RH (RH) 2006 Q1 法說會逐字稿

(OPERATOR INSTRUCTIONS). Please note today's call is being recorded. At this time I would like to turn it over to your speaker, Mr. Chris Newman, CFO of Restoration Hardware Inc. Go ahead please.

Good afternoon everyone, and welcome to Restoration Hardware's first quarter 2006 earnings release conference call. My name is Chris Newman. I the Company's Chief Financial Officer. I would like to remind you that the call is being recorded, and will be available for replay via webcast on our website at www.RestorationHardware.com under Company Information, Investor Relations, Event Calendar, or by dial in at 800-839-5493.

Leading our call today is Gary Friedman, the Company's Chairman, President and Chief Executive Officer. At the end of our remarks we will open the call up to questions. But before we begin let me address a few preliminary items starting with a brief statement regarding forward-looking statements.

Certain statements and information on this call will continue (sic) forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to certain assumptions, risks, uncertainties and changes in circumstances. Actual results or performance may vary materially from those expressed or implied in such statements.

These statements will include, without limitation, statements concerning or relating to implications of the Company's revenues, sales, and financial results for the first quarter of fiscal 2006; statements concerning guidance for the second quarter and full year of fiscal 2006; statements relating to the Company's anticipated revenue, comparable store sales, direct-to-customer sales, and earnings per share for future periods; statements relating to the impact of total revenue and order deferral on the Company's results in future periods; statements concerning the anticipated benefits of certain growth opportunities for the Company; and other statements containing words such as believes, anticipates, estimates, expects, may, intends, and words of similar import.

Important factors that could cause differences are contained in the Company's filings with the Securities and Exchange Commission, including the MD&A section in our most recently filed Form 10-K and our release posted on the Company's website regarding our results for the first quarter of fiscal 2006.

Any guidance we offer represents a point in time estimate. We expressly disclaim any obligation to revise or update any guidance or other forward-looking statements to reflect events or circumstances that may arise after the date of this call.

And now let me turn the call over to Gary.

Good afternoon. I'm going to comment on the highlights of our first quarter results, speak to our current trends and expectations for the second quarter, and review some of our important growth and operational initiatives for 2006 and beyond.

We are pleased with our results for the quarter, as we have significantly improved operating earnings year-over-year. Excluding the approximately $0.02 per share non-cash charge associated with the adoption of SFAS 123, our loss from operations improved to 2.6 million for the first quarter versus a loss of 4.3 million in the first quarter of last year. Our results were driven by strong sales plus merchandise margins that improved several hundred basis points due to the strategic repositioning of our product mix.

Retail comparable store sales for the first quarter increased 4% on top of a 5% increase last year. As mentioned in our press release, the comparable store sales increase was revenue deferral neutral, as the expected pickup of 2 to 3% from a reduction in revenue and order deferrals was not realized due to a greater than anticipated revenue deferral at the end of Q1. This was the result of higher than planned furniture sales, which were shipped, but still in transit at the end of the quarter.

Our direct-to-customer revenues grew 29% in the first quarter on top of a 50% increase last year. Despite the current uncertain economic environment, our business trends have accelerated heading into the second quarter as we expect comparable store sales to increase in the mid single digits on top of a 5.6% increase last year, and direct-to-customer revenues to grow 35 to 40% on top of a 50% increase in last year's second quarter. We also expect merchandise margins to continue to improve several hundred basis points in the second quarter as we benefit from the repositioning of our product mix that was initiated in the third quarter of last year.

As mentioned last quarter, we are focused on a core business in-stock strategy to maximize potential in Restoration Hardware franchise businesses. We have targeted selective inventory investments on product categories where we believe we have significant opportunity to drive higher revenues through improving our in-stock positions in both our retail stores and direct-to-customer channels.

