Good afternoon, and welcome to the Ethan Allen fiscal 2018 first quarter analyst conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. If anyone should require operator assistance, please press star then 0 on your touch-tone telephone. As a reminder, today's program may be recorded. It is now my pleasure to introduce your host, Corey Whitely, Executive Vice President, Administration and CFO. Thank you. You may begin.
Thank you, Jonathan. Good afternoon, and welcome to Ethan Allen's conference call for our fiscal first quarter ended September 30th, 2017. This conference call is being recorded and webcast live on ethanallen.com, where you will also find our press release, which contains supporting details, including reconciliations of non-GAAP information referred to in the release and on this call. As a reminder, our comments today will include forward-looking statements that are subject to risks and uncertainties, which 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. After our Chairman and CEO, Farooq Kathwari, provides his opening remarks, I will follow with some details on the financial results.
Farooq will then provide further updates on our ongoing business initiatives before opening up the telephone lines for questions. With that, here is Farooq Kathwari.
Yes. Thank you, Corey. I am pleased to discuss our first quarter results and focus. As you know, many changes continue to take place in the economy, in consumer attitudes, in the competitive environment, and in technology, disrupting many enterprises. I have stated before that today you better be a disruptor, or you will be disrupted. After Corey provides a brief financial overview, I will discuss our initiatives and the 85th-year celebration convention we held last week, which was attended by more than 550 team members from all areas of our enterprise. We discussed main areas of focus to help us increase sales and profitability.
These included the various channels we utilize to grow sales, continued development of talent, production of relevant offerings, expansion of our marketing efforts, the combination of technology with personal service, and the strengthening of our unique vertically integrated structure, which enables us to continue manufacturing about 75% of our products in our North American workshops. Corey?
Thank you, Farooq. For the first quarter of fiscal 2018, our total written orders for the retail segment increased 1.7% for the quarter, which followed an 8.1% increase in the prior year first quarter. The company estimates total written orders would have increased 2.5% without the disruption from the hurricanes. The hurricanes disrupted several key markets in which the company operates. 15 design centers in Florida, including 11 company-operated locations, plus 5 company-operated design centers in the coastal Carolinas, were affected by Hurricane Irma. 11 design centers in Texas, with 5 independently operated locations in the Houston market, were impacted by Hurricane Harvey. Design centers and delivery centers were closed anywhere from a couple of days to more than a week, with an effect on both written orders and net delivered sales.
Hurricane Harvey also disrupted the company's wholesale logistics as the temporary shutdown of railway shipping through Houston impacted shipments from the company's upholstery plant in Mexico. Ocean freight arrivals were delayed into the Port of Houston for products en route to our Oklahoma distribution facility. Our consolidated net sales were $181.3 million for the quarter, compared to $193.3 million in the prior year quarter. We estimate that the hurricanes and first-run production of new products disrupted consolidated net sales by approximately 7%-8%. Retail net sales were $141.6 million, and wholesale net sales were $111.6 million. At September 30th, our retail division backlog was up 11.6%, and the wholesale backlog up 61.6% from June 30th, 2017. We ended the quarter with 150 company-operated design centers, an increase compared to 145 in the prior year quarter.
Part of the wholesale backlog increase is related to $12.4 million of wholesale orders we have received from the Department of State, $10.4 million of which were orders booked in the first quarter. International sales were 11% of consolidated sales during the quarter. That compared to 10.9% in the prior year quarter. Consolidated gross margin for the quarter was 55.3% and was negatively impacted by the hurricanes and first-run production of the new products. The mix of retail segment net sales to consolidated net sales for the quarter was 78.1% compared to 78.8% in the prior year quarter. Adjusted operating expenses were $87.9 million compared to $89.5 million in the prior year, lower primarily due to decreased advertising expenses and lower variable costs. Adjusted operating margin was 6.8% and adjusted net income of $0.28 per share compared to $0.43 in the prior year quarter.
