RH (RH) 2007 Q2 法說會逐字稿

Welcome to today's teleconference. At this time, all participants are in a listen-only mode, later you will have the opportunity to ask questions during our Q&A session. Please note this call may be recorded. (OPERATOR INSTRUCTIONS) I'll now turn the call over to Mr. Chris Newman. Mr. Newman, you may begin.

Thank you, good afternoon, everyone, thanks for joining us. Leading our call today is Gary Friedman, the Company's Chairman, President and Chief Executive Officer. Ken Dunaj, our Chief Operation Officer is also with us today and will be joining us for Q&A at the end of our formal remarks. 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 1955. 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 limitations, statements concerning or relating to the Company's future initiatives. The expected benefits of the Company's cost-cutting actions, and investments. The expected benefit of the Company's merchandise initiatives and new brand concepts and other statements containing words, such as expects or words of similar importance. Important factors that could cause differences are contained in the Company's filings with the SEC including the MD&A section in our more 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 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 a rise after the date of this call, and now, I would like to turn the call over to Gary.

Good afternoon. Thank you for joining us today. I'll start today's call by giving you an overview of the quarter, discuss the factors impacting our performance and outline strategies to improve our operating results in the second half of this year and beyond. We entered this year anticipating a headwind and the first half was clearly more difficult than we expected. The challenging home furnishings environment driven by weakness in the home sector continues to pressure our business. There are two primary drivers in the revenue shortfall this quarter. First, our furniture business was substantially below planned, particularly in outdoor. The seasonal build we anticipated in June did not materialize and we took markdowns earlier than planned.

Second, we experienced increased softness in other departments more directly related to the slowdown in the housing sector such as hardware, bath hardware, lighting and window treatments. These categories are closely tied to a housing event. The purchase of a new home or the remodeling of a existing home. Business categories less impacted by a housing event, such as decorative accessories, bath textiles and bath accessories performed well in the quarter. With many of our core businesses directly impacted by the housing slowdown and the continued uncertainty in the market, we have cut our outlook for the back half of 2007 to reflect the current softness we are experiencing and believe it is prudent to remain cautious for the balance of the year. That said, while disappointed with our first-half performance, we do expect second-half earnings to be up significantly over last year as many of our growth and operating initiatives begin to positively impact our performance.

We also remain optimistic about holidays. As our business is not as reliant on the furniture and hardlines home categories that are currently under the most pressure. The product mix shifts dramatically in the fourth quarter to accessories, gifts and holiday decor, which are less likely to be impacted by the current macro environment. We have a number of initiatives in place that we expect will improve business trends in the third and fourth quarters this year and into 2008. First, as you remember, last holiday we delivered strong revenue growth because of the success of our gift strategy and new gift catalog.

This year, we plan to improve on that success with an expanded assortment of gifts and holiday decor in our stores catalog and online. Supporting our holiday assortment will be an expanded and redesigned gift catalog and a new gift website interface and new fixtures for our holiday decor and gifts in our stores. We feel confident our holiday strategy is meaningfully improved versus last year's successful season and remain enthusiastic about our prospects.

Second, two of our developing growth initiatives, the Restoration Hardware Bed and Bath catalog and our new Trade division continue to gain momentum and will contribute to revenue and earnings growth in the back half of this year.

Next, we are continuing to invest in the development of Restoration Hardware Baby and Child, which is planned for a spring '08 launch. For competitive purposes, we're not disclosing more specifics at this time but in short, we believe that this is an underserved market and think there is tremendous potential for this concept.

Our new brand, Brocade Home continues to evolve as we approach the first anniversary this fall. We will be increasing page count and circulation as we build our customer file and expand our assortment.

Finally, we launched a completely redesigned website earlier this month reflects improved product presentation, navigation and click logic. If you visit the site, you will see significantly enhanced visual merchandising, including collection galleries, which present our assortment dominance and authority in the core business. We believe this is particularly important as the Web becomes, potentially the first and most important destination in the customer shopping process.

I have described the key drivers that support our outlook for stronger revenue growth in the future, now let me put our earnings expectations into perspective for you. We expect to achieve second-half operating profits in the range of 15 to 19 million versus 12 million in the second half of 2006. The anticipated growth is primarily being generated by the cost-cutting actions we implemented this year and the timing of some of our investments, which had a negative effect on first-half earnings and should have a positive effect on second-half averages.