We have also moved up the timing of our summer, fall and holiday receipts versus last year to improve our in-stock positions for the important seasonal catalog drop, where our in-stocks have been historically low. This has created a variance in the timing comparison of year-over-year inventory levels at the end of each quarter, but does not affect our overall inventory investments for the year, as we expect to end the year with inventories up 5 to 10% year-over-year versus a sales increase of 18 to 22%.

Looking forward, we're very excited about the many growth and operational initiatives designed to further strengthen our business and our brand. In addition to the launch of our outdoor catalog, we will be announcing the introduction of our second Restoration Hardware category extension in the form of a new catalog title late in the third quarter of this year. We will provide more details about this new catalog introduction at a later time.

As mentioned, we are also testing the first mailing of our new value brand this fall. The brand will be positioned to bridge the gap above stores like Pier 1, Cost Plus, Target and West Elm, and below the Pottery Barns and Crate & Barrels in the marketplace. We are currently shooting photography for the fall catalog and believe we have developed a concept with a unique and fresh aesthetic that will prove to have broad appeal among female shoppers of varying demographics.

We have also embarked on the first phase of our strategic supply chain and systems infrastructure initiative. Our goal for phase one is to simplify the order process in our stores, call center and online, plus ensure order integrity and visibility throughout the supply chain.

By this fall we will have executed our national home delivery network strategy, which calls for a consolidation of our home delivery providers, allowing us to install common systems to both improve our service levels and lower our cost. We believe we are in the early stages of realizing the supply chain opportunities in our company, and continue to think of this area as having significant operating margin opportunity in the years ahead.

As reported earlier this month, Ken Dunaj was appointed Chief Operating Officer of Restoration Hardware. Ken joins us from Williams-Sonoma where he spent six years, with his most recent position being Senior Vice President of Logistics in charge of the company's retail and direct-to-customer distribution operations, domestic and international transportation, and national home delivery network. We believe Ken's passionate leadership and relevant experience will enable him to build a world-class supply chain and operational infrastructure at Restoration Hardware.

Reporting to Ken will be the supply chain organization, sourcing, IT and our Michaels Furniture factory. I would also like to thank John Tate for his leadership as both a Board member and executive officer at Restoration Hardware. As mentioned, John will be working with Ken through a transition period as he starts his own consultancy practice.

In summary, we are pleased with our results in the first quarter. We're encouraged by the accelerating business trends in the second quarter, and excited about the significant growth and operational opportunities that lie ahead. At this point I will turn the call back over to Chris.

This afternoon I will first take you through our financial performance for the first quarter of 2006. Then I will provide guidance with respect to our expectations for the second quarter and full year of fiscal 2006. At the end of my comments I will open up the call for questions.

First quarter net revenue was up 14% to 133.4 million versus 117.5 million in the first quarter last year. Retail revenues increased by 7.5% for the quarter, with comparable store sales for the quarter up 4.0% versus a 5.0% increase last year. Direct-to-customer revenue was up 29% to 42.3 million on top of a 50% increase in last year's first quarter. Along with the increases in revenue, we experienced expansion of our gross margin of 340 basis points against the first quarter last year.

Selling, general and administrative expense in the quarter expressed as a percentage of sales was higher than the prior year by approximately 230 basis points. I will cover the drivers of the change in gross margin and SG&A later in my comments.

Loss from operations was $3.5 million in the first quarter versus a loss of 4.3 million last year. This year's loss from operations includes $900,000 of expense related to the adoption of SFAS 123R, while last year's operating results did not include any such expense. For the first quarter the Company reported a net loss of $4.9 million or $0.13 per share, in the middle of our guidance range.

The impact of adopting SFAS 123R was $0.02 per share in the quarter. Additionally, because of the valuation allowance established against the Company's net deferred tax asset in the fourth quarter, the Company did not record a tax benefit in the first quarter of 2006. In 2005 loss per share was $0.09, but included a tax benefit of $0.06 per share.

