Ethan Allen Interiors Inc (ETD) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ethan Allen December 31st earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. (Operator Instructions).

I would now like to turn the call over to your host, David Callen.

Thank you, Marina. Good morning and welcome to the call. My name is David Callen, I'm the Vice President of Finance and Treasurer. With me today is Mr. Farooq Kathwari, our Chairman and CEO, who will provide some opening comments which I will follow up with a review of the financial results for the quarter and year to date ended December 31, 2009. Farooq will then conclude with a detailed review of the business initiatives of the Company and open up the call for questions.

Please note that in the earnings release and in the course of our prepared remarks, reference has been made to certain non-GAAP information which excludes the effects of restructuring impairment and related transition costs in the reporting periods. A reconciliation of this non-GAAP information to the most directly comparable GAAP measure was provided with the tables attached to the press release. As an added reminder, comments from this call should be considered in conjunction with the Company's reports filed with the SEC. Any forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking comments reflect management's current best judgment and are subject to various assumptions, risks, and uncertainties. Actual future events or results could differ materially from those contemplated in the forward-looking statements. The Company assumes no obligation to update or provide revision to any forward-looking statement at any time for any reason.

Net sales for the quarter were $143.3 million, compared to $189.6 million in the second quarter last year, and $136.2 million in the first quarter of this fiscal year. Retail posted net sales of $107.1 million, versus $147.2 million last year, with comparable design center delivered sales 25.3% lower than in the prior year quarter. Written sales in retail decreased 9%, and comparable written sales decreased 6.1% versus the prior year quarter, showing an improvement from the first quarter this fiscal year. Wholesale net delivered sales were $84.5 million in the quarter, compared to $108.8 million last year. The improvement in written orders resulted in an increase in our retail backlog of 34% compared to the prior year second quarter and an increase in our wholesale backlog of 54%.

Consolidated gross margin for the quarter was 48.2%, compared to 53.7% in the prior year quarter. The consolidation of four plants and the ramp up of our upholstery plants and transition to custom case goods impacted our gross margins with $3.4 million of transition costs or $0.07 per diluted share. Excluding these costs, our gross margin would have been 50.5% in the quarter. As noted in the press release, we expect to significantly reduce these transition costs the remainder of this fiscal year.

Operating expenses totaled $74.3 million, excluding $0.8 million of restructuring charges on previously announced actions, and another $0.5 million of related transition costs which in total equate to $0.03 per diluted share. Excluding these charges, our operating expenses were $73 million, or an annualized $292 million, demonstrating again the cost discipline in place during this transition of the business. Consolidated operating loss was $5.3 million, versus an operating profit of $10.1 million in the second quarter last year. Excluding the $4.7 million of restructuring and transition costs noted above, the net operating loss was $0.6 million. Net interest and other expense decreased $0.1 million from the prior year due to lower interest rate yields. The effective tax rate in the quarter was 53.9% compared to 33.6% in the prior year quarter. The mix of earnings between our legal entities resulted in a greater ability to benefit losses during the quarter. Relative to our normalized tax rate of about 36.5%, the rate in the quarter reduced our diluted loss per share. The diluted loss per share for the quarter was $0.12 compared to diluted earnings per share of $0.19 cents in the prior year. Excluding the transition restructuring and impairment costs and applying our normalized tax rate, the net loss per diluted share was $0.06 compared to earnings per diluted share of $0.19 cents in the prior year quarter.

Net sales for the first half were $279.5 million, compared to $395.4 million in the first half last year. The retail division's net sales year-to-date were $210.3 million compared to $303.1 million last year. Wholesale net sales were $165.8 million, versus $230.1 million last year-to-date. Consolidated gross margin for the first half was 45.6%, versus 54.1% in the prior year first half. As previously discussed, transition efforts affected our cost of sales this fiscal year with $8.5 million in the first quarter, in addition to the $3.4 million in the second quarter. Excluding these charges, consolidated gross margin for the first half of the fiscal year was 49.8%. Operating expenses year-to-date were $146.6 million, excluding restructuring and transition charges, 24% lower than the $193 million last year-to-date. Excluding restructuring and transition charges in both years, and our normalized tax rate the year, diluted loss per share year-to-date was $0.25 cents versus diluted earnings per share of $0.41 last year-to-date.

Our liquidity has continued to improve as we ended the quarter with $76.1 million in cash and equivalents, up $23.2 million or 44% since June 30. As a result of our working capital management actions, we have generated $20.8 million in cash from operations in six months, compared to $15.7 million generated the first six months of last fiscal year. This year-to-date, we have realized $10.1 million from the sale of properties and reinvested $5.3 million in capital expansions. We have also paid $2.9 million in dividends to our shareholders the first half of this fiscal year. We are pleased with the liquidity of the Company, and continue to make good progress in this transition toward a leaner profitable Ethan Allen.

