RH (RH) 2007 Q1 法說會逐字稿

Welcome to today's teleconference. (OPERATOR INSTRUCTIONS) Please note this call may be recorded. I would now like to turn the program over to Chris Newman. Please go ahead.

Thank you. Good afternoon, everyone, and thanks for joining us. Leading our call today is Gary Friedman, the Company's Chairman, President, and Chief Executive Officer. Ken Dunaj, our Chief Operating Officer is also with us today, and will be joining us for Q&A at the end of our formal remarks. But before we begin, I need to remind you that certain statements and information on this call will contain 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 the Company's goals for sales growth and the expansion of operating margins in future periods. The Company's guidance for future periods, the Company's future initiatives and other statements containing words such such as expects, or words of similar import. Important factors that could cause differences are contained in the Company's filings with the SEC, 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 to the first quarter fiscal 2007. 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, I'd like to turn the call over to Gary.

Thank you, Chris. Good afternoon and thank you for joining us us today. As discussed on our last conditions call, we knew the first half of the year would be challenging based on the macroeconomic climate expecting furniture and home furnishings retailers and the timing of both the growth and infrastructure investments we are making. The first quarter was actually more difficult than expected, as you know, April turned out to be a soft month for retailers across the board. We were particularly hard hit because the second mailing of our outdoor catalog was in home on April 5, the day the major storm struck the East Coast. As a result, our sales volume in outdoor and other seasonal products was substantially below planned across all channels.

At the same time, we incurred excess costs to retrofit our furniture distribution centers which also negatively impacted our earnings for the quarter. While the timing of the April outdoor catalog drop was unfortunate, our early May outdoor catalog mailing has rebounded and is meeting plans. We have also taken action to mitigate the short fall to earnings for the year.

First, we revised our catalog circulation plan. We made changes where we saw the opportunity to streamline some lower performing mailings and reduce page count in order to increase overall productivity. Second, we renegotiated catalog production costs which are expected to generate significant savings in the second half of 2007 and into 2008. Chris will provide you with greater detail on both of these initiatives later in the call. We're confident these steps will allow us to recover a substantial part of the first quarter shortfall and still deliver improved operating earnings to the year.

While we're operating in a difficult macro environment our business is positioned for much stronger performance in the second half of fiscal 2007. The growth in infrastructure investments that are having a deleveraging effect in the first half will benefit us in the third and fourth quarters. The expenses we're incurring for our growth initiatives, specifically our third category extension, the restoration hardware Bed & Bath catalog, and our new division restoration hardware trade will translate into incremental growth and profitability in the back half of the year. We believe our new Bed & Bath catalog further strengthens our position as an authority and destination for these strategically important categories. There is really no one else in the marketplace offering this level of design and quality at our price points. Our first mailing was in home mid April and we are pleased with the early response.

We also see tremendous opportunity for a new trade division which targets interior designers, home builders and the hospitality market. This business leverages our core capabilities and product strengths, plus requires little capital investment. We officially kicked off our efforts last month at the hospitality show in Las Vegas where our brand met with enthusiastic response. Our newest brand, Brocade Home is in its second season and continues to gain momentum every quarter. While the business is still relatively small, we remain optimistic about the longer term growth potential of this distinctive new concept.

As mentioned, we are also developing Restoration Hardware baby and child, this new concept will debut as a catalog and website in 2008 with plans to test retail stores in 2009. We believe there's a void in the market for a more premium and sophisticated offering of home furnishings and furniture for newborns and toddlers. I recently reviewed the initial assortment and I can tell you as a father of twin four and a half-year-old girls I wish there was a concept like this today today. As discussed we believe the opportunity exists to significantly improve our operating margins over the next several years with the goal of reaching 4 to 5% in 2009. Our success will largely be driven by the transformation of our supply chain and systems infrastructure. We are in the beginning phases of implementing a three three-year strategy that will provided the foundation to support and leverage our growth. Let me give you an update on our progress and outline our plans for the balance of the year and into 2008.

