Ethan Allen Interiors Inc (ETD) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second fiscal quarter earnings release call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions) I would now like to turn the conference over to your host, David Callen. Sir, you may begin.

Thank you, Shannon, and good morning, everyone. I'm David Callen, Ethan Allen's Vice President of Finance and Treasurer. Welcome to Ethan Allen's earnings conference call for our second fiscal quarter ended December 31, 2011. This call is being webcast live on ethanallen.com, where you will also find our press release which contains supporting details, including reconciliations of non-GAAP information referred to in the release and on this call. Our comments today will include forward-looking statements that are subject to risks which may cause the actual results to be materially different than expected when making those statements. Please refer to our filings with the SEC for a complete review of those risks. The Company assumes no obligation to update or revise any forward-looking matters discussed during this call. After our Chairman and CEO, Farooq Kathwari, provides his opening remarks, I will follow with some details on the financial results. Farooq will then provide more details about our ongoing business initiatives before opening up the telephone lines for questions. With that, here is Farooq Kathwari

Yes, thank you, Dave, and welcome to our second quarter conference call. Our positive momentum continued through our second fiscal quarter ending December 31, 2011 with good overall results. Net sales increased 5.7% over very strong prior year growth of 21%. Gross margins improved further to 53.6%, reflecting a higher mix of retail sales and continued strengthening of wholesale operations. Our operating income for the quarter, excluding net charges for special items which Dave will discuss in greater detail, increased 48.4% to $15.6 million or 8.5% of net sales. Adjusted net income for diluted share was $0.30 compared to $0.19 in the prior year quarter, a 58% increase. Our retail backlogs increased by 9.4% compared to December 31, 2010.

While we continue to improve the performance of our retail division, our operating margins were impacted by the continued clearance of current products on the floor of our design centers to make room for a very aggressive and exciting new product introductions. We expect to change about 60% of our product offerings from September 2011 to June 2012. The new products will make us more relevant and reach a larger consumer base. The clearance activity during the quarter ended December 31, 2010 had a net impact of about 150 basis points to our retail operating margin. We have aggressive product introductions also through the next two quarters. And as I said, by June 30 we will have changed the projection of our design centers by about 60%.

During the quarter, we purchased another $10 million of our bonds and finished the quarter with a healthy $92.8 million in cash and securities. We have reduced our net debt by $50.7 million over the last 12 months. Our retail written orders increased 10.3% during the second quarter, including comparable store growth of 6.7%. After Dave provides a more detailed financial overview, I will comment on our business initiatives enabling us to continue our growth in sales and profitability. Now to Dave.

Thank you, Farooq. Net sales for the quarter were $183.3 million, up 5.7% over the very strong growth of 21% the prior year second quarter. Our retail segment reported net sales of $143.1 million, an increase of 9.2% versus the prior year quarter and included comparable design center net sales growth of 6.5%. Written orders booked during the quarter by our retail division increased 10.3%, including 6.7% growth in comparable design center written orders. The Company operated retail group finished the quarter with 147 design centers, up from 143 at December 31 last year. Our wholesale segment net sales were $106.6 million, an increase of 5.8% over very strong growth the prior year quarter when wholesale division sales grew 19.3%. Our consolidated gross margin for the quarter was 53.6%. This compares to the 51.8% the prior year quarter.

Our retail segment made up 78.1% of our consolidated net sales for the quarter, compared with 75.6% the second quarter of fiscal 2011. The higher mix of retail business drives a higher consolidated gross margin rate, but also drives higher operating expenses as a percentage of consolidated net sales. During the quarter, we incurred special charges that netted to $1.7 million, but impacted our retail segment by $2.1 million for a loss on the sale of real estate and restructuring true ups. These were partially offset by a net gain in G&A of $400,000 in our wholesale segment, primarily related to insurance proceeds. Excluding special items from both years, our operating income for the quarter was $15.6 million, up 48.4% on a 5.7% increase in net sales showing again the significant leverage opportunity we have.

Our income tax rate this quarter was affected by the usage of certain deferred tax assets for which we had previously established reserves. As a result the reported tax rate for the quarter was 31.6%. As you recall, we also used some deferred tax assets and reversed tax reserves in the prior-year quarter which caused the tax rate to be unusual. The non-cash reserves may continue to reverse in future quarters resulting in tax benefits that will cause fluctuations from our normalized tax rate, which is approximately 36.5%. When adjusted for the items noted above in both periods, the earnings per diluted share for the quarter were $0.30 compared to $0.19 per share last year, a 57.9% increase.

