RH (RH) 2004 Q3 法說會逐字稿

Good day.

All sites are now on the conference line and in a listen-only mode.

At this time, I would like to turn the program over to Pat McKay, CFO.

Good afternoon, everyone, and welcome to Restoration Hardware's third quarter 2004 earnings release conference call.

My name is Pat McKay, the Company's Chief Financial Officer.

I'd like to remind you that the call is being recorded and will be available for replay via webcast on our site at www.restorationhardware.com, under Company information, investor relations event calendar, or by a dial-in at 888-566-0193 until December 3rd, 2004.

Leading our call today is Gary Friedman, the Company's President and Chief Executive Officer.

At the end of our remarks, we will open up the call the questions.

Before we begin, let me read our brief statement regarding forward-looking comments.

Certain statements and information on this call will constitute forward-looking statements within the meaning of the federal Private Securities Litigation Reform Act of 1995.

Such forward-looking statements involve both known and unknown risks which may cause the actual results or performance to be materially different.

These statements will include without limitation financial guidance and statements related to the implication of the Company's third quarter 2004 results on periods thereafter and statements regarding management's opinion and expectations regarding the business.

Important factors that could cause differences are contained in the Company's filings with the Securities and Exchange Commission.

At this point, I'd like to turn the call over to Gary.

Great.

Thank you, Pat, and good afternoon.

Third quarter represented significant progress as it related to the topline growth in positioning of the Restoration Hardware brand, and also clearly highlighted the challenges and opportunities still before us as we work to build the retail model that will produce predictable results.

Let me begin with our progress.

Total Company revenues were up 23 percent, making this the third consecutive quarter of 20 percent plus sales growth, despite the fact that the Company has added zero net new stores.

Comparable store sales for the quarter were up 8.7 percent, on top of the 2.9 percent increase last year and a 14.9 percent increase in 2002, representing compounded comparable store sales growth of 29 percent in the quarter since introducing the first phase of our new merchandising strategy in 2002.

We're now approaching sales per square foot and merchandise margins that should support a viable and profitable store financial model.

Direct to customers sales continue to grow at a rapid pace, increasing 78 percent in the quarter on top of a 46 percent increase last year and a 66 percent increase in 2002.

As you know, we launched a completely redesigned catalog in August which we believe communicates the premium positioning and quality differentiation of the Restoration Hardware brand.

The book is larger with more pages and presents a lifestyle approach combined with category dominance that is unique in the marketplace.

Clearly, our efforts to reposition the Restoration Hardware brand is resonating with our customers as we continue to gain market share at a faster pace than our competitors.

Now let me comment on some of the challenges we encountered and opportunities we have to improve our ability to convert topline performance and to improve bottom-line profits.

First, let me start with the mixed (ph) forecasting of our second drop of our new fall catalog.

As you may remember, last September, we advertised a fall furniture sale across all three channels which we decided not to anniversary this year.

When developing the sales and circulation plans for this year, we misprojected the lift from the furniture event in both our web and catalog channels, and therefore, over-circulated the September drop of our fall catalog and de-leveraged advertising costs as a percentage of sales in the quarter.

We quickly uncovered our error and made modifications to our circulation plans for the remainder of the year and beginning with the October drop of our catalog, advertising cost as a percentage of sales are back in line with historical rates.

Second, I want to address the opportunity that exists in our supply chain and distribution network.

Since 2000, the Company has been capital and resource constrained as it relates to making desired infrastructure investments.

Over the past three years, we will have increased the Company's revenues over 40 percent, and this has clearly surfaced the weakness in our distribution and systems infrastructure.

We began to experience difficulties at our Baltimore distribution facility in the third quarter of last year and the situation escalated in the fourth quarter.

We engaged a supply chain consultant in the first quarter this year and began a search for a full-time supply chain executive.

The top priority of this consulting team was to resume accurate and timely product flow to our stores and ensure customer furniture orders were being processed and delivered without damages.

While progress has been made, it has been a sense of progress as the focus was first on improving service to our internal and external customers and installing process improvements in training versus the focus on productivity.

We also opened a new West Coast furniture distribution center in the second quarter, plus expanded our Baltimore distribution center and opened a new call center in the third quarter of this year.