First, we completed the retrofitting of our furniture distribution centers in the first quarter of this year. We installed new narrow-aisle racking which will greatly improve space utilization, product handling, and productivity. Second, we are consolidating our small package direct-to-customer operations from 3DC's into one centralized distribution center. This will improve our in-stocks, inventory turns, and reduced freight costs. The transition is underway and should be completed by the end of the second quarter. Third, we are installing a new warehouse management system in our furniture DC's to improve order integrity, tracking, and productivity. We expect to have this installed by the end of the third quarter.

Fourth, we are reengineering our home delivered furniture network with the goal of improving the service experience for our customers and reducing both returns and damages. This initiative will be rolled out in the second half of this year. Fifth, we are investing in sourcing and production management in order to reduce our cost of goods in core merchandise categories. We expect to begin seeing the benefits of these efforts in the second half of this year and into 2008. And finally, we are developing an integrated multi-channel order management system. This will provide us with a seamless multi-channel experience for our customers and vastly improve order integrity across channels and delivery methods. We'll also have visibility into key data for all of our customers regardless of what channel they shop. This is a longer term initiative that we expect to complete in the second half of 2008.

Our team is working hard to put in place the operational capabilities required to achieve our operating margin goals, and provide the Company with the infrastructure to support our long-term growth strategies. In terms of our short-term outlook, based on the macro environment, as well our insight into current business trends, we remain comfortable with our full-year forecast with sale growth of 9 to 11% and operating margins in the range of 1.4 to 1.8%. We have navigated through difficult operating environments in the past and our business is much stronger today. We have a leading market position, a strong and experienced leadership team, and a multi-channel strategy that is driving growth from new categories, new markets, and new brands. We're looking forward to a stronger second half and more dramatic growth in the future. Now I'll turn the call back to Chris for a detailed financial review of the quarter and our outlook for the year.

Thanks, Gary. During the first quarter, we were challenged by both internal and external factors, the home furnishing sector, the change in seasonal trend that we experienced in April and the higher than anticipated costs to retrofit our DC's. I'll touch on each of these in greater detail during my comments.

Net revenue for the period was up 7% to 142 million. Growth wasn't as strong as we had expected, mostly due to below plan sales in outdoor and other seasonal products. Gross margin was down 240 basis points to 31.3%, reflecting the incremental costs associated with the retrofit of our DC's and lower product margins due to a higher than planned mix of promotional selling. These factors were offset slightly by leverage of store occupancy costs. SG&A as a percentage of sales was up 340 basis points to 39.7%. The increase reflects the higher volume in our direct business which carries a higher rate of SG&A than our stores. As well as the impact of growth and infrastructure investments.

Loss from operations was 11.9 million and operating margin came in at negative 8.4%, which compares to negative 2.6% last year. The year-over-year decline can be trace traced to the volume and margin pressure we experienced as well as investments the Company is making to drive future growth and transform our supply chain. EBITDA was negative 6.9 million, down from positive 1.7 million a year ago. Providing a little more color based on segments, results were as follows--The direct segment accounted for 41% of total revenue in the first quarter. That's up from about a third last year. As we've discussed, as our catalog and web assortments expand, there's a natural shift from our retail stores to the direct segment. This shift accelerated in the first quarter, and we expect this trend to continue.

Circulation in catalogs distributed during the period was up 41%, pages circulated were up 42%. The growth rate in circulation reflect the expansion of our Restoration Hardware outdoor catalog, which was introduced last year. The expansion of our home catalog, and Brocade Home. The contribution rate in both segments was lower than last year year. In the retail segment gross margin declined 590 basis point, due to lower margins and deleverage of store occupancy costs. SG&A increased as a percent of revenue by 220 basis points because of the reduced sales volume. In the direct segment, gross margin improved by 240 basis points, primarily because of shipping expense leverage. SG&A deleveraged by 130 basis points, reflecting our investments in growth initiatives.

Looking at the balance sheet, at the close of the quarter, the outstanding balance in our line of credit was 122 million, that's up from 88 million at the same time last year. The increase in borrowing levels reflects the Q1 operating loss and our 215 million inventory balance, which is up 11% or 21 million, against last year.