Net sales for the first half of this fiscal year increased 8.9% to $368.2 million. Our retail division's net sales year-to-date grew 12.8% to $284.3 million and wholesale net sales of $223 million grew 7% over very strong growth the prior-year up 25.7%. Consolidated gross margin for the first half was 53.3%,versus an adjusted 51.1% in the prior year first half. Excluding special items in both years, operating income was $29.2 million, an increase of 73.7% on 8.9% higher net sales. Our adjusted earnings per diluted share year-to-date increased 80% to $0.54 per share from $0.30 the prior year-to-date.

At the end of the quarter we had $92.8 million in total cash and securities, up $7.2 million versus last December. This growth in cash was achieved despite reducing debt the last 12 months by $43.6 million, including a $12.1 million reduction this fiscal year-to-date. We also repurchased $800,000 of our stock during the first quarter, invested $11.4 million in year-to-date capital expansions, and paid $4 million in year-to-date dividends to shareholders. Inventories continue to be closely managed and were $136.2 million at December 31, 2011. While macroeconomic conditions domestically have improved, we continue to manage the financial position of the Company carefully, to maintain the strength to aggressively pursue our business initiatives. Farooq will now walk you through the details of the many initiatives underway.

Thank you, Dave. We have many initiatives underway to grow our sales and profitability, including focus in the following five areas. Continue to refine our marketing program, that's our products, our message, quality, style and value under the umbrella of being aspirational and attainable. We are ready to further expand as we have made major, major structural changes. We consolidated, restructured, and expanded our manufacturings and logistics operations. We completed the consolidation of US upholstery manufacturing to our major site in Maiden, North Carolina, and expanded the Silao, Mexico operations from 35,000 square foot facility to a 240,000 square foot state of the art manufacturing operation. We consolidated our case goods to three US locations, in Orleans, Vermont, Beecher Falls, Vermont, and Pine Valley, North Carolina and also made a successful conversion to custom manufacturing.

For our Honduras plants, we have started to bring in equipment and qualified associates. We expect to start production in that facility within six months to provide added capacity to service our expected higher demand. Our excellent manufacturing plant in Passaic, New Jersey is also ready for expanded production and our logistics consolidated at Dublin, Virginia and Atoka, Oklahoma is also positioned for growth. We have strengthened our retail network and our position to grow in North America and internationally. We have retained and reenergized our experienced associates, a quiet entrepreneurial and talented interior designers and promoted management associates.

The design center network will also be ready to project an exciting attitude due to our major new product introductions. New products have been a major focus to strengthen the five lifestyles. As I said earlier, by June 2012 we will have changed our design center projections by over 60% in a one-year time period. The expanded product program is enabling us to increase our customer base, both from a design and also an attainability point of view.

Adding appropriate technology has been a major focus in retail and in the marketing of the enhanced website. Touch screen technology and now our new introduction of the Ethan Allen tablet will enable us to develop a competitive advantage of combining personal service with technology. We've also been adding necessary technology to our manufacturing systems. And our retail division has introduced the newer version of our retail information system.

As we indicated in our news release, we remain optimistic to grow our sales and profitability, due to the many initiatives and also the improving trends in consumer ad issues. We note that a consensus estimates of the analysts for quarter ending March 31 is an increase of 143% in diluted earnings per share of $0.17 from the previous third quarter year earnings. While a significant improvement in profitability, we remain cautiously optimistic in achieving this objective and I believe that the analysts will not -- and if they don't change these numbers, they will not miss them. And with that, I would like to open for any questions or comments.

(Operator Instructions) Brad Thomas, KeyBanc Capital Markets.

Let me congratulate you on a great quarter.

Thank you.

First of all, just to follow-up on your closing comments there, Farooq, you were referencing I think the consensus number of $0.17. Could you just repeat the comments that you made? Did you say that that number was reasonable or one that seemed too high? I just wanted to make sure I understood.

No, I said it was achievable and I also said that you folks are not going to miss it if you don't change these numbers too much.

Oh, it's too low right now? Okay.

I said the 17 is achievable.

Is achievable.

