RH (RH) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen, and thank you for standing by. At this time I'd like to turn the call over to Mr. Chris Newman. Please go ahead, sir.

Thank you, good afternoon, everyone and welcome to Restoration Hardware's second quarter 2006 earnings release conference call. I'd 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 800-283-4595. Leading our call today is Gary Friedman, the Company's Chairman, President, and Chief Executive Officer, Ken Dunaj, the Company's Chief Operating Officer is also on the call. At the end of our remarks, we'll open up the call to questions.

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 contain forward-looking statements within the meanings 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, or financial results for the second quarter of fiscal 2006, statements concerning guidance for the third 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-Q and Form 10-K and our release posted on the Company's website regarding our results for the second 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, and thank you for joining us.

We are pleased to announce record sales and earnings for the second quarter of 2006. As mentioned in our press release, this marks the first time that Restoration Hardware has been profitable as a public company outside the fourth quarter. We believe these results and the customer's strong response to our product further validates our work to position Restoration Hardware as a premium home furnishing brand in the marketplace. In reaching this milestone, I would like to thank all of our Team Resto members across the country for their contributions. I'd also like to thank our customers and shareholders for their continued support.

Our record second quarter results were driven by total revenue growth of 24% and significantly improved product margin, despite what many are pointing out to be a difficult home furnishings environment. Comparable store sales increased 4.3% versus a 5.6% increase last year. Direct to customer revenues rose 58% on top of a 50% increase in 2005 and a 103% increase in 2004, as we continue to execute against our direct centered growth strategy.

As you know, in March we introduced our first category extension, the Restoration Hardware outdoor catalog. This was the first of multiple category and branch extensions to be launched over the next several years. This holiday season, we will see the premiere of our second category extension, the Restoration Hardware gift catalog. This catalog features a fresh merchandising approach and will be supported by a unique web experience which will serve to position Restoration Hardware as a top of line gift destination in all channels during the holidays.

In addition, we recently announced the launch of our newest brand, Brocade Home, a fashion home lifestyle brand with a distinctive feminine appeal, targeted at the broader value market. Brocade, which is based in New York City and is led by Lisa Versacio who developed and launched the West Elm brand. Brocade Home will be introduced as a catalog this fall with plans for an e-commerce website next year. Our longer term plans are to develop a multi-channel retail platform over the next several years after we test and validate the concept. You can preview the brand and sign up for a catalog online at www.brocadehome.com.

We've continued to make investments to support our core strategy of innovation and product leadership and believe these investments have positioned the Company for long-term sustainable growth. We're also excited about the many operational and supply-chain opportunities that lie ahead. As you know, Ken Dunaj joined us last quarter as Chief Operating Officer. Ken and his team are executing both the short-term strategy to shore up our operational deficiencies and develop longer term to build world class service and operational excellence throughout our Company.

As part of our strategy to improve our current operating environment, we will installing order terminals in our stores this fall. This will allow our associates to check in stock availability immediately and place customer orders online all without making a phone call. We expect the order terminals to greatly enhance the customer experience as well as improve efficiency in both our call centers and stores. As well, we are implementing new systems in our distribution centers and home delivery providers in the second half of this year, which will allow us to improve order integrity and tracking throughout the supply chain. In the first half of next year, we will install a new order management platform across all three channels to greatly enhance the experience and provide additional cost efficiencies.

As you can see, we are in the very early stages of building a supply chain and operational infrastructure which we believe can add several hundred basis points of operating margin to the bottom line over the next several years. Both our investments in product leadership and operational excellence are designed to help us to develop a scalable and leveragable multi-channel multi-brand retail platform.

With that, I will now turn the call over to Chris for a more detailed review of the quarter's results.

Thanks, Gary.

This afternoon, I'll take you through our financial performance for the second quarter of 2006 and provide guidance on our expectations for the third quarter and full-year of fiscal 2006. At the end of my comments, I'll open the call up for questions. But before I share our results and guidance, I wanted to provide information about our recently completed review of stock option practices. This review, which began in July, was conducted with the assistance of outside counsel and was overseen by Restoration Hardware's audit committee. We undertook this review on a proactive and voluntary basis as we assume most companies are doing in light of the current regulatory environment.