During the first quarter, we closed a $265 amended credit facility. That includes $175 million revolver, a 15 million fully funded term loan and a 75 million accordion feature to accommodate future growth. This provides us with greater financial flexibility while reducing our interest expense.

Before I review the specifics of our Q2 and full-year guidance, I'll provide some detail on product margins and what we're anticipating for the balance of the here. Certainly we expect the difficult environment will continue to pressure our margins for the foreseeable future. We were impacted most significantly in the first quarter of 2007 with product margins down approximately 100 basis points relative to last year. We anticipate that product margins will be down slightly in the second quarter as well, but up modestly for the full year. We do expect relative improvement in margin growth in the second half as some of our product cost reduction initiatives begin to yield benefits and the year-over-year comparison eases in the third and fourth quarters. It's also important to note that the cost-cutting initiatives we announced earlier this month are expected to lower our operating expenses substantially in the second half of the year. We've renegotiated key portions of our catalog production costs and taken other actions including changes to our circulation plans to improve productivity and reduce our operating costs as a percent of sales.

In the first quarter, the investments we made, including the cost overruns we experience in our DC retrofit impacted operating margin by 250 basis points. We expect the impact to be about 100 basis points in Q2. This translates to an impact on EPS of about $0.09 for the first quarter, and $0.05 for the second quarter. We expect the benefits from these initiatives, along with the savings from the cost-reduction efforts I described to generate roughly 125 basis points of operating margin improvement in the second half of the year, an impact on pre-tax EPS of about $0.14.

Turning to our guidance for the second quarter, which is unchanged from what we issued on May 9, we anticipate total revenue of 195 to 199 million, reflecting growth of 9 to 11%. Operating margins are expected to be in the range of negative 1% to flat. Second quarter EBITDA is expected to be between 3.5 and 5.5 million. Inventory is expected to increase 25 to 30% year-over-year, driven by receipts for the revenue growth we're anticipating in the third quarter because we've shifted our marketing calendar and extended the outdoor selling season. Interest expense is expected to be between 2.3 and 2.4 million. And our effective tax rate will be close to zero. These expectations translate to a loss per share in the range of $0.12 to $0.06.

For the full year, we expect total revenue of 780 to 793 million. This equates to a growth rate of 9 to 11% over last year's 53-week period. Operating margins are expected to be between 1.4 and 1.8% for the year. We expect to generate EBITDA in the range of 34 to 38 million, reflecting growth of 6 to 16% against 2006. Inventory is expected to increase 11 to 13% over last year. CapEx is expected to be between 15 and 18 million with investments targeted primarily against our supply chain initiatives. We anticipate that interest expense will come in between 8.6 and 8.9 million for the year. And our effective tax rate is expected to be about 40%, the entirety of which will be booked in the fourth quarter. These expectations translate to EPS of $0.03 to $0.09 for the year. Thanks for joining us today, the operator will now open the call for questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question is from Laura Richardson from BB&T.

Wow, I'm first. Hi, everybody. Just was wondering if you want to kind of update us on the statement that was in the press release a couple weeks ago about weather affecting the outdoor catalog and there was some sign that when weather wasn't that crappy, the business wasn't that crappy either.

Is your question about--?

The question is basically leading you into, May didn't look that bad. So did you get any better results in May than you had seen in April?

Laura, our outdoor catalog, our May drop of our outdoor catalog rebounded, meeting plan.

Okay. Thanks. That's what I wanted to know.

Okay. And those -- that performance is embedded in the guidance that we I should.

Okay, thanks.

We'll take our next question from Laura Champine with Morgan Keegan.

Hi, I was surprised by the good growth in DTC but also by the decline in the retail business. Can you comment a little bit on what drove the weakness in the stores?

