La-Z-Boy Inc (LZB) 2008 Q2 法說會逐字稿

Greetings and welcome to the La-Z-Boy Incorporated second quarter fiscal year 2008 conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Kathy Liebmann, Director Investor Relations and Corporate Communications for La-Z-Boy Incorporated. Thank you, Ms. Liebmann, you may now begin.

Thank you. Good morning, everyone, and thank you for joining us on this morning's call to discuss our fiscal 2008 second quarter results. Present on the call today are Kurt Darrow, La-Z-Boy's President and Chief Executive Officer; and Mike Riccio, our Chief Financial Officer. Kurt will open this morning's call with some prepared remarks on the quarter will discuss the strategic direction of our business, and Mike will speak about some of the more unusual items this quarter. We will then open the call to questions.

As is our custom, the time allotted for this call is one hour. In order to allow everyone an opportunity to ask questions, please limit your questions to two, and if you have follow-ups, you may reenter the queue. A telephone replay of the call will be available for one 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 products. We will make forward-looking statements during this call, so I 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 to call to Kurt Darrow, La-Z-Boy's President and Chief Executive Officer. Kurt?

Thank you, Kathy. Good morning, everyone and thank you for participating this morning. As Kathy mentioned, I will begin with an update on our strategic initiatives and our performance for the quarter and then Mike will speak on several financial topics before I conclude with our prepared remarks and move to the question-and-answer period.

The credit crunch, the troubled housing market, lower consumer confidence, cautionary discretionary spending, you name it, they have all impacted the consumer's desire to spend money on furniture purchases. With these issues beyond our control, coupled with the difficult retail environment, we as a Company are focused on the business drivers we can control to position La-Z-Boy for the time when the market recovers, which it undoubtedly will.

As I have highlighted in the past, La-Z-Boy, with its strong balance sheet and the most recognized brand in the industry, has the ability to weather this storm and I have every confidence we will emerge from this period as a stronger Company, one that is strategically aligned to operate in a very different and new marketplace. We will remain a competitive manufacturer and distributor of home furnishings and our proprietary store system will run as an integrated chain, with all the efficiencies inherent in that model. Before I go through our results for the quarter, I would like to give those of you who are new to our story and remind those of you who have been following us for some time some perspective on how much our industry has changed over the last several years and the concurrent changes we've made to the La-Z-Boy business model to compete successfully in this dynamic environment.

First, we have rationalized our portfolio of companies. Several years ago, we had a group of 12 companies that were not providing the desired results and we went about a process of focusing our portfolio on what we believe are our core businesses for the future. We went through a process of first divesting ourselves of those companies that were not related to servicing the home, and second of evaluating the remainder of the portfolio using a filter of size, profitability, and strategic long-term fit to La-Z-Boy or our store system. As a result, we rationalized the 12 companies from three years ago to the three upholstery and the three casegood companies we currently have in addition to our retail business.

As we sit here today, those six remaining wholesale companies are all profitable and each company addressing a specific segment of the market, with very little overlap, with product, price point, and importantly, the various customers served by each company. Collectively, the companies that we sold, at their peak, were providing almost $300 million in revenue, but producing negative earnings over this time period. We generated over $100 million in cash from selling these companies and along with selling some other vacant properties, we used that cash to substantially pay down our debt. So while we have decreased the size of the Company, we now have a core business that we believe we can grow profitably.

Second, we transitioned our casegood business to be primarily an import model after the industry quickly moved overseas. At our peak, we had more than 20 casegood manufacturing facilities in the U.S. As a result, we also had more than a dozen quarters of double digit sales declines without earnings as we were unable to compete with Asian imports. In fiscal 2006, we righted the ship. Today, with two domestic plants and the highly variable cost structure associated with our import model, we are making money again, even on significantly lower volume in our casegoods segment.