In summary, the review identified errors in the dating of certain of the Company's stock option grants as a result of lapses in documentation and deficiencies in option plan controls. Specifically, the review identified errors with accounting measurement dates for certain previously granted stock options awarded primarily during the years 2002 to 2004.

The cumulative non-cash charge of $600,000 reflects deferred compensation expense that was under-reported for 2002 through 2005. The cumulative charge was reported in the current period since the amount of the stock option compensation expense attributal to each of the previous periods was not material to any previously reported historical period and does not expected to be material to the current fiscal year.

Now, to operating results. As Gary indicated, we were very pleased with our second quarter performance as it represented a significant improvement over last year and was also a key milestone in the Company's turn around as it was the first time the Company achieved an operating profit and recorded net income outside of the fourth quarter. Second quarter net revenue was up 24% to $179.3 million versus $144.8 million in the second quarter last year. Along with the increase in revenue, we experienced expansion of our gross margin of 310 basis points and leverage of our SG&A expense of 20 basis points.

Income from operations inclusive of $700,000 in costs associated with the adoption of 123-R and $600,000 in non-cash stock-based compensation charges that I just spoke to was $2.1 million and an improvement in operating results of $5.3 million over last year. Net income was a positive $0.01 per share, inclusive of $0.02 per share attributable to the adoption of 123-R and $0.01 per share attributable to the non-cash stock based compensation charge.

Looking at the total company results in more detail, gross margin in the second quarter was $59.2 million, a growth of 37% versus the second quarter of the prior year. This was the result of a 24% increase in revenue, coupled with a 310 basis point improvement in gross margin rate, which was 33.0% of revenue compared to 29.9% in the same period last year. The improvement in gross margin at the company level was a result of strong improvement in product margin.

SG&A expense for the company was $57.1 million in the second quarter of 2006, or 31.9% of net revenue compared with $46.4 million or 32.1% in the prior year's second quarter. The primary driver of the decrease in SG&A cost as a percent of net revenue was the level of revenue growth and the writeoff of store fixturing that was part of last year's store remodel. This leverage was somewhat offset by the expense associated with the adoption of 123-R of 30 basis points, the investment spending in our new brand and our supply chain and systems infrastructure of 80 basis points and the higher growth we experienced in our direct to customer segment. As we have shared with you previously in periods where we experienced more rapid growth in the direct to customer segment than in the retail segment, we have the effect of deleveraging SG&A costs for the company. Because the direct to customer segments, SG&A rate is higher than that of the retail segment.

Net income was $0.2 million or $0.01 per share. The impact of adopting 123-R was $0.02 per share and the impact of the non-cash stock-based compensation charge was $0.01 per share in the second quarter. Because of the valuation allowance established against the Company's net deferred tax asset, the Company recorded only minimal taxes in the second quarter of 2006. In 2005, for comparison, loss per share was $0.07, but included a tax benefit of $0.05 per share.

And finally, EBITDA for the second quarter of fiscal 2006 was $7.4 million as compared to $2.6 million in the same period in fiscal 2005. Excluding the non-cash charge of $700,000 for 123-R, and $600,000 for the stock based compensation charge, then EBITDA would be $8.7 million in the second quarter, an improvement of $6.1 million against the same period last year. The outstanding balance in our line of credit at the end of the quarter was $79 million, up from $58 million at the end of last year. The increase in borrowing levels reflects the increase in inventory of $23 million or 14% from the end of last year. Increases in inventory levels were driven in support of our sales growth and strategies improving in stocks for important seasonal transitions. Finally, diluted common shares outstanding were 38.9 million at the end of the quarter.

Now to segment results. In the retail segment, revenues increased by 9% for the quarter. As we experienced the 4.3% increase in comparable store sales versus a 5.6% increase last year. The remaining growth in retail sales is due primarily to the additional outlet stores year-over-year. Retail comps were driven by an increase in average retail dollars per transaction of 31%, combined with a decrease in total retail transactions of approximately 20% reflecting the changes in our merchandising strategy. Growth was driven across categories consistent with the merchandising and store layout changes made in the third quarter of 2005.

For the second quarter of fiscal 2006, our retail segment realized a $12.8 million four wall contribution or an 11.5% contribution margin as stated as a percent of segment revenue. This compares with an $8.6 million contribution or 8.4% of net retail revenue reported in the second quarter of the prior year. The change in contribution margin for the retail segment was driven by gross margin rate improvement and SG&A leverage.