Now to Farooq for his comments on our business initiatives.

Thanks, Dave, and good morning, and good to have you on the call. Dave has given the detailed financial information, but let me just focus on some important highlights. Our focus during the quarter ended December 31, 2009 was to maintain and improve our liquidity. That has been the focus throughout this last year, and as Dave said, our cash at 12-31-09 of $76 million was higher by 44% from June 30, 2009. We continue to maintain strong marketing initiatives to create urgency and to build traffic. We have continued our aggressive efforts to strengthen our operations, while, at the same time, reducing costs, at all levels of our vertically integrated structure. From December 31, '08, our headcount is down by 25%, our operating expenses on an annual basis are now below $300 million, as compared to $420 million that was for fiscal year ended June 30, '08.

Dave also mentioned our focus on inventories. They're now at $142 million, down $45.8 million, or 24.4% from 12-31-08, and $14.5 million 0.9% from June 30, 2009. Most of the decline was in finished goods inventories, both at our retail and at the wholesale levels. We also have been able to cut back on our capital expenditures. Fortunately in the previous years, we did spend a great deal on improving our technology, and also adding and owning a fair amount of properties. Our capital expenditures are down for the six months ended 12-31-09 to $5.3 million, from $22.5 million in fiscal '09, and $63 million in fiscal '08.

The other good news is that we have substantially completed the major consolidation and restructuring of our manufacturing, retail, and our logistics operations. We have also recovered from the major declines in sales in January-June period of 2009. Traffic has shown improvements, and we are slowly recovering from the impact of this severe recession. While still guarded, we are taking steps to be prepared for increase in business.

For the whole year, as I have mentioned previously, we did take a base zero approach in many parts of our enterprise. We have progressively offered excellent values, created urgency, and also made Ethan Allen more attainable and affordable to more people. We have invested in technology in all aspects of our enterprise, including the development of our state of the art website, the migration to the recent JD Edwards module for manufacturing, order entry and inventory availability, the investment in the new retail system that has been fully implemented in the retail division, the introduction of EATV as a training tool and incorporation of touch-screen technology that we are just in the final stages of testing for our design centers.

Despite challenges, we have maintained a strong national television presence. We are maintaining, and I'll briefly talk about, increasing our direct mail program. We also introduced this year electronic magazines and a stronger e-mail campaign. And very importantly we have maintained a strong communications and enhanced our training programs.

Upholstery manufacturing has taken a great deal of our time, as so has (inaudible) manufacturing, too. We are making a lot of progress in the consolidation of upholstery manufacturing to our Maiden, North Carolina facility, supported by our expanded Mexico operations. Our objective has been to create state of the art manufacturing operations that allow us to offer better quality, provide competitive values, and gives us the ability to increase our capacity. This past year we consolidated two major manufacturing facilities in California and Pennsylvania to our Maiden operations. We currently have 837 associates at Maiden as compared to 535 a year back. We have also increased our associates in our Mexico operation from 183 to 305. Despite all of these increases, and I'll also mention about our production, our overall net decrease in manufacturing, upholstery manufacturing is 166 from a year ago.

The Maiden facility has been working six days a week. In fiscal 2008, this facility produced at retail about $220 million of product, and this month is now producing in excess of $350 million with more increases planned as we move forward. Our objective was to minimize disruptions caused by this major transformation, and the transition did have an impact, as we mentioned in our press release, on production, on our costs, and on shipments in the second quarter. As we move forward, these transition costs are going to be reduced.

In our case goods manufacturing, we believed that to remain a manufacturer of case goods in the United States we had to take many changes. We have completed the consolidation of our main saw mill to our Beecher Falls, Vermont saw mill. And the products that were assembled at our Beecher Falls, Vermont have been transferred to Orleans, Vermont and Pine Valley, North Carolina, and the engineering has been completed on these transferred items. This was a great period of change in all our manufacturing.

The other major undertaking we took was to start converting our case goods facilities to product custom products. This has changed and will continue to change the way we do business in this category, similar to the success of our custom upholstery program. We continue to refine our information systems to reflect the case goods change to custom. By December 2009, about 50% of all products produced in our domestic wood plants were made to order. Keep in mind a year back, it was zero. And we expect that by May of this year 100% of US production of wood products will be produced, and like our upholstery programs they'll be made to order after receiving a custom order. This major undertaking provides us with more options for consumers, reducing SKUs, better quality and major improvements in our overall logistics network.