Third, during this time frame, the textile industry in the U.S., for all intent and purposes, moved offshore. The second and third largest suppliers to the industry, as well as to La-Z-Boy, went bankrupt, and a large portion of the textile industry now exists in Asia, specifically in China. While the Chinese manufacturers have come up to speed with respect to the manufacture of fabric, initially there were some hiccups as the technology, expertise, and the availability of looms were not up to the caliber, the speed, or the quality needed to service our domestic business.

Consequently, there were many disruptions in the supply chain, including fabric outages, obsolesce service disruptions that we needed to work through. Whether it was from the yarn manufacturer to the weavers or to the cut and sew facilities. All of this impacted our service levels and our earnings over the course of going through this change. Additionally, during this transition period, we went from sourcing a minimal amount of cut and sew kits to now sourcing over 50% of our fabric and leather and cut and sew form from China and other countries. Fortunately, we believe the lion's share of the fabric industry's transition is behind us.

Fourth, with the changes in the distribution landscape and the increasing importance of brand prominence, we have turned our focus to proprietary distribution, as we believe that is a primary channel through which to sell our product. With a need to have deeper penetration in the larger, more vibrant markets, where demographic data indicates substantial growth opportunities, we found ourselves the owners of a number of markets that were in dismal shape. Because of the scale of these markets, it made no sense to vacate them, so we had to set ourselves on a course of getting them properly structured to become profitable. We have spent the last two years working to fix them, through opening additional stores or relocating and converting existing stores while consolidating back office operations. This has been a long and expensive process and quite frankly, it is taking longer than we expected, principally because the overall retail environment is impacting our volume levels, impeding our ability to absorb fixed costs. I will peak more about our retail operation in detail in just a few moments, but I mention it up-front, as it is indeed an important pillar to this Company's future success and longevity.

To summarize, against the backdrop of the massive change that has swept our industry over the past three years, we have, one, rationalized our portfolio of companies; two, transformed the business model of our casegoods segment; and three, altered the majority of our fabric and leather supply chain; and finally, we have moved to strengthen and improve our La-Z-Boy store system with more corporate involvement and oversight than any time in our Company's history. So as you can see, we have faced challenges in each of our segments over the past few years, and we have dealt with them effectively. We believe we can do the same with our retail business and considerably improve its performance from today's levels.

Now against that backdrop, let me turn our attention to the recent quarter and our segments. First, upholstery. For the quarter, sales in the upholstery segment were off 11.4% year over year, but we improved our operating margin to 7.1%, a 50-basis point improvement from last year's second quarter. This is a direct result of our intense focus on controlling cost and streamlining operations. At our La-Z-Boy branded facilities, we are 70% the way through our conversion to cellular production and are on schedule to complete that product by the end of the fiscal year. In addition, we continue to analyze every facet of our upholstery operation to further improve our efficiencies and ensure that we remain a competitive domestic manufacturer and one that is committed to delivering custom furniture to the consumer quickly.

I trust by now most of you have seen our new television commercials, with a tag line "comfort, it's what we do." The proprietary distribution, a core focus for La-Z-Boy, our new ad campaign is designed to both communicate comfort as La-Z-Boy's core brand equity, while simultaneously driving traffic into the La-Z-Boy Furniture Gallery stores. While it is too early to measure the success of the campaign, preliminary feedback has been positive and we look forward to the continued rollout of these commercials highlighting comfort, our professional sales staff, our range of product, and our inviting store environment.

Now let me make some brief remarks on our casegood operation. In the second quarter, our sales were off more than 20% year over year. On such a significant drop in volume, we were still able to post an operating margin of 6.1% for the quarter, reflecting the high variable cost structure of our business, now that it is based primarily as an import model. Our casegood companies had increased attendance at the October High Point market and several of our new product introductions received excellent reviews, as well as written orders. Going forward, we will remain focused on unique new product introductions in order to increase sales throughout our segment while working to grow our business with small to medium-sized retailers who value the services we can provide for them in terms of inventory management, sales training, and quality product.

