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Q4 2008 Earnings Call Transcript

Published: 4 Aug 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the Ethan Allen Earnings Release Conference Call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Farooq Kathwari. Sir, you may begin.

[Farooq Kathwari:]

Yes. Good morning. I am Farooq Kathwari, Chairman and CEO of Ethan Allen. I'm joined today by David Cullen, our Vice President of Finance and Treasurer, and Peg Lupton, our Director of Investor Relations. Today, we are reporting the results for the 3 and 12 months ended June 30, 2008. I will make a few brief comments and David will provide more details on the financial information, and I will follow with an update on our business initiatives and then open it for questions. We expect to end the call by about 11

[David Cullen:]

Thanks, Farooq. Good morning. Please note that in the earnings release issued this morning and in the course of our prepared remarks, references made to certain non-GAAP information which excludes the effects of restructuring and impairment charges recorded during the quarter and year-to-date ended June 30, 2008, and year-to-date June 30, 2007. A reconciliation of this non-GAAP information to the most directly comparable GAAP measure is available on our website. Net sales in our fourth quarter were $235.9 million compared to $258.5 million in the fourth quarter last year. The company's retail division's net sales were a $176.5 million versus a $187.5 million last year. Comparable design center delivered sales were 11.1% lower than in the prior year period. Written sales in the retail decreased at 4.7%, and comparable written sales decreased 8.9% versus the fourth quarter of the prior year. Wholesale net delivered sales were $147.7 million in the quarter compared to a $162.8 million in last year's fourth quarter. Consolidated gross margin for the quarter was 54.2% as compared to 53.4% in the prior year period, reflecting improved efficiencies in our manufacturing and the increase in the proportion of retail sales to our total net sales. Gross profit for the quarter was a $128 million. Consolidated operating margin was 8.1% for the quarter, or 9.3% excluding the $2.8 million restructuring charges related to the plan announced in January. Wholesale operating margin was 13.9% and retail operating margin was 0.8%, excluding the restructuring charges. Selling expenses decreased $0.8 million on lower volume-related costs. General and administrative costs increased $1 million over the prior year quarter, as a result of our initiative to relocate a number of our design centers to more prominent locations, which generally have higher occupancy costs. Diluted earnings per share for the quarter were $0.39 on net income of $11.1 million. Excluding the restructuring charges, diluted earnings per share were $0.45 on net income of $12.9 million. This compares to diluted EPS of $0.65 per share and net income of $20.5 million in the prior year quarter. For the full year, net delivered sales were $980 million compared to slightly over $1 billion last year. Net delivered sales for the company's retail division increased 3.7% to $724.6 million, while comparable design center delivered sales decreased 3.2%. Written sales in retail increased 0.6% during the year, while comparable written sales decreased 5.6%. Wholesale sales were $616.2 million compared with $656 million in the prior year. The full year consolidated gross margin was 53.7% as compared to 52.4% in the prior year, reflecting the improved efficiencies in our manufacturing operations as well as the proportional increase in retail sales relative to our total net sales for the year. Consolidated operating margin was 9.8% or 10.5%, excluding the restructuring and impairment charges. Wholesale operating margin was 16.3% and the retail division posted a 0.6% operating profit, excluding the restructuring and impairment charges. Diluted EPS for the year were $1.97 on net income of $58.1 million. Excluding the restructuring and impairment charges, earnings per diluted share were $2.12. This compares to diluted EPS of $2.15 on net income of $69.2 million in the prior year, or excluding the restructuring and impairment charges in the prior year, diluted EPS was $2.41. Now for comments on the financial position of the company. During the 12 months ended June 30, 2008, we generated operating cash of $86.1 million. We used $69.7 million of our available cash to repurchase 2.3 million shares of our common stock. Also during the year, we used $60 million to fund capital expenditures, spent $7.8 million to acquire a cut-and-sew upholstery factory in Mexico and several design centers in the U.S., plus returned $25.5 million in cash to our shareholders through quarterly dividends. As Farooq mentioned, inventories were about even with the third quarter and have increased $4.4 million during the year, due mainly to inventory acquired through the design centers and the cut-and-sew operation in Mexico. We remain in a strong service position with respect to incoming orders, with over 90% of our case goods items available for shipment within four weeks. EBITDA for the year, excluding restructuring and impairment charges, totaled a $131.3 million, or 13.4% of sales, as compared to a $150.3 million and 15%, respectively in the prior year, also excluding restructuring and impairment charges. Overall, we are pleased with our operating results and financial standing in this challenging economic environment. Now to Farooq for his comments.