Yes, I'll take that. This is Gary. Our continued focus is on a multi-channel strategy, driving more and more business to our direct channel. And at the same time, the macro environment is certainly affecting performance of our stores. But to try to put it into perspective, if you kind of think about it, this year we had 452 pages in the mail between the three catalogs, home is 228 pages, our outdoor catalog at 132 pages and the Bed & Bath catalog at 92 pages. That's versus about 240 pages in the mail last year, and 168 pages two years ago. So the odds of a customer choosing products from our direct assortment versus our retail assortment goes up as we continue to pursue our direct-centered growth strategy and continue to expand our direct assortment beyond the four walls of the retail stores.

But Gary, shouldn't that -- shouldn't the increase in circulation and in catalogs mailed have driven traffic to your stores?

I think that's kind of irrelevant, if you think about it, because just put yourself in the shoes of a customer for a moment and think about buying outdoor furniture. You go into one of our stores this year today, there's three outdoor collections represented on the floor of the store. There's 11 outdoor collections in our outdoor catalog, and three more collections represented in our home catalog. So the odds of you choosing one of the collections that is not represented -- that is not one of the three in the store goes up exponentially as we grow these assortments. And that's true across all of our core categories as we continue with our category extension strategy, with these specialty catalogs, or the assortment growth even in our home catalog.

So again, if you just stand back and think, okay, two years ago this company had 168 pages in the mail for direct, this year they have 452 in the mail, and very important, strategically important catalogs like -- or categories, like outdoor, Bed & Bath, which affects our textiles business, our bedroom furniture business, et cetera. That is why we made the decision that comparable store sales are really not the relevant measure of looking at our business today. We really look at our business as a tri-channel total sales growth, and we measure that against our total investment spend on our ad costs as we mail catalogs into markets.

So is it fair to say that you're pleased with the way that the mix turned out in the quarter?

Yes, I'd say this, not pleased with the quarter at all, the macro environment, definitely, I think, continues to get more challenging. If you look at -- just to speak on the macro environment for a second, we kind of looked at how the home building environment is affecting our business, I mean, all the studies say that about 45% of retail sales are tied to a housing event. The housing event, is really described as someone buying a new home or remodeling a home or moving into a home. And when you look at the home industry, in '06, total home sales were actually up, if you aggregate the top six home builders in America, about 6 to 8% in aggregation. The interesting thing about that, their margins were down about 50%. So they sold a lot of homes on sale. If you look at it sequentially by quarter, okay, their business was good in Q1, started to flatten in Q2, went negative in Q3, went negative single digits in Q3, went negative low double digits in Q4. The interesting thing in Q1, they're down in an aggregate 30% from 22 to 46%, negative growth.

So I think this macro environment we're facing in the home sector, all of the selling, especially furniture and home furnishings based retailers, it's a different kind of headwind than I think any of us have seen for a while. So at a high level, am I happy with the total business? No. Am I unhappy that we probably had the worst timing you could have on an outdoor catalog drop? Absolutely. But am I concerned about how the sales happened by channel? I'm not. I think as we look at the second quarter, we're looking at our total revenue growth, and as we look forward in the business, we really don't care where the customer transacts. And I think we're taking kind of a leadership position in this area where we're truly -- we're truly looking at our business as a multi-channel platform. And we're looking at our ad investments and how much that ad investment drives in total revenue, no matter where the customer transacts, whether it's in the web, by a phone, or in the stores.

So it was a long-winded answer to your question but I wanted to put the macro situation in perspective. Because as we look at it, we didn't see this thing coming in Q1. There was a very stiff headwind out there that I think's affecting everybody. The key is, how do we out merchandise our competitors and try to gain as much market share as we can while controlling costs in this kind of environment.

And one last thing for you, Chris. Prepaid expenses were higher than I expected in the quarter. Can you talk about what's driving that year-over-year increase?

It's really driven by two factors. One is a tax receivable of about a million, and the balance is driven by the catalog growth. So as we are adding pages and adding issues, the prepaid number will go up.

Got it. Thanks.

We'll take our next question from Rex Henderson with Raymond James. Please go ahead.

Good morning or afternoon, excuse me. And a couple of questions. First of all, on the inventory build that you provided in your guidance for the second quarter, remind me, is there something special going on in the third quarter that you need to build inventory for? I was a little surprised by the magnitude of that.