Now to segment results. In the retail segment, as mentioned, we experienced a 4.0% increase in comparable store sales. The anticipated benefit to comps of 2 to 3 points from the greater than expected total order and revenue deferral from last year's fourth quarter was offset by a greater than anticipated increase in revenue deferral at the end of the first quarter due to the strength of our furniture business. This revenue deferral impacted comps by approximately 2 points in the quarter.

Retail comps were driven by an increase in average retail dollars per transaction of 31%, and a decrease in total retail transactions of approximately 18%, reflecting the changes in our merchandising strategy.

For the first quarter of fiscal 2006 our retail segment realized an $8.2 million four wall contribution after cost of district management, or a 9.0% contribution margin as stated as a percent of segment revenue. This compares with a $7.1 million contribution or 8.4% of net retail revenue reported in the first quarter of the prior year.

Segment gross margin for retail improved by 100 basis points as a result of much higher product margins, reflecting the shift from low margin accessories and discovery items into our core businesses. The improvement in product margin was offset by higher supply chain costs due to the higher mix of furniture this year, and by higher occupancy costs resulting from the increase in outlet locations and the depreciation expense from last year's remodel program.

Selling, general and administrative expense for this segment deleveraged by 40 basis points due to higher catalog circulation in the retail trade area, primarily from the addition of the outdoor catalog.

In the first quarter of 2006 we opened one new outlet store in Camarillo, California. In total, revenue for our seven outlets was 5.4 million in the first quarter, up $3 million from last year. The outlet stores have been designed to liquidate returned, damaged, or discontinued goods. This revenue has been reflected in the retail segment, but is not considered in the calculation of our comp store sales.

Turning to the direct segment, which includes sales from both the catalog and Internet, revenue was up 29% to $42.3 million on top of a 50% increase in last year's first quarter. Catalog circulation for the first quarter was up 25%, with pages circulated up 19%. The Web accounted for 53% of the direct segment's revenue in the quarter.

Profit in the direct segment was 7.5 million in the first quarter, a 17.7% contribution margin. This profit compares to 4.6 million or 14.0% as a contribution margin last year. Segment gross margin for direct improved by 260 basis points due to improved product margin and improved supply chain costs. Selling, general and administrative expense in the direct segment leveraged by 110 basis points due to the higher than expected revenue growth.

At the total company level we continue to see expansion in our gross profit in the first quarter to 44.9 million, or up 26% versus the first quarter of the prior year. This was the result of increased revenue, coupled with a 340 basis point improvement in gross margin expressed as a percentage of revenue to 33.7% from 30.3% in the same period in the prior year.

The improvement in gross margin at the Company level was a result of strong improvement in product margins, continued improvement in our supply chain and distribution costs, and more rapid growth in the direct-to-customer segment, which has a higher gross margin rate than the retail segment.

Selling, general and administrative expense for the Company was $48.4 million in the first quarter of 2006 or 36.3% of net revenue, compared with 40 million or 34.0% in the prior year's first quarter. The primary drivers of the increase in SG&A cost as a percent of net revenue were the adoption of SFAS 123R of 50 basis points, investment spending in our new brand and our supply chain and systems infrastructure of 100 basis points, and 150 basis points due to the higher advertising costs associated with increased circulation and the growth of our direct business.

As we have shared with you previously, in periods where we experience more rapid growth in the direct-to-customer channel than in the retail channel, it will have the effect of deleveraging SG&A costs for the Company because of catalog advertising, which makes the direct segment's SG&A rate higher than that of the retail segment.

Loss from operations for the quarter was 3.5 million, which includes $900,000 of expense related to the adoption of SFAS 123R. This year's first quarter results represent a substantial improvement over last year's loss of operations of $4.3 million, which did not include any expenses related to SFAS 123R.

And EBITDA for the first quarter of fiscal 2006 was a positive $1.7 million as compared to negative $200,000 in the same period in fiscal 2005. If we exclude the non-cash charge of $900,000 for SFAS 123R from EBITDA, then EBITDA would be $2.6 million in the first quarter, an improvement of 2.8 million against the same period last year.