As previously communicated, we have renegotiated our catalog production cost and expect significant savings in the second half of this year. Additionally, we recently announced a reorganization of our corporate headquarters and the elimination of positions that will generate 3.5 million in savings in the second half of this year and approximately 9 million annually. Importantly, these organizational changes were targeted so we were able to scale back without impacting our ability to execute against our growth strategies and supply chain initiatives.

Now, let me take a moment to update you on our supply chain initiatives as well as our longer-term outlook. The planned transformation of our supply chain remains on track and the first quarter of this year, we installed new racking and material handling equipment in our East Coast and West Coast Furniture Distribution Centers to improve productivity and reduce damages. In the second quarter, we consolidated our small package direct-to-customer operations from three Distribution Centers into one, which will improve productivity and inventory efficiency. Additionally, over the next 12 months, we will be implementing two important systems and opening a now facility that will greatly enhance our ability to service our customers and reduce our costs.

Let me provide you with some detail on these initiatives. First, a new warehouse management system will be implemented in phases across our network. This month, the system was successfully installed and is now operational in our Tracy Distribution Center. We expect the system to roll out fully by early 2008.

Second, a new order management system is slated for implementation in Spring of 2008. This is the backbone of how we service our customers and will provide us with seamless multichannel capability, improved order integrity and more insightful customer data. The platform we're installing is Commercial Ware, a widely-used and proven system, which has the ability to support our growing multichannel direct business model.

Third, we're opening a new Distribution Center next summer in West Jefferson, Ohio, just outside of Columbus. This new DC, will service all of our small package direct-to-customer operations, as well as small package retail store distribution to the Eastern and Central Regions of the country. This will allow us to phase out of third-party relationship, resulting in a more efficient customer service operation, a fixed cost structure that we can leverage and consolidated small package inventories, which will improve turns.

Now I will conclude with a high-level view of our longer-term outlook. We had planned for 2007 to be an investment year with more substantial growth coming in 2008 and beyond. Well the macro issues have created obstacles for us, we believe flexibility of our multichannel strategy will help us navigate the headwinds more effectively going forward. While we have cut costs to become more efficient, we believe it's critical to stay focused on the operating and growth strategies that will take our company to the next level.

The Restoration Hardware brand has undergone a dramatic transformation in the past several years and our supply chain initiatives represent the final phase at building a company that has significant growth and operating margin expansion potential. We remain focused on reaching our goal of 4 to 5% operating margins and a 1 billion in revenues by 2009 and believe we are building the foundation for a much larger and more profitable Restoration Hardware in the years ahead.

Thank you for your time today. Now Ill turn the call back over to Chris to review the financials.

Thanks, Gary. During the second quarter, the environment for the home furnishing sector remain challenging. Net revenue for the period was 184 million, up 2% to last year but significantly lower than we had originally planned. This revenue shortfall drove nearly the entire miss to our original second quarter earnings guidance and was primarily driven by the low-plan results in outdoor furniture and higher than anticipated back orders in other categories.

Gross margin improved 20 bases points to 33.2%, reflecting increased volume in our direct segment, which carries a higher gross margin rate than our retail segment. Within gross margin, product margins were down to last year, reflecting the challenging environment and the need to break pricing on outdoor furniture earlier than planned. Additionally, our fixed costs deleveraged because of low revenue growth.

SG&A as a percentage of sales was up 440 basis points to 36.2%. The increase reflects higher volume and direct, which carries a higher rate of SG&A than our retail segment, as well as the impacted of planned growth and infrastructure investments. Loss from operations was 5.5 million and operating margin came in at negative 3.0%, which compared to positive 1.2% last year. The year-over-year decline can be traced to the volume pressure we experienced, as well as the investments we're making to drive future growth and transform our supply chain. EBITDA came in at 200,000, down is from 7.4 million a year ago.

Before I get into segment results, I would like to discuss changes that occurred in our segment reporting. As we shared with you on our last call, during the second quarter, we consolidated all small package direct-to-customer shipments into one DC. Historically, these shipments originated from three facilities, one was our direct-to-customer DC, the other two were retail replenishment DCs. Beginning in the second quarter, the revenue associated with the shipments is now being reflected in our direct segment, consistent with how the orders are being fulfilled.

