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Edited Transcript of ETH earnings conference call or presentation 28-Jan-19 10:00pm GMT

Q2 2019 Ethan Allen Interiors Inc Earnings Call

DANBURY Mar 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Ethan Allen Interiors Inc earnings conference call or presentation Monday, January 28, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Corey Whitely

Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer

* M. Farooq Kathwari

Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO

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Conference Call Participants

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* Cristina Fernández

Telsey Advisory Group LLC - Director & Senior Research Analyst

* Ian Dominguez

* Jeremy Scott Hamblin

Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail

* Justin Laurence Bergner

G. Research, LLC - VP

* Brett Reiss

Janney Montgomery Scott LLC - Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Ethan Allen 2019 Fiscal Second Quarter Earnings Release Conference Call. (Operator Instructions) It is now my pleasure to introduce your host, Corey Whitely, Executive Vice President, Administration and CFO. Thank you. You may begin.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [2]

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Thank you, Rafael. Good afternoon, and welcome to Ethan Allen's Conference Call for our second quarter ended December 31, 2018. This conference call is being recorded and 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. As a reminder, our comments today will include forward-looking statements that are subject to risks and uncertainties, which could cause actual results to differ materially. Please refer to our SEC filings 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 I provide some brief details on the financial results, our Chairman and CEO, Farooq Kathwari, will provide updates on the business and our ongoing growth initiatives. We'll then open up the telephone lines for questions.

Our consolidated net sales for our fiscal 2019 second quarter of $197.2 million compared to $198.5 million in the prior year, and we ended the first six months of the fiscal year with a consolidated net sales increase of 1.4% despite challenging macroeconomic conditions. Our strong retail net sales of $158.5 million compared to $153 million in the prior year and resulted in net profitability for the retail segment for the second quarter and the first half, demonstrating opportunity our retail segment has in driving increased profitability.

Wholesale net sales of $107.7 million compared to $118.0 million in the prior year quarter. During the previous year, second quarter wholesale sales were at elevated levels as the shipping delays and high order backlogs from the prior year first quarter were getting caught up during the second quarter. This year, the wholesale segment order backlog levels in the first quarter were at normal levels, as our manufacturing is running much more efficiently this year with no shipping delays.

Wholesale experienced a 31% decrease in international sales compared to the prior year second quarter. And we also experienced pricing pressures on GSA contract orders that resulted in extraordinary sales discounts off our standard GSA pricing. We provided these extraordinary discounts in order to win important GSA bids, while another bidder was liquidating their inventory during their bankruptcy.

Consolidated gross margin for the quarter was 55.2% compared to 54.3%.

Retail sales as a percent of total consolidated sales was 80.4% for the quarter compared to 77.1% in the prior year quarter, increasing our consolidated gross margin due to this increased mix.

Our second quarter operating expenses were $92.7 million, and adjusted operating expenses were $92.4 million. The 2.1% increase in adjusted operating expenses was primarily due to distribution cost increases and increased variable costs at retail, partly offset by a decrease in advertising.

Year-to-date, advertising is running about 4.1% of sales.

For the quarter, the operating margin was 8.2%, was compared to 8.8%.

GAAP EPS was $0.45 per share for the second quarter compared to $0.54 per share in the prior year period. Adjusted EPS was $0.46 per share compared to $0.53 per share.

The tax rate for the second quarter was 25.1% and that compared to 16.0% in the prior year second quarter. With the effects of the 2017 tax act on last year's income, normalized to the current year rate, comparative adjusted EPS would have been $0.45 per diluted share in the prior year period.

Turning to the balance sheet. During the quarter, we paid $5.1 million to dividends and ended the quarter with cash and securities of $38.8 million with no bank debt outstanding. With that, I'll turn the call over to Farooq.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [3]

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All right, Corey. Thank you. As mentioned in our press release, our unique vertically integrated structure provides us an opportunity to differentiate and grow both sales and profits. Our key initiatives include expanding reach through new products. The recent introductions include artisan, more modern in style, smaller in scale, simpler and linear, Uptown, transitional, updated, take on traditional, dress year in style, passport, global in style and distress finishes. This spring, introducing relax modern, which is transitional in style with classic forms reinterpreted in a casual manner. These designs project a diversity of style in an eclectic fashion to attract a larger audience. All our products are developed in a consistent -- level of superior quality. These new products gives us an opportunity to expand our customer base. Our next important focus is always on talent. Our vertically integrated structure requires talent in many diverse areas, from managing a sawmill in the Northeast Vermont to manufacturing locations in North America, to a retail network, a logistics network and teams to develop various aspects of marketing, merchandising and also managing operations. Our major strength includes our 1,500 interior design associates who take customers and convert them to a long-term client.