Yes, Rex, we've shifted the timing of our bath event year-on-year, which is putting some more revenue into the third quarter. The other thing that we're doing is we're extending the outdoor selling season and that also drives incremental sales growth in the third quarter. So while we're not guiding third quarter revenue growth, it is an acceleration from what we're guiding the second quarter to. And that's what the inventory relates to.

Okay. Second thing is, is you told us in the fourth quarter call that you weren't going to report comps anymore and you didn't. And I was wondering whether the SEC has made a final decision on whether or not that's going to be acceptable or not?

Rex, the SEC doesn't have an opinion on comps, it's a non-GAAP measure.

Okay. Is there any -- you said you were seeking permission to stop providing segment information, and you needed some permission on that, was that right? Am I remembering that right?

Rex, we're still working, as it says in the press release, to revise our segment reporting to match how we look at the business internally. And we're working in partnership with our external auditors to come up with that approach. So, yes, it's not an issue of asking for permission, it's really an issue of what's the right external reporting, based on what is the internal reporting of the chief decision-making officer of the Company. So that would be me. So it's based on what is the reporting I look at and the senior management team looks at to make the key business decisions, and that should be transparent to the information that's reported publicly. So as we've transformed our business model, we're transforming our internal reporting and how we look at the business and we're working with our auditors to format that in a way that would be appropriate for external reporting.

Okay. A follow-up question on traffic. Can you give us any idea of what you're seeing in traffic, both in the stores, in the call centers, and on your website in terms of hits?

We're not -- obviously in the stores we're seeing some deceleration in traffic. We're not really seeing any deceleration in traffic on the website. So-- and based really on the increased catalog circulation. And the majority of our direct transactions are made on the web today and those continue to grow.

Is the increase in traffic on the website and at the call centers, is it proportionate to the growth in pages?

You mean are we -- yes, so it is directionally in the same direction. There is -- we do have Brocade included in the circulation statistics that we've put forth, so when you look at the relevant Restoration Hardware business, it is a little bit different number. But I would say that on the Restoration Hardware business, kind of the home and the catalog and whatnot, we are seeing proportionate sort of growth.

And I'd frame that by saying excluding the April 5, drop of our outdoor catalog, we are extremely pleased with the performance of our direct business. And so you wanted to look at that segment separately and historically. But as we look at it tri-channely, we believe that there's a headwind. We've got to battle through. And we had unfortunate timing on this outdoor catalog. As we're heading into the second quarter, the outdoor business that has rebounded. The catalog is meeting its plan and we're kind of back on track, except for what we say is an accelerating headwind that we've seen and we believe it's the result of the accelerating deterioration in the home environment, home-building environment.

Okay. And finally, in Brocade Home, what have you learned so far about what's working in that concept and what's not working, and is the assortment right yet, and what's your thoughts on that?

In a brand-new concept like this, the first time you mail it, you mail it into the dark. You start to build a little file, the second time you get some customer response to the assortment and you continually tweak the assortment and you continually build the file. So I would say at this point is we're pleased with the progression of the business, we're pleased with the consumer response to the second season of the business and I would anticipate, like any new concept in the early stages we will make many changes and have many iterations as this evolves over the next couple of years.

Can you give us any idea in terms of what categories work and what categories don't?

No, from a competitive perspective we'd rather not give that information.

All right, thank you very much.

We'll take our next question from Kristine Koerber with JMP Securities, please go ahead.

Hi. Can you talk about the promotional activity, or the discounting that you're doing? Is it across the board discounting, have you started discounting some of the outdoor furniture, are you going to hold off, is it categories that are performing well and you're not needing to discount at all?

Yes, Kristine, I'd say we're doing selective discounting throughout the business in our latest outdoor catalog, I think we have 3 of the 11 collections, on promotion that are performing under our plan. We have one of the three collections in the retail stores that just recently went on promotion. So if you aggregate it out, 14 collections, and 3 are on promotion in total. So which is -- I mean, you'd like to not be any on promotion right now, but clearly with that April drop of the book, we're behind. So we would expect to have inventory build in some areas and have some things not work so we've taken our markdowns there. And also, we've accelerated some of the markdowns with some of the seasonal categories where, again, with the effect of April, we got behind our curve and we had to accelerate some of these seasonal products that have an out date. And then there's selective promotional things happening across different categories where our business might be soft.