For a perspective in the second quarter of 2007, there is approximately 10 million in revenue being recorded in the direct segment that previously would have been booked as retail revenue. At the same time, as we pursue our operating and growth strategies, our business is increasingly driven by direct-to-customer transactions and we continue to see sales migrate from retail to our direct segment. This transformation is the result of our multichannel merchandising and marketing strategies, as well as the multichannel infrastructure we're building. Our segment reporting has been adjusted to account for those changes and to more appropriately reflect how management views and operates the business.

There are three primary adjustments to our segment reporting I would like to point out. First, we have changed the name of our retail segment to stores. We feel the new title is more appropriate since the segment includes retail stores, outlet stores and our warehouse events all primarily cash-and-carry businesses.

Second, as part of the revenue shift, a proportion of the amount of related costs will now be allocated from stores into the direct segment. And third, we have eliminated DC and other fulfillment costs from our operating segments to make our external reporting consistent with how we manage the business. We view our Distribution Centers, Call Center and Headquarters as support costs and do not include them as part of segment profitability. Importantly, we believe that a large portion of future margin expansion will be driven by supply chain and headquarters leverage. Isolating the cost in an unallocated segment will provide greater visibility to the leverage we achieve.

Now, with that as context, I'll review segment results with a little more color. While 2006 segment revenues did not change, expense allocations have been adjusted to conform with our current methodology. For direct, segment revenues of 93.3 million accounted for 51% of total revenue in the second quarter. That's up from 38% of total revenue in the second quarter of 2006. And reflects both the fulfillment changes and the natural migration from stores to direction that I just described.

Circulation and Catalogs distributed during the period increased 20% with pages circulated up 16%. The growth rate in circulation reflects the expansion of our Restoration Hardware Outdoor catalog, introduction of our Bed-and-Bath catalog and Brocade Home, which launched in the third quarter of last year. The web accounted for 67% of Web and Catalog business in the quarter, up from 58% last year. Contribution rate in the direct segment was 20.7% of sales, 180 basis points lower than last year. Gross margin declined by 120 basis points due to lower product margins, which were somewhat offset by shipping expense leverage.

SG&A deleveraged by 60 basis points, reflecting our investments in growth initiatives. In the store segment, revenues were 90.6 million and contribution margins declined 550 basis points to 10%. This pressure resulted from a 340 basis point decline in gross margins, due to lower product margins and deleveraged of store occupancy costs. SG&A as a percent of revenue, was up 210 basis points reflecting the lower sales volume.

Unallocated segment costs were 34 million, up 3.4 million from last year. The increase was driven by two factors. One, investments in our supply chain and headquarters to support both our operating and growth initiatives and, two, increased distribution costs associated with the additional space.

Now, looking at the balance sheet. At the close of the quarter, our inventory balance was 210 million, which is up 16% or 29 million from the same time last year. That is significantly lower than our guidance of up 25 to 30%. And reflects our efforts to actively reduce receipts during the quarter. At the end of the period, the outstanding balance in our line of credit was 106 million. That's up from 79 million at the same time last year. Availability at the close of the quarter was $39 million. The increase in borrowing levels reflects the year-to-date operating loss and our higher levels of inventory.

Before I review the specifics of our Q3 and full-year guidance, I will like to remind you of the cost-cutting initiatives that should lower our operating expenses in the back half of the year. Our actions including renegotiating our catalog production cost and reducing the head count at our Corporate Headquarters are expected to reduce operating costs as a percent of sales by more than 200 basis points annually. This will help us deliver expected operating profit of 15 to 19 million in the second half of this year versus 12 million in the second half of 2006.

Turning to guidance for the third quarter, we anticipate total revenue of 183 to 188 million, reflecting growth of 17 to 20% over last year. The substantial portion of the growth is due to the timing of marketing events this year versus last year. Our bath event, for example, was in the second quarter last year and fell into both the second and third quarters of this year.