The outstanding balance in our line of credit at the end of the quarter was $88.1 million, up from 58.1 million at the end of last year. The increase in borrowing reflects the increase in inventory up 36 million or 23% from the end of last year. Increases in inventory levels were driven in support of our sales growth and strategy of improving in-stocks for important seasonal transitions.

Finally, common shares outstanding were 37.8 million at the end of the quarter, up by 4.6 million to last year because of the preferred stock conversion that occurred in July 2005.

Turning now to guidance for the second quarter of 2006. For the second quarter we expect total revenue growth of 17% to 20%. Comparable store sales growth will be in the mid single digits. We expect to see second quarter direct-to-customer revenue increase by 35% to 40%.

We expect our operating income to be between a loss of $1 million and a profit of $1 million, which includes the estimated impact of SFAS 123R of approximately $600,000. Interest expense for the quarter is expected to be approximately 1.5 million.

We expect second quarter 2006 results to be in the range of a loss of $0.07 per share to a loss of $0.02 per share, with a share count of 38 million. The impact of SFAS 123R is anticipated to be $0.02 per share in the quarter. Because of the valuation allowance provided against the Company's deferred tax assets, we anticipate recognizing only a small amount of income tax expense in the second quarter.

Last year our second quarter EPS was a loss of $0.07 per share, but included a tax benefit of $0.05 per share.

Inventory growth is projected at 25 to 35% in the second quarter, in support of our sales levels and a higher level at quarter end of in-transit inventory. For the full year we continue to expect total revenue growth of 18 to 22%. Operating margin for the full year is expected to be between 1.5% and 2.0%, which includes the estimated impact of SFAS 123R of approximately $3 million or 40 basis points.

Inventory growth for the full year will be 5 to 10%, slightly higher than our original full year guidance, but still a lower increase than our projected growth in sales. Income tax expense for the year will be about $1 million.

I would like to thank you for your interest in Restoration Hardware, and now I will open up the call to questions.

(OPERATOR INSTRUCTIONS). Rex Henderson with Raymond James.

A couple of questions. First of all, the increase in the inventory level, although you explained that as partly timing and ensuring that you have adequate in-stock during product transitions, still it compels me to ask about how you feel about the need for markdowns, whether the old -- how you feel about your level of merchandise that you are exiting as you go into the summer season.

I will take that. This is Gary. If you think about the inventory, basically we're taking a picture at the quarter end period. And what we have done is we have moved receipts from the following quarter up into the preceding quarter to land the goods earlier and land more goods to precede the floor set and a holiday drop -- excuse me, a floor set and a catalog drop.

As we look at our content today, as we mentioned, we're guiding merchandise margins several hundred basis points over last year. Today our markdown activity has been less than last year. It will be less than last year in the second quarter. And we would expect -- we would expect markdown content overall to be less than last year throughout the rest of the year.

So you feel pretty comfortable that you don't have any overstocks in areas that you're getting out of?

You always have some overstock. You don’t guess it all right. But if you think about the year, we're planning to end the year with 5 to 10% more inventory, and we're going to drive 18 to 22% more revenue. So that would say our inventory this year is more productive than last year. Okay?

And the comps, you said that part of the reason comps were a little below your expectations was because they were deferred revenue neutral. I want to make sure I understand what happened. So essentially what happened was your order level remained -- was pretty much where you expected. But you expected some catch-up on deferred revenue. And instead the order levels you got shifted from, say, cash-and-carry merchandise to special delivery merchandise, mainly furniture. Is that a fair characterization?

That is a part of the characterization. I would say the other part is due to the mix in furniture, and the mix in furniture particularly towards the end of a quarter, and the mix of our direct business, particularly near the end of a quarter. So if you look at our balance sheet you would see the deferred revenue line is up sequentially from Q4 pretty significantly. We expected that number to be lower than it is. And so we had greater sales and stronger furniture sales in the quarter, particularly toward the end of the quarter, as well as direct-to-customer sales that were shipped but were still in transit at the end of the quarter. So this is one where we're still trying to model it right. But sometimes small behavioral shifts in our business in those last few weeks of the quarter can affect our revenue.