In our marketing, we have continue to maintain a strong marketing program which includes offering, as I said, special savings from our everyday best prices, which, as you know, was not easy for us to do, because we already were operating at everyday best prices. However, we have been able to use many, many techniques, including, of course, operating at somewhat of a lower margin during this period. But we are, today, able to get Ethan Allen to more customers, and we believe that this transition to custom as we move forward will give us an opportunity of also improving our margins.

Now, this quarter, that is from January to March, we have a very strong marketing program, which includes three weeks of national television. We have gone back to distribution of a strong direct mail, reaching both clients and prospects. Last year, we had drastically reduced the distribution of direct mail. E-mail is becoming a strong marketing tool, and this quarter we plan to have several blasts, including sending out three electronic magazines to our clients and prospects. Our website continues to be an important marketing tool for information, getting traffic, and now, as importantly, as an interactive tool between our design consultants and our clients.

We have maintained a strong retail base despite the issues of the recession. At 12-31-09, we had 284 design centers, 150 operated by the Company, and 134 by our independent retailers. We had 293 design centers. That is a reduction of seven, and most of the reduction was a result of consolidation of several company operated design centers.

Now, with that, I would like to open it up for any questions and comments that you might have.

(Operator Instructions) Our first question comes from Anthony Chukumba from FTN Equity Capital.

Good morning, thanks for taking my questions. I just had a quick question. In the press release, you talk about the fact that your retail backlog has increased 34%, and the wholesale backlog was up 54% from the prior year second quarter. I'm just wondering how do those numbers compare sequentially? In other words, what were those comparable figures, say, at the end of the first quarter of this year, or at the end of the fourth quarter of last year?

Dave, actually because of the storm here, I got stuck somewhere on the way, so I'm not in the office, but, Dave, do we give that information out, and, if not, we'll have to think about how much of that information we want to provide on that?

Right, Farooq, normally we don't disclose, but as we noted in the last quarter, we also saw a percentage increase in both backlogs going into the first quarter.

But to give you a little bit of a color, because I know you need that, I think that our backlogs, of course, are substantially higher than what they were December 31 of '08, compared to '09. Your question is on the last quarter. I think from 9-30-09 to 12-31-09, there was not much of a change. We more or less had increased our backlog by that time, and they more or less are about the same.

Okay, that's helpful, thank you.

All right. Thanks very much.

(Operator Instructions) Our next question comes from Maggie Gilliam from Gilliam, Inc.

Good morning. On the same subject, Farooq, could you talk a little bit about how far you're running behind on filling these custom orders? I assume a major chunk of the backlog is due to the fact it's hard to keep up with the change in the production.

Maggie, that's right, but most of it is really upholstery, and upholstery, as you know, we've always been in custom. In upholster, the reason is for two reasons why our backlogs increase. They're also increasing in case goods, also, and there is, of course, a longer time of delivery, and I will talk about that. But in upholstery, our backlogs have increased due to several factors. One is that in the last six months, we have used upholstery as a major way to get our message across for value. And as we know, in recessions, upholstery does hold up better. Upholstery also gave us an opportunity of focusing on categories without creating an issue of inventory development, which if we had done it on case goods, as you know, our model was we had to produce it, and if we didn't sell it, then we sell it, then we had an issue of liquidity. So in upholstery, every order was custom, and that is where, as we focused on it, our backlogs increased. And of course, at the same time, we were consolidating two manufacturing facilities into North Carolina, gearing up Mexico. And about a year and a half back, we had gone to shipping upholstery, 70% of it, within 30 days, and now it has gone about 70% we are now shipping, I think, closer to seven weeks or even sometimes eight. And our objective is to bring it down at least 50% to 60% back to 30 days in the next couple of months, or three months, as we are continuing to get up Maiden and Mexico.

That increase which resulted from running behind, is that a major portion of the increase in backlog?

There are two factors of the backlog. One the fact that our retail business has now declined 7% compared to what we were running major declines the first six months. So our business at retail has improved, obviously that has created a backlog. And, secondly, the backlog is also the fact that if we had delivered our normal production run and didn't have all of these transitions, we certainly would have delivered more in this last quarter.

Thank you.

Our next question comes from Budd Bugatch from Raymond James.

Good morning, Farooq. On the backlogs, I know you didn't want to give much of that data, but any way to quantify the dollar amount of the backlogs at this point in time?

Bud, as you know that our backlogs generally, at the levels of backlogs that we have, they basically do represent anywhere from 30 to 40 days, 45 days maximum of business. So we're not talking of backlogs going into quarters. So it is good that we have that backlog, and now, of course, which is I'm sure leading into your question, is the impact of it on this quarter. On this quarter, of course, the backlog is going to help, but also we have to see what business we do in January and February, which, at least in January and half of February, we should be able to deliver this quarter, and that will depend upon our business this quarter.