Third quarter operating margins are expected to be in the range of negative 3.8 to negative 2.7%. EBITDA is expected to be between negative 1.2 and positive 0.8 million. Inventory is expected to increase 5 to 10% year-on-year. Interest expense is expected to be between 2.5 and 2.6 million and we expect to pay taxes of about $100,000. These expectations translate to a loss per share in the range of $0.25 to $0.19. That includes an expected one-time pretax charge of $500,000 or about a $0.01 per share associated with the headcount reductions we announced earlier this month.

For the full year, we expect total revenue of 754 to 764 million. This equates to a growth rate of 6 to 7% over last year's 53-week period. Operating margins are expected to be about break even for the year, between negative 0.3 and positive 0.2%. We expect to generate EBITDA in the range of 20 to 24 million. And inventories expected to be up modestly in the range of 5 to 10% versus 2006. Capital expenditures are expected to be between 13 and 15 million with investments targeted primarily against our supply chain initiatives. We anticipate that interest expense will come in between 8.7 and 8.9 million for the year.

In terms of taxes, before the impact of valuation allowance we have in place, we expect to record a tax benefit of between 1.7 and 3.3 million. We anticipate a loss per share in the range $0.21 to $0.14 for the year, including the one-time charge for headcount reduction I just referenced. With that, I'll turn the call back to the operator so that Gary and Ken and I can take your questions.

Certainly. (OPERATOR INSTRUCTIONS) We'll take our first question from the site of Scot Ciccarelli. Go ahead, please.

Hey, guys, Scot Ciccarelli. A couple of questions. First, just trying to reconcile some of the guidance you guys provided. Chris, is it fair to assume you're looking for your SG&A to be down in dollars in the fourth quarter by the order-- on the order of 5 to $7 million, that is kind of what I came up with.

Year-on-year, that is probably a little aggressive.

Okay.

Probably a little aggressive.

Okay, but you expecting it to be down year-over-year in dollars?

Yes.

Okay, that was number one. Number two, you guys obviously have a lot of balls in the area and trying different line extensions, you have the supply chain. Do you have the manpower and capacity, especially in light of some of the recent headcount reductions to basically execute on the plans, in your opinion?

Yes, I think we feel very confident, Scot, that the reorganization is not targeted at any of the growth or supply chain initiatives and if you think about the last several years as we transformed the business and had a lot of initiatives on the front-end, this was probably a year that was a good year for us to kind of take a look at the organization and how we're structured and how we're organized and just finding ways of being more efficient and eliminating redundancy throughout the organization. So we feel we have made good choices and we don't think we put any of our initiatives at risk. None of our headcount reductions were targeted around any of the key initiatives we have in place.

Okay. Fair enough. The last question is just regarding inventory, obviously it was below your expectations but sales came in -- like can you comment on your comfort with the, I guess the quality of the inventory particularly, what we're dealing with in terms of the outdoor and what may still have to get marked down, et cetera. Thanks.

I think we're in relatively good shape. We're able to react early on the front-end as we saw the softness in outdoor early. We reacted to receipts in the second half. We're able to pull those back and have been aggressive taking markdowns in the lower-moving categories. So I think we feel we're in good shape and have reacted well to the shortfalls and I think the team has done a very good job.

With that said, I think there is still tremendous opportunity to be much more effective with our inventory, and we have new leadership in place that has taken a critical look at how wore doing that. And as you know with the consolidations on the back-end of the direct-to-customer business from three DCs into one and our plans next year of consolidating our retail and direct-to-customer small package inventories on the East Coast and in the central, there is plenty of opportunity ahead of us to continue to get inventory productivity in the Company.

We'll take the next question from the site of Crystal Kallik with D.A. Davidson & Co. Go ahead, please.

Good afternoon, everyone. I guess we're starting off. Chris, in Q1 you were able to quantify some of the increased infrastructure or the EPS impact of the infrastructure spend in Q1. Could you give us an idea of the magnitude of where that fell in Q2?

In Q1 it was, I believe that the guidance we gave was in the 250-basis point range. In the second quarter it was lower than that. It was closer to the 150 basis point range.

Okay. Okay and I think that is a little better than what you were originally thinking. Sounds like we continue to expect that to trend downward going further into the second half?

We expect in the back half of the year that we would not be in a net investment position because the investments we made in the first half begin to pay out in the back half. So where we continue to see spending on supply chain initiatives and other things, there are benefits that help offset that so it's essentially break even.

