La-Z-Boy Inc (LZB) 2007 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to La-Z-Boy Incorporated third quarter 2007 conference call. [OPERATOR INSTRUCTIONS]

It is now my pleasure to introduce your host, Mr. Mark Stegeman, Treasurer of La-Z-Boy Incorporated. Mr. Stegeman, you may begin.

Thank you, Jackie. Good morning, I'm Mark Stegeman, Treasurer of La-Z-Boy. I'd like to thank all of you for joining us on this morning's call to discuss our fiscal 2007 third quarter results. Present on the call are Kurt Darrow, La-Z-Boy's President and Chief Executive Officer, and Mike Riccio, our Chief Financial Officer. Kurt will open today's call with some prepared remarks on the quarter and will discuss the strategic direction of our business and then Mike will speak a little bit more in detail to the numbers. We will then open the call to questions and a telephone replay of the call will be available for a week beginning this afternoon. These regular quarterly investor conference calls are one of La-Z-Boy's primary vehicles to provide guidance and to communicate with investors about the Company's current operations and future prospects.

We will make forward-looking statements during this call so I will repeat our usual Safe Harbor remark. While these statements reflect the best judgment of management at the present time, they are subject to numerous future risks and uncertainties as detailed in our regular SEC filings and they may differ materially from actual results due to a wide range of factors. We undertake no obligation to update any forward-looking statements made during this call. With that let me turn over the call to Kurt Darrow, La-Z-Boy's President and Chief Executive Officer. Kurt?

Thank you, Mark. Good morning, everyone, and thank you for joining us on our call to discuss our results for the fiscal 2007 third quarter. As Mark mentioned, I will begin with an overview of our quarter and business conditions. Then Mike Riccio, our CFO, will take you through the numbers in more detail, before I conclude with our prepared remarks and move to the question and answer period. As most of you have heard from the other public furniture companies the retail environment remains extremely difficult and calendar 2006 trended downward as the year went on. With many in the industry facing situations of excess inventory and aggressive discounting. Against that backdrop, we were pleased with our wholesale business performance this quarter. Even in this challenging environment where it is difficult to get top-line traction, we aggressively managed our cost, our inventories and the balance sheet, while continuing to pursue our strategic plan of positioning our Company for the long-term. For the quarter we posted a per share net loss of $0.15, but income from continuing operations was $0.13 per share.

Let me make sure everyone understands some of the significant items that were included in this quarter's net loss. We had $0.02 of losses from VIEs, $0.04 in income from the anti-dumping duties collected, a $0.03 restructuring charge, and $0.28 in losses from discontinued operations held for sale, which includes Sam Moore, Clayton Marcus, and Pennsylvania House. While we are confident the consumer will return to the marketplace, our continued focus is to make our operations more efficient and ensure we offer the consumer a professional shopping experience, with vast choice, customization and quick delivery. Further we are taking the necessary steps to improve the performance of our Retail segment and expect meaningful improvement in the coming quarters. Last quarter we outlined five strategic initiatives to strengthen our companies results and positioning. I will touch on those points throughout the course of this call and elaborate on the progress we have made executing against them. Before reviewing the results of each business segment a discussion on the portfolio evaluation that we highlighted on our last call is in order.

In looking at our various companies we are using a filter of size, profitability and long-term strategic alliance with the La-Z-Boy brand and the La-Z-Boy stores. As a result of our review this quarter, we signed a letter of intent to sell our Sam Moore upholstered chair company to Hooker Furniture. And we also committed to a plan to sell Pennsylvania House/Clayton Marcus. We issued a press release announcing the proposed sale of Sam Moore simultaneously with our results announcement last evening and you can refer to it for more details. We expect the transaction to close in the fourth quarter and Sam Moore's results for this quarter are included in discontinued operations held for sale. It is important to note that while Sam Moore, Pennsylvania House and Clayton Marcus each have positive attributes. They do not fit our long-term strategy and we need to focus management's time and resources on our remaining businesses. Given the recognizable consumer brand name of Pennsylvania House and Clayton Marcus, we expect they will be very appealing to a prospective buyer.