Okay. Finally, in your guidance -- same-store sales guidance for the next quarter, is there any -- what is your expectation for deferred revenue catch-up there? Is this deferred revenue neutral or you are again expecting some catch-up on that?

We're being conservative based on not being able to be real predictive on that deferral line, but we are anticipating we could get a point, maybe 1.5 point in the second quarter from deferred revenue.

Finally, you talked about supply chain efficiencies being some benefit to gross margins. Can you give me some idea of what it was that you're doing there and what you have got in progress right now in terms -- on the supply chain side? You obviously had some expenses there in SG&A, but what you've got in progress there that will help gross margins in the future?

This is John. We're still getting some benefit year-over-year from justifying our transportation modes, and from cleaning up some of the waste in the supply chain. And that’s more than offset some of the year-over-year fuel cost increases. And I would expect that we will see those continue at kind of similar levels through the balance of the year.

Laura Champine of Morgan Keegan.

Gary, you mentioned that sales were accelerating into Q2, but the guidance is for a mid single digit comp, and you just did a mid single digit comp in Q1, and that 2Q guidance has I guess a percentage or 1.5% from the deferred revenues. Are you tracking ahead of your comp guidance so far in Q2?

I said sales were accelerating as we head into Q2. Yes, we're trending somewhat ahead of our comp guidance. And as we guided for Q2, our direct business is accelerating.

Is there a reason for the conservatism? It sounds more like perhaps the comp guidance in Q2 is conservative. Is that based on any change in industry climate or anything that is different year-over-year in your product?

I would say we're only a few weeks into the quarter and also if -- as you know well, almost all the homes people out there are having difficulties. Numbers are coming down and numbers are decelerating. Ours happen to be accelerating. But we are being I think somewhat conservative in our guidance.

And then just lastly, are there any specifics you can give us on the support for the new concept that you're launching later this year, as far as how many catalogs you'll be dropping, or any more information you can give us on that would be helpful.

It is going to be a pretty small test and we will reveal more specifics as we go forward. But it is not going to be -- from a financial perspective, it is just not going to be very meaningful to the year’s revenues.

Kristine Koerber with JMP Securities.

A couple of questions. First of all, I just want to follow up on the inventory question. Gary, are in-stock levels where you want them to be now on the core merchandise?

I would say in-stock levels in most cases are significantly improved. I think that is what is affecting some of our acceleration in our business across both channels. But a lot of that has happened towards the end of the first quarter. But I would think we're going to get better and better as the quarters go here. We have some specific internal initiatives targeting different departments where we have been significantly broken and chasing businesses.

And then furniture, you seem to be doing quite well with the furniture. Where is furniture running as a percentage of the mix now?

It is slightly higher than historical numbers. We haven't broken it out at a real detail level before, but it is up probably a couple of points -- a point or two in penetration.

It has been about -- it is a little more than one-third of the business across both segments.

That is your lowest margin category, correct?

We've done some things to improve the margins in that category. And we have significantly higher margins on our outdoor furniture business than we do in some of the other parts of our furniture business, so that is why you saw us kind of aggressively go after this outdoor business.

And then as far as the outdoor catalog, looking at the DTC, how much of the DTC business was from the outdoor catalog drop?

We haven't broken that out publicly. We think for competitive reasons we would rather not.

But the catalog is doing well?

Yes, we're very happy with the catalog.

And then trends during Q1, did you see any slowdown whatsoever? I noticed one of your competitors was out saying that there was some slowdown in April. Did you experience anything or were trends consistent throughout the quarter?

Not necessarily. I think a lot of retailers maybe read the shift incorrectly with the holiday movement. So we had anticipated March was going to be stronger than April. And March was stronger than April, but we had anticipated May was going to kick back up, and May has kicked back up, so it hasn't surprised us.