Now let's turn our attention to retail. In our Company-owned retail segment, we posted a $9 million loss for this quarter and a 12% decrease in sales compared with last year's second quarter. It's important to note that in last year's second quarter, we were still operating stores in Pittsburgh, Pennsylvania, and Rochester, New York, so a portion of our sales decline is attributable to our vacating these markets. While we continue to make progress in removing costs from the operations, principally through the warehouse and IT consolidation, as well as improving our gross margins, it is difficult to absorb our fixed cost in this segment when we are achieving less volume with more stores.

As I mentioned last quarter, we have additional occupancy of cost per quarter from the 14 new generation stores we have added in the Company-owned segment, including nine new stores and five remodels or relocations. Expanding the store system is definitely the right strategy in order to achieve the penetration in the markets in which we operate, but in this environment, the expense of those stores, coupled with decreased volume, is impeding the progress we are making behind the scenes.

Finally, once we complete the consolidation of our own warehouse and IT systems for our own retail division, we will expand this strategy and footprint throughout North America to service our entire base of stores. This is a sizable opportunity for both the Company and our retail system as a whole, and we believe we can service our network of stores -- our network of 338 stores with 10 to 12 strategically-located distribution centers throughout North America. This new model compares to more than 85 to 100 individual warehouses being utilized throughout our system today. This change will assist our dealer base, as it will allow them to focus on the front end of the business, removing redundant cost, while providing a better in-stock position because of the size and scale of this framework. System-wide, it will lower our cost, make us more competitive, and allow us to provide better service to the consumer. This initiative will begin in calendar year '08 and will be finished over a three to five-year period, depending on each of our dealer's individual situation regarding their current distribution arrangement.

As I said earlier in the equal, proprietary distribution, whether it's through a company or dealer-owned store, in our estimation, will be one of the keys to La-Z-Boy's future and we believe building a strong proprietary store system, where we can nurture and enhance the brand will serve as a critical platform for us to sell furniture. In the second quarter we opened two new Company-owned stores and closed one. Of the 70 stores we own today, 50% or 71% are in the new format versus only 37 or 54% at this time last year. For the remainder of the year, we will add eight new stores, including relocations and remodels. I will now turn the call over to Mike Riccio, our Chief Financial Officer, to go through our financials.

Thank you, Kurt, and good morning, everyone. As you can see from our financials, our earnings per share for the quarter from continuing operations before restructuring, the write-down of the goodwill, and the results from our VIEs, were $0.05. We had a $0.01 restructuring charge related to transition costs of the Lincolnton, North Carolina, closure, a $0.07 intangible write-down related to the goodwill in the Southeastern Porter market and a $0.04 loss on our VIEs.

On substantially less volume in our wholesale segments, as Kurt said, we were able to maintain fairly reasonable operating margins. Furthermore, even with the additional occupancy costs at retail combined with the 12% volume reduction, our retail losses were essentially the same as in last year's comparable quarter. Given the state of the housing market and overall business climate in Florida, our store system in Southeastern Florida has suffered double digit declines over the past 12 months. These issues lead us to defer our store buildout plans in that market for the time being. And as a result our valuation model was significantly affected and therefore our goodwill was impaired, which led us to write it off.

While we still believe the Florida market will be a good market in which to operate in the future, and it was when we entered it, we feel with the losses that we are sustaining currently, a delay of adding new stores in the southern Florida area is a prudent thing to do at the moment. We also completed the sale of both our Clayton markets and Pennsylvania house markets this quarter. The Clayton markets deal resulted in about a $5.8 million loss for the quarter, of which $3.4 million of the pretax loss relates to intangible assets.

The Pennsylvania House deal, where we sold the trade name of the business for $1.7 million, resulted in a loss of about $600,000 on the name itself. While we expect the liquidation of inventory from Pennsylvania House will result in additional 2 million to $3 million many cash, we did write down the inventory by $3 million during the quarter in marking the inventory to market. More importantly, though, is that this process is behind us and management can now focus its time and resources on the core La-Z-Boy branded business, specifically the retail segment. We did do a good job managing our inventories during the quarter, which are down compared to last year's second quarter, as well as this year's first quarter. We generated cash from operations of $14 million during the quarter, primarily the result of a reduction in our working capital.