[Farooq Kathwari:]

Thank you, David. Now, during fiscal 2008, our two main objectives were; first, to manage the business in the downturn; and second, to prepare ourselves for the next phase of the economic cycle. I am pleased with the progress we have made on these two objectives. Financially, we have maintained strong performance, and while investing about $63 million in capital expenditures and acquisitions and $69 million in repurchase of our stock, we've ended the year with a strong balance sheet. On the marketing and operational side, the main areas of focus were implementation of the lifestyle branding. Over 87% of the company operated retail and over 60% of the independent retailers have implemented this program, which projects our products in seven lifestyle presentations. These presentations project style, eclectic decorating, and help both clients and our interior designers. We have strengthened the retail division with many initiatives, including rationalization of our structure, with 23 newer locations added during the year including relocations. 8% of the network converted to design studios; 12 locations in underperforming markets closed; consolidation of 16 retail service centers to our larger service centers; and most importantly, implementing the team concept, with the development of over 280 teams of interior design teams. We ended the year with 295 design centers, 136 operated by our independent retailers and 159 operated by the company. During the quarter, we acquired three design centers from a retiring retailer. During the fiscal year ended June 2008, we acquired a total of five design centers from our independent retailers. During the year, 19 new locations, including relocations, were opened in the United States and four internationally. We've ended the year with a much stronger retail network in place. Last month, we also opened our flagship design center at 1010 3rd Avenue at 60th Street in Manhattan, with a very good reception by our clients. We have spent the last two years developing a new website. We expect to launch this in the September, October period. We believe this new website will enable us to add the newest technology of the web to the personal service of our interior designers, giving us a unique competitive advantage. The website will also enable our clients to place orders on the new website, and orders will be serviced through our retail network. We have strengthened our vertically integrated structure with many initiatives, including fine tuning our logistics operations, which enabled us to absolve most of the cost resulting from about 9% increase in energy costs during the year. As you know, we deliver our products at one cost nationally. We acquired a cut-and-sew plant for our upholstery division and is being absolved efficiently into our structure. We initiated a major information technology projects both for our manufacturing and retail network during the year, which should help us further improve efficiencies. By making important structural changes, we were also able to reduce our headcount in the United States operations, both retail and wholesale, by over 500 persons. During the past year, we increased our advertising spending additionally by about 11% compared to the previous year, with two objectives, to get across our message about our interior design services, the tag line "We will help you with as little or as much" and the need to make an appointment. In addition, our increase was to help our independent retail network spend less on advertising during this slower economic period. In June 2008, we initiated a 6% price increase, which will help offset costs both at wholesale and retail. As we indicated in the press release, it is not prudent to make forecasts on the economy. In these challenging times, it makes sense to be prepared for softening of the economy and also be ready for the next upturn. The initiatives we have taken, position us well. And our objective also remains to continue to perform well financially. And with this, I would like to open up for any questions or comments.

[Operator:]

Thank you. (Operator Instructions) Our first question is from Laura Champine with Morgan Keegan. Go ahead, please.

[Farooq Kathwari:]

Yeah. Good morning, Laura.

[Laura Champine:]

Good morning, Farooq. My question is on your inventory levels. They were up 2% on a sales decline down 9. How much of that increase is just attributable to increasing input costs? And how much is attributable to the potentially slower than expected sales levels that you saw during the quarter?

[Farooq Kathwari:]

Most, practically all, of the increase is due to number one, the purchase by us of this facility in Mexico in which we also acquired a leather inventory. And secondly, it also was due to the fact that we relocated 18 design centers from approximately 12,000 to 13,000 square foot of display to anywhere from 17,000 to 18,000 square foot of display. So, we increased our display inventory in our retail divisions. Those are the two main areas.

[Laura Champine:]

Got it. And then once again just to try to parse out the sales decline. Although you have raised prices over the past year, what type of price mix change are you seeing? Are you seeing a mix shift down that offsets the price increase or the price increase is actually flowing through to the topline?

[Farooq Kathwari:]

The price increase is mostly flowing through the topline. Last year, Laura, we also had almost all the company retail divisions implement this lifestyle projection, which resulted in over a 150 design centers having to sell off their floor inventories, at least 30% off of it, to replace it with new. So we had, a little bit, some of an impact on margin because of the changeover of the floor samples. But other than that, it did flow through into our sales.

[Laura Champine:]

Got it. So that would mean the units are down more than... on a comparable basis, more than the 11% same-store sales number?

[Farooq Kathwari:]

The units are somewhat down, yes.

[Laura Champine:]

Thank you.

[Operator:]

Thank you, our next question is from Anthony Chukumba from FTN Midwest. Go ahead, please.

[Farooq Kathwari:]

Good morning. Anthony, are you there?

[Operator:]

Please check the mute on your line, sir. I'm still getting no response. Our next question is from Barry Vogel from Barry Vogel & Associates. Go ahead, please.

[Farooq Kathwari:]

Hi, Barry

[Barry Vogel:]

Good morning, ladies and gentlemen.

[Farooq Kathwari:]

Good morning, Barry.

[Barry Vogel:]

I have a couple of easy questions for you. Could you give us the D&A for fiscal '08 and what your expectations are for fiscal '09? And also your capital expenditure estimate for fiscal '09 and what it was exactly in fiscal '08? That's my first question.