Okay. Okay. Great and you guys talked about some of the shifts in the selling trend as it relates to the home market. Certainly, you're bringing your inventory under control pretty quickly but, Gary, you talked about sounds like gifts being more important to you this year and some other categories being distorted. Is it safe to assume that furniture and some of the other items, categories that are more tied to housing with the de-emphasized going into the second half?

I wouldn't say they going to be de-emphasized. I'd say we're just planning them much lower based on the trends we have seen and that were seeing. So, if you think about our guidance, we're basically taking the end of the hard home part of our business that we believe is more tied to housing events and the slowdown in the housing market such as furniture, bath hardware, hardware, lighting, window treatments, et cetera. And we have taken those plans lower.

Where we have seen the business perform relatively well is in our accessories area. In bath towels, bath accessories, things less tied to the housing event. That gives us the confident as we think about holiday. If you think about last year, we saw the slowdown in our core businesses start to happen in Q3. We saw them accelerate into Q4. That impact didn't hurt hour our holiday season which is mostly driven from the accessories and holiday decor categories. And so we feel the current trends with, you know, we're seeing the greater deceleration in some of the core businesses tied to the hard home piece of it, but we're not seeing the same deceleration in the accessories or smaller ticket items.

So it gives us confidence as we look at the holiday season to buy the holiday season kind of to our original plans and we believe that they will perform to our original plans and we think we have got very exciting initiates around holidays I mentioned earlier.

Great. Sounds like the shift in the timing of the bath sale, you're happy with the way the performance went.

Yes, the major of the bath event, I think, performed well. Some of the higher-ticket items and, again, some of the categories not as well as we planned but the lower ticket pieces, you know, performed as expected. So we -- I think, as we assess the business today we're looking at it and saying look, there is clear trends here in kind of the hard home furniture lighting, window treatment, hardware kind of part of our business and there is no ignoring those trends right now. And we have taken our plans lower and incorporated that into our guidance. And accessories, which is the smallest part of our business during most of the year, turns into the biggest part of our business as home decor and gifts layer on to it in the fourth quarter and we're very confident about how that part of our business will perform during the holidays.

Okay. Great. And it also sounds like you have positive surprises in the Bed and Bath catalog launch since you had a fair amount of backorders occur.

Yes, we are -- I think we're very happy with the initial rollout of the book and the consumer response to that book, we're quite happy with it. So didn't initially have all the inventory in the right places with the new launch categorically, but that can be adjusted and fixed.

Good luck in the second half.

Great. Thank you.

Thanks, Crystal.

We will take our next question from the site of Claire Gallacher of Caris & Company. Go ahead, please.

Good afternoon. Could you clarify for me what the CapEx is associated, the new DC that will be opening next year.

Sure. So the Cap Ex, we're not building the building. We will be leasing the building. The CapEx for us is related to the equipment and the fixtures that go inside and we're still working on finalizing the specific details and also on the actual components of the financing of that. You might see that we were approved for a loan from the state of Ohio, earlier this week, so we're pursuing multiple different options on the equipment and we will be building and filling out the building as we grow into it.

Okay, so will this be more of like a Q1 '08 or a Q2 '08 expense or will it be over the process of several quarters?

Q1 and Q2, primarily and then not much more in '08, but as we expand into more the DC in the future than we'll continue to be spending.

And this will be included in your normal CapEx budget for the year. This won't be an incremental expense or will it be?

It's included in -- it will be included in our plan.

Okay.

Aggregate, we think it's 10 to 15 million over the life of the DC.

Okay. And then if you could clarify the $9 million that you've talked about for the run rate for savings with the headcount reduction, will that be $9 million you that have previously spent or some of that money that was budgeted for new employees or new benefits or whatnot. Is this an apples-to-apples where you're losing $9 million that you were spending or is it just a saving from a budgeted number?

It's a savings from a budgeted but also a forecast and guided number. There was a combination of filled and unfilled positions, the aggregate amount of that was 9 million on an annualized basis and those dollars were funded in the guidance that we gave at the beginning of the year.

Okay. Can you give us maybe some kind of ballpark of what you were spending maybe in '06 that you'll no longer be spending? Is it two thirds of that or half of that?