Now with the hiring of a new chief operating officer and a new senior vice president or supply chain, we believe we can begin to resume the independent management of these facilities, plus begin to focus on short-term productivity as we begin to develop the longer-term supply chain strategy.

I would conclude, while we're disappointed that we were not able to convert the positive sales performance into improved financial results in the quarter, we are optimistic about our future with the continued strengthening of our leadership team and the customer's favorable response to our efforts to build a brand that will stand the test of time.

Now let me turn the call back over to Pat.

Thanks, Gary.

First, I'll take you through our financial performance for the third quarter of 2004 and year-to-date and then I will provide guidance with respect our expectations for the fourth quarter.

At the end, I will open up the call up to questions.

Third quarter net revenue was up 23 percent to $118 million, versus 96 million in the third quarter last year with comparable store sales for the quarter up 8.7 percent and direct to customer revenue up 78 percent from that of the prior year's third quarter.

Despite the increases in revenue and expansion of our product margins, we experienced higher advertising, distribution and compliance costs in the quarter than expected.

Those items negatively impacted earnings in the quarter by approximately 5 to 6 cents per share.

As I review our performance with you, I will touch on each of those items in more detail.

Turning to retail performance, as mentioned, we experienced comp store sales increases of 8.7 percent in the quarter on top of a 2.9 percent increase in the third quarter of fiscal 2003 and a 14.9 percent increase in the third quarter of 2002.

These increases reflect the compounded growth of 29 percent in our comp store sales since the initial launch of our new merchandising strategy in 2002.

We achieve the growth in our comp store sales even with the discontinuance of the fall furniture event, which we did not anniversary this year as we saw continued success with the sale of our core product offerings and our famous fall lighting event.

During the third quarter, we had lift in both the average dollars per retail transaction of 8 percent and an increase in total transactions of approximately 2 percent.

For the third quarter of fiscal 2004, our retail segment realized an $8.1 million store contribution after the cost of district management, or 9.1 percent when stated as a percent of segment revenue.

This compares with a $4.9 million contribution and a 6.2 percent of net retail revenue reported in the third quarter of the prior year.

Leverage of store occupancy costs and higher sales, expanded product margins and reduced payroll costs as a percent of revenue all contributed to the performance improvement.

In the second quarter, we had experienced revenues from warehouse sale events which did not recur in the third quarter of fiscal 2004.

These sale events have been designed to liquidate returned or damaged or discontinued goods.

We actually will open our first outlet store in the fourth quarter of this year near one of our distribution centers in northern California.

A second is scheduled for the opening in the first quarter of fiscal 2005.

We do expect that we will hold an additional warehouse sale at the end of fiscal 2004 to supplement the opening of our outlook store.

In the direct channel, which include sales from both the catalog and the Internet, revenue was up 78 percent to 28.4 million on top of a 46 percent increase in last year's third quarter.

Catalog revenues were 59 percent in the quarter to 15.5 million and Internet sales grew 108 percent to 12.9 million for the third quarter.

Our catalog continues to provide significant product and overall brand exposure in our retail trade areas as well.

Catalog circulation for the third quarter was consistent with the prior year at $9.8 million with pages circulated the up percent.

While overall direct to customer revenue was up significantly for the quarter, as a Gary mentioned, we experienced poor performance of our September catalog mailing due to aggressive prospecting and circulation expansion.

This had the effect of driving our advertising costs up substantially expressed as a percentage of revenue.

As we look back on the performance of that drop, we see an opportunity of approximately 1.3 million in results from this mixed execution.

We made adjustments to the mailing plan of the October and subsequent books and the advertising costs as a percent of revenue are back to historical levels.

Direct to customer segment profitability for the quarter declined from second quarter levels of 15 percent to 6.6 percent for the third quarter of fiscal 2004 as the expansion in product margin was more than offset by higher advertising costs reflected as a percentage of net revenue.

At a total company level, we continue to see expansion in our gross profits with growth of 32 percent in the third quarter of 2004 to $38 million from 28.8 million in the third quarter of the prior year.

This was the result of increased revenue, coupled with a 210 basis point improvement in gross margin expressed as a percentage of revenue to 32.1 percent from 30 percent in this same period last year.