I would like to take this opportunity to thank all the employees and customers of all three companies for their dedication, loyalty and commitment over the years to La-Z-Boy and for their continued support throughout this transition process. Now let's go through our Company segments. First Upholstery. For the quarter, on significant lower sales compared with last year's third quarter, we maintained a 7.6% operating margin. Sequentially our sales were also below those of the second quarter and our operating margin improved from 6.5%. This performance demonstrates our continued progress in managing our cost structure and making our operations more efficient while taking advantage of increased global sourcing including cut and sewn cuts and other component parts. We are approximately 40% through the conversion of our branded facilities to the cellular production process and our Arkansas plant is now 100% complete.

In addition to reducing our costs by 25 to 30 million per year when completed, cellular also dovetails with our strategy to continue to differentiate ourselves in the marketplace by offering the consumer custom furniture with quick delivery. The cellular process in and of itself not only reduced cost and work in process inventories, but increases speed and quality. And as a result of the conversion, we will be able to deliver all custom furniture in four weeks or less 100% of the time. We anticipate the remaining branded facilities to be fully converted by the end of fiscal '08. Last quarter I mentioned that we had a large consumer research study underway on the La-Z-Boy brand. Since that time we received the results of the survey, which told us that the brand has universal recognition and nearly universal favorability. It also confirmed that we define the category for recliners and that consumers placed a high value on comfort, quality and durability, with La-Z-Boy enjoying a commanding presence, vis-a-vis these attributes over other brands. It also told us that customization and professional services are important to the consumer and are a competitive advantage for us.

The research gave us a wealth of information that I won't elaborate on during this call, but it has led us to undertake an advertising agency review to ensure that we have a fresh and refocused new campaign that will be launched this fall. Now let's turn to Casegoods. This quarter sales were off double digits compared with year ago levels and they were also down sequentially. Our operating margin, however, increased quarter over quarter from 7.9% to 9.1%. Also by recalibrating our business and transitioning it to be primarily an import model, we have a much higher variable cost structure, which has allowed us to turn in a respectable operating margin even on significantly lower volumes. As I mentioned at the outset, during the quarter our petitioning companies collectively received $3.4 million net of legal expenses and duties under the Continued Dumping and Subsidy Offset Act in connection with wood bedroom furniture from China. Expectation is that over $200 million will be collected by the government by September, 2007, and that money will be paid out to those companies who compromised the petitioning group. The amount we anticipate receiving could be substantial.

Now I will go through our Retail segment where we continue to make progress in improving the business. I'd like to reiterate that we believe building a strong retail presence with our La-Z-Boy Furniture Galleries store system is going to secure the long-term future of our Company. We are indeed investing heavily in Retail today and believe that we will be well poise to capitalize on the industry when the consumer demand accelerates. In the third quarter the segment posted a negative 11% margin on sales which were up 6.5% due primarily to additional stores in the system. Overall our loss is attributable to the difficult retail environment which impacted our velocity, as well as the high fixed cost structure currently in place, which is predicated on larger volumes. As we discussed last quarter we are working diligently to reduce costs and to get traction through better penetration in our Company owned markets so that we can better leverage our fixed cost basis. Last quarter we implemented a new point of sales system in our Northeast region, which is allowing us to run our business more efficiently.

By calendar year-end our entire network of Company owned stores will operate with enhanced version of this system and by that time we will also have consolidated our original 12 warehouses down to four major distribution centers. As we have discussed before, our strategy for Company owned stores is to concentrate and operate in the top 25 North American markets where we can achieve critical mass to spread fixed cost and have a deeper penetration of these larger markets. Therefore we made the decision to exit the Pittsburgh, Pennsylvania market this quarter as it does not fit the criteria and we are in the process of closing four stores and a warehouse. Collectively all these moves will save us between $8 and $10 million annually when fully implemented. Additionally, we expect to improve our gross margins by 300 to 400 basis points, which will convert to a $6 to $8 million annual improvement to the bottom-line, as we re-merchandise the markets we acquired.

The third leg of our Retail strategy is to build out our store system to achieve critical mass and we continue to make progress in opening new stores and converting and relocating existing stores. Last year at this time only 26 of our 64 Company owned stores, about 41%, were in the new generation format and today over half, 44 of the 72 Company owned stores, are in the new format. By the end of fiscal '08 we will have approximately 80 stores with about 65 in the new format, or over 80%. We also mentioned last quarter that we had engaged the Boston Consulting Group to analyze our Retail business. Not only did they look at Company owned stores but they reviewed the successes of our license stores to make comparisons with our overall system. We were pleased with the thoroughness of the research and not only did they confirm a lot of what we were doing, they gave us a multitude of actionable items. As we move forward with our plan to improve the Retail segment and make it more profitable, a large portion of what we implement will be rolled out to the entire furniture gallery system so that our systems, so that our systems operate -- so that our entire system operates as an integrated furniture retailer.