What I was saying is -- I was joking of course, Brad. For 20 years back and Budd Bugatch also made a comment as 20 years back I said we don't miss numbers, you folks miss numbers. So go ahead, Brad. It was just a joke and Budd made it yesterday in his reports.

I just wanted to make sure that was reasonable. In any case moving on, I was hoping you could talk a little bit more about some of the new products, the goal obviously 60% by next June. How far along are you at this point and what's the response been like?

In September and October we introduced our Elegance Lifestyles. The response was good and it's growing because that takes us a few months in terms of getting it fully integrated at retail level and working with consumers and our clients.

In January, this month, we also launched, again, a part of our new product introductions and through our advertising, our direct mail magazines, a very important element of it. And we will introduce by stages in February, in March, in April and May.

By May we will have completed the introduction of all the new products and these were the products that we did show in our Danbury design center when we had our investor conference, for they are waiting to introduce all those products. But to implement in the retail, we are doing it by stages.

And that also impacts this whole issue of clearance, because these are major undertaking. To introduce the products in January as we just did, we had to clear the products in December and in fact November and December. Now to introduce products in February, we have to clear the products in our inventories mostly at retail, but also some at wholesale in January.

And we'll be doing that every month until June. So new products are coming in, lot of activity going on. And by June, we would have had these products in all our design centers. And by that time also, cleared most of the Florsheim samples in inventory that we have.

What's the normal changeover in a typical year when you don't do things this significantly?

Maximum, 10%. This is a massive undertaking in this last one year.

Can you give us an update on advertising during the quarter and how much that was up versus last year, what level of investment you made?

For the last quarter and for the last six months, as I also indicated previously, our advertising at about the same as the previous year.

And would you expect that to continue in the back half of this year?

Yes. It is possible that there might be slight change, but substantially it will remain the same.

And then lastly, could you just -- you referenced the number of investments that you're making in some of the manufacturing facilities. Can you give us an update on where you stand in terms of capacity utilization, how much you could increase sales with the current and what your capital plans are for the year?

We've had to balance our ability to grow the business by making sure that we have the capacity to service. It has to be in balance and fortunately so far it has been in balance. Especially when we -- and I talked about the fact that we had these major consolidations of our manufacturing, case goods, upholstery, logistics.

But good news is that our case goods is operating more efficiently, which also does show on our operating at our wholesale margins. One of the reasons our wholesale margins are higher is because of the efficiencies of our manufacturing, all the changes that we've been making they are now starting to get somewhat normalized. It also has meant that we have a somewhat of a better capacity.

At this stage, I know it's a moving target, but we are approximately at 80%, 82% capacity in our manufacturing. But we are bringing in Honduras, we are adding capacity in our US manufacturing, and also continuously adding capacity in our Mexico operations, too, because that's also very, very critical. In terms of capital expenditures, we had said previously from $12 million to $15 million and I would say at this stage, it could be around $15 million to $18 million in that range.

Matthew Fassler, Goldman Sachs

I guess my couple questions are focused on top line. Can you talk about the relationship between the September quarter's written sales and the delivered same-store sales in the December quarter? It looked like there was a somewhat higher written sales number than we saw show up in delivered sales. Was there anything odd about backlog or anything like that that would explain the gap? I know sometimes these gaps do pop up.

First of all, our second quarter is generally lower in written sales because, as you know, December is not a strong month for us. So, really you're talking about if you compare our other month, it's like comparing I think 2.5 months to 3 months. So we end up -- and that of course also has an impact because of the fact that December quarter, our second quarter being lower in sales, does have an impact on the delivered sales on the third quarter.

Generally, our first quarter and the fourth quarter are the stronger quarters and that's how it works. In the second quarter, as you can see that we delivered based on the fact that we had our increase of 5.7% on top of a 20% increase the previous year, was a meaningful increase this year.

I would think that the opportunity we have is to have a stronger written sales in this quarter, because we've got January, February, and March. That's an opportunity we feel will then reflect in higher delivered sales in the fourth quarter.

I guess as I look at September, the written comp was, I guess, 11.4%. The delivered comp in December was 6.5%. I guess it was a bit lower than the written number would reflect. Would you say that in the March quarter, to the extent that you had a delivered sales number kind of in the mid to high single digits -- I'm sorry, written sales number in the mid- to high-single digits that the delivered sales growth could be higher than that by way of catch up? Is that the implication?