Segment gross margin for retail improved by 70 basis points as a result of significant improvements in core product margins, somewhat offset by the shipping costs associated with growth in our in-store ordering business as well as expansion of our outlet business. SG&A expense for the segment leveraged by 240 basis points due to the writeoff of store fixturing that was part of last year's store remodel and due to payroll improvements.

In the second quarter of 2006, we opened one new outlet store in Wisconsin outside Chicago. Revenue for our 8 outlets was 45.7 million in the second quarter, up $3.3 million from last year's revenue, which included 3 outlets. The outlet stores have been designed to liquidate returned, damaged, or discontinued goods. While this revenue has been reflected in the retail segment, it is not considered in the calculation of our comp store sales.

Now, turning to the direct to customer segment, which includes sales from both the catalog and internet, Revenue was up 58% to $67.9 million. On top of a 50% increase in last year's second quarter. Catalog circulation for the second quarter was up 67%, with pages circulated up 46%. The growth in catalog circulation was driven by our category extension, the Restoration Hardware outdoor catalog, which drove a significant part of our growth in the second quarter. The web accounted for 46% of the direct to customer segments revenue in the quarter.

Profit in the direct to customer segment was up significantly to $13.5 million in the second quarter, a 19.9% contribution margin. This profit compares to $6.4 million in profit and a 16.0% contribution last year. The expansion of contribution margin rate in the direct to customer segment was driven by both gross margin expansion and SG&A leverage. Gross margin for the direct to customer segment improved by 440 basis points due to improved product margin and improved supply chain costs. Supply chain cost leverage was a factor of significant efficiencies in customer shipping and increases in average order size. SG&A expense in the direct to customer segment leveraged by 50 basis points due to the higher than expected revenue growth.

Turning now to guidance for the third quarter of 2006. For the third quarter, we expect total revenue growth of 17% to 20%. Comparable store sales growth is anticipated to be in the mid single digits. We expect to see third quarter direct to customer revenue to increase by 30% to 35%. We expect our operating income to be between a loss of 5.5 to $3 million, which includes the estimated impact of 123-R of approximately $0.9 million. Last year's operating loss, which did not include expense for 123-R was $5.9 million. Interest expense for the quarter is expected to be approximately $1.9 million.

We expect third quarter 2006 results to be in the range of a loss of $0.13 per share to a loss of $0.19 per share with a basic share count of 38 million. The impact of 123R is anticipated to be $0.02 per share in the quarter. We anticipate recognizing only a small amount of income tax expense in the third quarter, primarily related to our Canadian business. Last year, our third quarter EPS was a loss of $0.11 per share, but included a tax benefit of $0.08 per share. Inventory growth is projected at 25 to 30% in the third quarter in support of our sales levels.

For the full-year, we are increasing our guidance as follows. We expect total revenue growth of 19% to 23%. Comparable store sales growth will be in the mid single digits. We expect to see full year direct to customer revenue increasing by 40 to 45%. Operating margin for the full-year is expected to be between 1.7% to 2.2%, which includes the estimated impact of 123-R of approximately $3.5 million or 50 basis points and the non-cash stock based compensation charge of $600,000 or 10 basis points recorded in the second quarter of 2006.

Inventory growth for the full-year will be 10-15% over last year. Higher than our last full-year guidance, but still a lower increase than our projected revenue growth. Income tax expense will be less than $1 million and due to the valuation allowance against our net deferred tax assets, will be recorded primarily in the fourth quarter.

Thank you for your interest in Restoration Hardware. Now I'm happy to open the call up to questions.

[OPERATOR INSTRUCTIONS] And it looks like our first question comes from the site of Rex Henderson with Raymond James. Go ahead, please.

Good afternoon and thanks for taking my call. Had a couple questions about the inventory. First of all, is there any impact on the inventory numbers from Brocade Home? Or the new gift catalog in those numbers yet? Or is that still to come?

Sure, this is Gary. Brocade Catalog launches in a couple of weeks, we've got the inventory right now.

Okay, so there is some impact there. Can you give me any sense of what the inventories might have been up year-over-year excluding the impact of Brocade Home?

We probably have about $4 million of inventory supporting Brocade's launch.

Okay.

At the current time.