Yes, I'm not sure what you're trying to get at, Claire.

Well, it's just, as far as what kind of expense you had running through your P&L last year that you won't have this year going forward.

I would look at the headcount as, I would say roughly half of it was, half of the positions we eliminated a third to a half are filled and the balance are open.

Okay. Okay. That's very helpful. Thank you very much.

Okay.

Thank you, we'll take the next question from the site of Rex Henderson with Raymond James & Associates.

Good afternoon, thanks for taking my call. I wanted to get back to guidance and make sure I understood what guidance implied, especially in the fourth quarter. Looks like the guidance implies for the fourth quarter somewhere around 240 to $255 million in revenue, which is about the same as last year and then operating income of around 20 to $25 million versus $12 million of operating income in the prior year, is that right, am I reaching those numbers right?

Yes, you're in the ballpark.

And the headcount costs account for half of the $8 million of savings this year? In the fourth quarter?

Not sure what you mean by the 8 million in savings.

You said that, you said that there would be, you gave us a basis point impact on SG&A in the back half and I think I calculated that worked out to about $8 million plus total.

The 200 basis points was an annual run rate, Rex.

Okay. Okay and that is a run rate rather than in the second half.

Correct.

All right, so, I'm still left with somewhere between 8 and $13 million of EBIT improvement in the second half on revenues that are roughly flat to up slightly and I'm trying to reconcile that. How do I get to substantially higher EBIT on roughly flat to slightly higher revenues?

There are four key components to that and Chris you can kind of piggy back on this. The first one would be significantly lower catalog costs. Specifically paper and printing.

Right. That was included in the $8 million in run rate of -- or the 240 basis points of -- .

Yes, just think about profitability year-over-year.

Right.

So you have got significantly lower catalog costs, specifically paper, printing and postage and you've got the headcount savings. We have much better advertising costs with our ability to mail the gift catalogs the second time versus last year. And we're going to be significantly smarter as we know how the customer responds versus a year ago and we're going to be much more productive in the mail-in of that catalog. And we have some gross margin upside because of the sourcing initiatives that we put in place in the beginning of the year.

Okay.

We were able to significantly renegotiate the costs on a lot of gift assortments and stocking stuffer assortments and we placed orders as early as February of this year to give our manufacturers a long time to make the goods to be very efficient on their end.

Okay.

Therefore, giving us opportunity to significantly lower our costs of goods for the holiday season.

Okay, we can expect some gross margin improvement and a pretty substantial amount of SG&A improvement in the fourth quarter then.

Right.

And Rex, the thing that I kind of add to what Gary said is last year was the first time we really flew out and we did a gift catalog and blew out the stocking stuffers the way we did. We think we learned a lot from last year and the execution and the results this year should be even better.

Okay and the second follow-up question, you said in your guidance the third quarter revenues, I think, would be affected by some timing shifts and promotions.

Yes.

Are you pulling revenues out of fourth quarter into the third quarter? Is that what you're doing?

It's more pulling revenues out of the second and into the third.

Okay.

So the bath event was an example that we cited that last year was all contained in the second quarter is now migrated into the third as well.

All right.

But there are just marketing changes year-on-year as well.

Okay, all right. Well, thank you very much.

Okay.

We'll take our next question from the site of Rob Wilson of Tiburon Research Group. Go ahead, please.

Yes, thank you. Gary, was the outdoor book successful this year versus last year?

It wasn't as good from an advertising cost as a percentage of sales as last year, Rob. If you -- you think about it, it was successful in general, yes. You would go out and mail that book in and it would be a good book. One of the problems we had with outdoor was some of the overlap between the outdoor book and the home book where we doubled depicted some collections in a second finish and those were highly unsuccessful. A big part of our outdoor mix was really related to the outdoor that was represented in our home catalogs and that was a significant part of the mix. We won't do that again next year.

I guess the question I'm really trying to ask is it looks like your competitor greatly increased their circulation of their outdoor book. And I'm wondering did you feel any impact from their decision to greatly increase their circulation of their outdoor catalog this year?