[Farooq Kathwari:]

Alright. Now, your first question is on your D&A, and all right, David, it is approximately $25 million. Why don't you give him the exact number? While David it's…

[David Callen:]

$24.7 million.

[Farooq Kathwari:]

$24.7 million there on the D&A. And it will be approximately slightly higher, a little bit higher than $25 million with all the investments we made in 2008, Barry. And as far as capital expenditures are concerned, we spent close to $70 million on capital expenditures, and acquisitions, we would spend anywhere between $40 million and $50 million. So we will reduce it substantially.

[Barry Vogel:]

Okay. As far as efficiencies, I just want to get this right. You talked about 500 people leaving the company in the fourth quarter. And I believe you had talked about savings on that. What would you say would be the minimum savings for fiscal '09 on those 500 people? That's the second question.

[Farooq Kathwari:]

Barry, the 500 was not all in the fourth quarter. It was during the year. So although there was a larger number in the fourth quarter, assuming everything else stays the same, the net impact of that approximately is going to be anywhere between... we have to add some other costs in some other areas but at least $12 million to $14 million.

[Barry Vogel:]

Okay. And as far as additional efficiencies and savings going forward, I'm sure you're not going to stop doing what you are doing because you have been very aggressive. Could you give us some idea if there are going to be additional moves in fiscal '09 to get more efficiencies?

[Farooq Kathwari:]

Yeah, Barry, I always believed that efficiencies come by making sensible structural changes. We don't just cut down just for the sake of cutting, I've never done it. Every changes we make to save also helps us become stronger. Like for instance, the retail teams did have ended up with having less people but it was came from the ground up. They wanted to have teams that made sense and some people were not able to fit into the teams, and it was our design centers from the ground up that made thing possible. Our changes are going to continue. In the last few years, as you know, we've consolidated our manufacturing from 21 plants to 9, and today we want to maintain those because having manufacturing in the United States as much as we have I believe is a competitive advantage today going forward. We are adding a lot of technology both in our plants. We have just installed and upgraded technology for our manufacturing plants, which will help us become more efficient, and we are in the process of launching in the next couple of months a new retail information system, which will also help us become more efficient and reduce costs and also help us not get costs. So we are continuously looking at how to make it better. We have made our advertising dollars, as you know, I said we increased it. But we're becoming more efficient. Now with the retail network that we have that we operate ourselves, we are able to take that money and have strong national programs, which helps our retailers also in this tough time. So we did spend more money on the wholesale side, but we did use that money from our own retail network, and it helped our independents, too. So we have ongoing programs across the board. Yet the bottomline, Barry, is that we want to increase the topline. Then we can see the leverage in our earnings.

[Barry Vogel:]

As far as Mexico, when will that be completed?

[Farooq Kathwari:]

It is completed.

[Barry Vogel:]

It is completed? So it started up already?

[Farooq Kathwari:]

Actually, we acquired an existing plant.

[Barry Vogel:]

Okay.

[Farooq Kathwari:]

And they used to do 80% of their business with us anyway. So it came into our operation and fitted right away.

[Barry Vogel:]

Okay. And as far as your operating rates domestically on your manufacturing, can you give us some idea of your average operating rate in the fourth quarter?

[Farooq Kathwari:]

Barry, I don't know about that. All those numbers as you know are all relative. But our case goods is operating, I'm just giving you some estimate, that's anywhere from 65% to 70%. Our upholstery is most probably closer to 85% or so. So we've a lot of opportunity to increase our efficiencies through more volume. That is the biggest opportunity we have.

[Barry Vogel:]

One last question on your stock buyback. I have to commend you on your consistency over the years, and I understand with economic conditions deteriorating, you are a little more cautious in the fourth quarter. But do you expect the buyback program, which continued last year very significantly, to continue?

[Farooq Kathwari:]

You are talking of the share repurchase?

[Barry Vogel:]

Yes.

[Farooq Kathwari:]

Barry, you know, last year we spent a fair amount of money, and as you rightly said this quarter I said let's wait and see and strengthen our balance sheet, so we are also ready to buy more if we need to as things as... it becomes a little bit clearer where we are headed. So we have a 1.6 million authorization right now and we will watch, and as we see somewhat more confidence in the economy, our objective would be to start our repurchase program.

[Barry Vogel:]

Thank you very much. Keep up the terrific work.

[Farooq Kathwari:]

Thanks, Barry.

[Operator:]

Thank you. Our next question is from Budd Bugatch with Raymond James. Go ahead, please.

[Farooq Kathwari:]

Good morning, Budd.

[Budd Bugatch:]

Good morning, Farooq, good morning, David, good morning, Peg. I really want to just focus for a second on the independent network and its strength. You made a qualitative comment in your remarks that you have strengthened the independent network. Talk a little bit about that. It looks like the cash conversion cycle has kind of expanded a little bit, and if I do my numbers right on the days outstanding of receivables, even though it is not material, they have gone up a little bit. And I am concerned about the independent dealer network even for a system as strong as Ethan Allen. Can you talk a little bit about that?