Okay. All right. And it looks like in the fourth quarter you're reaccelerating the growth of the direct to consumer channel. Is that the impact of the gift catalog and Brocade Home? Is that what I'm seeing there?

You've got a small impact from Brocade Home and a very, very small impact in the third quarter on from the gift catalog, barely at all.

Okay. And -- finally, Gary, you were talking a little bit about some of the impacts of the new technology in the stores and improvements in the technology. Can you just review that again quickly for me? And kind of what the -- what the margin impacts of that might be over time?

Well, let me just talk about what's happening in the second half of this year. We're currently rolling out order terminals in all of our stores beginning this week. We'll be in 35 stores live this week and we'll be rolling them out over the course of the next several weeks. That will give our associates the ability to check for product availability for furniture and other categories that we generally ship from a direct to customer mode or out of stock stores. It will allow the stores to place an order online and also track orders online.

We are also as I mentioned putting in some enhanced systems in our distribution centers and also in our home delivery network that will allow us to have improved order integrity. I think we've mentioned in the past one of the challenges we've had is we had an infrastructure here that wasn't built to support a multi-channel business. And we kind of -- previously we had a weak infrastructure and doubled the size of the Company over the last five years on top of this weak infrastructure. It's like taking a magnifying glass to a problem. As we grew the Company, the problems became bigger problems.

Some of these fixes, some of Canada's teams efforts to shore up the current infrastructure and allow us to ship an order with order integrity. Our distribution centers were never set up to ship -- to ship an order. They were set up to ship retail distros, so if you ordered a dining table and six dining chairs, our systems recognized those as seven individual orders and we had to try to aggregate that manually. Now we'll have systems in place that will allow us to pick and aggregate the order and also show, show the order all the way through the supply chain through our home delivery provider.

Okay.

and that's just the kind of the beginning kind of help shore things up this year. There's some more next year. Next year as I mentioned fully integrated true-channel order management platform that will support our retail stores, our web business and our catalog business. And that will be an important step towards just simplifying the customer experience and proving the customer experience and order and integrity throughout the company. And as we go forward, as Ken solidifies his longer term plans for the Company, we'll kind of share our strategic view of that.

Okay, but that's going to take -- it's going to take a year to get that whole system rolled out and operating the way you envisioned, is that right?

Yes, you'll see definite improvements happening in the second half of this year, impacts that will simplify the customer experience and reduce costs at both our stores and call centers, the order terminals will. And then when -- and then the impact of the systems in our DCs and home delivery providers we believe should have some kind of impact on the customer experience, as well as our ability to track and manage our inventory and reduce our shortage, we believe. And then next year we'll have even greater impact as we put in the integrated order management platform and beyond that, there's many enhancements that are planned over the next several years. If you think about it over a long-term view, we believe there's several hundred basis points of operating margin improvement based on our supply chain efforts over the next 3-5 years.

Okay. And one final question. Can you give us an idea of what the gift catalog is going to look like? You got rid of what you used to call the tchotchke items in the stores. What kinds of things are going to be in the gift catalogs that we haven't seen up till now.

One of the things that the category extension gift catalog gives us the opportunity to do is to expand the assortment in a more creative way beyond the four walls of the store. You'll see, I think, somewhere around half or over half of the assortment is catalog and web only. So the catalog will support the store's assortment, but will also allow us to reach the customer during that important holiday time with a very creative offering and a very giftable offering.

If you think about the fundamental assortment that we've built Restoration Hardware on, it's very functional goods. Cabinet and door hardware, bath hardware and bath accessories, window treatments, bed and bath textiles, furniture, lighting, et cetera. Those are not big giftable categories at holiday. And that's been one of the challenges that we've had over the last four years as we've repositioned this product mix. Mentally, we've taken the accessories, kind of what the Companies call discovery items, part of the business used to be 47% of the business and we scaled that back immensely. And it -- it's created over the last three years a hurdle for us in the fourth quarter because we've edited back the component of the business that was most holiday relevant while we built these other categories that were very relevant in the first three quarters, not as relevant in the December holiday time.