I think there is a tremendous amount of competitors in the marketplace this year and across the board everybody had an outdoor book so I'm not sure who you're specifically referring to. I can take a guess at that and everybody had an outdoor catalog this year. I think you will see a shakeout next year and I think you will see some people drop out of this space. And I also think, the other thing we erred on in our outdoor assortment, is I think we weren't as focused on the value proposition and our prices in some areas got too high. So we have learned from that. We value engineered a lot of the collections for next year. I think you will see us coming in with greater values and sharper price points and probably we got somewhat over assorted. Like I said, the double exposure in our home book was the same collections just in second finish was pretty much a disaster. So, we won't do that again and you will see us take a different approach.

We'll be smart and last year it was a home run, the lowest ad cost we'd ever seen. This year we probably went too big too quickly and made some errors on the value proposition and how to sort it between the two books. Next year will be much smarter. Probably won't grow the business as aggressively next year but we'll make it a lot more profitable.

Okay, this is a question for Chris. I'm trying to understand how you lowered your debt, approximately $15 million in this quarter. This is basically a break-even EBITDA quarter and inventory was down modestly. Can you help me understand how the debt levels were lowered in Q2 versus Q1.

I think you will see our working capital was much more effective this quarter than it was in the first quarter and part of that is timing based on when the quarter ends. We, I think, have gotten much more aggressive against managing our receipts and managing our inventory levels and our use of cash as our sales have softened and that is really what I would attribute it to.

Okay, a question here for -- while I have you, the changes that you motioned related to operating segment profitability earlier. Are these changes in addition to the changes you made in Q1 in your 10-Q?

Yes, this are incremental changes to some of the adjustments in Q1.

Okay. Any historical numbers related to different segments we should just ignore now.

Anything that was reported in the past will not be relevant but we will be including a revised prior year in the Q so you understand what the recast numbers would look like.

Okay, are you still going to report I guess you're calling it now store channel sales?

Yes.

Okay. And one final question for Gary, given your spotty history of being able to deliver on your earnings guidance. Why would you give what I think is a fairly aggressive guidance number for Q4 this call?

It's what we believe is going to happen. So we think we got pretty conservative numbers in place for our core businesses, but we're seeing the softness and we think we have got moderately improved numbers from a sales point of view. It was almost flat and the other pieces of our business was slightly up and if you think about our numbers that we're saying, we're coming out there with fourth quarter from a top-line point of view that are relatively flat to a year ago. And you're seeing the earnings being impacted by the cost-cutting measures that we've taking from a catalog perspective. The headcount reduction and reorganization [of] our headquarters and some sourcing and margin improvement in our cost of goods. So we believe that it's a fair representation of how the business is performing today and now it will perform in the fourth quarter.

Okay and -- .

One of the other things I would say, Rob, that can probably incorporate in is we have not -- (inaudible) versus a year ago, we have not modeled a bonus into the fourth quarter this year where we did have a bonus in the fourth quarter of last year. So that would be another number that would show a difference year-on-year.

Okay, that does help in clarify that for me. Thanks for taking my call. Good luck.

Okay, thanks, Rob.

We'll take the next question from the site of Ike [Buratral] from Morgan Keegan.

Hi, Ike.

I'm calling on behalf of Laura Champine who is traveling today. First, I wanted to ask you, did you see any deleveraging effects from the spending of your new concepts during the quarter?

Spending deleverage from our new concepts. We're talking about our investments in aggregate. Our new concepts are supply chain investments and when I talked about the roughly 150 basis points of G&A or of basis point impact rather, that includes some of the new concepts in there. We're not breaking it out per se. But, obviously, as we're building the business they probably are going to be at a deleveraging effect on the business.

Yes, I think one of the ways to maybe think about it sequentially is in the first half of this year, you had investment spending for Baby and Child, for Brocade, for Bed & Bath and for the trade division. You had kind of four growth initiates where you had investment spending with an aggregate deleveraging effect and probably a deleveraging effect from each one of them. And as we move into the second half of the year we would expect the Bed & Bath investment to go from a deleveraging to an earnings positive effect. That would also by the way be one of the points, if Rob is still on the call, that would be a positive in Q4 versus the first half. And the Trade Division goes from kind of an earnings negative to an earnings positive in the second half of the year. Both Brocade and Baby and Child will still be an earnings drag in the second half. Obviously, Baby and Child has no revenues yet and we would expect Baby and Child to go earnings positive in the first full quarter that it is mailed.