Adjustments in the current year quarter included $0.8 million of costs related to organizational changes that included costs associated with some headcount reductions made in our headquarters and distribution division. That also included an early termination of a capital lease. We also incurred a charge for the write-down of unamortized financing charges related to the early extinguishment of our term loan, which is reflected on the other income and expense line. The prior year quarter adjustment reflected a $0.6 million loss on the sale of real estate. All these items were tax affected for the adjusted EPS calculation. We estimate the impact to sales and operating expenses due to the disruptions of the hurricanes and first-run production reduced adjusted EPS by $0.14-$0.15. Our effective tax rate was 35.1% for the quarter. The company's structural rate remains at 36.5%. We have a strong balance sheet.
At September 30th, 2017, we had no debt outstanding under our credit facility, having paid off the term loan during the quarter. Our total cash and securities totaled $59.8 million. During the quarter, we paid out dividends of $5.2 million, an increase of 10.6% compared to the prior year quarter, and we invested in capital expenditures of $2.7 million for the quarter, compared to $7.4 million in the prior year quarter. We do expect about $20 million in capital expenditures for the full fiscal year. Compared to September 30th, 2016, customer deposits of $69.2 million increased $6.8 million, and inventory of $157.5 million decreased by $1.8 million. With that, I'll turn it back over to Farooq.
Thank you, Corey. The main highlights of our convention last week included recognizing the contributions of the many associates in our retail, manufacturing, logistics, and corporate networks. The convention was attended by more than 550 team members. That number includes management, as well as 235 of our top interior design associates from North America and overseas, whose achievements were recognized during the event. We discussed our key focus for growth, which includes increasing sales and profitability of the company-operated retail division. This is one of our largest opportunities to increase overall profitability. The company's retail division currently has 150 retail locations, representing 76% of our total design centers in North America. For fiscal 2017, total consolidated delivered sales for the company were $763.4 million, with an adjusted operating income of $65 million, representing 8.5% of sales.
Retail division net delivered sales of $603.7 million represented 79.1% of total consolidated sales, while the retail division's adjusted operating income was 1.3% of sales. For the fiscal first quarter ending September 30, 2017, due to disruptions, delivered sales for the retail division amounted to $141.6 million, representing 78.1% of total consolidated sales and an operating loss for the retail division of 2%. Over the years, we have been acquiring design centers from retiring retailers, repositioning them to more relevant locations, and strengthening their management, design, and logistic teams. We've also been opening new design centers in strategic markets, recently adding locations in the Flatiron area of Lower Manhattan, the Buckhead area of Atlanta, and in downtown Chicago. Over the years, we've continued to incur losses in transitioning the retail network.
For fiscal 2017 and for the first quarter of fiscal 2018, losses attributed to the locations in transition amounted to $4.1 million and $1.4 million, respectively. As we move forward, our objective in the next few years is to operate our company retail division at an operating income of about 5%, compared to about 1.5% of adjusted operating income in the last few years. As I stated above, increasing profitability in our retail division is a major priority and opportunity. The next area of growth we discussed at our convention is our wholesale business. Our wholesale division sells products to the company retail division, as well as to all outside customers. The wholesale business in fiscal 2017 had sales of $453.3 million, with adjusted operating income of 12.3% of sales.
For the first quarter of fiscal 2018, wholesale had sales of $111.6 million and an adjusted operating income of 12.8% of sales. During the last three years, wholesale adjusted operating income has averaged 14% of sales. With increased sales, the wholesale division has the operating leverage to improve gross and operating margins. In addition to growth from our North American independent retailers and international retailers, we are focused on expanding our contract business, including our association with the U.S. State Department. We have received $12.4 million in wholesale orders for the State Department, including $10.4 million during the first quarter of fiscal 2018. The program went live on the FedBid website on July 1st. During the month of October, no bids were issued after a hectic last quarter of the government's fiscal year ending September 30th. We expect the process to start again in November.