How's the overall furniture catalog performing?

What's that?

In house, furniture? Is the category performing okay?

In general, I'd say furniture is weakening, and we've seen some weakening trends in Q1 in the furniture business.

Okay. Then the timing of the Bed & Bath event, can you give us a little more color on that, the shift of it?

Sure. One of the key reasons of shifting it is we -- we're extending our outdoor season in the stores as well as what we've done is we've eliminated one of the drops of our fall catalog. So our least productive drop that we mailed last July, I think 27, we've eliminated in the first drop of our Fall catalog, I think is August 22, right around there. So what we've done is we've expanded the kind of Summer season and the outdoor season and contracted the Fall season and we believe that that decision will make us meaningfully more profitable than a year ago.

Okay. And as far as the baby and child concept that you're working on, how will that be differentiated from your so-called competition out there?

Well, if you look at the top hundred malls in America, there's four home concepts generally in those top hundred malls, Crate & Barrel, Pottery Barn, Restoration Hardware, and then regionally at the Gallery, or an Our House or someone like that. In those same top 100 malls, there's only one kids business, and that's Pottery Barn Kids. I think they have a specific point of view, and a specific approach to their business. I think you'll see ours be a higher level of quality, a more sophisticated, less decorated look to the goods, and I think it's going to look very distinctive and I think it's going to serve a big void in that marketplace that exists today, and probably no different than really if you look, in a lot of ways if you look at the difference between a Restoration Hardware today and a Pottery Barn today, I think there's two separate customers, filling two separate needs, even in similar categories, based on quality and where people are in their lives and what their taste preferences are. So, I think when you see it, it will look very different than the loan competitor in the top hundred malls today.

Okay. And then lastly, it's probably a question for Ken, there's a lot -- you have a lot on your plate as far as supply chain over the next couple of quarters, and just trying to figure out what gives you the confidence level that you can execute on the back end, especially after execute, I should say, on time and within budget after what we saw with the DC's in Q1?

There's really three major points around this. One is, we've implemented much tighter project management controls around all of our initiatives. Mainly in the areas of the timing and the sequencing of these initiatives around the supporting business activities, the deliverables of the initiatives and then also from a cost standpoint. So that brings a lot of confidence into our ability to execute on the balance of the year on our initiatives. We're also recently strengthened our supply chain management team that is specifically focused around these initiatives.

Thank you thank you.

Thank you.

We'll take our next question from Scot Ciccarelli with RBC Markets. Please go ahead.

Hi guys, Scot Ciccarelli, a couple questions. First of all, can you give us not necessarily a breakout but some sort of aggregate contribution for your newer brands and extensions?

No. Sorry, but we can't. We -- the extensions, what I would say is that the extensions, if you think about outdoor, that's essentially a mature business, the Bed & Bath catalog, we've got one issue out, but it is one that leverages existing categories, so that is going to achieve profitability much faster than something like, say, Brocade Home, which is an entirely new brand. Brocade we are still in the building process, and I think that's what I would say about the contribution of those different segments.

Okay.

Does that help?

Maybe ask it a slightly different way, maybe you can give us an idea. What was the direct growth of the core Restoration brand? That's what I'm trying to figure out, maybe there was channel shift because of the extra shipping in catalog. I'm just trying to figure out what might have influenced it. Obviously, there are certain things where you're shipping catalog and have website with there's no comparable stores, so I'm just trying to figure out what else might challenge that?

Got it. We're not breaking out the details, but I can tell you that Brocade is still, it's a very small part of our aggregate direct segment business.

Yes, I'd also add it that, Scot, the way to think about our business is these catalog extensions would be basically immediately profitable in the first quarter that they mail. So as you think about the outdoor catalogs, the Bed & Bath catalogs, and that would be our same expectations of our upcoming baby and child catalog, because all of those catalogs leverage our current customer file and leverage all of the infrastructure that's already in place. And they have a very good hit rate. So there's no deleveraging effect, except for the quarters prior to the launch of those catalogs where we have investments that we're making building the assortment, developing the catalog and the supporting website functionality.