Okay. And recently we seeing a trend upward in jumbo home mortgage rates. Could you talk about if that's affecting your business and if so, how much?

What I would say is that -- I would venture to guess that our customers have a higher percentage of jumbo mortgages than some other businesses. But we haven't seen a step function change in our business trend in the past several weeks since the rates have gone up.

Great, thank you very much.

Sure.

We'll take the next call from the site of Janet Kloppenburg of JJK Research.

Hi, guys, can you hear me?

Hey, Janet.

I was wondering in light of the challenges in the business if you thought you should go ahead with the investment in Baby and Child and the trade business. Maybe you should put that on hold right now given what is happening in the business. And secondly, I wondered if you incorporated some of the learnings from the outdoor catalog with respect to value, Gary, into the holiday catalog. Since I think the competitor profile won't be as tough. I am sure you agree.

Let me start with the holiday one. I think we're sharply priced and well-positioned for holiday. In fact, some of the early ah-ha's about our outdoor assortment drove a top-minded awareness and kind of drive within the Company to make sure that the fourth quarter was well-positioned from a price and value point of view. So, I feel very confident about Q4 abut the lineup of products, the presentation and value proposition, et cetera, and I feel that we're significantly better positioned than last year for holiday.

As you think about the growth initiatives going forward, the -- as I think about it, both Trade and Baby and Child, we kind of see it as kind of initiatives that will help us navigate through the headwind. The trade initiative is really based on building out a direct sales force that leverages the current assortment and distribution capabilities of the Company. So there is not a lot of capital investment. And there is a very quick payback on those investments. Like I said, it was earnings negative in the first half. We expect to be earnings positive in the second half.

As it relates to Baby and Child, Baby and Child should have the quickest ramp-up of any of our concepts. Our Bed and Bath catalog will be profitable in the first full quarter that it's mailed. We would expect the Baby and Child catalogs to perform better than that and that is related to the fact that there is no cannibalization of any of our other categories. Bed and bath is an extension of our current categories; bath hardware, accessories and bath textiles, bedding, bedroom furniture, et cetera. And to me, that is more risky.

We know we're not serving our customers who have baby and children in their homes who are furnishing those rooms. So today, those pages have no cannibalization effect. We think it's been a very underserved market and we think the assortment we're coming out with is completely differentiated in the marketplace. It will look like nothing else out there.

So I think you will find that is the quickest ramping business and it's kind of like a bullet that will pierce the headwinds, so to speak and may even give us opportunities to add some assortments to our retail format that allow us to garner additional business. So, we think both of these initiatives are quickly turning positive contribution and becoming earnings positive. So, we believe it is the right thing to continue to keep pursuing.

I think Janet jumped off.

Next question?

We'll take our next question from the site of Igor [Lutven] of [Soma] Asset. Go ahead, please.

Thank you, thank you for taking my question. I am sorry if I missed that. Could you spend a little time on your leverage and liquidity in particular; and your expectations with respect to leverage throughout the next two quarters. Thank you.

Sure, by leverage I assume you mean SG&A?

No, I mean as in financial leverage in terms of your total debt, the borrowings on the line of credit and the liquidity.

Okay. So we're at 39 million in availability and as we look at the back half of the year we-- (multiple speakers) you might want to clarify that. We had 39 million at the end of the quarter of available--.

To borrow on our credit line.

On our bank line, correct. So we could borrow 39 million more than what we have so far. As we look through the back half of this year, we are essentially at our low point of availability between now and to the end of the year. August will come in a bit lower than the 39 but from that point, our availability will build and we have no liquidity issues that we foresee through the end of the year. The current guidance from a debt standpoint would put us at a higher debt level than last year but it's not a dramatic increase.

No, that certainly helps. How much cash do we see generating between now and the end of the year, if any?

We generate a lot of cash. We're saying the full-year, we're generating 20 to 24 million of EBITDA. So, if you look at what we have generated thus this far, and back that out of the 20 to 24, you will get what our back half generation is roughly.

Okay. Got it. Thank you.

Okay.

(OPERATOR INSTRUCTIONS) There are currently no questions in the queue.

Okay, thank you all for your interest today and we'll talk to you next quarter.

Okay, thank you, everyone.

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