[Farooq Kathwari:]

Budd, you know, these are tough, tough times, and its tougher time if you are an independent retailer with only having one or two or three locations, and that area gets affected. Today to be in Arizona as an independent retailer, or Las Vegas, is pretty tough. Now, it just so happens that we operate those design centers there, so we can absolve some of the additional costs and losses in those areas due to the economic environment. So our retail network has been impacted. That's why our objective has been to see how do we help them through this difficult period. Now, one good news is that the ones that we have left for the most part are our stronger retailers, and even today 95% plus pay within our term of 15 days. So fortunately, our retail network is stronger, yet they are also under pressure. That's why we also decided last year that one way to help ease their pressure is to... for us to take on more of the advertising responsibility, which we did. It helps both ways. Of course it helps our build our brand, it helps the whole network, and it helps our dealers. And we had a dealer meeting, I guess, about three weeks back in Danbury, and we had a good meeting and they are very enthusiastic with all the changes we are making. Yet, on the other hand, the fact is that the situation on the ground is pretty tough. So we are also concerned and we are watching it carefully, and we are doing everything we can do to help our independent retailers remain strong and to grow with us.

[Budd Bugatch:]

Do you foresee the company taking many more retirements this year? Not many more. Do you foresee some additional retirements this year or potentially acquiring some of the independent network additionally this year?

[Farooq Kathwari:]

Budd, as you know, last year in a very tough, tough environment, we only took over five. But we also let a few... we didn't acquire a few that retired, because we also were selective. We said in some markets, it is better for us to wait, because locations are not in the right places for us to take those over, a few markets. So I think the same things are going to happen this year. A few will retire. A few markets where we may decide that instead of taking it over, we may wait, because then we will go back and we will go into the right markets and into the right trading areas. So we're being somewhat more selective ourselves, Budd.

[Budd Bugatch:]

Okay. I was also interested in part of what David said about some of the gross margin improvement in terms of the percentage being driven in the quarter by increased wholesale efficiencies. And I actually get about 20 basis points of wholesale gross margin improvement. Tell me how you did that with the volume degradation that you unfortunately had to experience? Did you have much downtime in this quarter versus last year? Refresh me about last year.

[Farooq Kathwari:]

In our case goods, we did have downtime. We closed our plants for about two weeks this last quarter to keep our inventories down, more it's approximately the same as the previous year, too. Our efficiencies continue to come from the benefits. I mean our efficiencies that we have seen in the past year were also a result of the steps we took in the year two or three before that, because as you know, we just don't get it in the year one. So we continued with the benefits of the initiatives we had taken in the previous years. And our efficiencies, for instance, in our logistics side, despite almost a doubling of the diesel fuel cost and we bear all their costs, we were able to benefit because two years before that we had closed two of our major distribution centers, opened two new distribution centers, and that gave us a benefit of efficiencies. The two new distribution centers in Dublin, Virginia and Atoka, Oklahoma, replaced two we had, one in Vermont and another one in North Carolina. All of those efficiencies have helped us. And I am also very pleased to say that at the end of the day, it is due to the fact of a lot, a lot of good people that we have. The average association of the management at Ethan Allen in our manufacturing, in our distribution, in our logistics, has an average association of over 20 years, so they are pros. And that experience counts a lot in a downturn.

[Budd Bugatch:]

But structurally now you think you are okay for a while? I know that you're not operating at the kind of operating capacity rates you would like to operate, but do you see any unfortunate manufacturing changes necessary to come?

[Farooq Kathwari:]

No, not really. In fact, we have absorbed the costs of operating in the United States, and it's harder to operate in the United States. But now we are starting to see the benefits of having a balanced manufacturing base. In fact, most of the new products that we are going to be introducing later this year, which we've already developed, is going to be made out of solid American woods. We operate two saw mills also. So our objective is to balance our manufacturing and sourcing with some key people that we have overseas and we have got very, very good partners. We have narrowed it down obviously in the last few years, and our manufacturing in the United States, I'm talking about good manufacturing. And I think the combination of the two has the opportunity of helping us increase our margins. But Budd, we also do need a better economic environment so we can have higher volumes.

[Budd Bugatch:]

And my last question just goes to Laura's question on inventories. I know you took over the Mexican operation and that leather inventory. I wonder do you have fewer retailer stores but probably more square footage this year? Is the retail inventory up year-over-year as well, or is that flat? Or can you give us a characterization of that?

[Farooq Kathwari:]

It is flat. It is even with increased... and we increased some finished goods. Keep in mind it's, what, 2.5%? 2.5%, yes. Most of that is, Budd, our finished goods inventory in leather and fabrics.

[Budd Bugatch:]

I'm sorry, what's 2.5%, Farooq?

[Farooq Kathwari:]

The increase on inventory...

[Budd Bugatch:]

The change year-over-year?

[Farooq Kathwari:]

Yes.

[Budd Bugatch:]

Alright. Thank you very much. Congratulations and keep up the good work.

[Farooq Kathwari:]

Thanks, Budd.