The continued positioning of the design centers to more relevant locations is ongoing.

During last 15 years, over 60% of the 200 design centers in North America have been relocated. The company operates 150 of the 200 locations.

Recently opened new design centers in Denver, Colorado, and under construction are design centers in all relocations, in Albany, New York; Carroll, Iowa; Tysons Corner, Virginia and Ann Arbor, Michigan. Internationally, last 3 months, we opened a large flagship design center with a licensee in Wuhan, China and also new design center in Phnom Penh, Cambodia.

Expanding our integrated marketing initiatives are critical. These include continued utilization of direct mail. In fiscal 2019, this last 6 months, we mailed about 10 million copies of our direct mail magazine. Also, expanded reach through digital campaigns. We are also implementing an advanced version of a CRM, a customer relationship management program.

Continued focus on improving efficiency of manufacturing and logistics, with 70% of furniture made in our North American workshops. Our national logistics delivers products in North America at landed costs, and our retail logistics delivers in a white-glove service to clients, resulting in excellent service and control on returns. We believe that our manufacturing and logistics gives us a competitive advantage. We've also continued to focus on conducting our enterprise in a socially responsible manner, including environmental, health and safety management. With this brief introduction, I'm pleased to open for questions or comments.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Jeremy Hamblin from Dougherty & Co.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [2]

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I wanted to start by seeing if we could get some color here on the wholesale division that looks like that was probably the significant difference between expectations, I mean, final results. In terms of the GSA contract, I had 2 things I was hoping you could provide color on. The first is, you noted that the Drexel or the Heritage bankruptcy led to some discounting to continue to win that contract. They've kind of gone through their bankruptcy proceedings at this point in time, but what type of impact is that going to have going forward on Q3 and Q4 results? That's part one. And then part two is, obviously, the -- with the government shutdown over the past month, what type of impact is that going to have on Q3 results, if any? Hoping you can provide some more specific color.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [3]

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Jeremy, good questions. The State Department bidding, as Corey just mentioned, had an impact, both on the top line and on the bottom line, because these were basically provided almost at cost with the result was that if it had our normal gross margins, the sales would have increased as well as operating margins would have increased. Now the good news is that most of this has already been delivered. So the orders that we have been getting in the last month -- 2 months, and they have been pretty good. We are now getting them at our regular gross margins, and they will be delivered in the -- our third and fourth quarter, which should help us the top line and the bottom line.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [4]

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Okay. So can you give more specifics in terms of -- Corey, can you help us on the total amount of backlog on that State Department contract at the end of Q2?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [5]

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Jeremy, I don't think based upon our agreements with the GSA, we are able to give all those numbers out. But as I said, I can use the word, it is good, it is strong, and it is going to help us, both at the top line, and we'll be able to recoup our margins that we lost in our second quarter.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [6]

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And maybe just to clarify a little bit on the volume, it hasn't been really substantially impacted because of the government shutdown.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [7]

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Oh, yes, the government has not -- interestingly, this whole area, this whole division was impacted to some degree but not much. The good news is now they are back, so they are actually -- they were just a little bit slow in sending orders but now, starting actually even today, they're very busy. So I think that -- they did not stop the orders coming in, they've just slowed them down.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [8]

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Okay. So you're saying that you expect the State Department-related contracts to be up on a year-over-year basis in Q3 and in Q4?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [9]

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Yes, right. Both in terms of sales because as we discussed, let us assume that -- let's say $1 million, and when you give it at cost I'm sure you're talking of -- taking off 30% on sales and 30% on operating margins. That's what it really means or maybe 30% plus. But that's the impact of that.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [10]

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And even with the discounts, they were up for the second quarter, just didn't make too much of a margin on them, but they were just slightly up on the second quarter.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [11]

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Understood...

