Good afternoon, and welcome to the Ethan Allen Fiscal 2022 first quarter analyst conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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, Vice President of Finance. Thank you. You may begin.
Thank you, Alex. Good afternoon, and welcome to Ethan Allen's analyst conference call for our Fiscal 2022 first quarter ended September 30, 2021. Joining me today is Farooq Kathwari, our Chairman and CEO, and Corey Whitely, our Chief Financial Officer. Mr. Kathwari will open and close the call, while Corey will speak to the financials 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 on ethanallen.com, where you'll find a copy of our press release, which contains reconciliations of non-GAAP financial measures referred to in this release and on this call. A replay of today's call will also be made available via phone and on our website.
As a reminder, our comments today will include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a complete review of those risks. The company assumes no obligation to update or revise any forward-looking matters discussed during this call. With that, I'm pleased to now turn the call over to Farooq Kathwari.
Thank you, Matt, and thank you all for participating in our earnings call today. We are pleased with the continued strengthening of many aspects of our enterprise, including our financial results, our talent, our manufacturing, our service, marketing, technology, and social responsibility. We have continued to strengthen our talent in our vertically integrated enterprise by adding to our workforce in manufacturing, logistics, and retail. Our headcount of 4,212 has increased 18.5% from the previous year first quarter. Continuing personal service of our interior design teams with technology has been a game changer and will continue to provide a major competitive opportunity to grow. Servicing our large backlog of orders is of critical importance. As of September 30, 2021, our retail backlog was up 73% from a year ago, which provides us the continued opportunity to increase delivered sales.
75% of our products are made, and most of them custom, in our North American manufacturing workshops, providing us a good opportunity to service our clients. We have taken steps to strengthen the business, including additional work shifts within our North American workshops, building a new addition to our Maiden, North Carolina plant, continuing our investments in Vermont plants, in Honduras, Mexico, and also in our various logistics centers, and also growing our manufacturing headcount by double digits over the last several months. Through these actions, we have increased capacity and are focused on servicing our large backlog of written orders. We continue to strengthen our product offerings, the projection of our design centers, and the various elements of marketing. For quarter ended September 30, 2021, we substantially increased our digital marketing, reaching over 15 million households with our 36-page digital magazine.
We reduced our advertising in other traditional mediums, thereby reducing our overall advertising spend to 2% of sales compared to 4.1% in the previous year quarter. Going forward, we expect to increase our advertising to about 3%-4% of sales. We had strong financial results during the first quarter of fiscal 2022, which Corey Whitely will now briefly walk you through. Corey.
Thank you, Farooq. We had a strong performance for our fiscal 2022 first quarter ended September 30. Retail segment written order demand continued to accelerate during the quarter, achieving 6.1% growth compared to the strong prior year period and 17.6% growth compared to the first quarter ending September 2019. Wholesale segment written orders increased 8.1%. Strong retail demand and contract sales growth, which increased 51.1% due to a rebound in government orders, helped drive the strong wholesale performance. Consolidated net sales for the first quarter were $182.3 million, a 20.7% increase over the prior year quarter. Our retail sales increased 31.3%, and wholesale sales increased 12.4%.
At the end of the quarter, both our retail and wholesale segments had record high order backlogs that we expect to get caught up on during this fiscal year. We were able to achieve a strong gross margin of 59.9% despite ongoing supply chain challenges. This growth was due to a shift in the ratio of retail sales to wholesale sales, improved operating leverage within our manufacturing from higher production levels, and benefits from our optimization of manufacturing and logistics initiatives. The retail sales mix grew to 85% of consolidated sales compared with 78.2% a year ago, which positively impacted our consolidated gross margin. We expect this higher percentage of retail sales to consolidated sales to moderate towards normalized levels as we ramp up delivery of the high wholesale order backlogs.
Our merchandising and supply chain teams continue to work through the current environment of rapidly escalating commodity and freight costs, product shortages, price increases, and shipping delays. While we were pleased with the strong gross margin of 59.9%, we expect our gross margin to return to a more normal range of approximately 58%-58.5% in the near term as the sales mix returns to more historical norms. Our operating margin was 15% for the quarter. Adjusted operating margin increased to 15.2%, primarily due to net sales growth, the improvement in gross margin, and controlling costs. Adjusted operating expenses of 44.7% of sales for the quarter reflected operational leverage under our vertical structure, along with reductions in certain selling expenses, including advertising costs.