Lastly, I just wanted to clarify something. So you're going to launch a new concept, test new concepts in the fall with a catalog, early fall, early Q3, and then you're going to test another catalog, is that correct?

Right. We will -- we have two initiatives happening. We have another category extension that we for competitive reasons we're not announcing yet that will be mailed at the end of Q3. That is a category extension off the Restoration Hardware brand. And then we are also mailing in Q3 the test of our new value concept.

(OPERATOR INSTRUCTIONS). Kevin Foll with Magnatar Capital.

Nice quarter. Can you talk about circulation plans for the rest of year and how to think about the timing of that?

Sure. In the second quarter year-on-year we do have an increase in both books and pages. More in books than in pages, as we are continuing incremental drops year-on-year of the outdoor book. Page growth will be up in the 40% plus range in the second quarter. And then for the year, we will be continuing that same sort of cadence in terms of higher book growth and page growth. Our circulated page growth assumption for the year is up in around the 30% range. The difference between the two is the category extensions have far less pages than our core book. So what happens is we will be mailing more books, but the page percentage will be lower than the book percentage.

I see. So it is a little bit of an incremental pressure on SG&A because of that as well, given the postage and all that, or not really?

The only reason that SG&A gets affected is the mix of our business gets affected. As the direct business grows faster than the retail business, direct -- all the advertising cost -- the biggest cost of the book is in SG&A, whereas your biggest cost on the retail side -- your occupancy -- is in occupancy. So whenever you grow direct faster, when you blend the two, SG&A -- it creates pressure on SG&A.

Did you comment all, I might have missed it, of the -- how much the merchandise -- the components of gross margin I guess in terms of merchandise margin versus leverage?

I don't -- we didn't give you the details on that. The bulk of the change is driven by product margin.

Okay.

There is a little bit of leverage, but not as much (multiple speakers) product margin impact.

Does it mean that the leverage (indiscernible) 150 basis points, or you don't want to comment -- because you commented in the past I guess on that.

It is roughly two-thirds product margin, one-third leverage.

That's helpful. Thank you.

Does that help?

Yes, it does. I guess -- obviously you're continuing to show very strong margin improvement. Can you talk about still some of the opportunities that you see in the supply chain side longer-term to get the operating margin up? And obviously the market doesn't seem to be realizing that four years ago you were at a negative 9% operating margin, and now you have improved it pretty significantly; yet your market cap is about the same. So any thoughts on how to -- have you ever considered any other kind of strategic alternatives to enhance shareholder value at these levels?

We think we're going to see some results that will start to enhance shareholder value this year and next year. As we look at the model, as we have said, we have had to focus the majority of our efforts, the majority of our capital to build a front-end model. We had to give ourselves a chance to, one, survive as a business, and we have done that. We have taken the real estate we have. It is a lot more productive. We have built product development teams, product design teams, product sourcing teams. We have put in a whole infrastructure here that can support a much bigger business.

And there is -- as we have grown the business and expanded the merchandise margins, some of those initial investments had to get offset. And so as we look forward, we think we’ve got a front-end model that is highly leverageable. And if we -- if you ask me, if we did nothing on the supply chain over the next several years, we would probably have a front-end model that could get us to mid single digit operating margins. And we think that there are another several hundred basis points on the supply chain side over the next several years.

So we are very excited about, as we look at this model today, how we see it unfolding over the next several years. The hardest work is behind us. Saving the Company from going bankrupt and building a relevant cost-customer proposition was -- those were the difficult times. Not that this business ever gets less difficult, because you can't rest and you always have to keep changing and reinventing yourself.

But we think we've got -- we think we have stores and catalogs and websites today that can compete with anybody out there to garner market share. And we think we have made some progress on the back-end of the business, but we have not been able to really invest any capital into the back-end of the business.