The improvement in the gross margin rate is attributable to leverage achieved on store occupancy expenses on the higher sales levels and the expansion of product margins which benefits were largely offset by higher levels of distribution costs.

Distribution costs have continued to be impacted by the improvement efforts underway within our distribution network, including higher temporary labor costs and the cost of consultants to oversee this activity.

With the recent hiring of our new COO and the addition of a senior vice president of supply chain operations, we see opportunity in the fourth quarter to reduce the cost of our distribution network by approximately $1 million from a third quarter run rate as we improve our labor productivity and eliminate the need for outside consultants in oversight of these operations.

Selling, general and administrative expense was 42.5 million in the third quarter of 2004, or 35.9 percent of net revenue, compared with 33 million, or 34.5 percent in the prior year's third quarter.

During the quarter, we were able to achieve retail store expense leverage on higher sales, reflecting a continued focus on cost reduction and management efforts around store payroll and supply costs.

However, higher cost of advertising, some of which was anticipated from the cost of catalogs circulated and Web marketing in support of our direct to customer business, grew disproportionately to revenue as the September mailing of our catalog proved less productive than planned.

We also incurred costs of approximately $600,000 in the third quarter associated with our first time ever brand advertising program, which included advertisements placed in nationally recognized home lifestyle magazines.

While we continue to make progress on improving our internal controls, the quarter was also affected by 500,000 in professional fees associated with the implementation of the requirements of the Sarbanes-Oxley Act, specifically Section 404.

Our operating loss for the quarter was $4.5 million, which was slightly higher than the amount reported in the prior year 4.2 million.

Our net loss for the third quarter of fiscal 2004 was 3.1 million, or 9 cents per share, as compared to 2.9 million, or 9 cents per share in the prior year's third quarter using a weighted average share count of 33 million shares.

On a year-to-date basis, net revenue was 338 million, a 24 percent increase over the same nine-month period in the prior year.

Comparable store sales for the nine-month period increased 9 percent on top of an 8 percent increase in the nine months last year, with again our full product offerings contributing to the retail sales growth.

Direct to customer net revenue increased 91 percent to 78.9 million in addition to a 53 percent increase in the same period a year ago.

Within our direct to customer division, net revenue grew 71 percent within the catalog and 124 percent in sales on the Internet.

On a year-to-date basis, circulation of our catalog grew 15 percent and pages circulated expanded by 53 percent.

The Company's net loss for the nine months ended October 31 was 9.1 million, or 28 cents per share and showed improvement over the nine-month period a year ago when the net loss was 10.8 million, or 36 cents per share.

Higher revenue, coupled with expanded growth profit, had positive influence on the year-to-date results.

Turning to our balance sheet, our outstanding balance on our line of credit was 64.2 million at the end of the third quarter, up seasonally from the 10.3 million at last year end and from the prior year's third quarter of 45.9 million.

The increase in borrowing levels reflects the increase in inventory of $55 million to 53 percent from year end, and that 35 million or 28 percent from the third quarter in the prior year.

The increase in inventory levels is in support of our continuing sales growth, which was 23 percent in the third quarter.

CapEx for the first three quarters was 10.1 million and 5 million in the third quarter with the largest portion of the third quarter's spend occurring for our new store in Southern California and store remodels, as well as spending for our distribution centers for both relocation and expansion activities.

Depreciation and amortization expense for the first nine months of fiscal 2004 was at 11.7 million, with 3.8 million in the third quarter of fiscal 2004.

We also opened one store at the very end of the quarter that had been temporarily closed for expansion and remodeling in Southern California.

Common shares outstanding were 33 million at the end of the quarter.

We finished the quarter with 8500 shares of preferred stock, which is convertible into approximately 4.3 million shares of common.

Turning now to guidance for the fourth quarter.

We expect increases in comp store sales for the fourth quarter to be into the 5 to 7 percent range, on top of a 1.7 percent increase from the prior year's fourth quarter.

We expect to see fourth quarter direct to customer revenue increase 42 to 50 percent on top of a 51 percent increase in the same quarter last year.

We expect our net income for the quarter to be in the range of 26 to 30 cents per diluted share versus net income of 21 cents in the prior year’s fourth quarter on a share count of 38.5 million shares.

Inventory at year end is predicted to increase by approximately 20 to 22 percent to support projected sales growth in the first quarter of 2005.