Our GAAP earnings per share for the quarter increased to $0.79 compared with $0.37 per share in the prior year quarter. First quarter adjusted diluted EPS increased to $0.80 compared with $0.36 in the prior year. As of September 30, our balance sheet remained strong with cash on hand of $93.7 million and no outstanding borrowings. During the first quarter, we generated $17 million of cash from operating activities and paid a total of $25.4 million in regular and special dividends. With that, I'll turn the call back over to Farooq.
Yes, Corey, thanks. Just to again focus on some of these important financial metrics. We had strong sales and profitability in this quarter. Sales of $82.3 million increased 20.7%. Gross margin increased to 59.9%. Operating income increased 134.2%, and an operating margin was 15%, and the diluted EPS was 113.5%. Also showing the impact of our vertical business and the leverage that we have on both our margins, gross margins, and profitability. Our retail segment operating margin increased to 9.3% from 2.3% last year. Again, a very important element.
Just shows the impact of sales and its impact on our margins because we are able to then have, you know, some a lot of our costs are fixed. On the balance sheet, we ended with cash of $93.7 million and no debt. We distributed $25.4 million of regular and special dividends. Our inventory grew to $158.7 million, due mostly to sold orders that have to be delivered and improving our manufacturing position to better service our backlog. We remain committed to our sustainability practices, including both corporate social responsibility and ESG practices, as they are fundamental part of our operations for the last 90 years. We understand that our approach to managing the business must be aligned with a commitment to sustainability.
Many of our decisions are based upon factors such as energy consumption, reduction of waste and emissions, effects of our operations on climate change, equality, equity, and inclusion in the workforce, employee safety and security in the workplace, all the more important in this last one year. Compliance with national and international legal standards for the contract business, and enforcing the most rigorous social standards in every jurisdiction in which we conduct business. We are pleased with what we have accomplished in the first 10 years of the major sustainability initiatives that we undertook and are setting our new 10-year goals through 2030. As part of those goals, we have established a commitment to achieving net zero emissions by 2050 and are developing methods, plans, and resources to meet this commitment.
Now, as we look ahead, our focus remains on long-term growth, and we acknowledge the support of our shareholder base with focus on longer-term returns, especially cash dividends. As I previously mentioned, we paid $25.4 million in regular special dividends, and our objective is to continue strong shareholder returns. Now I'm pleased to open for any questions or comments. Alex?
Thank you. At this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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 keys. Our first question comes from the line of Bradley Thomas with KeyBanc Capital Markets. Please proceed with your question.
Yeah, hello, is that Brad?
This is Andrew. Good afternoon, Farooq and Corey. Yeah, this is Andrew on for Brad. Thanks for taking our questions here.
Hi, Andrew.
Hi, Farooq. I wanted to start out by talking about capacity and delivered revenue. We know that in this quarter you saw about a $4 million increase in delivered revenue sequentially versus fiscal 4Q. As your capacity continues to ramp, how should we think about the improvements in delivered revenue over the next few quarters? Do you expect to continue to grow delivered revenue by a similar amount of $4 million sequentially in the quarters ahead, or do you expect to achieve a different pace?
Andrew, I would think that it would be somewhat higher than what we have done because we, as I mentioned, we have continued to invest in our North American manufacturing. Some issues that we have had in some raw material supplies have improved. I would say that it'll be somewhat of an increase from what you have seen.
Understood. Speaking of raw materials, I know in the past few quarters, foam the foam supply was, you know, a significant bottleneck for you all. What are you seeing on the foam supply and are you know, seeing continued improvement in that area of your supply chain?
Yes, we are almost back to normal.
Okay, great.
We—
And so—
Yeah. I'm sorry, go ahead.
As foam, you know, as it looks like foam has recovered, you know, back to normal, what are some of the remaining bottlenecks you have to work through on the supply chain to achieve to meet this higher level of demand that you're seeing?
Well, you know, as we have mentioned, that about 75% of our products are made in our North American facilities. You might have read about, you know, a couple of months back, I was in Vermont. I was hiking on the Green Mountains, and I said, "I better visit our plants." They were having a tough time in terms of getting labor. We have tremendous amount of capacities, investments, and so we discussed with our team, and then we increased the base rate from, I think, $13 to $16, and then, of course, increased other wages. All that, getting labor was a big factor.
Good news is, since we did that, we are starting to get good, strong labor, not only North Carolina, but we, of course, implemented it throughout North America, these new wages, especially in the United States. Labor was a big factor that is much better positioned. We are better positioned. The 25% or so of the products that are coming from offshore have been a challenge. We are in a better position than most, but still, challenge in terms of getting containers. The cost of the containers has gone from, you know, let us say it's about $2,000-$2,500 to $20,000-$25,000. It's not only the question of cost, it's been availability.