So you'll see a shift over the next -- if you thought about our capital strategy, the last four years we -- in 2002 and 2005 we had two significant remodels of our stores, both costing 15 to 17 million each time. And that was to rearchitect the box to present the core businesses that we are now in in a compelling way that had a – that it built a front-end of this business that couldn compete. And that took -- that takes every bit of capital and some debt to make that happen, as well as build the organization to support that kind of merchandising engine and marketing engine.

Now if you think about it, the majority of our capital over the next three years is going to be focused on the back-end of our business. And so you'll see us, as we allocate capital, it will probably be 60 to 70% of the capital will be allocated to systems infrastructure and the supply chain infrastructure that will leverage us. And because we've got a relevant tri-channel front-end model, we believe the next three years we can grow our business substantially with very little capital on the front-end by mostly focusing our capital -- on the back-end by really growing our business through the direct channel. You'll see multiple category extensions and catalog titles. And we think we can continue a pretty healthy rate of growth over the next three years without opening many stores.

That makes a lot of sense. And you are correct, your direct business is more profitable as well. Once you get the mix shift right.

Exactly. It is more profitable. It has a higher return on capital. It has a higher return on assets. It takes less inventory. It spins faster. All kinds of good things. Building a direct model that was relevant here was another key part of the strategy. If you think about it, we have got a front-end engine, a multi-channel engine that we can leverage the different parts the way we want to, grow the business mostly through the direct channel over the next two to three years, as we invest our capital into the back-end, build the back-end. When the back-end is all set, and to lever a much bigger organization, then we can step on the pedal on the front-end to start opening stores.

Last quick question on share count and interest expense for the year. Do you have any sort of -- and the tax rate, what to use?

The share count for the year, I think we guided to roughly 39.5, 40 million. The interest expense, we had 1.5 million for the second quarter, and I think that is a pretty good run rate to go forward. Then on the tax rate, we will be paying a combination of alternative AMT domestically with some international and state taxes. The aggregate of all of that, our estimate currently is about $1 million. Obviously that may change based on our level of profitability.

Laura Richardson with BB&T Capital Markets.

This is actually William Wallace on for Laura. Most of my questions have been asked, but I do have a couple of maintenance questions. CapEx in the quarter?

CapEx in the quarter -- we will get that for you. I think it was about 2.6 million.

And still thinking around the range of 15 for the year?

That is still our thinking.

And depreciation?

I want to say it is 20, around 20 million.

And then the last question that hasn't been asked that I had was regarding outlets. I believe you said in the past you thought maybe two to three this year?

That is still good. One of those two to three opened in the first quarter.

I feel like I remember you saying that you felt they would be weighted towards the back half. Are those shifting forward now, plans? Could we see another one in Q2?

There isn't one planned for the second quarter currently.

Emily Carter with Dunlap Equity Management.

It is actually Carter Dunlap. I was just curious. I don't know if I have every heard you talk about what you think the scope of the DTC business can be relative to the store business. In other words, a couple of questions. When you look at the footprint of your DTC revenues, how tightly correlated is it to your store service areas? And then the other question, how much does the tail wag the dog?

I'm not sure if I understand the tail-wag-the-dog question. Maybe you can add a little clarity on that.

I am sorry. At some point -- when you speak about the next three years and the tri-channel really driving front-end growth without really having to put a lot of capital into the stores, I guess my question is, how big do you think DTC can get without having to keep growing the footprint of the stores at some point? (multiple speakers) How correlated are those revenues?

If you think about it -- I think it was in 2001 that the direct-to-customer business here was 5% of revenues. This year it is going to be somewhere close to 30% of revenues. We think that the -- we think we can have in excess of $1 billion direct-to-customer business long-term. We don't see any limitations because of footprint.

The great thing about us, you know, we have 103 stores. We're in all the major markets. We have a highly identifiable brand. We think we have multiple category extensions and titles in our catalogs. We think we've got brand extensions in our catalogs that we can do. So we see a lot of opportunities. And then also, we see new brands like the value brand that we will test this fall. And it is less expensive, it is less risky for us to test and to grow that way. If we're not successful we can pull back circulation. We can pull back pages. And in many ways the direct-to-customer channel can lead then the expansion of the retail business, because we will know what categories are relevant, what our customers are shopping for. And we can fill in the marketplace in a more intelligent way.