We did not repurchase any shares during the quarter and we still have authorization to repurchase $5.4 million additional shares. The Company will continue to evaluate the use of this cash on a quarterly basis and will consider share repurchases depending on the overall sales environment, as well as overall stock market conditions. Our effective tax rate for the quarter was 46.6%, and for modeling purposes, you should continue to use a range of 38 to 40% on continuing operations for the remainder of the year. Our CapEx for the year is expected to be in the range of 25 million to $28 million, about the same as depreciation.

Finally, I would like to take a moment to speak about our bank agreements. The Company received an amendment from its bank group for a one quarter adjustment to its fixed charge coverage ratio requirements. While we were in compliance with the covenants for our private placement notes. Today we are working with our bank group to renegotiate our agreements, to refinance our debt with an asset-based lending agreement. We think that longer-term, this new arrangement will afford us greater flexibility to make our Company more profitable in the future as we complete the cellular processes, consolidate our distribution centers, expand our retail markets in the places where it make sense to do so, and continue to enhance our businesses at retail without being concerned about our quarterly covenants. I thank you for your time this morning and I'll now turn the call back over to Kurt. Kurt?

Thank you, Mike. Before we move to our guidance, I'd like to reiterate that we are aggressively managing our business and taking the necessary steps to grow our business profitably. Unfortunately, the headwinds from the retail environment are making it difficult to see the fruits of our labor. There may be a long road ahead of us, but we are confident we are positioning our Company for the future. However, given the difficult environment and our lack of visibility and based on our annual -- based on our performance for the first six months of this fiscal year, our current annual guidance will not be attainable.

With the unusual items in the first half of the year, we are updating our guidance for the second half to give you better perspective for the remainder of the year. We expect sales for fiscal 2008 period to be down 4 to 8% and earnings per share to be in the range of $0.06 to $0.14 per share compared with $0.30 per share from continuing operations in the second half of '07, which included an $0.11 per share charge for restructuring, a $0.14 per share gain on property sales, and a $0.04 per share in income from antidumping moneys. The 2008 second half range does not include any restructuring charges, potential income from antidumping, or the sale of any discontinued operations. We want to thank you for being on our call today and I will turn things back to Kathy to begin our question-and-answer period. Kathy?

Thank you, Kurt. We will begin the question-and-answer period now. Please review the instructions for getting into the queue to ask questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question is coming from [Chad Bolin] of Raymond James and Associates.

Good morning, Kurt, Kathy, and Mike, this is Chad filling in for Budd, who is traveling this morning.

Good morning, Chad.

In the past you guys have discussed operating margin targets for the segments of I believe 7 to 9% for upholstery, 6 to 8% for casegoods, and 3 to 5% for retail. Are those targets still valid? And when do you anticipate the retail division will break even?

Good questions, Chad. I think -- I think those targets are still valid, but we, given the tough retail demand out there without more volume, I think it's going to be tough to get into those ranges in the near-term and that's pretty much the same answer on our retail position. We continue to take costs out, we have more costs we can take out, but at the rate of decline and the consumer spending out there on furnishings, without some lift to make some spread on additional volume, getting to those margin targets will be a stretch for us in this environment.

Okay. And could you give us any color around the retail margin in the quarter and maybe a sense at the level of discounting and markdowns out there?

Well, it's a difficult environment out there, Chad, and we've had to do our share of being aggressive to make sure we get the consumer attention. But frankly, it's not a margin issue for us. We've been able to frankly, over last year, increase our gross margins. But it is a traffic issue, it's a consumer pullback issue, it's a lower average ticket issue. So it's -- it's just a tough environment and our people are working very hard to take care of every customer that comes into our stores. But everybody's being a little cautious at this time.

Sure. Understood. Last question and I'll defer to others, as far as the renegotiation of the bank agreements, what do you anticipate the timing of that will be and do you anticipate any additional expense associated with that?