Okay. That's helpful. And then have any of your vendors changed their credit terms or are the credit terms of maybe some of your -- within your extensions changed at all? I'm just trying to, maybe you described it a little bit, but I'm just trying to figure out exactly what happened to payables here.

So nothing happened with terms, what I can tell you about payables is really two things. One, with the calendar shift, this year's quarter ended on the 5th of a month, last year's ended on the 29th of the month. So there is a little bit difference in the check payment clearing that's going on. I.e., we had things in the payables last year at the end of the quarter that have cleared to some degree in the first quarter of this year. The other issue is that we have a smaller amount of receipts and in transits in the quarter, in the first quarter than we did in the first quarter last year. So those two factors really explain the reduction in payables.

I guess what I'm really looking at is, typically, most retailers are going to look at it as a payables to inventory type ratio. It doesn't seem like that's fully explained by those issues, maybe it is, maybe I don't know the size of those. I'm just trying to figure out, what else would influence that, number one? Number two, is that something we could see kind of normalize back at the let's call it 40% range?

I would anticipate that it would return to a more normal level in future quarters. And the factors that I talked about do explain the change year-on-year.

Okay. Sizable. Okay, thanks a lot, guys.

We'll take our next question from [Crystal Kallik] with D.A. Davidson.

Good afternoon everyone.

Good afternoon.

Just a couple of questions, and I think, Gary, you started to touch on this. It sounds like your thoughts on first half circulation versus second half, you said you're cutting a catalog in July. And I guess I just wonder, it sounds like definitely you guys are feeling a little more positive towards the second half. Are there any other changes in circulation in Q2 relative to the second half?

Yes. I, just to be clear, that catalog that we eliminated from circulation was not a reactionary move, that was a move we made when we developed this year's plan last year. And just based on the fact that our first drop of fall, that kind of late July mailing was always our lowest productivity catalog, and we just, as we looked at the productivity of the outdoor catalog in the summer season, it is more profitable for us to extend the summer season, even on promotion than to mail that fall book in that kind of late July period. So we look -- we ran the models on profitability, we're much more profitable eliminating that book. So that wasn't a reactionary move to the first quarter business, that was something we planned out for the year.

As we think about some of the reactionary things we've done, obviously when you -- you kind of get whacked like this in business, you look at everything. And we, as we examined our circulation plans for the balance of the year, and looked at our segment responses by different consumer segments by different books, we found that there was opportunity to eliminate some unproductive circulation without having it, an effect, meaningful effect on the top line sales that would increase our profitability as well as opportunities to tighten up page count in some areas, in some of the drops of the catalog. That gives us the ability to, again, get more leverage and drive more profitable growth.

Okay. So will there be an extra drop to the outdoor catalogs, since you're extending the selling season or no?

Yes. There is more drops at the outdoor catalog this year, I think we have two more drops.

Yes, yes. There's some at both ends. But the home coming out is such -- dropping, they're an outdoor going into that slot essentially. So from an aggregate circulation standpoint, we felt there was an opportunity to improve profitability and improve volume with an outdoor book in that place rather than a home book.

Okay. Okay. Great. And then I guess just in general, Gary, how do you look at balancing your promotional events and obviously brand equity is so crucial for your brand, how are you really balancing that and making sure you protect you're brand for the long run, given the pressure that's happening out there in the environment?

We look at that week-to-week, and we have this discussion everyday here, so there is an initial reaction when we had that April catalog miss on the outdoor book to react and move up markdowns and outdoor. We decided to hold our breath and wait until the next mailing to see what happened. So now we're glad we did that, the three collections we went on promotion with, we would have gone on promotion with, no matter, if I think that April mailing performed well or not. They just were not performing well. So we are going to stay with the same plan, promotional cadence that we had going into the season. Then throughout the assortment, we'll be taking selective markdowns and reacting to the business and also just reacting to the competitive environment. So if our competitors get promotional early in certain categories, that may put us in a position to have to get a little bit more promotional. But right now, it's kind of a week-to-week, evaluate the business, tell you this week we feel better.