We don't know because of the fact that today our lead times are relatively low. We ship pretty fast. So right now it's a little bit early, even in January, while as I said, early indications are that people are somewhat more optimistic, traffic has increased, but, Matt, the last five days of every month makes a big difference. January, February, March. And because of the fact of our lead times are faster, we do tend to ship faster during the quarter. So it will all really depend on what would happen in January, February, and March.

And I guess another question. On the clearance activity that you discussed, it sounds like the transformation on the merchandising front is going to be of great consequence. Was there any impact on velocity? Did the lower price points presumably associated with clearance materially hurt the sales number? Did the movement of goods out help the sales number? How would you say it impacted, other than on the margin side, just looking at the top line, how would you say it impacted the sales?

It is sort of a double-edged sword in terms of we do sell product at clearance. What it does is it takes away selling regular product at a higher gross margin. And that's what happens with clearance. And so while the chances are that if we didn't have clearance, most probably we would have similar or even more sales, but we would have that at a higher margin.

And then finally, you just alluded to traffic being better. It would be interesting to get your perspective on the last six months or so. Obviously, we entered the summer on a pretty good trajectory; there was a lot of headline risk popped up in July and August and it may or may not have persisted, but how have you seen traffic trends evolve over the past six months or so?

The traffic trends in the first quarter had improved. In the second quarter, we could see that the people becoming -- (inaudible) becoming nervous with all the political activity, all the foreign issues. We can see that with issues that are taking place. But then in January right now, we see this month traffic has increased, people are somewhat more optimistic. Yet on the other hand, Matt, through all this activity on the politics and the negative things that are taking place, we had to watch that also.

Budd Bugatch, Raymond James.

One of my questions has to do with what was the impact of the additional clearance on gross margin? I don't know that I heard a number. Maybe you did give it and I just missed it.

What I said was that on the retail division it had about 150-basis-point impact on our margins. So when you take a look at it, we showed in the retail division about $500,000 loss. We reported a higher loss, but as Dave mentioned, we had sold the vacant property in the retail division and loss of that property went into our expenses in the retail division.

So once you take that out, about $1.7 million -- $2 million that we took out, we ended up with a net loss of $500,000, and I had said that our impact, unusual impact of all this clearance that we're having, which is very abnormal, had approximately 1.5% gross margin or 150 basis points. And if you take that into consideration, we would have ended up with about a 1% operating margin in the retail division.

Secondly, just want to make sure I do have all the items and we do have that loss. David, you said there was an insurance gain in the wholesale? Is that right?

Right. We had a fairly minor flood in our Beecher Falls operation and just to cover the proceeds and actually had a gain in that.

I thought I remember that. That was the Beecher Falls issue?

Right.

Farooq, you talked a bit about expansion and I know we were expanding some of the upholstery production capability in Honduras. And you're talking about some of the other efficiencies and ability to expand. Is there expansion, too, of design centers happening? Do we have a cadence of that of when we're going to -- of if you're planning some of that kind of expansion?

We have right now 300 design centers, 147 operated by the Company retail division, others are licensees. Maintaining what we have has been a very important part of our strategy. And in fact, not only maintaining, but even weeding out design centers that were just trading dollars.

In fact, in last quarter we also had a couple of design, two or three design centers that we closed. In fact, we wrote off some of the leasehold improvements and everything else, but the leases we had we took an early, what you call, we terminated the lease earlier and were able to get out, but we did write off most probably close to $200,000 last quarter.

Our focus has been to realize more from existing and even to relocate. For instance, we just open up a new design center in South Miami a couple of months back. Tomorrow, in fact, I'm going to the grand opening of a design center in Indianapolis, it's in the town center over there. We open up a new design center in Seattle, Washington.

We are now in the process of looking to open up design centers selectively in the United States, because here really the issue is not just more design centers, making sure they're in the right places, and that we realize more potential from them and that's what we're doing.

Overseas has been somewhat more of a focus. We are in the process of expanding in Canada. As you know, we're already there, but Arne Borrey has joined us as International VP. I've been traveling with him to Europe, to India, to Canada -- our objective is to expand in Montreal. So as we go in the next six months, you're going to see us open somewhat more aggressively internationally and our China continues to grow.

So China at the end of last quarter, I think, had 61 design centers. How many are there now?

67.