Maybe I missed this, but how can you give us some good feel or some color on the efficiencies and how they may have improved as the second quarter unfolded, and how are they running now? Have you overcome some of the cost inefficiencies, and operations inefficiencies of staffing up and changing the method of operation?

Yes, absolutely. As I mentioned that in our upholstery, I mentioned we are now running at an annual retail value of $350 million in our upholstery operations. Which is substantially higher than what it was just three months back. In case goods, there we are going through this whole transformation into custom. 50% of our products, as I said, are now made to order in case goods, also, but 50% is still being run on the production run because all of our product lines have not been converted. This January and February we are now converting our living room products, and in March or April, we will be converting our bedrooms, and then we will have converted all our products. Our efficiency will greatly increase as we continue to operate with one way. 50% making production on inventory, and 50% on custom does create inefficiencies but by April/May all of that will be reduced. And we are progressively reducing it, Budd.

Okay. So as we look at your next quarter and the quarter thereafter's sales, you talked about reduced restructuring. Can you give us a feeling, David, of what the reduced structuring or how do we look at margins going forward.

Margins will be hard, but David how about, we discussed some numbers that it would be less than 50% of what we incurred in the second quarter going into third quarter, and then fourth quarter it would be even less.

And the IDA program, Farooq, how is that progressing, and what kind of success have you had?

IDA program is progressing well. We have now over IDA 600 members that have joined. They have also started to write business. We are developing a marketing program for them. So it is on track, and as I said that our objective would be to get 2,000 IDAs initially. We are actually ahead of our schedule.

Okay. And for Dan's program of developing design studio opportunities, what's happening there?

We are opening -- of course this is a very, very rough period, but we have a number of initiatives going on. In fact, one of them is just opening, I think, in April, in Kansas. It's an independent retailer. Dan is also working overseas, and as you know, we have opened a few and more. We're looking at more opportunities. Of course Dan and some of our people are going to Las Vegas end of this week. They have appointments with many many people. We have lots of interest, but this last year it was hard for people to make commitments. I hope that as we move forward we'll have more interest by new people. The good news is that we're very gratified that our own independent retailer base, despite one of the worst possible times one can think of, have been able to withstand this. And I believe that as they are able to get back on their feet, they will also be looking at some new opportunity, and we will be discussing with them new opportunities.

The last area of questioning is the credit world changes dramatically in February. Do you have your Simple Finance Plan Credit, and I think another program with General Electric, if I remember right. What's the likely outcome, and what's going on with credit penetration today?

We have just, actually, only last week we were able to offer, through, of course, working with our third-party financing company, a strong financing option. For instance, we've just started offering for clients a six month no interest with a small monthly payment, because, as you know, the law requires that there has to be some payment. It's basically 3% of the principal. But that's a very well accepted plan for our clients because this will give them breathing room. And we had to negotiate hard in these conditions, but we did, and it's a good financing on on every day basis. In addition to that, we have also been able to work with GE, a financing options for our clients, some of it we have just introduced and others, we will introduce in the next few weeks which will then make it possible for us to continue offering financing.

Now, your second questions is the impact on financing being offered. We have not seen much of a decline to our customer base. I think the interesting thing is that, yes, there have been some, there are toucher guidelines. They are looking at things very carefully, which is good, but I've not heard any, across the country, any major concerns of declines of credit to our clients.

Okay. Good luck on the quarter coming up and on the longer term, as well.

Thanks, Bud.

(Operator Instructions). Our next question comes from Barry Vogel from Barry Vogel & Associates.

Good morning to you. Farooq, I know you've had these special events, as you call them, over the last, say, 12 months. Can you have give us some color in terms of discounting in the industry, as we speak, and how many promotional or special events in number of events did you have in the first quarter, and how many did you have in the second quarter?

Barry, what's happening in the industry has been, of course, a very, very difficult situation to compete with, because people have been liquidating, going out of business, getting all kinds of special products, selling them off as is. We, of course, could not do that. And for the first six months of last year, we said when people were liquidating, giving 40%, 50%, 60% off, we said for the first few months it would be very hard for us to go and convince new people to come in, so we focused on our existing client base. So again, for instance, February of last year, we introduced what we called the rewards program. It gave 6% rewards to all folks buying new products. It was basically meant for our own clients, and it worked because our concern was that by offering maybe 10%, 15%, 20% that we would just end up giving up all margin and not get incremental business. But then as we went forward, by June we were able to develop programs in which we could offer value. Of course it did affect our margins, but we were also able to negotiate some special savings on fabrics. And we offered, from June onwards, June and July was the first time we offered a strong program of offering anywhere from 20%-plus savings on our upholstery programs, and that was well-received, obviously. It got the message across that Ethan Allen's quality was now really being offered at great value. So we continued every two months in offering special values in upholstery, and, at the same time, we added the products in case goods that we were converting to custom. So we used this opportunity also to use it to get our strategic message internally and externally out about conversion to custom. And, of course, it did cost us margin last year but we were converting to custom which by itself was costing us. On top of it we were giving savings.