So we feel like we're going to maybe not be as promotional. But this has been a very -- first quarter is very bumpy, and unpredictable. So we're trying to -- the other thing we're doing is trying to slow down receipt flow, and put ourselves in a position to not let the inventories back up. So one of the positive things we did, we've not placed all of the outdoor furniture orders yet, we had had time to respond and able to respond to about 30% of the orders on the back half of the year. And that put us in a position to not be as promotional on the direct side even with the Q1 miss.

Okay. Does it make any sense, you said sounds like furniture's slowing and perhaps maybe there is a little bit of price resistance out there. Are you kind of thinking about how you reassort your direct catalog or in the stores, perhaps, to maybe less higher-priced furniture items and maybe more lower price, does that make sense? Is that a conversation you're having right now?

Not necessarily. I think, what you don't want to do is completely change your positioning just because there's a headwind that you hope is temporary in the marketplace. So we felt good about our business positioning, and our business grew dramatically last year and still based on the fact that where our revenue growth is and it's projected to be without new store growth, would suggest that we're taking market share in the marketplace with our current assortment. So we'll continue to pursue our current strategy and make the minor adjustments that you always make in a business like this, when some things work, some things don't, you're always tweaking, and you're always unfinished and always on the move in the retail business. I would say there's no discussions about kind of strategic repositionings of our assortment or taking our quality or our prices downward.

Okay great, I know Chris, you're being tortured over the no-comp. release and I don't mean to at to that, I guess I just wanted to clarify something that you said. I think you said in the retail division, gross margins actually benefited from leverage on occupancy. Is that true?

The total business leveraged on occupancy within the retail segment, there was deleverage in occupancy.

Okay. That clarifies it. Thank you. Good luck on Q2.

Thanks.

(OPERATOR INSTRUCTIONS) We'll take our next question from Rob Wilson with Tiburon Research Group, please go ahead.

Thanks for taking my call. Gary, could you give us some indication on average ticket trends during the quarter in both the retail and the direct channels?

Yes, we continue to see our average orders increasing and our transactions contracting a bit on the retail side. But our average order growth continues to grow in our direct side of our business. If you aggregate across the total of the business it continues to grow.

And Chris, I believe you mentioned that product margin was higher, 240 basis points in the direct channel; is that correct?

I believe I said that gross margin was higher in the direct channel, and it was primarily because of leverage of shipping expenses.

So what would product margins have been in the direct channel? Higher, lower, directionally?

Directionally product margins in the direct channel would have been flat to down slightly.

Maybe both of you could answer this, why would there be a big disparity between the direct channel and the retail channel when it comes to product margin?

Well, you've got a much greater ability to promote your business in the retail channel because you can make decisions day-to-day in the direct channels where you're highly governed by a catalog, you've got printed prices. And you've got lead times on the printing of the book that you can't respond to.

I think the other thing that I would say, Rob, is that as the business continues to migrate, the mix of businesses that are growing year-on-year in the two segments will also be a bit different. So for example, if the outdoor catalog is one that has a higher percentage of growth in direct, that could influence product margins. Bed & Bath could. So that will change the mix of the individual channels and what's happening.

That's a really good point.

Okay. And you guys signed a new credit facility. Chris, could you give us your credit availability at the end of the quarter?

It -- I'm not sure that's a number that we disclose but it is substantially higher under the new credit agreement than it was in the past. It's in the tens of millions. And the accordion feature is something that we haven't tapped into yet. So we don't have any liquidity issues.

If memory serves me correctly, it is in your 10-Q?

Yes.

Okay. But you answered the question. Thanks for taking my call.

Thanks, Rob.

It appears that we have no further questions at this time. I will now turn the question back over to Chris Newman.

Thank you all for attending the call today and we will talk to you soon. Take care.

This concludes today's teleconference. You may disconnect at any time. Thank you, and have a great day.