67. So, Richard has grown by six more. And you have 153 non-Company-owned design centers? Is that correct now?

We have 147 Company and the rest are non-Company.

So to get to 300?

Yes, 299.

299, okay. And I know we'll get the breakout of that in the Q, I guess.

Right, yes.

Finally, you talk about having all the new product in place by June of '12. How much of it -- what percentage is done already? How many of the new patterns and new SKUs are already in the stores or were in the stores by the end of December and how many -- what's left to do?

Between what we introduced in September, October and what we just introduced in January, I would say it's approximately 40%. 60% has still to go.

So we have that same kind of clearance issue that's going to hit the first and second quarters of fiscal -- the last two quarters of this fiscal year?

That's right. Keep in mind, Budd, we have been able to overall increase our margins substantially, which has it been good. You can imagine that without all this activity going on, our margins would have been even better.

I understand you, sir, very well. You've done an excellent job of leading the Company through this transition.

We've got a great, great team, as you know, at retail and manufacturing and operations. And our people are, as you also know, they're very, very experienced. Our folks have been around with me for at least most of them for 20 years plus. The changes we are making are amazing from manufacturing to -- the amount of change is so major, if we didn't have the experienced group of people that we do, it would be chaos. It's already pretty hectic; it would be chaos.

I understand. Thank you very much. Good luck on the quarter and good luck on calendar 2012.

Todd Schwartzman, Sidoti & Company.

You talked about the gross margin, Farooq, citing the higher mix of retail sales and that certainly, I think, is a continuation of what you saw in first quarter. And also the strengthening wholesale operations. Could you expound a little bit more as far as the reasons for that sharp improvement? Especially, I'm interested in hearing about the 70-basis-point sequential expansion from Q1 despite slightly lower sales.

There are two major areas, Todd, that impacted it. One is the composition of retail to total sales. That has a major impact, was about 77%, 78%. And that is a major impact. The second is improvement in the gross margins in our US manufacturing, especially in our case goods division. Those are the two areas that contributed to this change in gross margins from 51.8% to 53.6% in our second quarter.

And what about the 52.9% to 53.6% from first quarter to second quarter of this year? That's pretty impressive right there.

But same thing, mix between retail and total and improved, continued improvement in our US manufacturing. Despite the fact we still have been gearing up Mexico. We've been absorbing those costs. We are now gearing up Honduras, but a little bit of that cost might have been special cost, but most of it we're absorbing. But we got to get those going. We are not going to be able to have the capacities to grow until we also continue to grow our manufacturing.

Now, Todd, as you know we're taking the difficult route. We could just have everything made by others, but 70% we make ourselves. And that is by itself on one hand it gives us a lot of costs. But I think longer run, it gives us an ability to maintain our quality, maintain our -- more control of our future.

Also, I heard your comments about the traffic trends for the quarter in January and that's certainly helpful. Is there anything else going on? Any other metrics that you're looking at that contributed to your citing the improving trends in consumer attitudes? Where is that most evident, if not traffic?

Well, there a number of factors. One, I think, is there is certainly from what we hear, as you know, I get a weekly report from every design center around in North America every week talking about trends. There's more optimism. There is -- people are somewhat tired of not fixing their homes. While there is some improvement in new homes, but the fact is people are spending more time in their homes and improving them.

So that's one fact. Other is that in December we don't have a lot of traffic. People are involved with buying toys and gifts and everything else. So they end up coming more in January. This year we saw a little bit more than we saw last year.

Finally, on CapEx you spent $8 million in the quarter, I think it was, Q2.

Yes.

The implication backing into the back half is spend of $3.5 million to $6.5 million fully for the second half of the year. Is that -- that's a reasonable target, you think?

We would, because our major expenditure was the purchase of the Honduras plant in our -- in the second quarter.

Right.

Now as we go forward, while we continue to invest in bringing up Honduras up, I would think that, as I said, anywhere between $15 million to $17 million or $18 million is what we'll end up spending at the maximum.

Joel Havard, Hilliard Lyons.

Appreciate that hint of what the new normal of guidance from the Company is going to look like. That's helpful. I got the joke. (laughter) The store count, if I got it right, dealer-owned went from 148 to 152 sequentially. You all added a store net.