Chad, I expect that we'll be completed with everything in early January. It will take us a little bit of time to -- since we are going to a more secured environment, it takes a little time for everyone to do their due diligence and get that completed. We will have, which we noted in there, we think our make/hold provision will be 2.5 million to $3 million. That is not, obviously, included in our guidance, because it's a one-off charge that we'll have to do on that. But we think we'll have that charge, will be about the only significant charge. The rest of the fees will be -- that we'll have to pay to get into the bank agreement will be amortized over an essential five-year term that we're trying to negotiate.

Thank you very much.

Thank you, Chad.

Thank you. Our next question is coming from Matt McCall of BB&T Capital Markets.

Thank you. Good morning, everybody.

Good morning, Matt.

Looking at the free cash flow numbers, it looks like you did a good job generating some free cash, managed working capital well. As we look to the outlook for '08, can you give me some kind of idea what working capital is going to look like in the back half? Remind me of some seasonality impacts there, and really what the free cash flow generation can look like in the back half of the year?

Well, Matt, if you look at our historical times, our third quarter is our highest generation of cash flow, historically, for us because we build up our receivables during the second quarter and then as volumes decrease somewhat in the third, since it's our second, I guess, worst quarter in line of how our quarters go. So we usually generate pretty good cash in the third quarter and the fourth quarter is pretty much just a wash. We're just going to keep controlling our inventories. That's our major focus right now, is making sure that on the volumes that we're currently selling at, that our inventories don't get out of alignment, so we don't have to go into any discounting to then get rid of it. Our receivables will be a function of what our sales end up being, but I think we'll generate good cash in the third quarter, the fourth quarter will be probably relatively flat.

So good cash, it sounds like it's a little stronger than your -- the Q2 levels?

Historically, I'm just trying to give you historical perspective, historically, our third quarter has been significantly better cash flow wise than our second.

Okay, okay. And then one clarification. The CapEx number that you gave, is that ex the benefit of the divestitures? I know you've got some inflow there. Is that number you gave ex, is that just a pure CapEx number, the outflow?

Yes.

Okay. And then you may want to comment, Kurt, a minute ago, you still have some costs you can take out. I know you quantified in the past some of the cost savings that you expect for many of these initiatives. What EPS benefit is left and can you give us some idea of the timing of some of these kind of non topline-driven cost savings efforts?

Matt, we have two major initiatives that are going to be completed in the second half of the year. One which has been a two-and-a-half year project which has been transitioning our manufacturing facility to cellular manufacturing and we're on the downward slide of that, but we do have 30% more of our factory space to transition over to cellular and we will get through that in this fiscal year. And the second part of that is that we're finishing our distribution rationalization of closing down multiple retail warehouses and getting down to four to service our network and also putting a common IT and point of sale system into all 70 stores, and we expect that to be done by the fourth quarter as well. So those two projects, major, major initiatives that we've talked about in the past a couple of times. We expect to get the further benefit of being through that as we roll out to the end of the year.

And the benefit of those initiatives would be fully reflected in this -- well, I guess, on a run rate, in the Q4 numbers that should be out there. Q4 should show a little bit of a benefit on the margin lines as you complete these?

That's correct. But the run rate of them isn't as big as we originally thought because of less volume and the conversion on the less volume, you don't get totally the original expectations, but yes. And I think the real benefit is going to be reflected in fiscal year '09, when changing all the processes, running duplicate system, having all the things going on, we will be fresh to go in '09 with our manufacturing transition and our wholesale distribution -- and our retail distribution transition behind us.

Okay. And to follow-up on that, the benefit's not going to be as much as you originally thought. At the current run rate of business, what -- you've broken out some levels of benefit that you expected from those, what level can you actually achieve next year at the current run rate of business, maybe as a percent of the total you originally expected?

I would think as a guide post, if our business is down 10%, the cost savings we would get is probably down 10%. It's proportionate, but the dollar numbers we put out there before won't totally be realized if we don't have the volume.

Got you, got you. Thank you, all.

Thank you. Our next question is coming from John Baugh of Stifel Nicolaus and Company.