[Operator:]

Thank you. Our next question is from John Baugh with Stifel Nicolaus. Go ahead, please.

[Farooq Kathwari:]

Good morning, John.

[John Baugh:]

Good morning, Farooq, and Peg and everybody. Has there been any change on your third-party credit? Have they tightened? And have you seen a pattern of usage change? And if you could refresh us again what percentage are you using credit?

[Farooq Kathwari:]

John, we are watching that very carefully. While we have not seen any change, but I would think there, most probably, is some change. Even though my folks tell me there is no change. I would think that there is some change, yes. Our customer base and the demographics we are dealing with is always less impacted by the issues of credit that we see at more of the mass level. So I have not been told, and I follow it very closely with our third-party financial. They have not come back to us. They seem to be happy. They are approving credit for our customers and approximately...

[John Baugh:]

If they had tightened the credit score, they would be required under your agreement to notify you of that?

[Farooq Kathwari:]

No, they don't.

[John Baugh:]

They don't have to.

[Farooq Kathwari:]

What we do is, the information we see is what we get from our own retail network, to see whether people are complaining. But as I said, the chances are they have tightened it. And I think most consumers also themselves know, that they can't complain too much. But we have not heard it. Our credit seems to be okay but I would think that they have tightened it, while I do not know that, because we don't get that information.

[John Baugh:]

Thank you. And my second question is we seem to be at an inflection point on imports. I'm curious as to what cost changes you see? And obviously, we have got the currency exchange and we have got inflation over there and it seems like its more expensive to bring product over on the boat every time we turn around. How has that affected your thinking going forward? I assume we still have tremendous gaps of pricing or cost on certain products out of Asia. So we're not going to see a dramatic swing back. But just curious of any color of what you are seeing on costs trends, import versus here, and how that changes your thinking? Thank you.

[Farooq Kathwari:]

Yes, John, we have maintained approximately 60% domestic and 40% imports, of which 35% of that is from Southeast Asia are approximately... and 5% to 7% is from the US and other countries. We made a strategic decision a few years back that we are going to maintain that balance even if it costs us more. And now, the gap is narrowing. The gap is still there, and as you rightly said it is reasonably significant gap, but it is narrowing, and we believe that it does make sense for many, many reasons for us to have this balanced approach to sourcing. It also gives us an opportunity to develop products which are much more distinctive than you can even get from overseas because of the resource of lumber we have in the Appalachian Mountain range. This is one of the best and the largest managed forests in the world. And we are taking advantage of that. We also believe that going forward that will give us a much greater opportunity of differentiating ourselves in many ways, in products, in quality, in style, and also the efficiencies of time and lesser inventories in terms of managing it. Yet having said this, we have very, very strong partners overseas and we want to grow the business with them. But I don't think that it will grow like... we went 40% pretty fast overseas. I think now we will grow both.

[John Baugh:]

Thank you.

[Operator:]

Thank you. Our next question is from Matthew Fassler with Goldman Sachs. Go ahead, please.

[Farooq Kathwari:]

Yeah. Hi, there. Good morning, Matt.

[Robert Higginbotham:]

Thanks. It's actually Robert Higginbotham. I am in for Matt, good morning. My first question is I'm trying to reconcile the change in total sales growth relative to the change in the reported retail levels, same-store sales growth. And what I mean is that total sales growth deep into a negative 9% decline, deeper than the negative 4% in the prior quarter. So a deepening of roughly 5 percentage points and your comp actually steepened to a negative 11% decline, down from a negative 1% decline previously, a 10 percentage point deceleration. Could you help me understand what the difference? What's driving the difference there?

[Farooq Kathwari:]

Good question. The difference between the comp and the delivery can also be explained... the number as well as of course the business is down. The other important factor is that we have had a record number of relocations this past year, 18 in our retail division. So 18 design centers were taken out and put into as we would consider them to taken from the same store to be considered new. And that had an impact in having this difference between the actual delivery and the comp delivery and the total delivery. And that was the major one and I would ask Dave, we'll see whether we can provide this information publicly or not, but I'll ask him to do a little bit of an evaluation of that. But that was the major, major reason.

[Robert Higginbotham:]

Okay. That's helpful. Could you also give us some color in terms of how sales tracked through the quarter? I believe you began the quarter roughly kind of down in a 2% kind of territory, I think that was listed some by the Easter shift. Could you tell us if trends deteriorated through the quarter? And if so, well, apparently that is so, but was it linear and to what extent has that weakness continued into July?

[Farooq Kathwari:]

July is a little bit too early because of the fact that until our periods of a month is over; it's hard to give any real information. So we just have to wait for that. But during the last quarter, we did see a continued decline. We also had a price increase in June and which resulted in some more business coming before that price increase and after the price increase, the business did considerably slow down. The other reason our business slowed down but in the middle of June and onwards was the fact that we implemented during that period our team concept. And then, we made the kind of changes we have made in June, and even in the first two weeks of July. These are major, major changes taking all of our design consultants and putting them into teams, changing their compensation, a lot of discussion. We brought 1,000 of them over here to our headquarters to discuss it with them. So that also was somewhat… it did create some disruptions during the later part of June and even in the first couple weeks of July, because we implemented the team concept on July 1. So overall, obviously the business still remains soft because of the economic conditions.