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [12]

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But overall, and keep in mind the previous year also, we were impacted because of that was the year when we were shipping the products where the sales were at a higher number, but the margins were impacted, because we had to ship a lot of product, if you recall. In the second quarter, in the previous year, we had to ship a lot of product in a very short period of time, which impacted our efficiencies and even deliveries to the rest of our retail network, that was not the case this second quarter of this fiscal year.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [13]

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Okay. And then -- and just another follow-up question here on the wholesale segment. I think, what I caught in your prepared remarks was that, did you say the China sales -- sales in China were down 31%?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [14]

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That would be that -- sorry, Jeremy, go on.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [15]

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And just, could you provide some color, or can you clarify that in terms of China? And then, you also noted that you saw your business in Canada down at retail as well. I'm just hoping you can provide a little more color on the international side of your business?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [16]

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Jeremy, let me give a basic overview and then Corey can add on. China was impacted, as we know, by number of factors. First, Chinese economy has slowed down. Secondly, the tariff situation also created a big problem, they held up. They were not sure whether it was going to be 25%. So we had to also work very hard in trying to determine what should we do? Where should the product be made in our operations? Should we make in Mexico, in Honduras? So all of this created a lot of confusion. And so the result was, they were holding up orders, so we also had to determine the source of manufacturing. And so the combination of the garment -- I mean, this whole issue of the taxes and as well as a somewhat of a slowdown in China had an impact. Now -- so the good news is that Chinese economy still is not as strong as it was, but there is somewhat of a less of a concern on the question about these tariffs, because it looks like -- I mean, we didn't go to the 25%, which was a concern last quarter, it is now about 10%. So 10% is a little bit more tolerable.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [17]

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And then to clarify, Jeremy, on the wholesale sales at 31%, referred to both China as well as Canada for the wholesale component of the Canada. So Canada impacted wholesale, and of course, it also impacted retail at the retail sales level.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [18]

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And Jeremy, just again, in Canada, the same situation was there for the beginning of the quarter, there was a lot of concern on the fact of tariffs on American products to China. So people got concerned, they were holding up. On the second thing is, in Canada, especially, on the West Coast of Canada, which was the same situation in the West Coast of the United States, Chinese residents also for number of reasons, slowed down their purchases, which have been a pretty good important customer base for the whole coastline from Vancouver down to San Diego. So that was another factor.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [19]

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Okay. So the potential for 25% tariffs in 2019 slowed orders at the end of 2018, like in your second quarter?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [20]

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Yes, right. Because that's really when the whole thing was implemented, or they were talking about the question of having a 25% tariffs, and this was -- the tariffs were supposed to start on January 1, then later on, they decided to hold off the implementing the 25% tariff. It created a lot of confusion.

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Operator [21]

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Your next question comes from the line of Cristine Fernández (sic) [Cristina Fernández] from Telsey Advisory Group.

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Cristina Fernández, Telsey Advisory Group LLC - Director & Senior Research Analyst [22]

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I wanted to ask about the cadence of the order intake during the quarter, it was down 3% to 4%. Can you walk us through what you saw, just given that you had ended the prior quarter on an increase note, it seems like it was a little bit more volatile here.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [23]

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Yes, it's an interesting situation that developed that we were up in November. We were doing extremely well to the middle of December, and then all of a sudden, with the issue of a number of factors, the stock markets were down substantially, the government shutdown, the tariffs -- you could -- we could see it that customers really held back in the last -- and most of our -- this change took place in the last 2 weeks of December. And as we said in our press release, the good news is that in January, people started coming back. And we've had sequentially increase in traffic in our design centers so far in January.

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Cristina Fernández, Telsey Advisory Group LLC - Director & Senior Research Analyst [24]

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Okay. So a second question was on the gross margin, it was up 90 basis points even with a lot of that pressure from the government contracts being low margin, can you help us understand what were the drivers of that expansion?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [25]

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Yes, as Corey mentioned, one of the main one was the relative increase, the percentage of retail sales to total sales. When that happens, Corey said, what it was, 80%?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [26]

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Yes, 80.4%.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [27]

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80.4% versus?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [28]

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77%...