Thank you. Good morning.

Good morning, John.

Cash proceeds from the sales of Clayton-Marcus and Pennsylvania House, what have been they been to date? Any more inventory wind down? I think you mentioned 2 million to 3 million going forward. Is there anything at Clayton-Marcus?

Clayton-Marcus we sold, and we gave that number, I think in the cash flow we've got a little over $4 million in the sale of discontinued operations. Since we just sold Pennsylvania House's name, we'll collect the receivables on it and we'll sell the rest of the inventory off. Of course, now that we've sold the Company and are liquidating the inventory, we had to take some reserve against the inventory, because on a ongoing basis, inventory is worth a lot more than when you say you're not going to replace it and not go ongoing on it. So I think you'll see the -- we're done selling the Company. The proceeds, we have some small receivables out there of about $0.5 million that were held back until we did some final working capital adjustments, but other than that, other than collecting the additional inventory and receivables, there'll be no cash generated from the sale of those companies going forward.

Okay. And, Kurt, are you comfortable -- you mentioned you're down now to 6 from 12. Is that where you want to be? Is that it?

Good question, John. That is it, obviously, for the time being. We certainly feel very good about where we're at. As I mentioned in my prepared remarks, all the companies are profitable. Our wholesale companies are doing a good job of keeping up respectable margins given the down volume they're doing and they're working hard every day to control their costs. My comment on the future would be, we still have the same size, profitability, and strategic fit issue and should one of our companies fall into that area in the future, we would have to evaluate it, but they all met our strategic rigor testing at this point and we're very comfortable where we've ended up with our six wholesale companies.

Okay, great. And then on the retail, it looks like you're running, I guess, around $180 million annual run rate of revenues. It looks, to me, like it could get a little worse before it gets better, at least cyclically. Is the strategy -- you mentioned some cutting of costs that's still coming from the finishing of the distribution, the IT and sales systems, but it strikes me as though the savings from that aren't going to be massive or significant, that the volumes are down and that's why we're losing 8 million to $9 million of EBITDA a quarter. If you would assume that we're going to stay in a very difficult retail environment for the next 12 to 24 months, is there a different strategy you're looking at employing, or is it you're just going to allow the wholesale business to essentially offset the retail and ride through the cycle for however long it takes?

That's just one question, John? It's a very good observation. We're looking at all types of alternatives and I think the way that we look at this and the investment community ought to look at this is that we're looking at it as an integrated retail operation and system and we think that there's margin expansion opportunities on the wholesale side by being involved in a proprietary distribution system. There's also the associated risks and it is apparent that you have to look at both the operating profit generated on the wholesale side negated against the losses on the retail side, but we're looking at options. We're looking at underperforming stores, stores that don't cash flow positive. We're looking at all kinds of options, none that I really want to reveal today, but it isn't our intent just to sit here and ride it out. We've got some other things that we're investigating and looking at, but obviously it's the biggest challenge the Company has going forward and one we're prepared to address.

Well, I guess from my perspective, it's obvious it's cyclical, can't do much about it. I guess another way to phrase the question, is are you confident you've got the right size to box with the right structure? I know you've referenced how you were making money, I think, in the D.C. area before the cycle went bad and I assume you sort of used that formula elsewhere and I'm wondering how easy or difficult it is for you to delineate, the issues are strictly cyclical and therefore we should stick to the format, sales, staffing, everything you do to maybe the box doesn't work the same in this area versus that area. Any thoughts there?

Well, your observation of how much is us and how much is the market, if you have any clarity on that, we would enjoy hearing that, because we look at that continually. But, no, we're not positive we have the perfect box. We're not positive that we're offering everything that the consumer wants to see when she comes into the store and we're going to be doing some test stores in the first of the year on some different size, some different product assortments, some things that aren't totally fully developed. But I think whether times were good or bad, I don't think retail is a stagnant business and we always have to be looking at perhaps what is the next format, what can we do a little different, how do we make ourselves different than the other retailer selling home furnishings. So that is something else that we are in the planning stages for and we'll have some test stores out there in the first half of '08.