We are also in the process of developing contract business through special relationships with organizations such as Margaritaville and Disney. The first project with Margaritaville involves furnishing about 1,100 homes and 186-room hotel in Orlando, Florida. We expect to start shipping for the first of the 1,100 homes in the fourth quarter of this fiscal year, and expect to complete the shipments over about a three-year period as the homes are built. The hotel furnishings are scheduled to ship based on an estimated completion of the hotel construction in the fall of 2018. A focus on increasing digital mediums such as ethanallen.com, Amazon and Disney, and live chat by our designers should result in increased online sales. The main benefit is customers visiting our design centers and interacting with our interior design professionals.
During the convention, we introduced our network to our new Uptown collection, with a consumer launch expected in April 2018. This follows the consumer launch of Passport in November 2017. During the past three years, our main focus has been on developing and expanding our more relaxed offerings, which included Santa Monica, Buckhead, and Brooklyn. Passport, while still in the relaxed category, has strong elements of a global attitude, with inspirations from many places in the world. Uptown, as the name implies, is more formal while maintaining the characteristics of livability. As with Passport, the new products were extremely well-received by our associates. Our focus and initiative regarding environmental stewardship, safety, and social responsibility is a major competitive advantage, as it motivates our associates and our clients and reduces cost. Acquisition, retention, and training of talent is a major focus.
At the conference, we discussed about our strong management teams in marketing, manufacturing, logistics, and retail. In our retail division alone, we have about 200 managers, most of whom have risen through the ranks of our organization. With more than 1,500 motivated and knowledgeable in-house interior designers in North America and about 2,000 internationally, we maintain a strong competitive advantage. The focus on acquiring, motivating, and retaining talent in other areas, including design, merchandising, manufacturing, and technology, was also a major focus of the convention. Our focus on marketing to expand our reach to more consumers. Today, about 70% of consumers who visit our design centers first visit us digitally via ethanallen.com and now through Amazon and shopDisney. During the first quarter, we focused our efforts on developing stronger and relevant messages.
While this was in process, we decided to change the timing of some of our advertising spend from the first quarter to the following three quarters. We have continued to increase our advertising in digital mediums while reducing in the more traditional mediums. Our advertising spend represented 4.1% of sales compared to 4.4% in the previous year. We also need to keep in mind that our marketing on Amazon entails a compensation which is not reflected in the advertising expenses. While in the first quarter of fiscal 2018, not significant, we expect it to grow. Our initiative with Disney continues at about the rate we saw in the last quarter, and we are just getting started launching stronger marketing in conjunction with Amazon. At this stage, while our online business continues to grow, most clients, even those chatting online, like to visit our design centers and interact with the designers.
Combining technology with personal service is the new reality. We discussed our investments in the last few years in appropriate technology for our manufacturing, logistics, and retail networks. Last year, the focus has been on having our interior designers qualify for live chat. Currently, 550 of our interior designers are qualified, and we expect that number to grow. We discussed initiatives to strengthen manufacturing and logistics. These included increasing capacity, faster delivery, and continued focus on quality. At the convention, a number of craftspeople from across our manufacturing division were on hand to demonstrate the work they do. These workshops were very well-received, especially by our interior designers. Our convention served to reinforce for all our associates these key initiatives and areas of focus for the company, and I'm pleased with the motivation and enthusiasm of our team. As Corey mentioned, we have continued to strengthen our balance sheet.
As of September 30th, cash on hand was $59.8 million. We had 0 debt and customer deposits of $69.2 million. During fiscal 2017, we distributed $20 million in dividend, representing 32.8% of our free cash flow. In the first quarter of fiscal 2018, cash dividends were $5.2 million, a 10.6% increase from the previous year. We continue to review the best opportunities to utilize our cash, while also keeping in mind that we are in a cyclical industry. With that, we will open it up for any questions or comments. Jonathan?
Thirdly, ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Bradley Thomas from KeyBanc. Your question, please.
Yeah. Hi, Bradley.
Hi, this is Smit Desai on the line for Brad. Good afternoon, Farooq and Corey. Thanks for taking my questions. On the State Department contract, can you talk a little bit more specifically about the $10.4 million of orders in the first quarter, and how we should think about extrapolating the run rate there? Whether there's any seasonality to that given their fiscal year-end, and what % of orders you think you're capturing. Thank you.