However, as I said, 75% coming from North America has given us an opportunity to increase our production and our deliveries.
Understood. That's good to hear. Shifting to written trends, it was good to see continued positive written sales growth through the quarter, despite the long delivery times. However, it's difficult to assess how written trends compare to the strength you saw in recent quarters, given the lumpiness of the pandemic comps. I was wondering if you could share how written trends are faring on a two-year basis, and how that strength compares to what you've seen earlier this year.
On this, Corey, for the quarter just ended, while we're up 6.1% to that really strong prior year when we saw the recovery just start after the lockdowns, you know. If we go back all the way to September 2019, it's 17.6% growth. It's still a good trend, you know, from either direction. That's been good to see. We're also seeing the growth on the contract sales as the GSA business has rebounded as well. We're just at the end of the government fiscal year. That helped on the order growth side, and then that'll turn, of course, into wholesale shipments as we then start delivering that product out.
Yeah, Brad, having said this, you know, where we have had strength has been in the State Department where the weaknesses has we have been in our international business because there's still a lot of issues, whether it's in China or in other Southeast countries or in the Middle East, that has been somewhat slow, but fortunately, most of the business is North America. State Department is a big part of our business, so they're doing well.
Understood. Thanks for the detail there. I'll, you know, pass it on to others and I'll jump back in the queue. Thank you.
All right, Brad. Thanks.
Thank you. Our next question comes from the line of Cristina Fernandez with Telsey Advisory Group. Please proceed with your question.
Yeah. Hello, Cristina.
Hi, good afternoon, Farooq and Corey, and congratulations on a good quarter. I had a couple of questions. I wanted to follow up on that order question, and maybe if you can talk more broadly about demand trends. How do you feel about continuing to generate positive orders over the next couple of quarters? As you look at the health of the consumer, I guess what gives you confidence that the strong demand we've seen for home furnishings can continue as we go into 2022?
Yeah, Cristina, that's a very important question. When we take a look at it in the last year, we have done extremely well. Corey just mentioned that in September quarter, we were up 6.1% in written against a very strong order that we had in the previous year. I believe that, you know, the consumer interest in the home has been very strong in the last year and a half. I would think that the consumer interest will not be as strong going forward, so we've got to work harder. We've got to be in a much better position. I would say that the easier days for our industry are over.
Now, having said this, we are in a better position because we have strengthened our offerings, we have strengthened our retail teams. We have really a very, very strong interior design network and combined with technology. Because even our retail, our designers are about 75% of the orders that they take is custom designed. If we didn't have the technology and the ability of our interior designers to work from their home or wherever else, or consumers working at home, we would not be doing this business.
I think we have an opportunity to continue our growth, and we have an opportunity to continue to expand our reach to more people as we are doing. In early next year, we are going to be introducing a very strong product offerings, which we held back. We held back because of you know the supply situation. We're gonna get that in the early part of this year, and I think that also is gonna make an impact. We are positive, but I think we are also cautious.
Okay. That makes sense. My second question, I wanted to delve a little more into the gross margin. I know it was very high this quarter, and it seems like, you know, some of it was due to the retail mix. As you look forward, 58%-58.5% is a little bit higher than what you talked before. I wanted to see if you could talk more about, I guess, how are you offsetting some of the supply chain pressures and, you know, where are the drivers of that higher gross margin?
Well, you know, Corey also mentioned this, that our gross margin of 59.9% that we had this quarter is very high. It reflected a number of factors. One was that we had higher total retail sales to total sales. As we increase the more shipments, let's say for the State Department contract, that gross margin may slightly go down, but it has a positive impact on the operating income. Keep that perspective in mind. You have to look at gross margin, and you also got to look at operating margins. I think that the gross margins, if you're able to maintain at the rate more close to the rates we have, that's a very, very strong gross margin.
It also reflects the fact that we have been able to even offer great savings to our clients and also absorb some of these costs that we've talked about, some of the raw material costs. We've had to absorb on 25% or 30% of our products coming from offshore, very high freight factors. Now we have passed on some increases, but we have not been able to pass all because I would hope that those crazy increases in container costs are temporary. We have taken some price increases, but we don't want to overdo it. I think this gross margin of you know close to 58% or so is a very, very good gross margin for us.