Now I will open up the call to questions.

(Operator Instructions).

Rex Henderson, Raymond James.

Good afternoon.

A couple of quick questions here.

First of all, it appears in miscalculating the catalog circulation, it appears as I understand that you misunderstood how much the furniture sale was driving your revenue in that catalog dropped last year.

Is that right?

That is true.

And would that make you reconsider the furniture sale for next year?

Not necessarily.

I think what we miscalculated (technical difficulty) the lift of furniture from that furniture sale, but also the lift of related categories, particularly on the Web site also.

So we are looking at that and contemplating that.

But long-term, we believe it's better to kind of grow the business in a non-promotional manner.

Okay.

And your new senior vice president -- is that right -- senior vice president for the distribution centers -- is he in place yet?

He is.

And how long has he been in place?

One week.

One week?

Okay.

And are the consultants out of the DCs at this point, or are they going to be there for awhile yet?

We have a plan to transition during the Q4 period.

Okay.

And what do you think the savings is going to be on a run rate basis once they are completely out of the DCs?

I think it is too early to really make that estimation, but John Tate, our Chief Operating Officer and our new supply chain executive, will put together a plan and make that assessment.

I think, Rex, as I mentioned, we feel that we are comfortable with about a $1 million decrease in the run rate where we were in Q3, looking at our Q4 performance, and that is reflected in our guidance.

And Sarbanes-Oxley -- $500,000.

Man, that's a big nut for a business of your size. is that going to stay that big quarter-in, quarter-out, or will it eventually get smaller?

I think as all companies have been experiencing this first round of compliance, the Sarbanes is pretty intense, and particularly for a company our size that hasn't had the history that goes with a lot of years of development of the documentation, etc.

So I think that number is going to come way down as we fast forward.

So it will be a fraction of that number on a run rate basis.

How long will it take to get to that lower run rate?

Q1 of next year, you will see that plummet.

And then in merchandising, I'm just wondering where you saw strength and what categories you saw strength in?

We continue to strength in our textiles area and in our baths and hardware businesses and to a degree, in categories of our furniture business.

Okay.

Finally, you mentioned some numbers about transactions and tickets, and I missed them.

Can you fill me in on what was going on with transactions and tickets?

Transactions were actually up 2 percent, and I think you'll probably remember, Rex, that we've been relatively flat over a bunch of quarters and the average transaction dollars were up 8 percent.

Okay.

And finally, what about tabletop?

Is there any more discussion about when tabletop's going to enter the stores?

Right now, it is kind of tabled at the moment, if you will.

We believe there's still lots of opportunity in the core businesses that we're merchandising.

And our plan is to continue to kind of expand and dominate the businesses that we're in to kind of build a competitive barrier versus our competition.

And in the future, we are still open-minded to tabletop.

But we have kind of pushed out the idea of launching it anytime soon.

Okay.

Do you have any other -- it seems to me that when I going into the stores, and this was an issue, has been an issue, but they're still a little bit under-merchandised and that tabletop was going to fill an extra void in the stores.

Do you have any other ideas about what is going to fill up the stores and can complete the merchandise offering?

We do, and for competitive reasons, we don't want to mention it at this time.

All right, thanks a lot.

Paula Kalandiak, Roth Capital.

Good afternoon.

My first question has to do with the distribution of that September mailing.

Was part of the issue who received the mailing?

And if so, where did you get the list to expand the mailing?

Sure, Paula.

We mailed the book, I think that particular catalog had a 13 percent increase versus a year ago, plus there was a significant page count.

And really, we should have just mailed significantly less catalogs in that second drop.

And when the group assessed that drop from a year ago, I think we basically underestimated the lift that that had, the promotion in that drop that the catalog gave us, and we mailed into too high of a list last year and did not seem to get the same response.

So the good news is, as we looked at it versus the October drop from a year ago when we had the famous fall lighting sale in the October drop, the famous fall lighting sale this year, we saw that the performance, we're really performing at historical levels.

But we don't really feel we mailed to the wrong people, we just mailed too deep into the list in the second drop.

You would traditionally pull back the second drop of the catalog.

In the catalog business, generally, you get three drops per book.