Yes, Smit. This is sort of somewhat unknown in the sense that this just got started in this last quarter. The last quarter for the government is when they do tend to give large orders. We're going to see as they open it up again, that as we understood initially, that it is approximately close to a $50 million annual contract before the FedBid. The FedBid does, to some degree, reduces the amounts. I think that if that is the case, you're talking about anywhere from $12 million-$15 million a quarter, even though keeping in mind the last quarter is strong. We do not completely know all the numbers. I believe that we did get a substantial portion of the contract.
Okay, that's great to hear. If I could talk about Passport. I believe you're launching the new product assortment in November. Did the first-run production of that represent the majority of the increase in the retail backlog? How significant is the presentation going to be on your floor space?
The retail backlog is different than the wholesale backlog. The Passport impacted our wholesale backlog because the retail backlog really is sold orders to our customers. Passport had no impact on the retail backlog. It had basically more at the wholesale level. Retail backlog was really sold orders to the customers.
Okay. Can you comment on how significant or what % of your floor space may be allocated to Passport?
It's relatively small. We are introducing product lines, even the next one, the Uptown, is very tight, very careful. I would say, if I just had to guess, no more than about 800 sq ft or so.
Okay, great. Thank you.
Thanks.
Thank you. Our next question comes from the line of John Baugh from Stifel. Your question please.
Hello, John.
Hello, Farooq. I know you touched on advertising, I apologize, I missed the commentary. I know it was a point of earnings leverage this quarter. Could you tell us maybe the next three quarters, what the plan is on advertising as well as on promotional activity? I believe you had talked about tightening that up moving forward. As a follow-up, and maybe in conjunction with that, the key drivers to the 350 basis point expansion you're talking about in retail margin. Thank you.
Okay. Good, John. Today, I said that our advertising for the quarter, and I used the word traditional advertising, not the advertising now that we are doing through all the digital mediums like Amazon, was 4.1% this quarter versus 4.3 or 4.4 in the previous year. Going forward, John, I think one has to also keep in mind when we talk of advertising, we also have to take a look at the promotional impact. Today we have to, whether we like it or not, there is somewhat more of, you might say, higher discounting going on, even though for us it's relatively small compared to others. We got to also keep that in mind in terms of the special offers that we make and the impact that they have in the business.
Going forward, I would say that our advertising spend in the more of the traditional manner would range for anywhere between 4.5%. Our promotional activity will be similar to what we have today.
How does the margin in retail improve? Is it strictly volume related? Are there cost reductions planned? Is there reduced promotional activity? What will be the keys to making that happen?
Yeah. That's an important question. The top 10%, you might say, of our design centers already have produced over 8% operating profit. The reason is this, when you take a look at our operating profit, even like a negative 2%, a lot of it is due to volume. As our volume decreased in this quarter, it has an impact on the breakeven. Increasing sales is tremendously important. We are already at a level where any incremental sales will have a significant impact on our margins. We see that at a wholesale level, and we see that at our retail level. Increasing profitability is important. The second is that we have gone through the transformation continuously of many of these retail locations that we've taken over from our independent retailers, and then we have relocated them. That process has been a major process in the last five years.
The good news is, I think at this stage, we are slowing that down, and that will give us an opportunity to catch up and not have these losses that we have in what we call the transitional stores.
Okay. Thank you. Are there any raw material issues, I guess foam is a popular topic today. Any pressures there that concern you? I think you did your pricing already for the year, if I'm not mistaken, but any adjustments needed on pricing given raw material inflation?
John, there's always some pressures from some sources, but nothing significant that will not be covered by the price increases that we took.
Great. Thank you. Good luck.
All right, John. Thanks.
Thank you. Our next question comes from the line of Jeremy Hamblin from Dougherty & Company. Your question, please.
Yeah. Hello, Jeremy.