So every two months we have been doing it, in terms of focusing on upholstery and focusing on certain elements of our other products, especially case goods, which we are converting to custom. Right now it's living room products, and in March and April we'll have bedroom. So every two months we are offering products and approximately 75%, 80% of the sales we are having, Barry, is products that are being offered at these special values. Last year the world did change, and we were somewhat caught in a difficult position because we were already offering everyday best prices, and we did not feel that had to raise our prices so we can give discounts. And we did give better values on already better prices, and that message we had to get across to our consumers. For instance, last month I talked to all our 2000 associates and told them, look, these values we're giving, and for the first time in 30 years we lost money. Tell your clients that we are able to do it not because of gimmicks, but because it's a real savings. And that message is getting across, and Barry, in the next few months, we'll continue with that plan of offering values, although, as we are going, we are moderating it now. So it will have less of an impact on our margins as we go forward.

So in the current quarter, it will have less of an impact on your margins than the prior two quarters?

Yes, that's our objective, and as we go forward, we will do that, too.

Going back to, was it Maiden, North Carolina? You said you have 837 associates now. Can you tell us roughly what the maximum could be at that facility, based on your belief in terms of how much upholstery sales you can do?

Barry, I'll tell you about 25 years back when I became President, I was involved in building a plant, one of the plants over there, and we said at that time that if that plant produced at retail about $15 million annually we would be happy. Now including the other plan, the combined plants, are producing at $350 million a year. We could not even think of it. And our objective is, through continued production -- and of course Mexico plays a very important role in it, without our Mexico operations, we would not be able to do this -- our objective is to take it up to potentially we can take it up to $450 million or more.

Was that on a retail basis or wholesale?

Retail basis.

So as far as the number of associates, obviously there's room for more associates in Maiden, North Carolina.

Absolutely, and the good thing is there are good people. As you know, we have right now 270 or so people going through our training program. That has also been a cost but this is something we've got to absorb. But we are already starting to see increase in production and there's more opportunities because today we just can't afford not to have the state of the art manufacturing. We had seven manufacturing plants a number of years back, upholstery plants, producing about half of what we can do today.

Now, as far as Mexico, in terms of number of associates, how many more associates do you think you would add there?

In Mexico, we have just in the last year, doubled the size, and we are right now in the process of doubling the size again. And the good thing about where we are in Mexico, there's a lot of good labor supply, good in sewing, because it's basically a cut and sew operation. I'm telling you, a lot of stuff, and all of our friends in our industry are listening to this, Barry. So we have a lot of potential there.

Dave, I have a question on these transition costs. When you transition to custom in case goods, do you consider that a transition cost?

Right. Barry, the dollars that I've highlighted for the quarter include the inefficiencies of the cost of that transition, as well as the incremental costs incurred for training and so forth that we've talked about on the upholstery side.

Okay. Thank you very much. You did a great job, and I'm looking forward to significant earnings gains.

All right, Barry, we're at base camp and now we have to go up from this base camp.

Our next question comes from Joe Feldman from Kelsey Advisory Group.

Hi, good morning, how are you, Farooq. One question we was can you parse out how much of the backlog, that increased backlog that you had, do you think is related to the increased demand versus some of the transition issues to the custom production?

I would say, again, we may have to do a lot of financial analysis, but I would say in my judgment about half and half.

Okay, that's helpful, thank you. And then on the expense side, it's good to see you're going to step it up a little with some of the marketing. Is that going to be incremental, or are you expecting that to be pro rata with sales growth, or how should we think of that?

I think it will be related very much with our sales growth.

Okay. Got it. And then the last thing we wanted to know was just, as you think about the coming quarters, when do you think we should expect to see you you tip into the positive side on the earnings again? We're assuming it will be sometime this year. I would expect you guys were thinking the same?

We are. I think we just have to be cautious. Even though our business is improving, we still are going through this transition, we still are gearing up. Because with the amount of declines we took last year, we have to get back to the base. And I would say that in the next quarter or so, we are going to maintain progress, and hopefully in the quarter after that, which that's my objective, we have the opportunity of being in the black.

That's great. Thanks very much, and good luck with the next couple of quarters.

All right. Thanks.

Our next question comes from Brad Thomas from KeyBanc Capital.

Good morning. Farooq, you mentioned that the traffic is improving. When we look at the written comp, down 6.1%, can you give us a little color on how the ticket versus the transactions played out?