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [29]

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Versus 77%. So as you know, the retail gross margins are much, much higher and that had an impact. And the other factor is -- I'll just mention it that our operating margins were impacted also by not only somewhat lower volume but also higher freight costs that we had to somehow -- towards the end of the year there was lot freight costs that we had to incur. But having said all of this and rather important thing is this which shows the leverage of our business that our retail sales increased during the quarter, there's a delivered sale by 3.6%, and our operating margin went to a positive 2.2% versus a negative 2.1%. That's a major thing, because I've always said that our business has leverage on both sides. So similarly, our operating margins at 8.3% is -- in our industry, that's on the more or less towards the middle or the higher side. But for us, it's on the lower side. So I think that leverage we have on both sides, on operating side as well as on our Retail's Division is pretty good leverage. And being a vertically integrated company, we get impacted both ways when sales are somewhat down, it impacts our operation retail, it affects our manufacturing, our sawmills, everything. On the other hand, with even a slight increase, we have an opportunity and ability to take our operating margins. And I would say that many years back, our operating margin was much, much higher. But going from 8 -- I mean, going up to 10% or so with some increase in volume is within reach.

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Cristina Fernández, Telsey Advisory Group LLC - Director & Senior Research Analyst [30]

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And one last question for me. Marketing spend, based on my calculations seems like it was down about over 20% this quarter. Can you confirm that? And how should we think about the marketing spend going forward against the pretty big increase as you saw last year?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [31]

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Yes, I mean, this quarter, we spent about 3.8% versus 4.3% the previous year quarter. And if you go to the first -- the third quarter of last year, we spent 7.6%. So it will be lower, and it will be closer to 4% or in that range as against 7.6%, because we spent a fair amount of money last year in the third and the fourth quarters.

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Operator [32]

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(Operator Instructions) Your next question comes from the line of Justin Bergner from Gabelli & Company.

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Justin Laurence Bergner, G. Research, LLC - VP [33]

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So I wanted to ask about the comment in the press release about January traffic or January activity improving. Is that supposed to suggest that January traffic or -- some sort of comp or orders number was positive in January? Or just that it was sort of less negative than what you saw in the second quarter?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [34]

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The January, we compare it to the January of the previous year. And when we say it's positive, it's positive to the January of the previous year not to our second quarter. And now as you know, the next 3, 4 days are critical, because that's when a lot of our business is closed. But the positive trends have been, as I said, in December, last 2 weeks in December, we just saw people just held back. So in January, progressively, they have started to come back. So our traffic has increased, and it's increased compared to the previous year not to the second quarter.

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Justin Laurence Bergner, G. Research, LLC - VP [35]

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Okay, great. So it is a traffic metric. That's helpful. And then are you able to quantify how much higher transportation costs or how much higher transportation costs net of what you were able to recover, impacted margins in the quarter?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [36]

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Corey will tell you, but the impact of this was on several fronts. Impact of it was, for instance, on the transportation of products from the East Coast to the West Coast. So that is taken by our logistics division. The cost also increased from some of the shipments from Mexico and Honduras to the United States. The cost increased also at the retail level in terms of the additional cost that our retail had to pay in delivering the products to the consumer's home. So if you take it at all different levels, Corey, you've given any details?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [37]

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Yes, it's over $1 million.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [38]

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In the wholesale.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [39]

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In the wholesale side, then because the volume at retail, the variable component for the home delivery, that also increased. What we're seeing is higher costs in drivers, in contract carriers and then the fuel. So it's kind of across the board. We also have shipped a little bit more on the ground basis versus on the rail basis just because of the service levels and the timing that rail has grown to. So...

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [40]

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Also, Justin, we were talking earlier about the State Department contract, so we shipped a lot of this product, because, of course, we're taking it at lower margins, but we pay the freight from our distribution centers to the ports. And so with greater than margin, we had to bear that too. But going forward, with the higher margins, we'll be able to take it in.

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Justin Laurence Bergner, G. Research, LLC - VP [41]

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Okay, great. And were any of those shipping pressures eased or not yet?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [42]

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This is a bit too early, but I think that -- I'm just making a judgment that business overall, I think, people are somewhat softer and we are doing all right, I mean, our business, as I said, January was positive. But it depends on the how the overall economies of the business is. If that is the case then there will be less pressures. In the last and the second quarter, there was a lot of, lot of demand for shipments, and so we will see. So at this stage, we are just counting on whatever we spend in the first and in the last 2 quarters.