So the first drop is in August, the second drop is in September, the third drop in October and the second drop was relatively close to the size of the first drop and we should have mailed less books.

And we would have probably, based on our estimations now and looking at it in hindsight, we would've done about the same volumes with probably a million less books.

Okay.

And then my last question relates to furniture.

I know you didn't have the furniture still this year, but I did notice that some items in the Laurent (ph) collection were on sale.

And I was wondering what was behind that decision?

Just underperformance against our expectations.

So just like anything in a retail business, it doesn't perform to your expectations.

You want to keep the inventory moving.

And so I think you see the markdowns in that collection are relatively small as a percentage of sales.

It is our highest priced collection. unfortunately, when we developed that collection, the euro was at 105, and when we bought the collection, the euro was at 125 or 147.

So it kind of surprised us.

We did not think we were going to have to be at the retails that we were when we first developed the collection.

And then when it shipped, we were kind of stuck.

So probably the retails we're charging for it now are the retails we wish it would have been at.

Unfortunately, we don't get to enjoy the margins we thought we would be at, based on the exchange rate.

Okay, thank you and good luck in the fourth quarter.

Kristine Koerber, JMP Securities.

Hi.

First of all, can you maybe give us some background on the new supply chain executive that you've hired on?

This is John Tate.

We hired a gentleman named Bob Hassan (ph), who was the supply chain leader at KayBee Toys and had been with them for I believe the last eight years.

And before that, he had various logistics and transportation positions at Esprit, Polo Apparel and Sun.

So Bob has about a 20-plus year career starting from the warehouse, a deep background in transportation, some pretty significant exposure to distribution and warehousing and has only been with us a week and a half, but actually is getting remarkably quick traction.

One of the things that attracted us about his experience at KayBee was, although they certainly don't ship furniture, they have lots of vendors.

They have 1400 stores.

They have lots of breakable merchandise and all different sizes of things.

They also have a small direct business on the Internet.

So it came fairly close to filling our ideal profile.

I don't know if you mentioned what catalog circ (ph) was going to be in the fourth quarter and how much prospecting you're going to do.

We did not.

We have a catalog circ, it will be up about 15 percent in Q4.

Is most of that to existing customers?

Are you doing some prospecting?

There is a percentage of prospecting in every drop as we mail it.

So you can imagine, our direct business is growing rapidly, so there's always a pretty good percentage of prospecting.

And outside of some of the furniture collections that your promotion on, were there other items that you had to be promotional on that were not turning?

I think, again, there is always something that does not sell very well.

I think in general, if you look at just our sales performance and margin performance, sales were up 8.7 comps, but our merchandise margins were up over to 200 basis points over a year ago.

So in general, we're pretty happy with the decisions we made and the performance of the product.

And then just two last questions.

Backorders -- are there any customer backorders that you experienced in the quarter?

And then maybe could you comment on early read of the holiday merchandise and kind of what demand you are seeing?

Regarding backorders, we do have a relatively high backorder rate that we experienced in the quarter, and mostly on the furniture side of the business and in the leather part of the business.

We had a challenge with one of our major suppliers who had some systems issues in the early part of the fall season that got behind in deliveries at about 10 to 11 weeks behind, and that has caused late receipts in the upholstery side of our business.

And we think, not only do we have higher backorders, but we think we have considerable lost sales because we have not been able to fulfill those orders in a timely manner.

But that's where a good piece of the backorder part of our business lies, really directly related to one key vendor.

And then also on the other side, we had one kind of runaway product that I don't really want to talk about because I don't want our competitors to know.

Could you quantify the amount of back orders?

I don't have that information at my fingertips right now, and we really have not done that historically.

We had a lot of discussion last year when I that one of our major problems in terms of execution.

But that just hasn't been really kind of our discussion topic, but if you want to call me back later, I will be happy to provide it to you.

Okay.

And then the demand for some of the newer products for holiday?

I think it's early to tell the holiday season.

I would say our book's off to a relatively good start, it is performing close to plan, and regarding the retail business.

I don't if any retailers are talking about this yet, but there's two extra days in the shopping season between Thanksgiving and Christmas.

Those two extra days fall in December.

And I think that the challenge that all of us have as retailers is -- how do you predict the percentage of your business that's going to fall in December versus fall in November?

