Prepared remarks
Good afternoon, and welcome to the Ethan Allen Fiscal 2026 Third Quarter Analyst Conference Call. 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.
Thank you, operator. Good afternoon, and thank you for joining us today to discuss Ethan Allen's fiscal 2026 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 up the call for your questions. Before we 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 will find a copy of today's press release, which contains reconciliations of 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 10-Q. 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.
Thanks, Matt, and thank you all for participating in our third quarter financial results call. As we reported, despite many challenges, we performed reasonably well. We were mainly impacted by a reduction of business from our State Department contract, primarily due to government shutdown, lower international sales and to some extent, sluggish demand for home furnishings. Our written sales in North America were flat compared to last year, while our wholesale orders declined 7.6% from reduced, as I mentioned, U.S. government sales and slowdown in our international business. Tariffs also impacted our earnings, especially the unexpected tariffs on our Mexico manufacturing products. The increased tariffs during the quarter of about $4 million were the main reason of our reduced earnings. Matt will now provide more information. And after Matt, I will review our initiatives. Matt?
Thank you, Mr. Kathwari. Our third quarter financial performance was highlighted by strong operating cash flow and a robust balance sheet despite operating in a challenging macroeconomic environment. Our consolidated net sales of $136 million benefited from a higher average ticket price, increased clearance sales and fewer returns. These increases were offset by lower contract sales, a decline in delivered unit volume and inclement weather. Retail segment written orders were flat versus last year, while our Wholesale segment declined 7.6% due to macroeconomic challenges, reduced government activity and a slowdown in our international business. Demand levels were choppy and the pace of written orders declined slightly throughout the quarter. Our retail written trends were strongest in July despite adverse weather, which slowed traffic late in the month and continued into February. There was a pullback in demand during March following the Iran conflict, but we are excited for the introduction of several new products this spring and believe they will complement the current home furnishings Ethan Allen has to offer. We ended the quarter with wholesale backlog of $42 million, down 23% from a year ago. Lower U.S. State Department and international business, combined with improved customer lead times helped reduce our wholesale backlog. Our consolidated gross margin of 59.4% was impacted by incremental tariffs, delivering out orders with increased promotional activity and higher clearance sales, partially offset by a change in sales mix, lower inbound freight, reduced headcount and a higher average ticket. Our adjusted operating income was $6.8 million with an operating margin of 5%. Lower operating margin was driven by higher tariffs, incremental digital and technology spend, fewer U.S. government sales and delivering out orders with higher promotions. Disciplined spending, cost control initiatives and lower headcount helped to drive SG&A expenses down 3% and offset additional investments we are making in our business. At quarter end, we had 3,105 total associates, a decrease of 6% from a year ago, with decreases noted in both wholesale and retail. Adjusted diluted EPS was $0.24. Our effective tax rate was 24.2%, which varies from the 21% federal statutory rate, primarily due to state taxes. As noted earlier, our business has been impacted by the current tariff environment, which remains dynamic and uncertain. Since the beginning of 2025, the U.S. government has announced several different measures regarding tariffs. More recently, in February, the U.S. Supreme Court invalidated certain IEEPA tariffs introduced last year. Shortly thereafter, a new 10% global import tariff under Section 122 was made effective and lasts until mid-July of this year. Our current exposure is concentrated on the 25% tariff that took effect in October 2025 under Section 232, which is on upholstered wood products produced and exported out of our Mexican manufacturing facilities. Our remaining exposure is under the aforementioned Section 122 tariff, which applies a 10% tariff on furniture manufactured and exported out of our Honduras facility as well as on imported wood furniture from Indonesia, select fabrics from Asia and imported home accents. In total, we estimate our current tariff exposure to be in the range of $15 million to $20 million annually. In the past month, the U.S. Customs and Border Protection Agency released guidance regarding IEEPA tariff refunds, including last week's April 20 launch of software that will process IEEPA refund claims at scale. We are currently working through recoverability of previously paid IEEPA tariffs and expect refunds to take up to 80 days to receive. Now turning to our liquidity. We remain debt-free with substantial liquidity to support long-term growth. We maintain a robust balance sheet and ended the quarter with $181 million in total cash and investments. During the just completed third quarter, we generated $15 million in operating cash flow, up from $10 million a year ago due to improved working capital. Through the first 9 months of fiscal 2026, we have generated $22 million in free cash flow. In February, we paid a regular quarterly 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 $0.39, which will be paid this May. We continue to view our dividend as an attractive use of cash and a positive return to shareholders. As I conclude my prepared remarks, we are pleased that our business model helped deliver another quarter of profitable growth. Our efforts to identify ways to leverage operating expenses are constant. We seek to properly balance investing in future growth while managing ongoing costs. Ethan Allen's vertical integration and focus on one brand are core differentiators that will help us navigate through these current industry headwinds. With that, I will now turn the call back over to Mr. Kathwari.
Yes. Thanks, Matt. As I mentioned, we have continued to take steps to strengthen our unique vertically integrated structure, including strengthening our product offerings. During the last six months, focus has been to introduce new relevant product programs, strengthening our retail network. We have continued to reposition our retail network in North America; design centers now number 172 locations with smaller footprints and major introduction of technology to help our talented interior design associates. We continued strengthening our North American manufacturing, which produces about 75% of our furniture, almost all made custom on receipt of orders. We have continued strengthening our North American national and retail logistics, which enables us to deliver our products with what we call white glove delivery at one delivered price to our clients in North America. And importantly, combining personal service of our interior designers and our manufacturing associates with technology has been a game changer. This has helped us provide great service while reducing costs. With this brief overview, happy to open for any comments and questions.