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Justin Laurence Bergner, G. Research, LLC - VP [43]

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Okay. And then lastly, just -- could you maybe say a few more words about the relaxed modern product line, that's coming up this spring?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [44]

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Yes. Well, I hope you're able to come next month to Denver, which you really should because this is a beautiful, beautiful program. And I think that is good that you raised it. Our objective really has been to expand our reach. So that we -- our brand is similar. I am just using an example of BMW or Mercedes that these great companies have taken a brand and expanded their reach to, you might say, younger people or even folks who are interested in products that are somewhat smaller in scale. It's similar to that, these are products that we have been introducing, whether it's an artisan or whether it is this new modern, it reflects an attitude like those great automobile companies created a 3 and a 5 and a 7, this, you might just say, is the 3. We already had a 5 and a 7, so this will expand our reach, and we got to market it a very -- in a manner so people will understand that today at Ethan Allen, we have an opportunity of reaching a wider consumer base but maintaining our quality and great design.

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Operator [45]

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And we have a follow-up question from the line of Jeremy Hamblin from Dougherty & Company.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [46]

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I wanted to just ask about the operating expenses, $92.7 million. In terms of the increase, could you quantify -- that's about $2.5 million, up year-over-year. Of that increase, how much of that was related to the wholesale distribution cost versus the increased variable cost at retail? Corey?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [47]

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Yes. Retail had about $1.1 million of increased costs, much of it was variable. And then you take -- if you take $1 million of the distribution expenses on the wholesale side and then there were some other minor costs. So at a high level, that's how I would look at it, Jeremy.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [48]

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Jeremy, as Corey said, half of that is due to the increase in sales and deliveries of retail, and the other half is basically, as we mentioned, increased logistic, I mean, distribution and trucking costs.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [49]

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Okay. And where does the distribution cost stand today compared to where they were in Q2? We know that there's been some tightness out there in terms of the trucking systems across the country?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [50]

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I think it's more or less similar. We are watching it very carefully. We did, just to give you -- I mean, I am giving too many details, but we decided also in the second quarter to ship products from the East Coast to the West Coast by rail, because of Christmas holidays and everything else, so we decided that, that was an important thing to do. That most probably added $0.5 million to our costs in the second quarter. Right now having no Christmas, in this quarter, we are not going to do that.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [51]

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Yes. That is by truck versus rail and the truck is higher than the rail.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [52]

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$0.5 million cost, Jeremy, on that, just in the last quarter.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [53]

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And that's all part of the demand. Rail has taken longer and for those holiday deliveries, we really wanted to wow the customer with a very speedy delivery.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [54]

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So in terms of looking forward here back half of the year, is your kind of baseline SG&A run rate closer to this $92 million to $93 million range or closer to the $90 million that you saw in Q1?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [55]

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Jeremy, just keep in mind, of course, even can make an assumption, it also is a factor of how much whether you are considering flat business, because our operating costs, especially at the Retail Division, are variable, especially both in terms of the compensation to our designers as well as the delivery cost -- is a variable cost based on sales. So depends on what you use, you can then use your judgment, based on that you can use the numbers. But they are variable costs. If you...

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [56]

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I understood. If all else is equal, if your sales were exactly the same and the split between retail and wholesale were exactly the same as last year for Q3 and Q4, what would that translate into?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [57]

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It would translate in the wholesale side at least $0.5 million less, and on the retail side, about the same.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [58]

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On a year-over-year basis?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [59]

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No, in the quarter. Just in the 1 quarter. Right, Corey?

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [60]

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Compared to Q2?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [61]

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Compared to Q2.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [62]

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Okay. So about $92 million, it seems to be the baseline run rate?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [63]

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Yes, the $91 million to $92 million. It's going to depend on where freight actually finally comes in at and...

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [64]

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Jeremy, $92 million is fine. It's all right.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [65]

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Okay. No, I am just trying to clarify. So that we can...

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [66]

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It could be a little bit lower, Jeremy.

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Operator [67]

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(Operator Instructions) Your next question comes from the line of Ian Dominguez from Schonfeld.