The last calendar year that has the same shift is 1999, so we're studying 1999 and trying to determine how our business flows.

But I think in the first two weeks of November, it is hard to say how good is Christmas going to be.

If that makes sense.

Hello?

Yes, thank you.

Kevin Fall (ph), Next Generation.

A couple of my questions were asked, but just going into I guess the -- looking into the fourth quarter, has your level of confidence changed in regards to your backlog and your fulfillment rates versus last year, given the consultants in place?

Secondly, regards to the follow-up, is there any transition risk involved with transitioning these consultants from the DC kind of away from the business since they've been there for a long time?

And then lastly, are you experiencing any delays in terms of either the West Coast port or the railcars?

And what percentage of your flow might be affected by some of the delays on the West Coast, particularly which seems to be affecting most of the furniture deliveries?

I think there is some buzz out there about some modest delays.

Our flow for holiday is largely done.

We experienced our peak shipment week about receiving into and shipping out of the DC in mid-October.

So we don't feel at all exposed in a material way for the holidays.

It's hard to predict beyond that, but there's nothing out there on the horizon that would give me concern.

To your first question, one of the most important things that the consultants did for us was to get a very solid second line of management in the Baltimore distribution center who I have high confidence in.

I've spent quite a bit of time with him.

So I don't have concerns about the DC continuing to operate in the manner that it's achieved.

What we will be focusing on this quarter is making ourselves more efficient, bringing down the level of temporary labor.

Okay.

And then, in terms of the backlog, I did some research on the Web site and I noticed some of the holiday products seemed to be backlogged a little bit, still obviously in time for the holidays.

But is that a concern at all for now, or is that just related to the Web site, or is that also kind of at the store level?

Kevin, was that an early (indiscernible) that you had done?

Yes, it was an earlier one, and I just kind of followed up.

Not a material number of items, but it just seemed like some of the bigger, like the -- I think the airplane car toy, and things like that, (indiscernible) shipped from the manufacturer.

Some of the items that might be Web or catalog only that are drop shipped that are maybe bought in small quantities for just the catalog and Web.

If we have a run on those and we're doing drop-ship, that could be a delivery issue.

I think the item you're relating to, though, is not carried in our retail stores.

I think the catalog holiday drop, we had one of the strongest in-store positions we have had when the catalog dropped.

I think that is a good point.

We are in the best in-stock position we've been in retail and in the direct business for the beginning of the holiday season.

It's the best we've been historically in the last few years.

Do have any idea what the fulfillment rate is so far on that holiday product?

It is not a number (inaudible).

Okay, thanks.

(Operator Instructions).

Rob Wilson, Tiburon Research.

Thank you.

Gary, I guess I'll ask the question everybody wants to ask, is what is the impact from Williams Sonoma home on your business?

I don't think it has any impact today, Rob.

I think relatively, I don't know how many books they mailed, 2 or 3 million, and there's no stores out there yet.

So we tend to see it position somewhat higher than we are in the marketplace and I think they look like they are pursuing a unique positioning and we think we are pursuing a unique positioning.

So, so far, I would not anticipate any impact, but we'll see in the future how it shapes up.

There was no correlation in your September mailings versus the drop of the Williams Sonoma home catalog?

I don't think so.

What was the first mailing of that catalog I think was October, wasn't it?

Of their catalog?

Yes, their catalog.

I thought it was an October drop, their first catalog drop.

I can't remember.

I am almost positive it was October.

I don't want to pretend like I'm watching it too closely.

We, clearly, when we dug into it, if you look at last year's performance in the Web and the catalog, when we broke it out by week, we had performed in the first four weeks of August last year at about 60 to 70 percent over last year.

And then in the next four weeks of September when we mailed that promotional drop, we were performing at about 120 percent, 135 percent over last year.

And then we returned in the third drop in October last year to about 70 percent, 75 percent over last year.

And we nailed into that 120 to 130 percent growth of that promotional book, and we should have just really pulled back circulation.

That really is the story.

And if the team had looked at how we circulated, they really looked at just the furniture lift and pulled out the furniture lift.

But really what happened, what we have learned is with the book being promotional, it just drove overall performance in the catalog and the Web.