Questions and answers
And our first question comes from Taylor Zick with KeyBanc Capital Markets.
Well, I just wanted to first ask kind of about the retail written orders. You gave some good color here, trends slowed a little bit in February and then you saw a pullback in March, I assume, related to the geopolitical situation. Any sense of how retail written orders are trending here so far in April? I assume there's some Liberation Day noise in there as well, but maybe if you can kind of touch on that?
Yes, it's an important question. In this quarter, despite all the challenges we have had in the economy, our written retail held up. In fact, our retail division's written orders were about the same as last year, which is tremendously important. As Matt also mentioned, the decline was mostly due to international issues and the State Department issues. Our business has held up. And now in April, it's actually been positive. There has been positive news so far, and we will continue the progress that we saw despite all these challenges last quarter. We maintained our retail, and I think in April so far it has been positive.
Great. And then maybe if I can ask maybe on the tariff side, and maybe I can wrap two questions in one here. You also gave some great color on the tariffs and where you're exposed. You called out, I think, $15 million to $20 million of exposure on an annual basis. Can you kind of just talk a little bit about how you plan to mitigate some of those tariff expenses? And then related to that, maybe if you can touch on the gross margin as well because we also have rising diesel costs and increasing foam prices as well. So if you don't mind touching on.
I'll say a few words, and Matt can also join. Our tariffs impact products coming from imported sources, which is mostly Asia, and more recently tariffs were imposed on our North American operations in Mexico and Honduras. Mexico has been close to 25% and Honduras is 10%. The advantage we have in Mexico, to some degree, is that we operate and own the manufacturing operations. According to Mexican law, we can ship products from Mexico to the United States at a relatively small margin, I think about 5%. Even with that 5% margin, we were still substantially impacted by the tariffs in Mexico, and to some degree by Honduras. Our products that come from Asia also faced very high tariffs, although in the last six months tariffs have been reduced from Indonesia, India and other places, even in China. We hope there is some resolution to what is taking place between the United States and Mexico. A lot of politics has resulted in those high tariffs, and it is not primarily about business.
That's a great question. The tariff situation is dynamic and ongoing, meaning the rules and regulations continue to change. The Section 122 10% global tariff rate was a 150-day set rate set to expire in July, so the rules may change again. We have taken steps to mitigate tariffs, including partner or vendor cost sharing, sourcing diversification, identifying alternative sources when possible, absorbing some of the costs ourselves and implementing price increases. We took about an average 5% price increase in October and November of 2025. Those actions have helped mitigate some of the incremental tariff exposure that I quantified as $15 million to $20 million.
Yes, those tariffs really impacted our operating margins. When you look at our operating margins coming down, it's mostly because of those tariffs. Our retail business in the United States held up.
No, I think we covered it here. I'll pass it along.
Your next question comes from Cristina Fernandez with Telsey Advisory Group.
I had a couple of questions. The first one is on the State Department contract and just the whole wholesale contract side of the business. It's been a pressure point now for at least a year. What is your outlook from here on that part of the business? Do you think it's near reaching stabilization? Or should we expect weakness for the rest of 2026?
Cristina, a number of factors. We have had a long-term contract with the State Department. Recently, the contract has been up for renewal and we had to bid, and I'm sure others have bid on it as well. The bidding has taken place and the State Department is currently reviewing the bids. We do expect to hear from the State Department, and depending on the outcome, we do have an opportunity to increase some of our prices based on the tariff issues. I think in the next couple of months we will know about the new contract. Right now, we do have the current contract where we are getting business, not at the level we did last year, but business is coming in under the current contract.
Then the second question I had was on the impact of promotions you mentioned during the quarter. Is that mostly related to the increased promotional activity back in the second quarter and those deliveries being made now? Or did you offer incremental promotions to consumers during this current quarter versus a year ago?
There are two factors. First, we decided to increase our marketing spend, especially in our digital channels. We increased that spend, which is the right thing to do because our digital channels are tremendously important. So when you look at advertising, a lot of it was due to that increased investment. We have flexibility going forward in determining how much we spend, but last quarter we spent more relative to sales, which is why our percentage of marketing was higher.
And then the last question I had was on the real estate plans. In the press release, you noted a couple of new locations planned for this year. Do you still see opportunity, mostly in the U.S., to enter newer markets that you're not in? Or are most of these store openings relocations or updates to existing stores?
It's both. Over the last three years, we have spent significant effort and resources to reposition our existing network. That repositioning has involved investing in our existing design centers to make sure they project well and also reducing their size. We have been able to reduce the size of our design centers overall by at least 25% to 30% because of the technology we use to help our designers work with clients. We currently are working on about five new locations in the United States and have opened one or two locations in Canada. We will continue to open new locations and relocate current ones. As I said, bringing in lots of new products meant we had to sell through existing inventory, which had some impact on our margins because we needed to sell those products.
There appears to be no additional questions at this time. I will hand the floor back over to Mr. Kathwari for closing remarks.
Well, thank you very much. As I said, on one hand we are going through challenging times, but the good news is we have continued to position ourselves well. Every week, I focus on five important things. First is talent. We are blessed with very strong talent in our vertically integrated enterprise from our manufacturing to our logistics to our merchandising and marketing. Second is technology. Technology has played a tremendously important role in everything we do today. Third is marketing, important at both the national and retail level. Fourth is our focus on making sure that we provide great service. And fifth, and tremendously important, is social responsibility. Those five things are critical and I think have helped us maintain a strong presence in all our operations. Thank you very much for participating and I look forward to our continued focus on growing our business.
Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.