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Ian Dominguez, [68]

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I have question, 2 actually. One is on, I guess, in the Q, it mentions a release of intercompany profit previously held in inventory that served to increase gross profit by $1.1 million. Can you just explain how that works? And then, second on lease accounting, the ASU 2016-2, I also noticed in the Q, it says, expects -- kind of expects you'll have a material impact on our consolidated balance sheet, can you just outline early thoughts as to what that exactly looks like in terms of the material impact?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [69]

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Sure, Ian. This is Corey. On the inventory side it is really what kind of drives the release of that intercompany profit. So our inventory that we held at December of 31st was about $6.5 million less than where it was at the end of the prior quarter. So when we relieve that inventory, we capture the embedded wholesale profit at the time that retail relieves it. So that's the capture. So as inventory decreases, we get the capture of the profit, as inventory increases, then it kind of works the other way and the profits held until it's sold. On the lease accounting, in our 10-K, we have about $175 million of lease obligations. So under the lease accounting rules, we'll net present value that and throw it up as a asset with a corresponding liability on the balance sheet, there's really no P&L impact as a result of the lease accounting change just primarily be the asset and the liability, basically, at a net present it'll value, at a high level.

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Operator [70]

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Your next question comes from the line of [Brett Reiss] from [Janney's.]

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Brett Reiss, Janney Montgomery Scott LLC - Analyst [71]

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Do you give out net store count figures and is in a metric that even one should pay attention to?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [72]

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Yes, we give our counts. It was in the press release also. But at the end of the quarter, our company operated, we had 146 design centers and 305 in total with our independents and that compared to last year, our retail had 148. So there was also a difference in total store count, which had an impact on the difference in total written sales.

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Brett Reiss, Janney Montgomery Scott LLC - Analyst [73]

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Okay. But you mentioned the 3 or 4 that you're planning to open. Do you, at year-end, do you think you're going to wind up the year with more or less design centers?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [74]

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Yes, it's a good question, because our focus has been to reposition the design centers in the right places. So all these locations that I talked about are basically relocations. Keep in mind that, our -- historically, all the design centers are almost 95%, 98%, 15 years back, were operated by licensees.

And then as they retired, and we took them over, then these stores had been opened up in the 1960s and '70s, and we started relocating them. So the total number, would more or less stays the same. In some cases, when we close before we determine that we may have another location close by, which will get the business, so we don't -- we look at it very carefully whether it is going to have any major negative impact. If we don't relocate, then 1 location is better than 2 if it can do the business. So that's we have also been consolidating that way. But all the ones that we have listed today that we're going to open are relocations.

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Brett Reiss, Janney Montgomery Scott LLC - Analyst [75]

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Okay. Could you talk to me a little bit about your design consultant? You have 1,500, is there a great -- is there low or high turnover of these people? And with unemployment being so low, if somebody leaves, are they hard to replace? And what's the timetable on a learning curve for design consultant to come up to speed?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [76]

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Yes. Again, a very, very important and relative question which we deal with all the time. The 1,500 designers, we -- our turnover is very, very low. These designers are -- I would say, the vast, vast majority have come through many years of being associated with Ethan Allen. And we have also been able to get many interior designers who ran their own businesses, and they come and join us, because under our umbrella, they have the ability to operate a business of our interior design in an entrepreneurial manner but also disciplined. They get the benefits of being an employee, but they also have the benefit of being an entrepreneur, because their compensation is based on the business that they do. Yes, there has been some pressures because of the economy. On the other hand, the many businesses that were involved with interior design are no longer existing. So there are not that many companies left over there that do what we do. And so we have the opportunity of getting a really strong interior designer to come and join us.

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Brett Reiss, Janney Montgomery Scott LLC - Analyst [77]

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Right. Right. That's helpful. I appreciate that. And how correlated is your business to new housing sales? They have been soft the last couple of reported data points on that. Is -- are you -- is there a -- what's the correlation there in your experience?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [78]

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I understand, it is not necessarily one-to-one, because in our case, really, the more important factor is consumer confidence. If consumer confidence is impacted as it was with, for instance, with the stock market being down or the shutdowns and all of the external factors makes -- help people hold up. And obviously, we do have an impact, a longer-term impact with the housing, but this is not immediate for us, because we are not dependent on necessarily owning new homes. A lot of our business does -- comes from existing homes where people are redecorating. So we don't see it immediate impact, of course, longer term, it does have some impact.