And so drop one performed reasonably close to what we expected, drop three performed reasonably close to what we expected and drop two was just way off.

And the difference was the lift last year.

That helps.

Pat, can you help me understand the advertising expense miss in Q3?

Did this have any relation to the national advertising campaign in the magazines, or maybe the tipping point campaign that Gary referenced in the last call?

Yes.

We did spend $600,000 on that brand campaign, but the advertising increased.

It really kicked up in this quarter as a percent of revenue, really as a consequence of why Gary and you just had that exchange about is that second drop.

The miss on the second drop cost us to 2 to 3 cents per share.

Pat, you've mentioned something about an additional warehouse sale at the end of this quarter.

Should we bake in another 3.5 million in sales?

I think probably about 2.5 would be a good number.

And as you know, we pretty much run those at a breakeven.

So we would not expect any bottom-line performance from that.

Got it.

The Richmond and Cleveland stores were opened a year ago.

Do you notice any discernible difference in the performance of those stores?

The Richmond store is really performing at or slightly above our expectations and the Cleveland store is performing below our expectations.

What we hear from other people in that Cleveland Center is that everybody is performing -- everybody is somewhat underperforming in Cleveland.

And so the other thing that I think is hurting us in Cleveland quite frankly is that (inaudible) we have our worst delivery times in the middle of the country from a furniture point of view.

And when you look at us competitively against Pottery Barn or Crate and Barrel and others, we really have got to fix the middle of the country.

Because when you look at Chicago or Cleveland or any of those areas, we are outside of three weeks and sometimes four weeks to those customers.

And we have our competitors in 1 to 2 weeks.

And I think it is really hurting our business.

But in Richmond, we're real competitive, we're performing well there.

I will say too, we're quite happy with the other new stores we've opened.

Our remodeled store in, Cordo Maderas (ph) California is one of our top stores in the country.

It's doing over $1000 per square foot in selling.

We opened a store in Costa Mesa, California this last spring, this last summer, and it's performing above our expectations.

And then we just opened Newport Beach a couple of weeks ago and it's so far performing at expectation.

So the new stores across the board, except for the kind of Cleveland phenomenon, which I think everybody is somewhat disappointed with Cleveland, are working quite well.

And one final question.

Why would you hold off on the tabletop initiative?

You know, essentially, we spent a few days in an off-site meeting with our key merchandising executives and marketing executives as well as our key (indiscernible) executives just really looking at the next 30 years of Restoration Hardware and how we position the brand and what's going to define the brand and what categories that we need to win in that are going to be critical to have a brand that's what I call a defendable brand over time.

And we really came to the conclusions that, at least over the short-term, that the categories that we compete in today needed to become more dominant and we needed to become more authoritative and experts in those categories.

So you will see us continue to really expand the core businesses that we are in and take a more dominant position in those core businesses.

We think that will make this brand more defendable.

If you start to look at our dollars per square foot by the end of this year, based on where we think we will be in holiday, we will have started -- I think when we started this repositioning, we were at about $488 per square foot selling.

And I think against Williams Sonoma, it's 640 or 650, in that range.

We will end this year right around $600 per square foot in selling space.

And we started out 37 percent behind Williams Sonoma Inc. if you look at the combined concepts, and it's sales per square foot.

We will end this year somewhere around 12 percent behind them in productivity.

And we thank the key here is that just key becoming clearer and more dominant in categories that are unique to Restoration Hardware.

And there's competitors out there in tabletop, even though we think we can differentiate it, we think it would be a good addition.

As we look at the space allocated to the store, we think that space is better allocated to the expansion of existing businesses than we do new businesses.

One good point of references on this too, is if you looked at the Williams Sonoma concept in the early '90s, the stores were about 2000 square feet of selling, 3000 square feet total.

And over time, we've doubled the size of the store and doubled, more than doubled the volume of the stores as we did the (indiscernible) stores.

And there was not one new category that was added.

It was basically an expansion of existing categories, and that concept became more and more dominant in the categories that they competed in to the extent that where you almost have to be dumb to want to compete with the Williams Sonoma brand in a shopping center in their core categories.

And nobody competes with them effectively in their core categories.

So as we think about Restoration Hardware, we have some distinct categories that are unique to us, whether it be hardware, bath hardware, the way we positioned our textiles business and our lighting business and furniture business.