Will they be smaller, Kurt?

Not necessarily. We have stores throughout our system that range from about 11,000 to 16,000 feet. Given the cost of real estate in some of the more expensive markets, you have to go with smaller square feet, but I don't think for the size of our program and to be a legitimate competitor, I don't think we can go much below the 10,000 feet and really offer a compelling experience for the consumer.

Thanks for answering my questions.

John, the only one thing I wanted to clarify is you made an annualization comment about our sales. Just for reference point, over the past years, our first and second quarter at retail are usually our weakest quarters and our third and fourth quarter are usually stronger quarters for sales.

Got it. Thank you.

I didn't want you to leave that annualization out there.

Thank you our next question is coming from [John Kernen] of Morgan Keegan and Company.

Good morning, guys. This is John Kernen calling in for Laura Champine.

Okay.

Can you explain how total written sales were below same-store written sales?

We shut more stores down than we opened up, so on a total store basis, our sales were down. On total stores, you're normally looking at it, saying that we added more stores, but we've actually closed more underperforming stores than we opened up, so our total sales were down because of that.

Okay. That explains it. Thank you.

Thank you. Our next question is coming from David Cohen of Midwood Capital Partners.

Hi, everyone. I had some questions about the -- in the past there's been a series of cost savings targets and you've already answered one around the lowered improvement from cellular production conversion. You mentioned, for example, in March there was a restructuring that was targeted to save $11 million. There was retail consolidation of the systems that was $9 million and retail gross margin improvement of $7 million. As you look across that set of specific actions what is the current thinking on the level of savings that comes from those actions?

I think those savings are still within the ranges that we would be looking at with the caveat of the down volumes. As I said earlier, the wholesale margins on approximately $50 million less volume this quarter were essentially the same as last year. So obviously the costs are coming out and some efficiency improvements are happening. So we're still confident about our three large initiatives of higher capacity utilization because of the plant closing, the benefits from cellular, the benefits from the retail distribution alignment. But again, they're not fully realized if you keep having double digit sales decreases.

Okay. And what is the -- as you think about the retail business, ultimately, what kind of target margin do you think you can get in that or what kind of four-wall contribution return on invested capital? Because it seems to me, there aren't the best, at least for us public guys, the best sort of benchmark to look at is to the profitability of that strategy is in Ethan Allen and they look like they still make all their money and have all their return on capital coming from their wholesale business. So what is the -- I understand the strategy element of controlling your distribution, what's the financial return in a better environment likely to be from that?

Well, I would answer that question that even though Ethan Allen is not showing huge margins in their retail business, it allows them to make an above average margin in their wholesale business. And you have to look at the two blended and you still get a pretty good return. And that's certainly how we're looking at it as well. The extra volume provided and the margin opportunity provided by having a proprietary distribution system is all part and parcel to the strategic reason behind it. And looking at them stand-alone is a little more difficult to do, because there's so many interdependencies, but I think the overall operating margin, even with essentially a break-even retail business like Ethan Allen has today is still pretty respectable in this industry given these times.

Thanks, guys.

Thank you. Our next question is coming from [Jan Dello] of Lehman Brothers Inc.

Good morning. I have a couple of questions. I wanted to ask first about the availability -- can you tell me what your availability is under your bank line right now? I know you're renegotiating it.

In our 10-Q, we put in there that it's $48 million, approximately, right now. On the amendment, they put an asset test in there just to, as we're renegotiating it, just to be able to maintain, we we have nothing borrowed on it right now and then we're allowed $5 million of additional debt besides that.

Okay. And is this -- so the size of its going to be basically premised on your asset base?

Right. The current availability has no basis for what our availability will be on a new line. That's just a transition debt over the period. But it will be based on our eligible inventory and our eligible receivables and how we do that going forward.

Are you targeting a certain amount?

I'm not prepared to discuss that right now. We will be putting something out probably in January where we stand on that.