Transactions are down by anywhere from 12% to 15% in terms of the amounts. People are buying less, obviously, and I'm talking the last quarter. Right Dave -- compared to a year before?

That's right, Farooq.

The transactions 12%. And that's for the written comps, so the ticket would be up?

No, I'm just saying, is no, the ticket is down compared anywhere between 12% and 15% compared to a year back.

Okay. So the transaction or the traffic would be up?

Traffic is up.

And then in terms of the pace of sales in the quarter and how things are trending thus far in January, could could you give us a little sense of what you've seen?

Brad, I'll be happy to do it but the last time I did it, and the next month was different and all of a sudden everybody focused on it. This is the time last year when we started seeing the impact of the recession on our business. So our comparables are going to become easier even though that is not a consolation because at the end of the day we have to do enough to be profitable. So I think we are seeing steady progress. It is not something that is a rush of business coming in, but it is a steady progress that we are seeing since June. As we have noted, that our declines went down to 6%, 7% compared to 20% and even 40%, which is mind boggling. So going forward, I think we have the opportunities of continuing to improve, going from a decline and hopefully going into positive numbers.

And factoring in those easier comparisons, do you believe we could see total sales growth move into positive territory before the year is over?

That's our objective.

Okay, thanks again, and best of luck.

Thank you. Our next question comes from Justin Moore from Lord Abbott

Good morning, Farooq, how are you? Just to follow up on that last question, I want to make sure I was clear, when you're talking about the ticket being down 12% to 15%, that's on the written business, right?

That's right, yes.

Thank you. And just to that end, you mentioned in response to Barry's question that 75% to 80% of the mix of the featured items, and you alluded a little bit to the margin pressure, can you give us some sense of order of magnitude of the difference? Because I know when you first started that program a year off go, say, you were talking about taking advantage of fabric buys and some other things, that I at least took to be it was maybe margin neutral. Is that not generally the case?

We have a number of factors here. We have to take a look at the margins of retail. Based on our suggested pricing, it does have an impact on the margin of retail, so we are concerned about making sure that our dealer network remains healthy. So while we have taken the hit on many margins, we have tried very hard to keep suggested pricing, which will maintain reasonable margins for our retail network. We have also, for instance, taken a hit on the delivery of products to our retailers. And, as you know, we have delivered price on our products, and in many, many cases, there was not enough product coming in to make it into an optimum delivery that we would like to see. But, on the other hand, if you wait too long, they have a cash flow problem. So we decided that keeping everybody standing was more important, so we took a hit.

Now as our business is increasing, we have the opportunities of improving margins in many different ways. For instance, our upholstery margins were negatively impacted from more production than less production. We have been working six days a week. We have been working overtime and have been training over 200 people at this time. All of that as we are moving forward in this quarter, next quarter is going to start moderating, and create a benefit. Our case goods, while this last quarter we didn't have any -- fortunately we didn't have any days off, but we did have inefficiencies, and also we had less working hours in terms of balancing our production. And as we are moving forward for the first time at this time, our production manufacturing in case goods is also working 40 hours, somewhat inefficient, but much better efficiency than it was last quarter.

And then last year, we also closed a number of retail design centers, consolidated them, which also had an impact on margin. So not only is our margin impacted by these savings that we have talked about, but throughout our vertically integrated structure from manufacturing to logistics and to retail. And the good news is, we have an opportunity of improving it right across the board. The same thing happens in our vertically integrated structure. When we have a negative, it affects all or operations. When we are positive, it impacts positively all across. At the same time we are also moderating some of the larger discounts that we gave in the last six, seven, eight months.

So as we think about the gross margin going forward, historically you've run 53%, 54%, and you're bouncing around 50% if you take the charges out that you guys alluded to. With those orders in backlog of the 75% to 80% of the featured items, as you're finishing off the transitional costs and you have better leverage at the plant because you're working six days a week, can we start to see those margins move up maybe towards, certainly not at the higher levels, but towards that despite the fact that so much of that mix is of the lower priced items?

If you take a look at the numbers, David gave that. David, did you say 49.5% gross margin ex all of the restructuring and stuff last quarter?

Yes. Farooq, it was 50.5% last quarter, year-to-date is 49.8%.

Okay. 50% despite all of this stuff we have gone through. So to answer your question, we have that opportunity.

How does retail feel generally? You've always talked about consumer confidence being the key, and stock market and what have you, and certainly with lower ticket items, whether it's Williams Sonoma, Pier One, and others, seeing a life in their business, Are you seeing more activity? Like you said earlier, you fell like since June it's stabilized, but how are you feeling maybe about the breadth of the business? Can you tell at all relative to do people tend to buy, call it more upholstery, when things are tough, that that's all they buy, but as things get a little bit better, maybe they are more willing to buy bedrooms, or dining rooms, or whatever? Are you seeing that open up at all maybe as time goes on?