This quarter we began to realize the cost savings from the moves taken thus far and saw sequential improvement in our gross margin. We still have a lot of work ahead of us and anticipate continued improvement as the quarters progress and we expect to start breaking even in the Retail business in about 15 months. Now I will turn the call over to our CFO, Mike Riccio, who will take you through the numbers in more detail.

Good morning, everyone, and thank you for participating on today's call. I'd like to review the numbers for the quarter in detail and show there in clarity with respect to the businesses held for sale contained in the discontinued operations line, the restructuring costs and the anti-dumping monies that we received. As Kurt reviewed earlier, we have analyzed our businesses and reviewed our portfolio of companies and determined that Sam Moore, Pennsylvania House, and Clayton Marcus do not fit with our strategic direction long-term. As a result of this decision, we have restated our prior year numbers on our consolidated statement of operations to record their operations in the income loss from discontinued operations and that's net of tax. There's a detailed description in footnote 13 of our 10(Q) that summarizes the charges by line item but let me quickly review the components. It includes goodwill and trade names write downs, fixed asset and inventory reserves, in addition to the losses associated with the operations. Net of tax that totals a little over 14 million.

As required by the accounting standards, our prior year balance sheets and cash flows have not been restated for the change in classifications at discontinued operations. In the current year the various assets and liabilities have been consolidated to one line item in assets and liabilities for those businesses we have identified for sale. In analyzing the earnings per share, it includes $0.03 in restructuring expense, relating primarily to the cost associated with exiting the Pittsburgh market, which Kurt referred to earlier. It also includes costs related to severance and benefits, as we have consolidated our warehouses, and other restructuring costs. For the quarter, as Kurt mentioned, our VIE's lost is $0.02 per share, as they too faced a difficult retail environment, and stock option expense remained consistent at $0.01 for the quarter, but on a nine-month basis it rounded to $0.02 per share. And we had $0.04 per share in income from the Byrd Amendment money relating to the anti-dumping on wood bedroom furniture and that was classified in other income and expense.

For modeling purposes we expect depreciation to offset our capital expenditures and our effective tax rate on continuing operations to be in the 39% to 40% range. Also you need to remember that as you're modeling sales, that our sales now have been restated for Sam Moore, Pennsylvania House and Clayton Marcus and those sales numbers have been restated in our 10(Q). With respect to our balance sheet, we paid down debt by 20 million during the quarter and decreased our debt to cap ratio to 25.4%. Our inventories and receivables are also down for the quarter. We continue to focus on inventory levels as we have seen the sales declines over the past six months. In addition, we did not repurchase shares during the quarter and have 5.4 million shares remaining in our program. Hopefully that has given some transparency to the reported numbers. I will now turn the call back over to Kurt for his concluding remarks and we will be available to answer any questions you may have on any specific line items.

Thank you, Mike. Before concluding I would like to take a moment to discuss two important appointments made during the quarter. One board appointment and one in management. First we were delighted to appoint Alan McCollough to our Board of Directors. Alan is the recently retired Chairman and CEO of Circuit City stores and brings with him a wealth of retail experience, as well as expertise in distribution, logistics and global supply chain management. He will undoubtably make a great contribution to our business as we expand our La-Z-Boy Furniture Galleries network of stores. We also appointed Tony Moretti to the newly created position of Vive President of Merchandising for the Company's non-branded upholstery operations. Tony has worked in the furniture industry his entire career and spent the last 20 years with Jordan's in Boston. He brings a unique approach to our merchandising efforts. This is just one example of how we are executing on one of our five strategic objectives, strengthening our management team.