Okay. Are you expecting to use your bank lines for the 2008 maturity, the private placement that's coming due, or is that something that you think you'll be paying out of cash?

I expect that I'll be replacing my private placement with this new line when I get it in place.

Okay. I just wanted to make sure that I understood the correctly the conversation about the proceeds from the asset sale. You're expecting proceeds from all the asset sales to be in the neighborhood of $4 million, and the majority is already on the balance sheet. Am I understanding that correctly?

Well, I think what I was saying, just to be clear, is we sold the companies in the quarter and collected the cash. The assets that are still left on the books in our discontinued operations are the items that we did not sell as part of the deal. For Pennsylvania House, we just sold the trade name, we kept the inventory and receivables, we'll collect the receivables and inventory. That will be in the range of anywhere from 3 million to $5 million additional from what we have on the books, and then after that we'll have nothing left in really discontinued operations.

Okay. So another 3 million to $5 million from basically working capital runoff?

Yes, but it won't be for the sale of discontinued ops. It will just be the collection of their working capital.

Okay. I understand, then. I guess the other question I had was about the covenants, you've gotten now waiver from -- you're talking to your banks, but usually private placement covenants are not that far off the mark from the bank covenants. I guess I'm wondering, are there discussions ongoing with the private placement people as well?

Yes, but as we said in our 10-Q, we will be -- we'll get this loan completed in the third quarter and then if and when we determine that we're not going to make the covenants going forward, then we'll discuss with our private placements about making them whole and paying them off as we have provided in our agreement that we're allowed to do.

Great. Thank you.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question is coming from John Pinto of Brightleaf Capital.

Hi, yes, Kurt, if you could talk a little bit more on the retail side and looking at what Ethan Allen has done so well in terms of sales training on the floor and then also looking at your assortment or breadth of product versus theirs. Is there anything, can you just talk about what you're doing on the sale side in terms of your own company stores some of these dealer stores as well as maybe looking at either other products to bring in or other brands?

Well, I think Ethan Allen certainly has been at this longer than we have and we have great administration for what they've been able to do. We are -- we have a retail division that's very focused on hiring quality people, getting them trained. We too have an in-home design program that we're utilizing throughout a lot of our own stores and -- but it's a difficult environment for salespeople. There's a tendency to want to look around for other opportunities and I don't believe we're as good as we can be with all of our sales processes and working with the customers to the degree that we should. But certainly we understand where some of the gaps are, we do some mystery shopping to make sure we know what's going on at retail. We have fairly robust training programs and detailed selling processes that we go through. But I don't think you're ever satisfied with how you're doing in that area and I'm sure we have some improvement that we can make.

Okay. Is there a, I guess, the environment is not going to get better until maybe sometime middle of '08 or who knows when. Is there some sort of event that happens that makes you start to pull back your retail exposure? I know you've closed some stores, but you're repositioning more than anything. Is there something at some point that you say there's too much fixed cost here, I need to pull back, just like you've done on the manufacturing and sourcing side, but now in this other area where you've got fixed costs?

Well, that's a good question as well. I think we -- last year we vacated both the Pittsburgh and the Rochester market because we didn't think they had the size or scale that we wanted long-term, and as I mentioned previously, we're looking at all alternatives at this point. We have a network of 338 stores out there and a lot of them are doing fairly well right now, even in a tough environment, and we could do some repositioning, but we're very committed to our store program. It's something we've had for over 25 years and we think is a key strategy for us.

So we're not going to put our head in the sand and as one of the other questions was asked about just riding it out, because I think there's lots of things we can do to improve. But could we vacate a few stores, could we look at a certain number of markets? Absolutely. But we've got three or four markets where we've got nine, ten, twelve stores operating right now and we wouldn't consider, at this point, pulling back from that because we think we're positioned well for the long-term.

Okay. Great. Thank you.

Thank you. There are no further questions at this time. I'd like to hand the floor back over to management for any closing comments.

Thank you, everybody, for participating this morning. I will be available for the remainder of the day should anybody have any follow-up questions. Have a good day.

Thank you.