Hi. Thanks for taking the questions, and congrats on the traction you're seeing in some of these programs. I wanted to see if I could clarify some things on your backlog. If you look just at your wholesale backlog, and the color that you provided, that increased by nearly $30 million in the quarter. I think if you add in the 11.6% retail backlog growth, that's probably combined almost a $40 million increase in your backlog over the last three months. Can you give me a sense of when you can deliver on those backlogs? How long is it going to take you to work down those backlogs, given the time of year and holiday production demands and so forth?
Jeremy, I would say that we expect about half of that to be delivered this quarter and about half in the next quarter.
Kind of as a follow-on to that, it sounds like maybe the traction that you got on the State Department contract surprised even your highest expectations. Two questions here. The first is it fair to assume that you guys captured more than 50% of the orders that were posted since it went to an online process in early July? The second one is, I believe you have a 60-day requirement to deliver on that, and it sounds like you're putting that maybe a little bit at the front of the line, and that could be some of the reason why your retail backlog grew as much as it did. Is there any risk to not delivering some of those orders on time and needing to ask to an extension?
I'm sure that you're prioritizing that contract, given the size of it and the newness of it.
Yes, Jeremy. It is fair to say that we did get over 50% from what we understand of the orders. The 60-day requirement was and is somewhat of a challenge because some of the product lines were not our current product line that we were running. In fact, one of the product lines we had to bring in was a product line called Georgian Court that we were selling in the 70s and 80s. We brought that back because it's an 18th century design, and they like it. We did have to get going and producing this product line in a relatively short period of time. At the same time, we were also making floor samples on our new Passport collection. All of those contributed to creating some backlogs for the retail division that they did not receive the sold orders because of the timing of this.
The good news is we are fast catching on, we are also, as I had mentioned previously to John, that we would expect that this backlog half of to be covered in this quarter and about half in the next quarter. As far as the State Department is concerned, I don't think we have any issues. One good thing is this, that after they place all the orders, our team has been in touch with all the embassies, and some of those orders they now want in a little bit extended time period, that also works good for us.
Oh, great to hear. Just one more, I'll hop back in the queue. Your operating expense run rate about $88 million in the quarter, given the adjustment there. I think what you said was your advertising was only down like $300,000. In terms of thinking, I realize there's a variable component related to sales being down $12 million, I think even if that was a more normalized number on sales, does it look like your run rate is closer to $90 million? Which is where you've been the last couple of quarters, rather than up in the $91 million or $92 million range.
Yeah. Just to tell you, our advertising, again, I use the word traditional advertising because we did spend money in other mediums, which affected our cost of goods and margins. I think the advertising was down by about $1 million or so.
Right.
Right. It was 4.1% this year versus 4.4% last year of sales. That says about 1.1%.
Yeah. What was the next question, Corey? Jeremy had.
This on the longer term, the operating expense run rate. It feels like or it looks like it's pulled back a little bit and maybe that's part of getting to a slightly higher margin, that it looks like your run rate, even if you normalized sales to be equivalent to last year, probably would have been about $90 million as opposed to $91 or $92 where the run rate had been tracking previously. Is that fair to assume? Is that something where you've just tightened it a little bit?
Let me give you a little perspective on that, because we have fixed costs and then we have variable costs. Variable costs, especially in the retail end of the business, for instance, payment to all our interior designers, our logistics, is somewhat of a variable cost. As we increase our sales as a percentage, the chances are our operating expenses will be same or lower, but in dollar amounts, they could go higher. I don't mind having them go higher because they will go high because they're increased in sales. On the wholesale side, obviously, there are some variable costs, but less. We do have an operating leverage, as I mentioned, both certainly at the wholesale level and even very much also on the retail level. I would say that the leverage is there, but overall costs could increase based on increase in business.
At this stage, about $90 million is a run rate.
Understood. I guess what you're saying is over the next couple of quarters, as you deliver on these in this massive growth in your wholesale backlog, that won't translate to as much variable cost because it's a wholesale order, correct?
That's right. Yeah.
Okay, great. Thanks, guys. Good luck.
Thanks, Jeremy.