[Robert Higginbotham:]

Okay. And one last question on expenses.

[Farooq Kathwari:]

Yes.

[Robert Higginbotham:]

In terms of your service level and how you might have adjusted that throughout the quarter? As things softened through the quarter, how did you make, if any, adjustments in your level of store... labor in the stores? How much further could you go or how far down can you go and maintain what you feel is the minimum service levels?

[Farooq Kathwari:]

Well, in fact, our objective is to increase the level of service because the issue really is; our business is based on the fact of converting the people who come. We take the customer and turn them into a client. We really want to give them more service. Where we have been able to reduce costs is by creating these teams, and these teams also have resulted in less people, and very importantly and the major benefit is going to be substantially less turnover. We have already seen an 80% decline in turnover in one month. A major, major change as we go forward. That is one of the biggest benefits to us, less turnover, more stability.

[Robert Higginbotham:]

Got you. Great. Thank you.

[Farooq Kathwari:]

Okay.

[Operator:]

Our next question is from Todd Schwartzman with Sidoti & Company. Go ahead, please.

[Farooq Kathwari:]

Hi, Todd, good morning.

[Todd Schwartzman:]

Good morning, folks. First of all, on the gross margin, based on today's demand and cost environment, how should we think about the gross margin for full year '09?

[Farooq Kathwari:]

Well, Todd, as you know, we are not giving projections but we also don't… our objective is to maintain a steady business. Our whole structure is based on an everyday best value, no sale events. Always there are some external factors. Our gross margin should be fairly steady, but keep in mind the gross margin also is impacted by volume. So volume has an impact also on our gross margin dollars, even obviously percentage in terms of how much we are able to absorb. But overall, I would say that it should remain pretty constant.

[Todd Schwartzman:]

Got it. Is it too soon to evaluate the productivity of the smaller design studios? And also, how many of those are actually open now?

[Farooq Kathwari:]

The studio concept right now, as you know, it is a concept. It basically is that if you are a smaller market and two designers can do the job, why put six or eight people? It is obvious, but sometimes the obvious is not obvious until you do it. So we have some of those we converted, but some of them are from the old larger spaces with less people. We have it coupled with smaller spaces, but it is more a concept of the way we operate rather than size, even though we are going to get a few with smaller sizes also. So far, the experience is good. But you are right, it is still early. In the next year, we will know more but I must tell you this. It's so simple and so common sense that it is working. And places like Davenport, Iowa and Altoona, Pennsylvania, they are doing almost about the same business they did last year with at least 60% less people.

[Todd Schwartzman:]

Okay. And the design consultants that have left the company, could you speak to what extent those were largely underperforming individuals or just maybe fallout of underperforming stores that perhaps were closed?

[Farooq Kathwari:]

Well, we had, just over 500 people I mentioned were across the board. These people were in our service centers, which we consolidated. Some also, in our other wholesale operations. They were at retail. And in the retail end that you are referring to, with effect to many factors. Some of them were due to this consolidation from a design center to design studio. And also we closed 12 design centers completely. So everybody there had to go. And then on top of it, when we are creating the teams, some of the people were not able to fit into the teams for lots of reasons. So those are the reasons why we had to make the changes of having less people.

[Todd Schwartzman:]

Farooq, would you say that roughly half maybe were victims of closures or consolidations? Is that a fair assessment?

[Farooq Kathwari:]

Well, if you say consolidation, meaning even creating a team, you are excluding the team structure?

[Todd Schwartzman:]

Yes.

[Farooq Kathwari:]

You see you got to remember, the team structure affected everything. It affected our design studios. It affected existing, and then there were others who were impacted due to the service side. So, those are all the reasons how these people were affected, Todd.

[Todd Schwartzman:]

I want to talk about sourcing for a moment. Have you seen any change within case goods, within case goods manufacturing, the mix within Asia away from China? Do you foresee that happening over the next several years?

[Farooq Kathwari:]

I am not completely familiar with what is taking place in our general furniture industry at the mass levels. We have maintained a very steady business between three countries that we deal with, that's Indonesia, Philippines and China, and that balance has been maintained for us. But overall for the rest, it really is hard to say for me.

[Todd Schwartzman:]

And for Ethan Allen specifically in terms of the mix of case goods produced overseas, how high can that go over time?

[Farooq Kathwari:]

Overseas?

[Todd Schwartzman:]

Yeah.

[Farooq Kathwari:]

Right now it is approximately 50/50. Our total becomes 60 because almost out of our upholstery is made in the U.S., so that's why the total becomes over 60%. I would say that for the foreseeable future, I would like to see that 50/50. And then we will see what areas make sense for us to invest in for further sourcing.