In summary we are pleased with the way in which we managed our business this quarter during such difficult times. In terms of our five strategic initiatives this quarter, we made incremental progress in our Retail business, we acted on our portfolio optimization, we continued to convert our facilities to cellular manufacture, we improved our production cycle and added strength to our management team. We are confident our strategy is correct and that with the unparalleled strength of the La-Z-Boy brand and a strong store system we are well-positioned for the future. Looking ahead to the fourth quarter we believe the industry overall will continue to be challenging and expect sales to be down 8% to 10% compared with last year's fourth quarter sales of $450 million. We expect earnings per share to be in the range of $0.03 to $0.07, including up to $0.01 per share charge for stock option expense. In last year's fourth quarter we reported a loss of $0.20, which included a $0.44 write down of intangibles. We thank you for being with us on our call today and I will turn things back over to Mark to begin the question and answer period.

Thanks, Kurt. We will now start the question and answer period. Jackie, if you would just quickly review the instructions for getting in the queue to ask questions, I'd appreciate it. Thank you.

Thank you. [OPERATOR INSTRUCTIONS]. Our first question is coming from John Baugh with Stifel Nicolaus. Please proceed with your question.

The question is really around the discontinued, and I don't have access right now to the 10(Q) or the breakdown of the restructuring loss, but can you tell us what the operating losses were for Sam Moore and Pennsylvania House/Clayton Marcus, first of all?

John, this is Mike. I guess the answer would be if you look at the numbers that we outlined gross in the footnotes it ends up being somewhere around $2 million for operating losses if you subtract everything else from the numbers of the write-downs we had to take.

So 2 million per quarter, or 2 million was the quarterly operating loss for all three of those, or two of those businesses combined?

Well, it's all three of the businesses combined for the quarter. It's probable just a little under 2 million.

How does the Casegoods -- then you mentioned a 9.1 operating margin for Casegoods. Obviously that benefited from taking Pennsylvania House out, what was the sort of the pro forma EBIT margin on Casegoods? And I'm curious going forward if we continue to see a 10% decline in revenues in Casegoods, is it all variable and we'll be able to hold that 9% EBIT margin or is that going to come under pressure if volumes keep dropping?

John, I think to answer that question, without getting as specific as you want us to, I think you can do the math through our footnotes and all. The impact on margin with Pennsylvania House/Clayton Marcus being in the Casegoods segment was significant. The impact on margin and sales of Sam Moore being in the Upholstery division was insignificant due to its size relative to the size of the base. So we want to get through some of these transition periods before we make any new statements about what our continuing expectations are of our remaining Casegood companies. But we will be in a position to do that next quarter.

Lastly, this survey you got back about the La-Z-Boy brand, what did it tell you about your ability or inability to sell dining room, bedroom furniture in the La-Z-Boy stores or did that survey not address that?

Well, it told us a lot of things, John, and we revealed some of them today on the call. But I'm, frankly, a little reluctant to go into much more detail because some of it is sensitive to us from a competitive standpoint and would tip our hand into some things we may or may not be doing strategically. So I think I would just pass on that question and leave our comments to our prepared remarks.

But you did -- can you just tell me that you did get some feedback on that, whatever it was?

Absolutely. We got feedback on a wide range of things including the transferability of our name to broader categories.

John, just real quick, the net -- I was giving you gross numbers, it's about 1.3 million net of tax for those companies. I just want to make sure that was cleared up.

Any weighting between PA House and Sam Moore in terms of that 2 million gross? We are not going to give any more detail than that, John. Okay. Thank you.

Our next question is coming from Budd Bugatch from Raymond James. Please proceed with your question.

Good morning, Kurt. Good morning, Mike. Good morning, Mark. That's kind of where I was trying to start to go, the gross margin change was notable to the positive, which is really very nice to see and I was kind of curious, if you would at least flavor-wise give us a feel of how that margin improvement can be seen? I mean retail was a little bit larger part of a mix now, so that would give you some bump and same in SG&A, I guess. But I was trying to get a feel for Upholstery gross margins and Casegood gross margins. To the extent that you will give it to us.

Well, we probably won't give it to you to the extent that you'd like. But I think, Budd, you captured -- I think there's three elements to it that all played into it. Number one, as the Company's wholesale business shrinks and the retail business grows, the impact of the higher gross margin in the retail segment has an overall larger effect on the business in totality. Number two, the businesses that we have put in the held for sale category weren't performing as well as the remaining one and that made a change as well. But candidly, our businesses, given the tough environment, our wholesale businesses performed very well and there was a real pickup in gross margins in both the Casegood and Upholstery segment this market through performance. So it's a three prong answer that there's a little bit of all three elements taking place here on the gross margin improvement.