Thank you. Our next question comes from the line of Cristina Fernández from Telsey Advisory Group. Your question, please.
Hello, Cristina.
Hi, good afternoon. I wanted to follow up on your commentary regarding the operating margin opportunity and how you could benefit from the relocated stores being more profitable. If you look back at some of the stores that were relocated a few years ago, how long does it normally take, how many years for those stores to get to that sort of mid-single-digit operating margin?
There is no one simple formula. It also depends upon where the locations are, what kind of volumes we are doing. I would say if you had to generalize something, I would say it takes between two to three years.
Okay, that's helpful. On a different topic with regard to the Amazon interior design website, I guess, can you share what you've learned so far and what has been selling better through that site?
It's a little bit early because this was somewhat of a learning experience for both sides. As you know, what we established on the Amazon was an Ethan Allen design studio, not just selling it as a commodity. We also established with them live chat, which in fact took a fair amount of time to get going, and which is now operating with still some bugs, but it's operating. What we have learned is the fact that it does expose us to more customers. We are doing some business on Amazon, but as I said earlier, we are also seeing that a lot of those folks do come into our design centers and meet our clients. Some of them are starting to do live chat, and if they do any live chat, then obviously we credit Amazon for the sale.
It's a little bit early, but I think we're going in the right direction. In fact, we just launched with them what they have what's called a holiday gift guide. We participated in that with two or three items, they are very heavily marketing that. Those few items from us, as they're doing with many other items too. Most probably you may be seeing those two or three items from Ethan Allen as part of the Amazon gift guide for the holidays.
Okay. Then one last one on the Disney collection. How is that doing as you've expanded to new channels like disneystore.com and some of the international locations? As you look to introduce Passport and Uptown over the next six months, do you expect the square footage of Disney to remain the same in your design centers, or you plan to make changes to that?
Yes. We have seen, as I said in my comments, the rate in the United States is approximately what it was before. Has been somewhat more of an increase in China. They are doing well. As far as the space is concerned, our objective was to give it a reasonable, in fact, a fair amount of space for about a year and a half. Then we'll still give it space, but that space will then be utilized for some other programs that we are intending to introduce in next summer.
Okay. Thank you.
All right, Cristina.
Thank you. Our next question comes from the line of Justin Bergner from Gabelli & Company. Your question, please.
Yeah. Hello, Justin.
Hi, Farooq. Hi, Corey.
Hi.
Just wanted to clarify a couple things. The advertising spend is now going to be on the order of 4%-4.5% versus just over 5% of sales last year. Is that the current thought?
Well, I think that, we have had, perhaps there was only one period that our advertising went to 5%. Most of the time, it has been in the range of between 4%, 4.5%. That's where it really is a question of, if you take a look at it, for our last fiscal year, it went to 5.2%. Before that it was 4.3%, 4.2%. I think it'll range between 4% and 5%, Justin.
Thank you. I think I missed a comment that you made at the beginning of the Q&A regarding the State Department. Was there something that's affected the overall size of the program?
What I said was this, that this is the first time the State Department has put it on this FedBid, which makes it that you got to bid on every one of the contracts. What it has done is, because it has made it more competitive, so I think it has, to some degrees, lowered the overall contract, in our opinion.
Lowered the overall ASP or lowered the actual amount of merchandise?
No, no. Overall, they had expected it to be close to, in $50 million or $60 million. It'd be most probably somewhat less than that, but still pretty significant.
Okay. Got it. Is the margin on the State Department business, are you expecting it to mix up or mix down versus your wholesale margin?
It most probably will be somewhat lower than our regular margin because of this FedBid, but what it does is, having said that, it has a very major positive impact of creating an overall operating margin improvements in our manufacturing because incremental business has an opportunity of creating more incremental margin, even though for the State Department, it may be somewhat lower than the margin we get from selling at retail.
Okay. Just to put words around that, the incrementals might keep pace with the margins in the wholesale business today, even though if you were to look at a standalone basis, it would be lower margin business.
That's right. That's a better way of putting it.