We now have crossed the line so to speak where now we believe we can layer, we can add a layer of gift assortment back into the stores. We can support it with a unique catalog. We can offer a broader assortment of gifts through our catalog and online. And we believe the catalog will then kind of bring awareness back to the brand as a great place to go for creative and innovative gifts. You'll see an assortment that we believe is very unique in the marketplace and reflects restoration Hardware's point of view. But they aren't things that you'd see year-round in stores. And we believe, also, you know in our stores or in our catalog. And also goods that if we tried to wedge them into our current catalog, it would kind of pollute the positioning of the home book. That's what you saw in the third quarter this year, we introduced our core catalog, now it says Restoration Hardware Home. And just as the outdoor catalog said Restoration Hardware Outdoor. Now you're going to see a Restoration Hardware Gift catalog.

Thanks very much, I'll let someone else ask questions.

Thank you our next question comes from Kristine Koerber with JMP Securities. Go ahead, please.

Yes, hi, congratulations on a great quarter. Couple of questions. First of all, if you can talk about your markdowns during the quarter. Obviously the gross margin was up significantly due to merchandise margins, but how did you end the quarter as far as clearance merchandise?

We ended very clean, Kristine.

As far as the margin improvement, how much is that, can you break that down between merchandise and supply chain?

Significant part of that was merchandise margins.

Okay. So we have yet to see a supply chain, really any supply chain improvements kick in at this point?

Just a very modest one.

Okay. And as far as the gift catalog, how, how many pages is this catalog? and I'm assuming it's much lower price point merchandise and I'm kind of interested in the return on investments.

It is, it is lower -- obviously doesn't have furniture. And some of the other high-ticket categories. So you're going to have a smaller average order, smaller average transaction around this book. But it's the kind of goods that have the highest hit rate during the important holiday -- holiday time frame. What we're excited about is we believe this gift catalog gives us the opportunity to expand our circulation beyond our current targeted customer base where today we have a very high average order.

And we, can we talk about that number externally? We have an average order excess of $500 an order in our direct business. That precludes you from mailing real deep at times. This new segmented catalog with a, much lower average order allows us to go to a much broader group of customers during this time of the year. So we believe the return on investment is going to be good. We wouldn't be doing it unless we thought it was going to be a profit vehicle. So I wouldn't think of this just as a marketing catalog. This catalog and web experience on its own will be a profit center for the company. That's at least how we're planning it today. And then the increased benefit of driving top-line awareness and people to our retail stores and to the web.

When is the catalog supposed to hit homes?

End of October.

Okay. And as far as holiday sets, are you rolling out holiday well ahead of last year? Is it going to be rolled out at the same time?

No, exactly the same time.

Okay, and lastly. Talk about momentum throughout the quarter, I mean, what you're seeing macro, have you seen the customer, high-end customer kind of pull back at all?

We're not economic experts here. So we wish we had a crystal ball that would allow us to know what to do. But we don't manage our business based on macro issues. We focus on our product, our service, and operational efficiencies and those are the things we can effect. We've given guidance for the quarter and we feel confidence in the guidance we've given.

Did you see any changes in momentum throughout the quarter? I know you went into Q2 with pretty strong momentum. Any change in trends throughout the quarter?

You know, we -- we're giving guidance on a quarterly basis and reporting on a quarterly basis. So we think you can do brain damage by trying to segment the weeks within a quarter. So as I said we feel confident about the guidance we've given for Q3 and that's what we're reporting today.

Okay. Fair enough. Just thought I'd try, thanks.

Thank you, our next question comes from the site of Laura Champine with Morgan Keegan, go ahead, please.

Good afternoon. Given the margin improvement that you made in the most recent quarter, your implied margin guidance for Q3 looks conservative to me. Is there a reason driving that? That you won't see more leverage in this quarter and do you view the margin implications for Q3 as conservative?

Q3 is where we did the remodel last year and consistent with that remodel, there was a rearchitecting of the margin of the brand and so the gains we saw in the first half of the year will not be as large in the back half of the year. Less revenues in Q3 than Q2, so you're going to get less leverage in certain areas.

Got it. Thank you.

Thank you our next question comes from the site of Laura Richardson with BB&T. Go ahead please.

Thanks. Can you talk about the catalog circulation growth you have planned for Q3 versus Q4? It sounds like Q4 should be significantly higher, more like what you had in Q2, I would guess.

Yeah. It's your pattern is consistent. You would see a higher growth in fourth quarter than in the third. So I don't know that we'd get quite up as high in the fourth quarter as we did in the third because we have a larger base.