[Todd Schwartzman:]

Okay. So no plans to expand beyond Indonesia, Philippines and China for the time being?

[Farooq Kathwari:]

That's right

[Todd Schwartzman:]

Okay. Thank you, Farooq.

[Farooq Kathwari:]

Thanks, Todd.

[Operator:]

Thank you. Our next question is from Anthony Chukumba with FTN Midwest Securities. Go ahead, please.

[Farooq Kathwari:]

Good morning, Anthony. Your telephone works? You know it its alright here.

[Operator:]

I'm sorry, sir. I'm getting no response. Our next question is from Joe Feldman with TAG. Go ahead, please.

[Joe Feldman:]

Hi. How are you Farooq?

[Farooq Kathwari:]

Good morning.

[Joe Feldman:]

So quick question for you, a couple quick questions for you. We were pretty impressed with your ability to maintain the logistics costs despite the higher increases in gas prices and other energy costs. We are just kind of wondering what you found out there? Was it better just leverage of distribution, better shipments? If you can just delve into that a little bit?

[Farooq Kathwari:]

It is a combination of a lot of factors. One was this consolidation I talked about of 18 service centers is a continuing process whereby we are becoming more efficient in delivery of our products to the final consumer. Now, as you know, we deliver our products to a consumer's home at one price anywhere in the United States. So we have been affected by all these costs. On the other hand, efficiencies are taking, for instance, 18 service centers it meant all the costs associated, occupancy costs, personnel costs, logistics costs were taken out. And secondly, our wholesale division... we have a trucking fleet which delivers to the service centers, retail service centers, which then deliver to the customer. We had to go to 18 less service centers. So our wholesale had to deliver to 18 less, which of course as you can see has implications of mileage, gas and everything else. Secondly, our everyday best price has enabled us to be more in stock, which has given us an ability now to have less warehouse space with our retail operations. That's why we consolidated 18. When we had six or eight sales, we had ups and downs, and we needed more space in our retail service centers to take care of these high sale periods, and then low sale periods that were empty. Because of that, this efficiency both at wholesale, we have less space. We are using it more efficiently. At retail, we have less space and are using it more efficiently. And then a lot of it is also good common sense by good people, lots of hard work there. So a combination, that is also a very important factor in this.

[Joe Feldman:]

Got it. And then just to follow-up on that topic, it would also imply that you are probably seeing less damages and less returns, just given the better efficiencies. Is that a fair assessment?

[Farooq Kathwari:]

Absolutely. Our returns, I'm never happy with returns but they are lower than whatever we had before, and always they are the lowest most probably in our industry.

[Joe Feldman:]

Great. Got it. And then another sort of topic, I think when we saw you at your new flagship store presentation the other day, it definitely seemed... we seemed to pick up a little more willingness on your part to expand internationally, that that could become more of a growth vehicle going forward. I was just wondering if you can discuss that at all in any kind of a timeline, and when you might become a little more aggressive with international expansion.

[Farooq Kathwari:]

Yeah. That is right. We have so far, other than China, where we had operating 26, and now 27 I think, and they are doing well. They are growing at a good rate and we have great partners over there. We have now also just established an operation in Central Europe, and we are looking to see the opportunities over there. And I think that in the next year we would start doing some business there. We are also becoming somewhat more aggressive in the Middle East, for instance, in Dubai and other places, we are right now in the process of doing some negotiations. And the reason is just that unless you give it a lot of effort, it really does not work. And so far we have been so busy domestically, we had more opportunity and still do in Chicago and Denver and Minneapolis than we do in, say, Belgium or France. However, having said this, our objective is to leverage the Ethan Allen program, because we have the program, 90% of our products are in stock, and we can help develop the retail business. So you will see more retail business in the next year. International business, I'm sorry.

[Joe Feldman:]

Right I Understood. And then just one final one before and then I'll move onto other people. When we were talking before about the relocated stores and we understand the strength of those stores, I guess the question we had was sort of the timing of... when do we start to see a good chunk of them start to come into the comp base, where they will have an impact? Will it be as early as this first quarter or is later in the year?

[Farooq Kathwari:]

I would say you would see it more in the second half, because most of these that we opened were opened in the second half of the fiscal year.

[Joe Feldman:]

Okay. Great. Thank you.

[Farooq Kathwari:]

Thanks very much. Alright, we will take one more question.

[Operator:]

Thank you, sir. Our final question is from Joel Havard with Hilliard Lyons. Go ahead, please.

[Farooq Kathwari:]

Yes. Hi. Good morning.

[Joel Havard:]

Thank you. Good morning, Farooq, and everybody. The dealer store count, Farooq, that wasn't in the press release. I didn't catch it in your opening remarks. Is that an intentional exclusion?

[Farooq Kathwari:]

No, I did mention it. I will say it again. It is 136.

[Joel Havard:]

I thought that would help.

[Farooq Kathwari:]

And 156 is the company operated.