Secondly and, Mike, this is for you, this is a plea for some additional disclosure in terms of the restated financials. We appreciate the fact that you gave us restated quarterly numbers at the segment level, but we don't have the financial reported income statements to get prior quarter gross margins after that or SG&A or even the impact on some of the below the operating line numbers. Hopefully you would get that disclosed and released as soon as possible and as practicable.

Our goal was to try and at least get the segment information out there. Obviously we have to put all those numbers, it will be in our 10(K) next quarter. We will look to see what we can do there, Budd. It was not in our current thinking to release all those numbers right now, but I understand your issue and I will see what the opportunities are.

Just while I got you, you said 1.3 million after tax on the operating side of the discontinued op, my numbers was 1.1, I know that's a nit but you had 13.7 million after tax, I thought of the write-down on a $14.8 million total just stops. Is that -- ?

Budd, the problem is that the effective tax rates within those various categories is all different because of how they were put in. So it's somewhere in the neighborhood of 1.2 something in total net. So you're not far off from there.

Okay. Kurt, you talked about the three prong filter and you've talked about that for awhile for the disc ops and obviously the question goes now as to do we see any more shoes to drop? I'm sure the strategic review is ongoing, but the other divisions, I think, probably don't fit in terms of the size criterion on that issue. Is that a fair conclusion?

Yes, Budd, that's a fair conclusion. I think you have to look at they don't fit from a size basis point of view and I think as you see from now the operating margins of the combined companies, they don't fit there either. So we believe we have dealt with today's issues with our strategic filter as aggressively as we can and we are moving forward with what we have on our plate today.

Well, for our modeling sanity check, that would be very helpful if we don't have to go back and always continue to restate but that's our issue, not yours. My final question is you've given us corporate-wide or system-wide comps for the retail, can you kind of flavor that by Company owned comps and maybe give us a feel of how they differ from system comps?

We have a lot of in and outs with our Company stores because of new stores and new markets, exiting markets, things of that nature, and until we get a more mature business, Budd, we decided not to breakout our own Company owned performance versus that of the system. We think the system one is more meaningful. You see the financials of our Company owned stores every quarter and we are going to stick with giving out just the overall system here for the time being.

My last question has to go with how you think quarter four will unfold. If you're going down 8% to 10% on your top-line guidance, any thoughts of how that unfolds during the quarter or is your crystal ball as broken as mine?

I would concur with your last remark. I think one of the things to keep in perspective, I think the business climate a year ago at this time was the best it was in all of 2006. So the industry is going up against higher comps this first quarter, for calendar quarter than that at any time in last year and given the degradation that's happened in the sales velocity, it's challenging and our crystal ball says that we are going to have some struggles, probably at worst the first half of the year and at best it could be way into the fall before there's a meaningful change with the economy, with housing starts and things of that nature.

Thank you very much and congratulations on, I think, the better improved operating performance.

Thank you, Budd.

Our next question is coming from Susan Maklari with UBS.

Good morning. Can you talk a little bit about the inventories? You did a very good job of taking those down in your overall working capital management despite the fact that things are so difficult. Can you just give us some sense of maybe what's going on there and how we should think about that as we go through the upcoming quarters?

Good question, Susan. It's a constant challenge, I congratulate my entire team on being prudent on that. We are trying to operate the Company is to work on the things we can control. It's hard for us to control consumer demand right now, but we can manage our inventories, manage our balance sheet, manage our costs. That's what we are trying to do. It's always a judgment of how much discounting should you be doing to move out slow-moving product, how do you slow down your supply chain, where do you put your emphasis and we've placed a lot of emphasis on our inventories over the last year and a half and I think it's starting to show what we are doing.

We have no intention of having our inventories balloon, but could they fluctuate up and down here as we go through this difficult period with demand? Yes, I don't think it would be anything out of the ordinary and you have to make a judgment between the level of inventories you need to properly service your customer, as opposed to the amount of risk you want to take with slow-moving and obsolescence. And we don't profess, by any means, to have it all figured out but we are certainly working hard at keeping the proper relationships between our sales volumes and our inventory balances.

Our next question is coming from Ivy Zelman with Credit Suisse.

You had talked about last couple of quarters that you talked about a mix shift to lower price Upholstery products, are you still seeing that and is part of it that that's the consumer who can actually buy furniture today as opposed to higher end is suffering from the weakness in home price deflation?