Okay. That's fair. And is it typical that when you have -- you said 67% circulation growth, you obviously got a good pay back on that, but you don't have every new catalog recipient placing an order. Your revenues were up 68% in the catalogs on that circulation growth? Is that kind of a modeling metric to use?

Laura the right way to think about it, when a company's mailing multiple books, I would think of it from a pages circulated increase.

Okay.

If you think about it in Q2, our book circulation is up 67% because we got an extra title out there. But our total pages circulated are up 46%.

Okay.

Our revenue is up 58% on a 46% increase in pages circulated. That's the right way to think about it from profitability.

Yeah, that makes sense. And just for Q3 because you don't have any incremental book going out, Brocade sounded like a small mailing. And it is going to happen in Q3?

It is going to happen in Q3, and it's a very small mailing.

Okay. That is fair. And then the refixturing last year due to all of those expenses hid in Q2 last year, we're not comparing against that anymore in Q3?

That's correct.

Okay and then the stock option review for this year, I'm not -- I'm not clear and I think Dow Jones got one of these things, perhaps wrong, did the non-cash $600,000 for that and the cost of the legal or professional fees, did that all hit in Q2 or is it going in Q3?

It's in Q2.

Okay. And then any comment in terms of your like the individuals involved in those grants, is it board level people? Or executive level people --

Thank you, our next comes from the line of Janet Kloppenburg with JJK Research.

Sorry, we didn't get to finish that last question, operator. Laura Richardson was still asking a question. Operator? Did something just go wrong here?

I don't know what happened.

Is everybody there?

We just lost the call.

No, we're still on. Operator, are you there? We think we lost the call, guys, I don't see any lights.

No, the lights are on.

The lights are on? Okay, they're getting Laura back on the line.

We can go to the next question and bring Laura back.

Thank you for your patience, we are having a little bit of technical issues and we will be getting back to that last question in just another brief moment. Ms. Richardson, if you could please requeue if you're still on the line. Laura Richardson, your line is open.

Oh, thank you so much. Usually people want to stop the questions from analysts rather than give you more time.

Laura, you were in the middle of asking a question.

Yeah.

I guess it dropped your line.

We didn't want you to think that we cut you off.

Thank you I appreciate it. Just on the stock options. Any comments on the individuals involved in those grants? Are those people with the company? Board people? Management?

Laura, we can't make any comments about the specific people involved with the grants. And it's a wide range of people. It's not focused at a senior level, at a board level, at a managerial level. It's across the board. There's no pattern to it.

Okay. Thanks. And then one more question. Demographically, you have always said that your mission is to be basically more upscale than Pottery Barn, which we all know has had some issues recently. But have you said specifically what's the average income of your customer?

We haven't.

Want to do it now?

No.

But would you stand by the notion it's above Pottery Barn?

Yeah, we said we want to position ourselves as the premium home furnishing brand in the marketplace, positioned above the current lifestyle retailers like Pottery Barn, Crate & Barrel, Z Gallerie and others and below the interior design trade.

Got it, thanks a lot.

Okay, thank you.

Thank you our next question comes from the site of Janet Kloppenburg with JJK Research. Go ahead please.

Can you hear me?

Yep.

Hi, congratulations.

Thanks, Janet.

A couple questions. First, I'm wondering about the SG&A leverage in the stores. You said there was some payroll improvement. And I'm just wondering what kind of leverage or what kind of comp you need to get more than 20 basis point improvement in SG&A.

We probably need to do around a five or a six.

Okay. And do you think at that point you could leverage more meaningfully? Or are there just investments that need to be made in the stores that will take some time before you we see some over 100 basis point improvements? Those kinds of things.

Yeah, we would need to see some significant strengthening of comps we'd have to be doing much higher than a four or five.

Janet, just to be clear, is your targeted at overall SG&A or store payroll?

I assume about store payroll.

Yes.

Okay so in the retail segment.

In the retail segment, that's right. But last year you had spent a lot of money on the improvements, hadn't you, on the refixturing of the stores?

I'm sorry, Janet, can you repeat that?

Last year you had spent quite a bit of money on refixturing the stores, correct? What I'm trying to get at is without that in the numbers, going forward, how we should think about leverage on the store operating expenses.