Okay. Another question I had was on marketing. You mentioned today that the goal is to get to 3%-4%, up from 2% this quarter. You know, back at the pre-pandemic, you know, it was more like 4.5, 4 or 5% if I recall correctly. Has anything changed in how you're thinking about marketing and how much you wanna spend and in what ways you wanna spend it?
Yeah. Cristina, that's a very good question. Our marketing people, I say we're going to control our destiny rather than leave it to all these characters out there. I don't want to give you all the names of these companies that are utilizing, you know, they're taking a lot of our money online, you know, on the digital medium. We said we're gonna control it ourselves. We went and decided that we have the ability to reach consumers, clients ourselves or prospective clients through digital medium that we didn't have before. That's why I said we are now mailing close to 15 million copies of our digital magazine every month. We're buying the prospects. They are much less expensive than the traditional media. We're gonna continue with that. That was one very important factor.
The other one was we felt that with this high demand for consumers' interest in the home, there was no need for us to spend a lot more money. As we go forward, we'll spend some more, but the medium that we will spend on will continue to be different than what we did in the past.
Okay. Very helpful. One last one, which is just more of a modeling question. The increases that you've made on wages, particularly in the manufacturing, I guess, how material are those to SG&A or I'm not sure if those are on cost of goods sold going forward over the next couple of quarters?
Yeah, that's a good question. I think that, you know, both I think Corey and Matt are trying to figure that out. You know, it has two elements because on one hand, it does increase your cost of goods, but on the other hand, it reduces because we can produce more. So if you're not able to produce more, you may have lower labor costs, but you don't have the profits, you don't have the products. So overall, I think the benefit is going to be better to be more beneficial for us because we increase our production. If we don't increase our production, then of course, it goes the other way.
Okay, got it. Yeah. Higher labor costs, but you're gonna manufacture more, so you get more leverage on those costs. Okay, that makes sense.
Exactly. Yeah, that's the main thing. Yeah. If on the other hand, we increase all of this and don't increase, then that's gonna be an issue, Cristina.
Okay. Thank you. Very helpful. Appreciate it.
All right.
Thank you. Our next question is a follow-up from the line of Bradley Thomas with KeyBanc Capital Markets. Please proceed with your question.
Yeah.
Hi, thanks again for letting me in here. This is Andrew for Brad. Just wanted to follow up on some of the written trend commentary. Was wondering if you could talk about the cadence and what you saw on a monthly basis throughout the quarter, and if those trends have continued thus far into fiscal 2Q.
Are you talking of the first quarter that we just ended?
Yes.
Yeah, I think that what we saw, the trends were as usual, we had strong end of the months. You know, that's what happens every month, and that continued every month. Now in October, we haven't closed the month. It's always in the last week we are able to do 30% of the business. However, we are now comparing to very high numbers last year. We've got to always keep that in perspective. Our comparisons are going to be more tougher, most likely, unless, you know, I'm pleasantly surprised that we have very high numbers. I think we are going to have lower increases or, as we move into the quarter than we had in the last previous year.
That's what we are thinking at this stage because we are comparing to very high numbers.
Yeah, yeah. Understood.
I would just add that the Labor Day was also a strong period for us.
Okay. Got it. Thanks for that. Just wanted to follow up. I know that earlier in the call, Corey, you mentioned that retail segment written order growth was up 17.6% on a two-year basis, if I heard that correctly.
Yeah.
That compared—I mean, that's, you know, that's very strong. That compares to last quarter where you saw around a 42% increase in retail segment written order growth, if my notes are correct. What do you think drove the deceleration there? Do you think it has anything to do with these extended lead times?
Corey, you look at the numbers, but, you know, Andrew, we are comparing with numbers when we had a lot of our business was closed. You know, you're talking last year, right?
The two-year stack. I think part of it, though, is also just the timing of the quarter, you know, the September quarter versus the June quarter comparison. It's a little hard to compare from period to period, but still, you know, positive growth as we moved along. Also the marketing programs that we had running at the time have an impact in that as well.
Okay. Got it. Appreciate the detail. That's all for me. Thank you.
Thank you.
All right. Alex, any other questions?
No. Ladies and gentlemen, there are no further questions in the queue. I will now turn the call over to Farooq Kathwari for closing remarks.
All right. Thank you, Alex. Thank you all for participating. As usual, if you have any comments, questions, please make sure you let us know. Matt is available, and I'm sure that he'll take your questions. We look forward to continuing this very, the journey. We have lots and lots of opportunities and, of course, challenges too. I think we are well positioned, so we are in a good position to continue the positive growth that we have had. Thanks very much.
Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.