People are still concerned. We are still not out of the recession. Unemployment numbers are high. However, on the other hand, consumer confidence is better, and for us, consumer confidence is a very important factor for our client base. And we have seen people being more interested in projects as against product buying, as you indicated. So we are seeing all of those positive signs, and yet people are impacted by weekly news, what's happening in the stock market, what's happening in the economy. We see it. Having said all of those things, we are getting positive feedback from the retail network that people are somewhat -- they're not as concerned as they were a few months back.

And just one quick administrative question for David. The delta between the wholesale backlog and the retail backlog, is that indicative of any way that your dealers have stronger books of business, or is it just a timing issue, or what is that a function of?

It's a bit of a function of the smaller number that makes up the wholesale backlog, relative to the size of the number on the retail side.

Got it. Okay. Thanks, guys. Good luck.

Any other questions?

Yes, we do have a question from Todd Schwartzman from Sidoti & Company.

Hi Farooq, David. A couple of quick ones. Is it possible to quantify second quarter delivered sales by products category?

You mean between case goods, upholstery, and accents?

Exactly.

Dave, do we give that information out?

Historically we have not, Farooq.

I will just give you, again, some broad -- I don't have the numbers in front of me -- I'll give you some ranges, how is that, Todd? Upholstery anywhere between 55% and 60%. Case goods about, again, 37% to 42%, and accents between 10%, 12%, and 13%. That might be more than 100, but that's sort of the ranges. As you can see, upholstery has gone up, case goods and accents are down. Accents generally go down in a recession because whole design centers sell a lot more of what they have rather than getting more accents, and good news is it does create a little bit of a vacuum, so when things are a little better, they have to re-merchandise.

Okay. On SG&A, as there are a few moving parts at this point, what's the best way to think about adjusted SG&A as a percentage of sales for the second half of the fiscal year?

That depends on sales. What you see right now on an annualized basis, we are running at about $300 million, slightly less than that. So we've got $150 million for a sixth-month period. So if our sales are $300 million we got 50%, and if it's more than $300 million, the percentage will come down.

And what about freight expense? What are you seeing there, what did you see there in the quarter, and what would you expect for the back half?

Our freight expense, as I had answered earlier, our freight expense goes to our selling expenses. All the products that we deliver to our retail network at the wholesale level is part of our selling expense. So our retailers, normally the rest of the industry, when the retail buys the product, they generally put their selling expenses in their cost of goods. So that's why they even operate sometimes it shows they're operating a at a higher margin but they also have to pay on freight. In our case, our retailers do not pay freight. We cover the freight from delivery from wholesale to retail. The retail pays freight when they deliver to the consumer's home. And our opportunity is to reduce that number as a percentage due to the fact of, as we are seeing somewhat of larger volumes has an impact of reducing our freight.

And also, Todd, in all of this restructuring we have done, we have also closed a number of distribution and retail service centers in the last year. For instance, right now, our whole national distribution primarily is operating out of one facility, when we used to have seven. And, some of those costs are still recurring, but as we go forward, a lot of those costs are coming out of our system. We have also consolidated many retail operations, retail service centers, into larger service centers which we own. As we had indicated at our conference, our objective from '08 to I think '10, '11 is to reduce about $7 million in our rental experience. Dave, what was the number?

I think that's about right, Farooq.

We provided all of that information, Todd. But that has been a very major focus on reducing our total operating expense. All of that is going to have an impact on the improvements of our costs relative to freight.

And where do you stand with CD SOA payments?

What's that, Todd, I'm sorry?

The antidumping?

Oh, the antidumping. Lazy Boy and others owe us a lot of money, because they have been getting all of it, and I've been telling them that. We have actually filed a complaint, along with others, that we should be getting a share of it, and that complaint is under consideration by whoever, I don't know who. And if it is ruled in favorably, we'll get some money. As you know, we were not one of the signatories to that complaint, and so far the money has gone to those folks who signed. Yet we believe very strongly that we should have gotten it too and that is our position.

I know you had filed a while back, we hadn't heard anything lately and I was just wondering if you had any updates.

It was what, Dave, $8 million or so, is something that we think we should be getting. But of course we are not accruing it. And that is, Todd, that's where it stands.

Okay. Thank you.

Our next question comes from Joel Havard from Hilliard, Lyons.

Good morning Farooq, good morning Dave. I'll just try and hit a couple of quick ones. '09 versus '08, the G&A specific expenses were down pretty significantly. We look to be flattening into 2010. Farooq, are we sort of hitting you base zero line with regard to that line item, here at $39 million, $40 million a quarter?

We're talking about --

Specifically G&A of SG&A.