The growth in the dealer, I suppose, Farooq, was all international. You've got a couple of years of that or more under your belt now. What do those stores, the international stores, maybe particularly China, what does their top line performance look like relative to other internationals relative to US?

China, of course, has shown the most growth, domestically, compared to domestic and even other international, because of the number of stores that they have opened up and the locations that they have. I don't have the exact numbers in front of me, but I would say that just giving an approximate, I think they've been growing in the last year or so at about 20%, 25%.

And on a total dollar basis, Farooq, again just approximate, are they typically going to be half the total revs that would be driven by a typical domestic store or is it a totally different type of number?

As you know, it's wholesale in the sense that it affects our wholesale business. Domestically, of course, is greatly impacted because of our being in the retail business. All our business international, other than Canada, is through licensees and reflects on our wholesale business.

What I'm getting at is on a per-store basis, the dealer bucket has been on a, looks like a slightly deteriorating trend line. I'm just wondering if that's a function of the more rapid growth of the international side and the fact that maybe they are -- the overseas stores particularly maybe run a little bit less total volume.

I didn't understand, Joel. The fact is this. In the last three years we have had a consolidation in some of the domestic licensees. In some markets it was not worth maintaining it, just a few markets; in others, a few others we took over from our retiring retailers, as has been our custom in the last 15 years. That's what we continue do.

We've got a strong group of our independent retailers in North America. And the ones who are operating are strong. They are investing in their businesses. At this stage, not many of them are opening up new design centers or new stores. And that is not also something that we recommend they do. We really want them to make sure that they are, they remain healthy, they do well from what they have to realize more potential and that's what we do in our retail division, too.

At this stage, I don't have a tremendous interest in opening a lot of stores in North America. I want to make sure we double our business from what we have and that's the opportunity we have, Joel.

And, Farooq, thanks for that clarification. You've also talked about the migration, at least at the margin, of some of the domestic dealers to smaller footprints, in some cases replacing a traditional box with the more boutique format. I'm sorry, I'm drawing a blank on the name you use for it.

We call them design centers. You're talking of studios, but really what we've done -- for instance, where this -- we just opened a design center in South Miami, which was a 15,000 square foot and now it's opened, now it's about 7,000, 7,500 square feet. We just opened up one in Indianapolis that was, I think, 15,000, 18,000 square foot and replaces by 10. We just opened one in Seattle that was also 15,000 and we opened it, it was 9,000 or 10,000.

I think it is tremendously important for us to be in the right locations and somewhat smaller space, because today that brings us to the talent that we're acquiring. We are acquiring very talented interior designers, 90% of them who ran their own businesses. They are able to do a lot more with less. In fact, most of them when they ran their own businesses didn't have much product.

Secondly, technology is playing a very important role. Our website, our touch screens, and now as we go into the next generation of the tablets that we are introducing, technology, personal service also relates to smaller floor space.

Barry Vogel, Barry Vogel & Associates.

Congratulations on superb performance.

Thanks, Barry.

Farooq, I want to ask you a capital allocation question. I commend you for doing the no-brainers on your bonds. That truly is a no-brainer. And of course you haven't been buying many shares over the last few years and that's understandable. And you have raised your dividend. So, going forward, in terms of your excess cash generation, your current balance sheet strength, which is exceptional right now, how would you -- what would you list as far as priority in capital allocation?

Well, I operate in an old-fashioned way. I say to my folks, I need about $100 million or close to that in cash and if we've got extra money -- First, of course, we've got to make sure we've invested in our business, like we purchased Honduras. We, in fact, even purchased some proper design centers.

Fortunately, Barry, as you know in the last 15 years I went against the conventional wisdom and we own 40% of all our real estate in our stores and we own 100% of all of our manufacturing distribution. This recession has given us an opportunity to show that it does work and we generate cash. If we didn't have it, the real estate costs can kill you. So we will selectively, when it makes sense, keep on repurchasing real estate, if it makes sense.

We are investing in technology. Our manufacturing is in pretty good shape. Now we got to make sure we get it operating at even higher levels, especially Honduras, Mexico, our US operations. And then, as you rightly said, we pay what, about 5.375 on our bonds? Interestingly, considering that they are not investment grade, they sell almost at the investment-grade levels. The market gives us a A rating anyway, so we are not able to buy them too much at a discount, a little bit. But, as you know, we already purchased $50 million.