Ivy, I would say this quarter we did not see any further acceleration of mix change and, frankly, for most of our companies, we don't really participate in the high-end to any great degree. Most of our companies are positioned mid or mid upper, so we are staying in that range and within that category of customer we are not seeing a huge shift towards less and less, lower margin items. And so for this quarter we were pretty consistent as how we were with the second quarter.

And then just on the Upholstery overall, how much of the Upholstery segment now is core La-Z-Boy brand?

We try not to give out, Ivy, our individual companies but certainly the La-Z-Boy brand is now in excess of half the Company with these changes we're making. And you can probably figure out the math through that, but we are not -- we don't want to disclose individual volumes of our individual companies.

With respect to margins, obviously, you are looking at Casegood margins that are up higher than your target and looking at your guidance, however, for the future, it sounds like obviously sequentially we are going to see a decline. I want to understand what's happening to margins. It sounds as if margins are going to be under pressure, just the volume and what is a sustainable margin given your old comments or your previous comments with respect to your target on Casegoods?

I think the question was asked a little bit earlier, Ivy. We've got some things to work through. There's a number of shared services in our Casegoods Group with the Pennsylvania House company and we want to get through the separation of that before we give a new target of what our anticipation is on an ongoing basis for Casegoods. And we will be prepared to do that on our next call next quarter.

I understand, Kurt, and I appreciate that, but you also are indicating, based on your guidance, that margins are going to be down, if you do the math. So realize you have shared services with Pennsylvania House, I think the reason the question is being asked again is you are not answering it to all of our satisfaction. What's going on that margins are going to be down?

We have a difficult environment out there, Ivy. I think we have less predictability of what our sales velocity is and we are being cautious in how we think about our business here the next 90 days because with our having a month lag to the quarter we are also heading into the springtime. Our market time is different than historically before and we are just being very prudent and cautious about our optimism going forward.

And also we do have a lot of variable cost within our Casegoods Group, but there is with our distribution centers and we do have some factories and everything, it is not all variables so with the decline in sales there is only so much limit we can absorb that without having it affect our margins.

So your decline in sales, with that expectation of sales to be down as you indicated, what's somewhat disconcerting is the fact that there definitely others that are indicating that business has been better recently and we are hearing year-over-year increases for many retailers out there so far through the first several weeks of the new year. And with the exception of places like Florida, where I would say that it is not the case, it seems like there's a little bit more optimism in the channel checks that we are doing. So is it a function of losing share and maybe the Chinese are getting more and more of that retailer space, but we certainly have not heard the same cautiousness in the last several weeks that you guys are indicating?

Ivy, I think maybe we just have a difference of opinion and what we've seen from some of the other companies guidance of the next, the first calendar quarter, we see them in line with where we are at.

But those are domestic public companies. I'm talking about people that are in the retail world are not necessarily reporting earnings and they are in the public market. There is definitely something going on out there, it seems as if there's a bit of a share issue and some of the other public companies actually admit that they are losing share. Would you say you guys are losing share?

I think the difficult we have today is I don't think we have a real good handle on what the industry dynamics are with all the imports. The Asian manufacturers don't give us their numbers. We are not positive exactly the growth. We are also hearing about a big slow down in China. We had some people over there last week and there was a number of manufacturers who indicated, obviously they were smaller, but the number of manufacturers who indicated that after Chinese new year they were not reopening for business because business has been so difficult there. So this is our best guesstimate at this time, Ivy, and we are going to stay with what we have on the horizon.

Okay, thanks, guys.

Our next question is coming from Todd Schwartzman with Sidoti and Company.

Good morning. Based on your fourth quarter outlook and also given the current housing environment in particular, do you expect year-over-year earnings improvement in first quarter of fiscal '08? This year earnings were, I think, just $0.02 in the first quarter?

Based on our last conversation with Ivy, Todd, we are having enough problem forecasting the fourth quarter let alone make a comment on the first. If we had more clarity about the demand level, I think we could be a little more accurate on where we thought our earnings would be. But until we get through whatever decline here that the segment is going through, and we believe it is a segment issue, we believe there's been reports from all facets of the industry, including Pottery Barn and other retailers that have been hit with a slow down, until we get some more traction on what we believe volume is going to be, we are just taking a very cautious approach and I think it would be irresponsible right now for us, Todd, to make some comment on this summer's business.