Just the G&A?

Yes, sir.

Yes. Dave, I don't have those numbers in front of me.

That's about right. As we mentioned in the previous quarter, the efforts now are more focused on building the business as opposed to taking those costs out.

Yes. Certainly a great job thus far, it looks like it's starting to flatten out, and I want to make sure that we're getting -- I liked your line, Farooq, about base zero. Dave, for you, then, the $3.9 million in Q2, was that all in cost of goods?

No, $3.4 million of that is in cost of goods, and $500,000 is in the operating expense line. In selling, specifically.

All right. And, again, those are inefficiencies, or were these more direct costs?

Both. There are significant direct costs associated with training, and then there are also inefficiencies associated with training. When you have to train an upholsterer, of course you have one of your best upholsterers training them, and they're not as efficient on the line.

So there's the nonrecurring element, you're taking production out for some temporary period of time, it is coming back if it's of that magnitude, is that right?

I was conservative in my numbers, meaning I didn't adjust it for as much of the indirect side of things as I did the costs I could actually capture.

All right. Good. And the last one, Farooq, did I understand you were at 159 stores, company stores, at quarter end?

Yes, let me just give you the exact numbers.

150.

150, and 134 is independent.

So a total of 284.

Right.

Got it. And that was four or five company stores shuttered, and was that moved into one of the newer?

We had 293 the year back, so there's seven less.

I was looking sequentially. Okay. And were those all consolidations, or did you go dark in a particular market, for instance?

What do you mean, dark, meaning --

That you wouldn't be in Ft. Worth, Texas.

No, no, there are some markets, like, for instance, we are just in the process of going dark in Fargo, North Dakota. In some markets where we for the time being felt that our leases were up, and when we go back, we have to go to a different format, a smaller format in the right place. Some markets are like that, but in most markets, it was the fact that we had design centers where we felt we were just trading dollars.

All right, guys, thanks, good luck.

Our next question comes from John Baugh from Stifel Nicolaus.

Just quickly. Just curious, when you ran your sales events before going to everyday low pricing, my recollection was a 10% type of discount, but you only put it on about a quarter of your product line-up. What was the percentage of your sales during those events that was in that on-sale product a it relates to your comment that now it's running 70% to 80%?

What I said was, let me clarify. I said 75% to 80% of our sales were from products that were put on special savings, while most probably it reflects no more than 15%, 20% of our total product line. Now, you're right, previously we took about 25%, 30% of our product, gave approximately an average of 10% lower prices at retail, and that represented about 75% to 80% of sales during that period.

Okay. So it's fairly similar. And the comment again, I just want to make sure I understand it correctly, is that even though you had some special fabric buys and other things that helped deflect the cost of the discounts, the gross margin impact from the level of discounting in the last six months should dissipate, say, over the next six months in terms of written business. I understand there's stuff in the backlog that has yet to flow through. Is that correct?

That's right, absolutely. And also I think that the other reason was, especially in the case goods side, because of lower volumes, because of inefficiencies, because of also down time in the last six months, that all affected our margins. As you go forward in the other direction, we have an opportunity of going the other way in margin as well.

Okay. And then just quickly. If you had to look out six, 12 months, store count is up, down, flat?

Approximately flat.

Okay, thanks, good luck.

Our next question comes from Rob Wilson from [Hyber Research].

Real quick, the $3.4 million that you pointed out in cost of goods sold, Dave, is that accelerated depreciation like it was last quarter, or are those those inefficiency and training costs that you reference?

Yes, that does not include any accelerated depreciation as we saw in the $6.6 million last quarter.

And one last question, Farooq. When we see Pottery Barn doing positive high single digit, low double digit comp store sales, and we compare it to your company's negative 25, why are they doing so well and you guys on a relative basis are doing much more poorly, relative to Pottery Barn?

I do not know what period that you're talking about.

Are there differences in the business model that would suggest that they would be doing better at this stage of the economic cycle, or what could explain the difference?

I do not know completely, but I would think that they are, they do -- it also depends upon how much of a focus they have had on promotions. They are somewhat more of an item seller than us. We are more, we work with clients. We have somewhat of more of a project orientation, where people are holding that back. So I think that might explain the fact that they are more item sellers. They also have a lot of products at somewhat of a lower price, other than furniture, where I think they have been able to most probably take advantage. Where for us, at our price points, and for the design services we offer requires somewhat more of a commitment, and we are starting to see that come back, but I think those might be the reasons.

That's very helpful. Thanks for taking my call.

All right, let's take one more call, Marina. We have extended our time this time, because I think it's an important time.

I'm showing no further questions at this time, sir.

All right. Thanks very much, and any questions and comments, please let us know.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the conference, and you may now disconnect.