Janet, you want to think about the investment that we made in the stores is depreciated over the life of the investment. So we have -- we have a cost there in the P&L that's hitting every month.

And will for quite some time?

and we depreciate fixtures and equipment over five years or so. Yeah, so you've got it, you've got an investment that was made last year of roughly $15-16 million on average 5 years depending on the life of the leases that are left the life of the leases in the stores.

Okay.

But we are getting relatively good leverage, from our point of view in our stores today. And a payroll perspective and a lot of that is driven by a higher average order lower transaction count, more efficiencies in our stores.

and we should look for that level of improvement to continue?

We would think so. We would think so. So Janet to frame it it's tens of basis points rather than hundreds of basis points.

For the next couple of years or so? Hard to say --

I don't know if we'd go out that far.

I just wanted to get an idea because the question is how far can the gross margins go?

We believe can the gross margins of the Company can get to 8-9% over the next 5-year period.

I think, I think if we think about our supply chain initiatives.

Right.

That will have an impact in both gross margin expense and in SG&A. So you can't just think about gross margin as a product margin variable.

It's the systems investments, as well. We'll offset some of that is what you're saying?

Correct.

Okay. Fine. Gary, can you talk a little bit about the furniture business and how it's trending and how you view it as, if you view it as a growth business for the company or if it's something that's, I wouldn't say maturing, but going to experience slower growth going forward?

Well, let me put it in perspective what we've always said here. When we first started the repositioning of the Company, we said the furniture business at aggregate at our retail store level was too big of a percentage of sales for the mix. And furniture used to be 35% or so, 37% of the business. And we said we wanted to shrink the furniture business as a percentage of sales while we grew other categories and tried to have furniture more in the 25-30% range and total revenues at the retail level. It's a different mix in the catalog and the direct channel.

Right.

So what we've done is we've been, you know, moderately growing furniture while we've been growing other categories more substantially. We believe we've got the right balance today and our plan is to grow the furniture business in line with the rest of the categories.

And would it grow faster in the direct business?

Well, the -- the furniture today as a total mix is is a bigger percentage of the direct business than it is in the retail business. So as long as we're growing the direct channel faster, you're going to grow total furniture faster.

Thank you. And I know you just dropped your fall catalog and I was wondering if you could give us some idea of where the strengths and weaknesses of the business are right now.

We said it in, I think, our last comment. We kind of guided to our revenue growth for the quarter and we're not going to get more specific or into mid quarter trends.

Okay. And on Brocade, it's a different customer so you must be looking at a list that you've purchased from somewhere? How do you -- how did you think about that, Gary?

Completely different customer. So we're looking at different lists and we're also in some cases mining our current list a little bit. We think it could relate to second homes and second bedrooms and other things. So, it's very experimental at this stage and we're going to learn a lot over the next six months of who responds and what segments of what lists respond.

So today, we're using our best judgment to mail, who we think is the appropriate list where we access customers from. With any of these catalogs and new brands, you learn so much in the first 6-12 months that it's hard to speculate at this point.

Okay and just lastly on the gift catalog, we've seen the gift assortments in the past, I have a rough idea of the kinds of categories you target for your gifts in the stores. Will it target those similar categories or will there be some new categories that you will be investing in, as well?

Yeah, there's similar categories and new categories. And we don't want to get too specific for competitive reasons. So, everybody will see it when the customer sees it.

How many pages is that catalog?

I think we're at 80 pages, 88 pages.

A substantial catalog.

It's a real catalog.

Good luck and thank you.

Thank you our next question comes from the site of Rob Wilson with Tiburon Research. Go ahead, please.

Yes, congratulations, that was a great job, Gary.

Thank you.

Could you speak to your -- the rollout of your nationwide home delivery network that you suggested may be in place by the fall or winter?

I'm going to let Ken take that.

We've been working on a consolidation program to really focus on the providers in the regions that really do the best job from a service and a cost perspective. So we -- we've been in the process of doing that consolidation and we'll continue over the balance of the next quarter.

Would you care to share with us how many providers you had today? I believe a couple quarters ago you said it was roughly what 30, Gary?

I think we were at 29 last year. I don't know how many we'll get down to this year, Ken.

Yeah, we're currently running around 11 and the plan is to get under 4.