Our capital allocation is going to be to selectively buy bonds, but still making sure we have enough cash for our business, for our expansion. Then also we have increased our dividend last year and if it does make sense and with the Board of Directors, we will discuss about the possibility this year of, again, a small increase that would make sense to consider.

And then if we have something left, we'll see whether it would make sense to buy our shares back. That to me is somewhat of a lower priority, Barry. In the last five, seven, eight years we bought $500 million of our stock.

I know. So basically what you're saying is bond purchases would be number one, dividend increases number two and number three might be share buybacks?

Yes. I would just slightly reverse that. I say number one is we invest in our business --

I know that. That's understood.

Right. Other than that, exactly what you just said.

Okay. And can you tell us a little bit about Honduras? That announcement had come out after your last quarter's conference call and I probably just put it in my file, so I don't have any color on that. What did you pay for that purchase?

Did we say that? I'm asking Dave. Barry, we got a great deal for a fantastic facility. You can know that we spent so far in our capital expenditures, you'll see that also includes Honduras and you can see it was overall not a lot of money we spend. But it's 164,000-square foot facility on 18 acres. And it was a case goods plant.

Based on what we spend and what we'll need to get it going will cost us about, anywhere between $10 million and $12 million, because we've got to bring in the high-tech equipment. Approximately half of that we've already spent, the other half we'll spend in the next year, year and a half, Barry.

And so what are you going to produce there, strictly case goods?

That's right. Initially we're going to be making chairs.

Chairs?

Right. Right now our chairs are made all over the world. We're going to get them back under our own control.

David, as far as the operating rates in the last quarter, breaking down case goods and upholstery, because I know you've talked about -- in an answer to a question you said it was 80% to 82% combined. Can you break that down case goods and upholstery operating rates?

The same -- well, I would say that upholstery -- I would say the same because of the fact of the opportunities of capacities of growth we have in Mexico and Honduras.

You think upholstery was only 80% to 82% in the quarter?

You are talking about --?

The operating rate?

Yes, if you take into account the capacities, the additional capacities we have in Mexico.

Okay, okay. I was just thinking domestically, excluding Mexico. You said your costs on the Mexican expansion are falling. Can you give us some color on that?

Sorry, you said cost in --

You said that in your commentary that the costs of your Mexican expansion, which was a significant expansion over the last few years, are falling.

I don't know what I said, but I think what perhaps you mean is that we've already spent most of the money in Mexico operations into the capital expenditures and buildings and everything else. Now we've done that. Now we are increasing production. We've got to still spend, continue to spend some money, but most of the money capital expenditures we've already spent.

Okay. And, David, can you tell us what the D&A now is projected at for fiscal '12?

Around $20 million to $21 million, $22 million maybe.

Jeffrey Matthews, RAM Partners.

You talked a lot about what you're doing manufacturing-wise in your US plants. And I know that's the bulk of your, two-thirds or so of your manufacturing. Could you talk about the relative competitive disadvantage that US manufacturing in general has been under over the last 5, 10 years and how that maybe has changed to your advantage?

It's a very important issue that if you take a look at -- our upholstery manufacturing gives us a very great competitive advantage relative to offshore because of the custom nature of our business.

And also because of the fact that while labor costs are still very high in the United States compared to offshore countries, we have been able to develop a fair amount of technology that we've brought into the United States and then supplemented with a very high-level operation, which is cutting and sewing, which we've taken to Mexico. When you combine that, that gives us a good competitive operation in terms of relative to cost when we compare it to overseas.

On wood products, case good is a different story. In case goods, three or four years back or five years back when everybody started going overseas, it was really evident that the cost of doing business in the United States, in building case goods, was such so high that people went overseas.

We decided that while we will also go overseas in those areas which were tremendously labor-intensive, we'd maintain our manufacturing. Because first we are located in areas which has a great history of craftspeople. Once you close, you lose craftspeople. Second, we are in one of the greatest forests. The Appalachian Mountains is one of the greatest resource of hardwoods left, I think, in the world, which is growing and not going down.

Third, we have been continuously investing in our plants over the last 20, 25 years. That gave us an awful good head start, but yet when we started three, four years back, the competitive disadvantage was almost 20% to 25% in terms of a gross margin of cost of making overseas and then making it here. Now with customization that gives us a competitive advantage, because it's very hard to develop custom manufacturing overseas. That's why kitchen cabinets and all of that stuff is made more domestically.

