreme Court has still not decided on the validity of the IEPA tariffs. And it's possible that it goes away, and that will impact 40% of our exposure if they take it down completely, with an annual savings of approximately $8 million. But again, as I said, we are hoping that happens, but our plans are to... keep them on the side while making all changes so that we are able to maintain strong margins.

Thank you for that, Collar. I had a question on the January trend relative to the second quarter. What would you attribute it? Do you think it's marketing? Promotions seem pretty similar to last year. What would you... What would you attribute the improved trend?

I think the most important one is that the consumers came back. I think in the last quarter, with all the uncertainty, government shutdowns, people were scared. People were not coming in. What we've seen in January, people are coming back. Now, the good news is because of our structure, because of our interior design network, And we have, most likely, the strongest interior design network. They have maintained good contact with their clients. And what we've seen is that traffic has increased. People are coming back. Again, you know, there's still some concerns. But the concerns we had in the last quarter about all the uncertainty in the marketplace, that created issues. We see in January, you know, the government shutdown was not there. There's somewhat of a better... a consumer attitude. So people also, the people or designers worked with clients. And as in last quarter, the ones who did not close, they are closing the business now.

And the last question I had was on marketing, the 25% increase. I mean, do you expect that level to continue as we move through the year? And where are you mostly seeing the benefit of this marketing? Is it better traffic? Is it new customer acquisition? How are you measuring the efficiency of that marketing spend?

Yeah, that's a very important issue. Now, if we knew that the government shut down and all of those were going to take place, we would not have increased our marketing by 25%. That's what we did. But the reason, it is mostly on digital marketing. This is the digital marketing is where clients today, you know, it used to be that our designers had to spend a tremendous amount of time working with the clients physically. Today, consumers and our clients and our designers are able to work virtually with the amount of technology that we have. So all this was to help bring more people through our virtual advertising and also help them close business. And that will continue to do, but having said this, we are going to reduce some of our advertising expense in some other mediums. Look at 10 years back, we spent a lot of money on national advertising, zero. Then in the last year or so, we spent a fair amount of money on sending magazines, digital magazines and print magazines. So one of the things we looked at was the impact of a digital magazine where we were spending close to, I think, close to $18 million a month. We decided that we'll take it down to $9 or $10 million and still make an impact, and especially spending this more money on the digital marketing will help us. So those are the areas we are looking at.

Thank you.

All right.

Thank you. And with that, there are no further questions at this time. I'd like to turn the floor back over to Farooq Kathwari for any closing remarks.

Well, thank you for joining. I would say that we are stronger today. We have spent a fair amount of time. First, we've got, you know, as you know, every week I get about 40 reports They don't all report to me, but they have to write on five things. First is talent. What have they done to improve talent? The good news is we've got strong talent. We have less people, but strong talent. And as I said, our headcount today is about 30% less than what was only five or six years back. Now that is due to high talent, and it's also due to technology. So we're going to continue to have technology at tremendously important. Second, third thing is marketing. And marketing, again, is tremendously important, but the means of marketing are constantly changing. And this also reflected what we did last quarter in terms of spending more money on digital mediums. We'll continue to do that. And service is critical. That's our fourth tremendous important area. And the services provided by interior designers, services provided by our logistic teams, as I said, that we today deliver our products at one price nationally to a consumer with service. And then finally, social responsibility is tremendously important, and we'll continue to do that. So thanks very much for joining, and look forward to our continued discussions next quarter.

Thank you. And with that, ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a wonderful day.