Wow, okay. And Gary, or maybe Chris, this is for Chris, could you speak to your ability to sort of predict the revenue deferral each quarter? Are you guys getting better at that now?

Yeah, we're getting better every quarter. So I don't have any issues with our ability to predict the revenue deferral in ways that are better than prior years.

I think the question on the revenue always comes down to how strong is our furniture direct business in the weeks before the end of the quarter. So if we have a surge in our direct business or a surge in our furniture business towards the end of a quarter, that's going to create a bigger deferral. And that's -- that's still a part that -- it's hard.

It's probably fair to say that we won't see material shifts any longer now that we're anniversarying it.

We don't believe so, no.

Okay and finally Gary, last year you suggested a lighting sale this year in October, I was wondering if you made any strategic changes there that would enhance the event this year?

We have. We think we've, you know, last year was -- as you recall was the first year we launched all the new fixturing and 85% of the assortment was new. I think we're much smarter this year. I think our assortment is fine-tuned. I think we have figured out how to be more creative from a catalog marketing perspective and in store marketing perspective. So we feel -- we feel very positive and optimistic about this year's fall lighting event.

Did you make any special buys for the event this year?

We always make some special buys for the event.

Okay. Well congratulations, thank you.

Thank you.

Thank you.

Thank you, our next question comes from the site of Kevin Foll. Please go ahead.

Hey, guys, nice quarter, congratulations. Can you break out how much the outlets contributed this quarter? In terms of revenue?

I think it was in the script. I think it was $5.7 million?

Okay. I probably missed that. And then I apologize if I missed this, but what your plans are for catalog mailings and pages circulated for third quarter and fourth quarter? Terms of the percentage increase?

We didn't give specifics but we said the third quarter would be closer to the first and the fourth quarter closer to the second, but probably not as high of growth.

Okay. Thanks very much.

Sure.

Thank you, and our final question comes from the site of [Steve Granjean with Granjean Research]. Go ahead, please.

Yes, hi. Good progress, that was terrific. I guess this is really, I don't want to get too macro. But Gary this is sort of directed at you. Because as I recall you got yourself started at Willams-Sonoma just in time for the last great California real estate recession in the late 80s and early 90s. Even though you've got to run your business and can't be an economist, but clearly -- when you ordered your inventory you had to have some kind of an assumption. Don't you have to have some kinds of assumptions as to what you expect in terms of new housing, housing turnover, et cetera. How did you take that into account?

And then you all have stores that are in some of the areas if you call it the housing industry -- if you look at the statistics being the most impacted. Parts of southern California, Phoenix, the Washington, D.C. area, et cetera. Are you seeing any differentiation yet in terms of how the stores are doing by geography?

We're really not, Steve. We're not seeing any consistent pattern. And as it relates to how we think about macro things. Of course at a higher level, at a strategic level in the company. We believe there's going to be economic factors that might impact our business, that will force more of a conservative view in our planning. And you know, so we always, you know, we'll always have that tension inside the company. My point is we don't, you know, we don't like to sit around and talk about things we can't control.

I mean, you know, if we -- I can tell you today if you looked at our business by category, we've got categories that are copying tremendous and we've got categories that are not comping well. And if you dig into it, it's always a product issue. And, as long as I've been in the retail business, if you have the right product, presented the right way, the right value proposition, you're doing well. And when you don't have the right product presented the right way with the right value, you don't do well. And the way to run a retail business is category by category, subcategory by subcategory, product by product.

And that's how we think about it and that's how we run our business. And I can tell you that all of the years I've been in this business, I've seen some of the best comps run during the worst economic times and some of the worst comps run during the best economic times. And we're in a -- doesn't matter if it's a good economy or a bad economy. We're in a market share gain, so we're competing for the dollars that are out there. And our focus is on those things that we can control and those things that will put us in a position to win.

Congratulations. Stores look good and I think the catalogs look terrific. So keep up the good work.

Thanks, Steve.

Thanks, Steve.

Thank you and this concludes the Q&A portion of today's call. I'd now like to turn the call over to our speakers for any closing remarks.

Again, thank you for your interest in our Company, and thank you to all of our associates all throughout the country for their hard work and efforts in helping us reach this milestone and we look forward to talking to you next quarter.

This concludes today's teleconference, ladies and gentlemen, you may disconnect. And have a great day.