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Brett Reiss, Janney Montgomery Scott LLC - Analyst [79]

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Right, right. Now in my own business, it's been a challenge to reach out and curry favor and win business from millennials. It seems in looking at your business, you're having the same challenges. Can you talk to me a little bit about how that's going and how are you going to hit the right buttons there?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [80]

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That's an important issue certainly, and I was referring to it earlier question, I think it was Justin when he talks about the -- and asked me the question about our newest product program that we introduced last year, this last quarter, called artisan, and he asked about that. And I answered that our objective has been to expand our reach, and our objective has been to expand our reach in a manner that is consistent for us. In our industry and many, many industries, I am just using the auto industry, and many years back, General Motors, to expand the reach they developed a lot of different brands. Similarly, some furniture -- home companies have developed a lot of different brands. We've held that our one brand, Ethan Allen, is a brand that is well -- is desired, is well-known, and obviously, it has been known somewhat for you might say the folks not necessarily the millennials of the younger folks. So our objective has been to reach them, but reach them in a manner that would be consistent in maintaining quality, maintaining good design, but -- and offering folks design and a price point that would be somewhat more comparable without taking off quality. Similar to as I mentioned earlier, companies like Mercedes and BMW and Audi have been able to do. So you got to see us being much more focused in reaching out to folks, millennials as well as everybody else, that today Ethan Allen has the opportunity of reaching a larger consumer base with our offerings in design, in quality, price points, yet, we are going to maintain great quality. And you're going to see a lot more of that as we go forward.

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Operator [81]

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And we have a follow-up question from the line of Justin Bergner from Gabelli & Company.

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Justin Laurence Bergner, G. Research, LLC - VP [82]

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Just a quick couple of clarification questions. The adjustments that you took to your adjusted results in the quarter, it seems to include -- and I guess, asset purchase cost in your -- in some of your retail asset purchase cost. What's that?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [83]

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Go ahead, Corey.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [84]

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Yes, that was associated with a location where we had a retailer that retired, and we acquired some of those assets and are continuing to operate in that market. So there's certain cost that are incurred during that process.

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Justin Laurence Bergner, G. Research, LLC - VP [85]

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So an independent became company-owned?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [86]

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Yes, yes. That's the one that shows as a transfer on the design center chart in the back of the press release.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [87]

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This is a very great family in San Jose for the last 50, 60 years, the second-generation retired. I've known them for a long time. We sat down and like we've done with all these other folks. So we kicked it over just last, I think, on December?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [88]

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In December, end of the month, yes.

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Justin Laurence Bergner, G. Research, LLC - VP [89]

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And so that $160,000, that represents the entire cost to bring them in?

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [90]

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No, that just represents certain costs that go around the acquisition-related activities, not -- the other cost is really just purchasing inventory.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [91]

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That's our main cost. It's inventory, and that we've, of course, taken to inventory.

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Corey Whitely, Ethan Allen Interiors Inc. - Executive VP of Administration, CFO & Treasurer [92]

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That's a basic asset purchase. The inventory purchase shows up in our operating cash flows.

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Justin Laurence Bergner, G. Research, LLC - VP [93]

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Okay. And then the wholesale -- sorry, the international being down 31%, that is mainly China and Canada, but there are some other markets in there too, right?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [94]

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There are, especially, the Middle East. They have been down too. As you can see the situation in Saudi Arabia, in Dubai, in Qatar, Kuwait, Jordan, they all have been impacted. The good news is, they're all motivated, they want to -- they're still operating it. They want to keep it going, but they've had a tough time in the last -- with all the problems that are -- that's taking place in the Middle East.

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Justin Laurence Bergner, G. Research, LLC - VP [95]

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Okay. Then lastly, the special dividend, obviously, was just paid out $1 per share. Does that sort of exhaust your cash return for this current fiscal year or, is it still possible that we could see share repurchases pick back up?

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [96]

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Well, we just declared our -- we just also announced our -- today, our regular dividend, so we'll continue with a regular dividend. Then we will see what we need to do. We have continuously purchased -- as you know, we've purchased 42% of the company back. I've just got to make sure that we have no -- we got to also watch the float over there. But we have been doing both things, we have been buying shares, we have been paid a $0.5 billion of dividends since we took this company private. We invested about almost $800 million in capital expenditures. So we have been fortunate so far. We've been able to buy our shares back, pay a lot of dividends, invest in the company. And at this stage, basically, we have used up most of the cash, Justin. So we've got to build the cash back up.

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Operator [97]

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And there are no further questions at this time. (inaudible) Please continue.

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M. Farooq Kathwari, Ethan Allen Interiors Inc. - Chairman of the Board, President & CEO [98]

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All right. Thanks very much. And good to have everybody on the call. And if there are any questions, please, let us know. Thanks very much.

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Operator [99]

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This concludes today's conference call. You may now disconnect.