And we think we can just become more dominant in this categories.

And there are categories that are relatively unique to us and we think that's the right long-term way to win, as well as they tend to be less seasonal and higher margin categories.

Fair enough.

Thank you.

Brian Wilhite (ph), Nolenberger (ph) Capital.

Hi, good afternoon.

It's actually Brian Wilhite.

I think this topic has been pretty much beat to death, but I do have a question around the decisions to not have the furniture sale.

And I guess I was just curious -- how many years have you had this furniture sale in the past?

Last year was the first year we really marketed the furniture side.

I think the Company did a furniture sale in 1999 or so, before I got here.

And so really, we had done kind of more ad hoc sales in furniture over the last several years.

But last year was really the first time we really, since I've been onboard here, marketed a furniture event.

And as you know, the challenge was the furniture business is already a difficult enough business to run from a logistical point of view.

And by trying to push a lot of businesses through the pipeline in a short amount of time, it just put too much pressure on our infrastructure and caused many delays in product deliveries and it's very difficult to forecast the performance of that business.

So we did a lot more sales and didn't necessarily make any more money.

And so we thought long-term, maybe it's better to give back maybe a little bit of marketshare and not necessarily grow that business as aggressively and focus on growing other businesses.

And we thought that there was enough newness in the assortment and enough excitement in the catalog (indiscernible) the furniture business would still perform adequately without an event.

Okay, that helps me understand.

And then with regards to the other promotional events, I know you mentioned early on that you wanted to (indiscernible) use different words than you did, but to deemphasize promotional events.

Would that be related to just for furniture because of the infrastructure strains and your desires to have just a have normal traffic flow, or is that (multiple speakers) all of the events?

No, I think the Company for a few years, I guess probably over 20 years, has had its famous fall lighting sale.

And I think it's well known for that and we will continue to have the famous fall lighting sale.

And I think it stands as a category that -- rest of uniquely dominant in the market, at least in the marketplace, as far as the malls and the high streets with that categories that we will continue there.

And then about 1, 1.5 years ago, we started in January to do an annual bath event and then also did it in July.

Those are two periods where traditionally, the department stores and others have white sales and a big focus on textiles and basics.

And a lot of times, stores are in transitions and getting out of summer goods in July and then getting out of holiday goods in January, it's not a pretty time out there in retail.

We've had it as an opportunity to have our stores get behind a category again that was unique to us that we wanted to allow ourselves to kind of market the business more aggressively, drive top of mind awareness, get people into that category and kind of hopefully spread some buzz and spread the word about that category for Restoration Hardware.

So that's why we decided to focus on the bath business in January and in July, and that has been very successful for us.

I see us continuing to do that.

It's a promotional time of the year anyway for retailers, so it allows us to take one of our core businesses and get slightly promotional with it.

We can then drop more catalogs, because the catalog has a better response rate when we're in a promotional state like that, and drive more awareness in the category.

So you will see us continue with this famous fall lighting sale and continue with the bath event.

Other than that, I don't see us adding anything in the future.

One final question.

Are you experiencing much pricing pressure from the standpoint of your suppliers?

In some areas, clearly, the exchange rate in Europe is a challenge.

And we have some of our categories for us in Europe, whether it be Italian bedding or Belgian linen, drapes, etc., so there is some pressures there.

And we are trying to negotiate effectively.

And then there's some raw metals challenges, as price of steel and brass and other raw materials have gone up around the world.

And that has put some pricing pressures on certain categories.

But I think what we feel good about is we think we have a differentiated enough product line in most categories that we have been able to tap on those increases to the customer without seeing it affect sales.

Okay, thank you.

Kevin Fall, Next Generation.

On your guidance for the fourth quarter, are there any SG&A -- or what kind of margin assumptions are you looking for implicit in the guidance?

I think what you should expect is you would normally see is obviously a significant leverage from Q3 levels as you just have higher sales ramp in Q4.

We do expect that we would have SG&A that will leverage over the prior year that should moderate, and we expect to see some expansion in gross margin as well.

Good.

Thanks.

It appears we have no further questions at this time.

I would like to turn the call back over to management.

Thank you everyone for your interest and we'll talk to you next quarter.

Have a great holiday.