[Joel Havard:]

Yes, sir. Sort of a philosophical front here, do you believe the current marketing message/campaign is pertinent in, let's call them uncertain economic times, and that's kind of a yes or no. Obviously I'm hoping you'll elaborate on a little bit and tell me where you think it could go, should go, etcetera.

[Farooq Kathwari:]

That is there. You are right. It is a philosophical and a strategic question. It is how we position ourselves. I believe that anybody who is caught in the middle, and I have said this for a long time, is going to have a tough time. We have been running a furniture store with decorating advice and that is being in the middle today. Today a lot of other folks are offering furniture store with decorating services. Our opportunity is to really focus on providing interior design services but to a large base of people, and not just what traditionally interior designers did. Now that also has impacted all the steps we have taken in the last few years. For instance, in the last about three years back we promoted 300 of our... just in the company retail division, our independents did also, the total was 500, of our interior designers were promoted to project managers. So we could really start training them to really start managing teams, and when we felt comfortable... and at the same time, we also went on an aggressive plan of hiring new interior designers. I myself approved over 1,500 because I wanted to see the caliber of people coming in. So we had new designers, all with interior design backgrounds not furniture sales people with a little decorating help. That was the nature of our industry. It still is. And you've been there a long time. So we then ended up, by having interior designers, by having project managers, and we felt we were now ready last year to really more focus on the interior design services, to create teams, to get the message across, because this is not just an advertising campaign. It is not going to work unless you back it up with an infrastructure and a philosophy and a commitment throughout the organization. This is one of the toughest but in my view one of the most important changes we have made to take our business to the next level.

[Joel Havard:]

Farooq, I actually very much agree with the fact that I think you guys have built the back end support or the customer interface support, but now let's go back to the advertising part. Do you believe that in this kind of environment, it really doesn't behoove the company to maybe turn up the advertising effort? And you just think the customer isn't going to really get there in the volume you need to make those ad dollars worthwhile at this point? And you are just going to kind of wait for a recovery to begin to materialize hopefully in the next year or so. Or do you think there is an opportunity for the company to maybe tweak the message or just increase the volume on the message?

[Farooq Kathwari:]

Well, we have increased the volume in terms of, if you are saying should we let them know we have got some kind of great values and sales, that's the other side.

[Joel Havard:]

Exactly.

[Farooq Kathwari:]

No, I don't think so. For us to do that is going to be caught in the middle. There is a sea of sameness out there; they are all saying the same stuff. That is, come and get us… come and get it because...

[Joel Havard:]

I don't just mean to be more promotional or go back to some sort of sale, but to expand the number of placements you are making, maybe reach into some new media.

[Farooq Kathwari:]

I'm sorry. Yes, absolutely. In fact, let's face it. We have increased our national advertising messages through prime time, through television, through cable. We have also...

[Joel Havard:]

Going up.

[Farooq Kathwari:]

We are also getting a very strong message through our direct mail. We are also getting more into shelter magazines, which we did not do before. Yes, so we are using more mediums and most importantly, in September/October we will introduce our new website and we will also advertise for the website.

[Joel Havard:]

Okay. Now just having made the point that I will hope you'll spend money in order to make money, what could you tell us about your philosophy on G&A control. Even in this tougher environment, that expense has been going up. Obviously, some things going on internally that may have caused that. Can that number start to come down or at least hold flat?

[Farooq Kathwari:]

You know, when you talk about spending money, last fiscal year we spent 11% more in advertising dollars at the corporate level, Its National advertising. So we increased our messages last year.

[Joel Havard:]

Good, good.

[Farooq Kathwari:]

And now as far as the G&A is concerned, we are looking at every possible way to improve the structure of our business. I also mentioned because of our increased improvement in our structure, we were able to reduce about almost 10% that's over 500 persons this last year in the company. And that is a major change. We didn't it, we didn't do this because of the fact that we wanted to let people go. We did it because they made some important structural changes

[Joel Havard:]

Alright.

[Farooq Kathwari:]

And that's a major, major impact on G&A.

[Joel Havard:]

Does that then suggest that we… obviously a little pull back in Q4, is that where we are starting to see the benefit or is there really room from here?

[Farooq Kathwari:]

The benefit is next fiscal year. But again deep in mind, we have extremely a fine-tuned machine here. We need more volume. We have a lot of things in place. We've got great design centers, great people. Now you folks have got to help us to move this economy a little bit.

[Joel Havard:]

I fear my wife and two preschoolers are doing their part already, Farooq. Guys…

[Farooq Kathwari:]

That's what we need. We need better consumer confidence. But as I said, we are prepared for both. We are prepared for a slowdown, but we are also prepared and ready for the next phase of the economic cycle.

[Joel Havard:]

Thanks for your time, guys, good luck.

[Farooq Kathwari:]

Alright. Thanks very much. Alright. Well, thank you very much. If you have any further questions, please let us know. If not, good to talk to you.

[Operator:]

Ladies and gentlemen, that concludes the conference. Thank you for your participation. You may hang up at this time, and have a wonderful day.