Okay, Kurt. Also as far as reaching critical mass or cost cutting that you've, you already achieved, are there any individual markets in the third quarter where you made the most headway that you'd want to the highlight?

I'm not sure that I want to go into each individual markets, Todd, but certainly we have seen the benefits in our northeastern markets, which is Philadelphia, New York, Connecticut, Boston. We have seen the most benefits in improvement with our new enhanced point-of-sale system, our singular distribution point and the focus of our team now on sales and taking care of the customer and conversion factors as opposed to worrying about structural issues with the business. We are very pleased with what was happening in our Northeast region of stores due to the consolidation efforts between both systems and warehousing, that we think we will see lite pickup on that as we roll that out through the whole system this calendar year.

On Pennsylvania House and Clayton Marcus, were there any costs involved in the quarter, administrative, consulting fees, for example, that we should know about in terms of your plan to sell these businesses?

No, there wasn't anything unusual in the quarter on the three businesses we put up for sale.

And lastly, cut and sew as a percent of Upholstery sales for the third quarter?

For the third quarter it probably didn't move a whole lot from before. It's still in the 30 to 35% range overall for our combined upholstery companies. And we think it's probably going to level out there, maybe just a little bit higher, Todd. But given our strategic positioning of wanting to have competitive opening price points but then take care of the customer with a custom order capabilities and us doing nearly 40% of our business through the La-Z-Boy stores and special orders, we think the balance of cut and sew to rolled goods is probably leveling out where it should be going forward.

By the way was Sam Moore consistent with that 30, 35% number.

Sam Moore, because it was almost 80% custom order, Sam Moore did very little cut and sew.

Thanks, Mark.

Our next question is coming from Laura Champine with Morgan Keegan. Please proceed with your question.

Good morning, Laura.

Mike, this one may be for you, it looks like this fiscal year from a free cash flow and an earnings basis, you won't cover the dividend. What's your dividend policy now and in the future and what's your level of willingness to lever the balance sheet in order to pay a dividend or buyback shares?

Laura, for this quarter we actually had some pretty good cash coming out ,of operating activities but we've also reduced our debt to cap to 25.4% this quarter. So we don't feel that we are very highly leveraged and we do see selling some of these businesses and creating some cash flow that right now we feel comfortable with where we are at and not leveraging the Company too heavily to do that and that our debt even came down 20 million during the quarter in order to -- and still pay the dividend. So we are still feeling pretty comfortable there as we move forward and I think we will generate enough cash through operations and through some of these discontinued sales and assets that we have to facilitate that.

The value of the new leases that you're assuming or ones that you guarantee or ones related to the VIEs, if I count the new debt that's off balance sheet from the operating leases there are you still down on a net/net basis in terms of leverage?

I would say we are pretty even on that, if not a little down from the beginning of the year because of the payment -- the decrease in the actual debt that's on our balance sheet being paid down. It's probably offset it. We are not any worse off than we were.

[OPERATOR INSTRUCTIONS] We have a follow-up question coming from John Baugh with Stifel Nicolaus. Please proceed with your question.

A couple things real quick. One, when and how do we find out the transaction value of Sam Moore? And then secondly, I wanted to make sure I heard it correctly, the pro forma gross margins within Upholstery and Casegoods both were up year-over-year? Those are the two questions.

Well, first question being when we complete the transaction of Sam Moore in the fourth quarter we will probably give more clarity to the details of that transaction. The second one being, we are not giving out the pro forma gross margins for our segments since we are not required to give out the gross margins of the segments period. So that would be something that we would not want to delve into, if I understood your question.

But I thought there was a comment that they were up if you took out Sam Moore, Pennsylvania House, that Upholstery and Casegoods gross margins -- .

The comment, John, was the improvement in our overall corporate gross margins on the remaining businesses came from three factors. One, pulling out the businesses held for sale had an impact. Two, retail being a larger percentage of the total Company now and operating in that business model with a higher gross margin to start with, but I don't want that to mask the fact that there was real improvement in gross margins by the remaining companies in each of our segments this quarter. So our improvement in gross margins is a combination of all three elements.

Okay, thank you.

Mr. Stegeman, there are no further questions at this time.

Great, let's wrap it up. Thanks everyone for joining us.

This concludes today's conference. Thank you for your participation.