Okay. Got it. Your cash balance is building up. Are there any plans to do anything with that cash balance, resume share repurchases or other activities?
Yes, Justin, we always keep that in mind. As you know, we have been, over the years, always proactive, but I don't mind sometimes having some money in the bank. We decide what to do with it.
Okay. Is there a sort of point at which you do a special dividend if you don't sort of want to ramp up the repurchases? Does the cash balance just get too big?
Yeah. Obviously, we have done that in the past. We have purchased our stock. We have given special dividends. All of those things will be under consideration.
Okay. All right. Thank you for taking my questions.
All right. Thanks, Justin.
Thank you. Our next question comes from the line of Matt Kupersmith from Iron Compass. Your question, please.
Yeah. Hello, Matt.
Hi, guys. Just a few questions focused on the retail business. First up on the dollars per order. Were the dollars per order in the retail business down year-over-year?
No. You're talking of retail tickets?
Retail orders, retail ticket orders, Matt?
I'm talking about however you calculate orders, the amount of dollars per retail order.
Per average order. Yeah, our average order is approximately the same as last year.
Okay. I guess, I'm trying to understand how weather impacted the quarter, again, the retail business a little more specifically. You guys put up a negative 9% comp, it looked like only a pretty small number of your company-operated stores were actually closed for either of the hurricane events. Maybe you could put some more metrics in around it. I know one of your competitors in Havertys has reported some specific metrics in how weather impacted them.
Corey?
Yeah. What I would say is on the delivered sales for retail, which you're referring to, because our written orders were actually up. On the delivered sales, there were two things that had an impact on delivered sales during the quarter, and part of it was the hurricane impact, and then also the new product production, the first-run production of new products in our plants, both for the State Department orders and the new Passport collection. As the wholesale backlog increased, as Farooq mentioned, that also had some impact on shipments being delayed to retail, which has then created the impact of the retail backlog increasing a little bit then as well. Had retail backlog not increased, then those orders would have flowed through the delivered sales and it would have been a much less of an impact.
It was really a combination of both the hurricanes as well as new product production.
Yeah. I think the other difference I would say in our case is that our written sales increased despite the hurricanes and everything else. It was our delivered business that was lower. Please keep that in mind.
Okay. I think last quarter, you guys commented on sort of a real-time look at orders in July. Can you provide that for October?
It's a little bit early. I think the reason it's early is because this one week is going to determine how well we do. We do get 40%-50% of the business, unfortunately, in the last week of the month. This is a very critical month for October. We've got strong programs, strong initiatives, we'll be able to get a better understanding, obviously, after the end of the month.
Got it. Okay. All right. Thanks, guys.
Thanks very much.
Thank you. Our next question comes from the line of Budd Bugatch from Raymond James. Your question, please.
Hello, Bud.
Hey guys. Hey, it's Bobby actually filling in for Bud. Appreciate you taking my questions. Most everything's been answered. I just have two quick follow-up questions. Corey, on the detail about the delivered comp, is there any way to parse or help us understand what was the bigger impact? Was it the hurricane the bigger impact of driving the down 9% delivered comp, or was the Passport collection delaying the delivered orders the bigger impact?
The State Department too, Budd. Yeah. The bigger impact was the combination of State Department, new product production and orders, and the Passport. The secondary impact was the hurricanes.
Okay.
Because new production affected everybody.
Okay. The last one from me. On the first-run production and some of those inefficiencies that impacted gross margins, moving forward, now that you have that, you would expect everything to kind of return back to normal in terms of efficiency, or does it take more than just a quarter or so on a first-run production basis to get back to a level that you're used to for production?
Bobby, in the first-run, about 70% or so will be over, then about 30% will go to the next quarter, but most of it is behind us.
Okay, that's helpful. I guess real quickly, Farooq, the comments about the retail margin, the goal of 5%. How does that play into your thoughts about your store base today, being 150 company-owned stores? Is that a number you're comfortable with, or do you still see room for real estate expansion? How do we think about that in our model on a couple of year basis, long-term basis?