Don't misunderstand my question, I think your DTC business is great. I was just trying to figure out like now, how much -- do you catalog outside of the major markets that you are footprinted in? And if you do, what kind of penetration do you --?

Yes. We have -- about 60% of our books are mailed in the trade areas today, 40% outside of trade areas. And I think we've got about a seven mile circle around the trade -- around the stores.

What is the productivity of the 40% that is in the non-trade area?

They are generally more productive. Yes, they are generally more productive. It all depends. So --

Rob Wilson with Tiburon Research.

Gary, I know you have opened these outlets, but why did you have to have a warehouse sale in San Francisco this past weekend?

Why did we have to -- I guess we chose to. To just to continue to move through inventories. And if you think about our model and again what is different, what’s changing -- the mix of furniture in the direct-to-customer business is a higher mix than in the retail business. So when you grow furniture faster -- excuse me, grow the direct-to-customer business faster, you wind up with more furniture and you wind up with returns on furniture going up.

It is just -- today it is still a viable way of us moving through inventory that has been returned and might have a nick or a dent in it or it has been handled and we can't sell it as brand-new. I think one of the challenges we have, and will always have, is because we positioned ourselves at a premium part of the market -- someone's finest, $2,000, $3,000 dress shirt, when it gets delivered, they expect it to be perfect and brand-new out of the box. So from a return point of view we can -- sometimes we can recondition the goods and sell them as new, but many times you are just better selling them through the outlet store or through a warehouse sale.

We still see some warehouse sales over the next few years probably, until we fill out our marketplace with outlets. And as the direct-to-customer business probably moderates that might help us. But generally in models like ours where you have a real tri-channel business, the outlets generally are moving a greater proportion of direct-to-customer goods and returns than retail goods, because in the retail stores you have a channel. You can mark down the goods. You can clear them. In the direct-to-customer business, when things don't sell, or they are returned, you really have nowhere to sell them unless you put sale pages in, which you can only do so many of those. That is the continued need for warehouse sales. But if you think about it, the numbers are all in our margin. So when we tell you that merchandise margins are up several hundred basis points, that is inclusive of warehouse sales.

I understand that. But if I remember correctly, I thought you said a year, a year and a half ago that you were going to move away from warehouse sales. That is why I brought up the issue.

Yes, we would hope to at some point. But right now at the pace we're growing the business, especially the pace we're growing the direct business, we're probably another year or two away. At some point we might still need one or two a year because some of the goods are more appropriate to sell at a warehouse sale than in an outlet store.

On your CapEx, you're spending 15 million in CapEx this year. Are there any systems, infrastructure improvements that you're undertaking this year?

Yes, there are. We have some kind of echo back happening. We said about two-thirds of the CapEx is targeted towards systems and infrastructure. I think that sounds about right.

Can you give us some sense for what exactly those systems are?

Rob, I don't know if it is your phone that is creating an echo -- if anybody else hears that echo. Okay, it has gone away now. I think we communicated that we're putting in new order management systems in our call centers and in our stores, new warehouse management systems in our distribution centers, specifically focused on our furniture distribution centers this year. We are investing and are now going live on a tri-channel merchandising database that will allow us to manage our inventories tri-channely and view our inventories and be much more efficient and effective at deploying inventories.

As well as we're working on in the future installing order terminals in our stores, so our stores don't have to call a call center to place an order. They will be able to just input an order on a terminal. It will save us phone calls and expense and time. So we have a series of a whole three-year kind of strategic systems and supply chain plan in place that we're executing against.

One final question. With your debt levels, are there any liquidity issues this year?

No. There are none.

There are no further questions in queue at this time. I will turn it back over to our speakers for any further closing remarks.

Thank you everyone for your interest, and we will talk to you next quarter.