Second is the fact that we have been continuing in narrowing down that difference. But still, the difference in gross margin if you just look at it is about still 15% between what we make here and what's made overseas. So we have decided in the short-term we will take that lower margin, but keeping in mind their overall margins are still relatively healthy and healthy compared to others. But longer-term it gives us a competitive advantage, because once we give it up, it's an issue.

Like for instance, we are now shipping 60% of the product we sell in China from the US. In fact, as we're quite interesting, we have a operation in Passaic, New Jersey, which makes our accessories and lamps. Right now we're making thousands of lamps for China. Five years back, it would've been a joke to say that we will be making lamps in the United States for China. So things are changing and we are glad that we have that capacity to manufacture in the United States.

Thanks. That's an excellent answer. And when you earlier said that you really got (inaudible), I thought that was a -- something got garbled there. But thanks for clarifying. That's a great answer.

(Operator Instructions) Joe Feldman, Telsey Advisory Group.

Congratulations on the quarter. I know you touched on it before about it seemed like the consumer being a little more optimistic in January and, I guess, what was it that gave you that impression? Were you seeing the size of what people were buying or the quality of what they were buying, trading up? Anything to back that up a little more?

Joe, keep in mind, it's only three weeks or so in January. Always if you keep in mind. But if somebody were to ask me what the trends have been this month, because for us January is an important month, having said that in December, we don't do a lot of business.

What we have seen is with the reports we're getting is -- it's from our design centers. I mentioned also that we are very close to our design centers. I personally get a report from every design center manager every week. We have conference calls, we get information and what we're seeing is first, we have higher traffic. Their numbers, we know that.

Second, more important is the attitude is somewhat better. And now, how much it's going to translate into business, I think that we will see as we end January and then we go into February.

And then with the new products coming in, and I know it is still early, but if I recall at your investor day, we talked about also having some more entry price point product as well for consumers. I guess I was wondering if you're seeing any difference in the mix or also is the margin any different on the entry price product? I would assume not, but just curious.

Joe, one thing of course you know that we make one level of quality of products. Whether it is in our upholstery or sofas, it doesn't matter whether it's $1500 or $3000, the construction, the internal construction, external construction is exactly the same. It is the fabric that one uses, the option one puts in.

Same thing in our wood products. We have one level of quality. What we've been able to do is to develop products with our level of quality, for instance, in upholstery at fabrics that are still very good, but at less expensive rates, because you can go a grade of a fabric from selling at $1500 to selling at $4000.

So we have been marketing and you're going to see a lot more projecting the attainability of Ethan Allen within our current programs without changing our quality. So you're going to see a lot more of that in our marketing as we move forward. Not completely right away, but in the next coming months you will see more of that.

I know some people have touched on it, but with regard to operating, the costs and the expense side of things, you have continued to do a good job there and you got leverage even with slightly less sales than what some of us had modeled. Is there more to go there? Can you keep driving those costs down and controlling and -- how do you do it?

Right now, we have been -- we are benefiting from the leverage. As you know, Joe, when things in 2009 they go the other way, being a vertically integrated company, everything is impacted from sawmills to case support, upholstery, manufacturing, logistics, but on the other hand when we start going up, we are able to benefit and we also benefiting from all the major consolidations that we did in our manufacturing, that we did in our logistics, that we also have done in region, are still doing.

As I said, five, four or five years back you could put two stores pretty close by and get away with it. Not anymore. Today you got to make sure that they are in the right place and that affects our operating expenses. I think from an operating expense point of view, most of it is behind us. And we've gotten a tremendous amount of leverage.

Now we're going to, as we go forward, we're going to have somewhat of a more normalized increase in our earnings relative to increase in sales, not 50%, 60%, or 80%. I think we have benefited from that. I think we should hopefully have a healthy increases, but I think 70%, 80% increases are [somewhat] normal.

Got it. Thanks very much and good luck with this quarter.

And you know folks also take a look at the model, that model we gave three years of the various scenarios, interestingly, we are pretty close to it, even today.

Thank you. I'm showing no further questions at this time.

All right. Well, thank you very much. Good to have you all on the call. And Budd, I'm sure that you think that all my comments are on the joke about you folks have to do a better job in not missing our numbers, but with that, look forward to continuing our conversations. Any questions, please give a call today.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.