Yes, Bobby, I think that 5% is something we've got to do. What it'll require is really some incremental business because our overheads are covered. That's what's going to do. As I said, 10% of our top design centers average over 8%. Our objective is to do that by the fact that they are in better locations, we have stronger teams, and now we need more volume. That's where our focus is. As we go forward, our rehab, to a great degree, completed the transformation of our design centers. Over 60%, 70% of the stores that we acquired, we have now relocated. Some more will be done, but I believe that the pace of change is going to be much, much less. That will give us an opportunity not to have these startup costs for our retail.
As you know, we don't keep them separate. We keep them as part of our expenses.
Yep. My apologies, this might be something you've touched on in the past, and if so, I apologize for asking again. Out of the 150, do you have any type of statistic of how many of those you've touched in the last couple of years in terms of maybe relocations or redesigns or anything like that to give us a sense of how much is in the new and modern-day style or location?
As I said, I would say that at this stage, this is a process that continues. 10, 12 years back, that's before the Great Recession, things were different. We were opening 18,000 sq ft stores in great locations. Today, we are opening 8-10,000 sq ft locations. I would say that while the process will continue, the majority, I would say 80% plus of our stores are in the location they need to be today.
I appreciate all the additional color. Very helpful. Best of luck, going forward.
Bobby. Thanks.
Thank you. Just as a reminder, if you have a question, please press star then one. Our next question is a follow-up from the line of Jeremy Hamblin from Dougherty & Company. Your question please.
Yeah, Jeremy.
Hi. Thanks for the follow-up opportunity. In terms of those top 10% of your stores that are generating 8% margins or better, what are their average unit volumes?
Average is a tough thing, but, and maybe Corey can look at it, but Jeremy, I would say that it's interesting they can range from $3 million-$15 million. It all depends upon where they are, what their occupancy cost is, what their other costs are, how much of sales they are doing relative to their total expenses. It's right across the board. Yeah. Right, Corey? Right.
Okay. Fair enough. Then just one other follow-up here. Your gross margins, it sounds like that was impacted by a couple of things. First, around productions, clearly, some logistics issues related to the storms. You still generated a pretty solid gross margin given those headwinds and having sales down over 6%. Do you still feel comfortable kind of 56% as a target for your gross margins, even though your business is likely to skew a little bit towards your wholesale division over the next couple of quarters?
Yeah, that's a good question. If you take a look at our gross margins, fiscal 2015, we had 54.5%, fiscal 2017, 55.7%, fiscal 2016, 55.8%. We did, and of course, one quarter we went over 56%, that is the first quarter of last year. I would say that, having 55%-56% is a very healthy gross margin. The more important issue is having higher top line. That really then drives it down to the bottom.
Right. No, understood. I guess, the point that I'm driving at is, even though you do have much better operating margins with your wholesale business, I'm assuming that you're not gonna have the hurricane impact, this current quarter or the next one likely, unless we have more. I'm assuming that just because you're gonna have a higher skew of wholesale business, typically that does relate to a little bit lower gross margin.
It does
overall.
I think that you're absolutely right. You see, what I think we need to keep really in mind is the operating margins.
Right.
The gross margins are fine, but it's operating margins that really matter. That's where we have the opportunity. Gross margins are also impacted by even some of our special offers of discounts. We just can't assume that today we have to stay relevant. Every month, we've got to figure out what should we do that will maintain our credibility with our clients, with our designers, and also create something special for our clients. Not easy, because everybody else is there giving 60%-70% off every day. That's what we have to deal with. How do we convince new people to come in when we give 20% discount for us, it's a major thing. For new customers, they're used to something different.
We have to contend with that, I think what I'm really looking at is maintaining a healthy gross margin, really more importantly, maintaining a healthy operating margin.
Agreed. All right, guys. Good luck. Thanks.
All right, Jeremy. Take care.
Thank you.
All right, Jonathan, I think that should do it, right?
Yes, sir.
All right. Any questions, any comments, please call Corey. Thanks very much, and good to talk to everybody.
Thank you. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect.