RH (RH) 2013 Q3 法說會逐字稿

Good afternoon. My name is Shiv and I will be your conference operator today. At this time, I would like to welcome everyone to the Restoration Hardware Holdings third-quarter conference call.

(Operator Instructions)

I turn the call over to Cammeron McLaughlin, Investor Relations, Restoration Hardware Holdings. You may begin your conference.

Thank you. Good afternoon, everyone. Thank you for joining us for Restoration Hardware Holdings third-quarter fiscal 2013 financial results conference call. Joining me today are Gary Friedman, Chairman, Creator, Curator and Co-Chief Executive Officer; Carlos Alberini, Co-Chief Executive Officer; and Karen Boone, Chief Financial Officer.

First, Gary and Carlos will discuss our recent management change announcement. They will then discuss highlights of our third-quarter performance and provide an update on the Company's key strategic priorities. Karen will conclude our prepared remarks with a discussion of our third-quarter financial results and our outlook before opening up the call to questions.

Before I turn the call over to Gary, I would like to remind you of our standard label disclaimer, that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook for our business and other matters referenced in our financial results press release and our management change press release. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially.

Please refer to our SEC filings as well as our financial results press release for a more detailed description of the risk factors and that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call. And we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.

Also, during our call today we will discuss a number of non-GAAP financial measures which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release, as well as a reconciliation of adjusted P&L items on pages 11 and 12. A live broadcast of this call is available on the Investor Relations section of our website at IR.Restoration Hardware.com.

With that, I will now turn the call over to Gary.

Thank you, Cammeron. And good afternoon, everyone. I would like to start the call with Carlos and I addressing the news that he is stepping down as co-CEO, and then move to the highlights of our third-quarter results.

Let me begin with a quote and some thoughts I sent in a note to our team just minutes ago. Ralph Waldo Emerson penned the famous quote -- Do not follow where the path may lead, go instead where there is no path and leave a trail. I've always admired those people who have demonstrated the courage to chase their dreams and chart their own course in life. And today one of the people I admire and respect most has also chosen to do so.

My partner, brother, and one of my best friends, Carlos Alberini, has decided to step down from his position as co-CEO of RH effective January 31, 2014, to pursue his lifelong dream of running and building a company. As you know, he has accepted the position of Chairman and CEO of Lucky Brand based in Los Angeles. Like many of you feel right now, I was initially stunned and saddened by this news.

But as Carlos made it clear, that this was about chasing his dreams, I realized that is exactly what our culture is all about. And how could I feel anything but love and happiness for a person I care so deeply for.

Earlier, when Carlos and I were sharing this information with one of our teammates, he told us he had two tears running down his face. One of sadness and one of joy. He asked us if we were happy and he told us -- If you two are happy, then I'm happy.

I, too, experienced those same two years. And I can tell you today that I am happy for Carlos, and proud he will remain a member of our Board of Directors, where we will continue to benefit from his wisdom and leadership.

On behalf of myself, the Board and the entire RH team, including our partners around the world, I want to express our deepest thanks to Carlos for his numerous contributions. His leadership has been invaluable and his partnership will be very difficult to replace.

As mentioned in our press release, we are developing a transition plan and will initiate a search for Carlos' replacement shortly. In the interim, I will reassume oversight for Carlos' direct reports. And it's only prudent to expect that my focus will be on the growth and execution of our core business and real estate strategy, while applying a slower burning fuse as it relates to both financial and human capital regarding our new business initiatives.

I'm confident this exceptional leadership team will continue to deliver industry-leading growth and results, as we continue our quest to build one of the most innovative and admired brands in the world. Let me end by saying it is truly a lucky day for everyone associated with Lucky Brand.

With that, let me turn the call over to Carlos.

Thank you, Gary. And good afternoon everyone. I want to start by thanking Gary and our entire RH team for some of the most rewarding and fulfilling experiences of my entire career. Gary has been a source of inspiration for me.

He is someone that I admire and respect greatly. And we have built an incredible relationship that I treasure, and I will miss every day in this new chapter of my life.

To our team, you are an extraordinary group of people and I am honored that I got the privilege to work with all of you. I'm so very proud of our accomplishments and I look forward to your continued success and wish you all the very best. You are and will remain family to me.

Very recently, I have been presented with an opportunity that I believe will allow me to fulfill my lifelong dream to run and build a company. Making the decision to leave RH has been one of the most difficult decisions I have made in my 35-year career. My decision has nothing to do with RH and my confidence in our Company, my relationship with Gary and our team, or any financial reason anybody can think of.

In fact, all of these have inspired me greatly since the moment that I joined this journey. My decision has everything to do with pursuing my professional dream, and supporting my wife's preference for where we will live our life.

I will be 59 years old and realize that my time to pursue this dream is now. I have worked very hard my entire career and I have made many sacrifices to get to this position. And I look forward to this new chapter in my life.

I will be joining Lucky Brand as Chairman of the Board and Chief Executive Officer. I will be partnering with the private equity firm, Leonard Green, for the acquisition of the company, and will become a significant shareholder. I will remain with RH until January 31 of 2014, and will ensure that we have a smooth and orderly transition, working closely with Gary and our leadership team during this time.

We have a very strong team and I have complete confidence that the Company will not miss a step. I'm truly honored and thrilled that I will continue to have the opportunity to serve on our Board. It will be a privilege to continue to be a part of this amazing story and stay close to Gary and my RH family.

I have no plans to sell stock now, but may consider future sales for diversification purposes, as my investment in RH is by far the biggest that I have. That said, I plan to remain a significant shareholder of the Company. My plans reflect my confidence in Gary and the RH team and my strong belief that RH will someday be recognized as one of the strongest and greatest retail stories of all time.

Thank you. And with that, I will turn it back to Gary.

Thank you, partner. We are pleased to report another quarter of record financial results. Our ability to innovate, curate and integrate new products, businesses and experiences, and then present them in our own unique and distinctive point of view, is at the core of our success, and differentiates our brand from the sameness that exist.

Our business continues to greatly outpace others. And we believe it's disrupting the large and highly fragmented luxury home furnishings market. We delivered 39% growth in total revenues, driven by a 47% increase in direct revenue and 29% comp store sales growth on top of 29% in the year-ago quarter.

We believe this significant growth in our direct and total business demonstrates that the most recent evolution of our Source Book strategy was a highly profitable decision, and will accelerate our ability to reach double-digit operating margin and cash flow positive versus our previously communicated expectations. The strong top-line growth, coupled with advertising savings and operating leverage, drove a 390 basis point increase in operating margins, and 389% increase in growth in adjusted net income for the quarter, while we continue to invest in our infrastructure and new businesses to support our future growth.

Based on our strong third-quarter results and continued confidence in our fourth-quarter outlook, we are increasing our fiscal year 2013 guidance. Looking forward, I would highlight four important data points, and share with you how we think about the evolution and development of our business model.

One, the current data suggests that the new Source Book strategy will be accretive to operating margins by approximately 100 to 120 basis points on an annualized basis. This is not inclusive of the additional savings we expect that should result from better execution from a simplified once-a-year strategy as it relates to inventory management, lower back orders, higher fulfillment, lower shipping costs, and other cost savings throughout our model.

Two, the newness that would have been mailed last fall will now mail with the spring book newness, giving us a significantly greater year over year increase in product assortment in 2014, versus 2013. We were planning on approximately 400 to 500 pages of new pages for fall 2013, that we'll now mail in spring 2014, with the additional 400 to 500 new pages of planned spring newness. So, directionally, we will have an increase of approximately 800 to 1,000 pages in our core businesses in spring of 2014.

This should provide the product fuel we need to bridge us through 2014 until our real estate strategy ramps up. So, the way to think about it, when you pull back, it's not necessarily an elimination of a book that provides assortment. It's really a timing move of the newness from fall 2013 into spring 2014. And then on an annualized basis, we've got much greater product assortment growth.

Three, our 2013 operating margin forecast of nearly 8% begins to move us closer to a double-digit operating margin which now looks attainable, even before we realize the expected leverage of our real estate strategy. This gives us the long-term confidence that we will be able to reach a mid-teens operating margin once we transition our fleet to the next-generation full-line design galleries, which have a superior four-wall model, and additionally provide significant leverage as it relates to corporate SG&A.

Four, we believe our new, high-quality, low-cost Source Book and full-line design gallery models, plus our significant online business, will create a superior platform for growth and long-term competitive advantage.

With that, let me turn the call back to Carlos.

Thank you, Gary. We remain focused on transforming our legacy real estate portfolio into 45,000-plus selling square foot for Line Design Galleries. And we see opportunities to open this new model in 60 to 70 locations in North America. This larger format store will allow us to showcase more of our growing product assortment.

As we have consistently stated in the past, we see anywhere from a 50% to 150% lift in sales when a product is shown in retail. This is the key point of our real estate transformation. We believe this transformation will take place over the next five to seven years, resulting in more than quadrupling our selling square footage.

Once our real estate transformation here in North America is complete, we believe that RH will be well positioned to generate over $4 billion to $5 billion in revenue with mid teens operating margin. We currently have five Full Line Design Galleries that are continuing to perform ahead of expectation. These are located in Los Angeles, Houston, Scottsdale, Boston and Indianapolis.

So far in 2013, our stores in Los Angeles and Houston combine our Company nexus of 34% compared to the rest of the fleet at 31%. This location also continued to be very productive and are expected to deliver between 2,200 and 2,400 VARS in sales per selling square foot on an annualized basis. This is approximately $1000 higher than the rest of the fleet, further validating that these large-format locations are truly allowing us to unlock the value of our assortment.

Our Scottsdale gallery celebrated its one-year anniversary last month and also continues to perform extremely well, trending to produce close to $1,200 in sales per selling square foot this year. Since opening in April, our locations in Boston and Indianapolis are experiencing store demand in excess of 70%, in addition to a significant lift that we are experiencing in direct demand for those locations.

In fact, we continue to see the direct business perform very well in each market with the Full Line Design Gallery, ranging anywhere from 25% to 80% growth during the third quarter. An additional factor contributing to the overall performance of our direct business this period.

We have recently completed the conversion of approximately 32,000 square feet of backroom storage space into productive selling footage. In addition, as we discussed with you last quarter, we plan on adding 17,000 square feet to our gallery in New York in Flatiron. This is one of our largest markets. This additional square footage will require this store to be removed from our comp base once the construction is complete in spring of 2014.

We are thrilled to open our newest Full Line Design Gallery at the old historic post office in Greenwich, Connecticut, in early 2014. This location will have over 19,000 square feet of selling space in an architecturally unique and dramatic setting. And it will significantly expand our presence in this very affluent market.

We will be opening a new 30,000-plus square-foot Full Line Design Gallery on Melrose Avenue in Los Angeles in late 2014. We also are on track to open our first next-generation Full Line Design Gallery consisting of more than 50,000 square feet in Atlanta in late 2014. And 10 or more Full Line Design Galleries [currier] beginning in 2015.

We have built a world-class infrastructure that will provide operating leverage and support our future growth. During the third quarter, we made very good progress in our efforts to insource our furniture deliveries in top markets, and we added hubs in Miami and Dallas. We now have hubs in 7 of our top markets, representing nearly 50% of our furniture deliveries.

With that, I would like to now turn it over to Karen, who will review our financial results. Karen?

Thanks, Carlos. And good afternoon everyone. I will start with a review of our third-quarter performance and then discuss our outlook for the remainder of the year.

We are extremely pleased with our record performance during the third quarter. Total revenue increased 39% to $395.8 million. Our comparable store sales increased 29% during the period, on top of 29% comp growth last year.

We're also thrilled to report that direct sales increased by 47% during the quarter, driven by strong web traffic despite a significant reduction in circulation due to the elimination of our fall Source Book. Growth in all of our channels was driven by our customers' overwhelming response to our product offering and assortment. Gross profits increased by 38% to $140.8 million during the quarter.

Gross margin decreased 30 basis points to 35.6% from 35.9% last year. While the product margins declined versus last year, we saw significant improvement in our margin trend relative to what we experienced in the second quarter, as we begin to anniversary the strategic pricing initiative introduced last fall. Our DC occupancy cost as a percentage of revenue increased relative to last year, due to the investments made in our Dallas furniture facility and Ohio shelf stock facility expansion. These impacts were partially offset by continued improvement in leverage of our retail occupancy costs.

Our total SG&A expenses increased 17% to $116.9 million in the third quarter versus $95.9 million on an adjusted basis in the prior year. As a percentage of net revenues, adjusted SG&A expenses decreased by 420 basis points. This decrease was predominantly driven by advertising savings resulting from the change in our Source Book strategy.

Adjusted operating income increased nearly 300% to $23.9 million from $6 million last year. Our operating margins expanded nearly 400 basis points to 6% from 2.1% last year. As a reminder, operating income and SG&A for the third quarter of 2012 was adjusted to remove IPO-related costs and other nonrecurring items.

Adjusted net income for the third quarter increased 389% to $13 million, up from $2.7 million in the prior year. And is calculated based on the normalized 40% effective income tax rate. Adjusted diluted EPS increased 357% to $0.32 versus $0.07 last year.

Turning to the balance sheet, inventory levels at the end of the third quarter were $448 million, up 34% over last year and position us well for the top-line growth plan for the fourth quarter. We continue to expect our inventory to grow in line with sales for the fourth quarter and full fiscal year. Our year-to-date capital expenditures were $57.6 million as of the third quarter.

Including expected accruals, our capital expenditures were $73.3 million. And we continue to expect CapEx in the range of $95 million to $100 million for the full fiscal year.

As we have previously stated, we anticipate investing more than half of our 2013 capital expenditures on real estate, including the build out of several Full Line Design Galleries scheduled to open in 2014, and the conversion of backroom storage space into productive selling square footage in several locations. Our capital spend also includes our recent DC and supply chain investments, as well as IT and other infrastructure investments to support our growth.

Turning to our outlook, for the fourth quarter, due to the continued strength of our core business, we are maintaining our revenue guidance of 31% to 34% growth on a comparable 13-week basis. This reflects second-half growth between 35% and 36% on a comparable basis. And continues the strong top-line growth achieved in the first half of the year of 34%.

Our business remains strong and we are optimistic about the remainder of the year. We continue to expect our gross margin in the fourth quarter to be roughly flat to last year. Our adjusted net income for the fourth quarter is expected to be in the range of $34.3 million to $35.5 million, with diluted adjusted EPS in the range of $0.82 to $0.85.

This reflects a revised diluted share count of 41.6 million shares. For fiscal 2013 we are raising our adjusted diluted EPS guidance to a range of $1.71 to $1.74. This is based on adjusted net income in the range of $69.4 million to $70.6 million. And reflects a revised share count of 40.5 million diluted shares outstanding.

For the full year we expect revenue growth of 34% to 35% on a comparable 52-week basis. We are currently finalizing our plans for the next year and plan to share our 2014 guidance on our fourth-quarter earnings call in March.

We remain confident in our ability to meet our long-term financial goals for the 2014 fiscal year. We expect that our revenue growth will accelerate through the year as we benefit from the product newness introduced with the spring Source Book, and as we execute our real estate plan.

In closing, we have an amazing growth story and strategy. Based on our robust product assortment and real estate pipeline, we continue to feel confident that we will drive significant top-line growth and meet our long-term financial goals of revenue growth in the low 20%s, adjusted EBITDA growth in the high 20%s, and adjusted earnings growth in the mid to high 20%s.

With that, I would now like to open up the lines for any questions. Thank you.

(Operator Instructions)

Lorraine Hutchinson from Bank of America Merrill Lynch.

Thank you. It's Paul Alexander for Lorraine. Can you talk about the acceleration in the direct segment? Why the step up in web traffic? Was that a gradual acceleration over the year, or it seems like more of a step function here in third quarter. Was there additional web marketing to drive that traffic? And did that exceed your expectations?

Hi, this is Gary. Yes, it did exceed our expectations. We had a step up, as you said. We didn't have any significant, meaningful marketing events year over year. So, we just saw a good movement in the Business, and a slight shift from retail to direct.

With the direct growth up so strongly, will there be, or was there, any gross-margin pressure related to shipping? Or is that negated by the furniture hubs?

You would have seen that in our results in the quarter, which weren't apparent. As you know, our performance was above our expectation.

Yes, and really, when you think about how our Business has evolved to what it is today, we ship direct to consumer in the majority of our Business. We're talking about 97%, 96% of our Business ship direct. So, whether those orders are generated via the direct business or in the galleries today, you will still see the same type of delivery cost. It's more about mix.

Yes, I will just add that -- we didn't mention the transportation-specific impact on margin. And those margins were roughly flat to last year. So, we didn't see a decrease.

As Carlos mentioned, we don't really care. We are truly channel-agnostic, in the fact that we don't care if it's shipped -- it's all shipping from the DC, so whether the order's placed in the store or the order's placed online, we don't drive promotions that are one channel. All our promotions are across all channels. So, we really, truly, in all sense of the word, we are channel-agnostic.

Great. And then just one last follow-up, and forgive me if you already said it. How do orders look for fourth quarter?

We didn't say that, and we don't generally give that.

We haven't done that. If you look at our press release, and from our script, we are comfortable with the fourth-quarter guidance we have.

Great. Thank you. And all the best to Carlos.

Daniel Hofkin from William Blair & Company.

Good afternoon. I will add congratulations on the bittersweet news. But it sounds like a great opportunity.

Regarding maybe the fulfillment side of the Business, could you just comment about -- obviously, you've identified that over the last couple of years as a big opportunity to -- whether it's inventory investment or supply-chain investment -- to improve that. How do you feel that stands right now? What do you see, if anything, as further opportunities? That's my first question.

This is Carlos. And thank you, Dan. I would say that we have made significant progress on this. You may recall that we had set this as a big strategy for us, to enhance our inventory position, and made a strategic investment in inventory. The great thing here is that our vendor supply network has responded very effectively. And we continue to see a significant improvement in how those orders are fulfilled -- purchase orders, I'm talking about.

So, as a result of that, you saw our inventories are up 34%. We are thrilled with that type of growth. And we have seen a greater ability to fulfill inventory orders -- I'm talking about now with customers. Our buy quarters are lower than they were a year ago, with a significant increase in our Business. So, we are very, very pleased with this. And, meanwhile, our strategy will continue to be further investment in inventory.

Another thing that is helping greatly is that, because we went to one mailing a year, then there was a significant newness in Fall. And that is allowing us to continue to get better with the product assortment that has been available since Spring.

Okay. And I'm sorry, one part you said: What was lower year over year? Are you talking about the back orders were lower year over year?

Right. (multiple speakers)

Okay. And then the other question, if you can comment a little bit: Obviously, there's been some consumer cross-currents. It would just be helpful -- over the course of the quarter, more recently, have you seen any changes in either traffic patterns, either online or in store? Any volatility there that you could point to, one way or the other?

As you know, we are in the holiday season. So, the traffic patterns are very different, naturally. You can tell that our Business has been very strong. So, clearly, we are thrilled with the trends that we are seeing.

Okay. Thank you. Best of luck.

John Marrin from Jefferies.

Nice job on the numbers, guys. Congrats, Carlos, for getting your dream job.

Just two questions: Can you speak to any of the progress you are seeing on the securing of new leases for anchor tenants, anchor tenancies? And then maybe give us some more color on the continuity and the effort as it transfers from Carlos to Gary?

And then, following up, can you just talk about the new product that you moved from the Fall to the Spring? And maybe discuss that a little bit, and focus on the impact that we might be seeing on product margins from that new product.

Sure. We will both take these questions back and forth. The progress on leases has really been terrific, and the enthusiasm for the new concept accelerating. We have had our feet on the ground now in almost every major market in North America -- same locations and negotiating deals. Last week, actually this week at the ICSC in New York, we got feedback that we are getting even more enthusiasm behind the concept.

And we are seeing a consistent deal structure being presented amongst the development community. So, we have high optimism that we are going to be able to achieve the kind of economics that we want in each market: store size, locations. And long term, we believe this is really going to be a superior economic model than anything that exists, at least in specialty retail.

If you just pull back and you think about it, the history of retailing, especially if you deal with it from a somewhat mall-specific point of view for a second, over the last 50 years or so, there's been anchors on the ends of a mall, or two ends or three or four, and then space in between the anchors. And that space in between the anchors is basically spaced as auctioned off. And you are either auctioning -- you're auctioning for 30 feet of frontage, 40 feet of frontage, et cetera, et cetera, to 100 feet of frontage. But you are auctioning for the same space, and you're basically getting a store front.

When you think about what we are going to be doing, and the kind of retail presence that's being built with our, if you want to call us, a mini anchor, somewhat of an anchor-tenant strategy, in many cases here, the landlord is taking either -- in Denver's case, a department store that he's tearing down and putting up a new RH. Or taking a plot of land that connects to the mall, and positioning us as an anchor tenant.

If you ask yourself: When was the last time there was a new anchor tenant in luxury shopping centers? The phenomenon really hasn't happened since Nordstrom's strategy, which started in the 1980s, was really the last new platform that was rolled out.

What's really good about this is we become accretive square footage to the center. And we are not in a position of competing for the auctioned-off space between the anchor tenants. That allows us to create a financial structure that is very good for us, and accretive to a landlord. And that's why we've got a different kind of model, and one that we don't see anybody else being able to replicate.

So, we are very excited. It's good for everyone, and that's why everyone is excited about it.

The new product that has moved from Fall to Spring -- again, the way to think about this is: We were in development and production to mail a Fall book. And as our data continued to come in on our test segments, of tales that we have been measuring over a two-year period -- and we are talking about segments from 200,000 to 500,000 people that we would hold out and measure against, ones we mailed and ones we didn't mail -- it became very clear. The data became very strong that said: The incremental lift for mailing someone another book six months later was not worth the cost to make that decision.

So, the ability to pull out and not mail that book really put us in a position to say: The newness that was developed, and the pages we went into production on, would now just move to Spring. So, what you have in Spring is you have the Spring newness that was planned, plus the Fall newness that was delayed. And now you really have two seasons coming together.

And remember: Our product is very different than some of the other people you might compare us to in the home furnishing space. Many, many other people run a fashion-type model, a seasonal-type model. They've got Easter plates, and things that are painted and seasonal in nature, and colored to a color palette that is seasonal in nature. Our product is not that. So, the delay of Fall product to Spring, from a customer's point of view, outside of our outdoor furniture assortment, is indistinguishable.

You are going to now see two seasons of newness up against last year. And that will then run throughout the year. You will have that year-over-year increase of, call it, 800 to 1,000 pages. The reason we're giving you a broad range: We are in production right now, and we're putting together the books, and working on photography and editing, and so on and so forth. It will be somewhere in that range. Then you will have that increase for the whole year, if that makes sense.

And its impact on product margins: The way I think about the margins is really the ability for us to have consistent fulfillment and lower back orders, and increased fulfillment rates and not have to go to a home multiple times from a furniture delivery point of view, is a significant opportunity in our Company. Moving to one book a year simplifies our whole process throughout the Company, allows our vendors to manage their business more predictably and over a longer period of time. We believe it's going to be multiple opportunities, as I outlined.

Carlos, do you want to say something on this point?

I just want to add a couple of things. On the real estate side, we, in addition to seeing the kind of interest that Gary was referring to, we have made significant progress in moving the game up forward with specific deals. We have about seven letters of intent on many, very key locations. And we are very close to going into lease. And, in many cases, we have been negotiating leases already.

We feel pretty good, and we feel great about every one of those locations. And I think we have said in the past that we are in discussions for over -- about 30 locations, and the list continues to grow. So, very excited about that.

The other thing I wanted to add is that I think that Karen mentioned that our plan for 2014, what Gary alluded to, we are expecting that the growth is going to accelerate in the second half of the year, or starting even with second quarter because those books are introducing all that newness and additional assortment growth. When you think about the growth for the year, you should see a growth that is back ended, in a way, meaning from the last three quarters of the year.

Okay. Very helpful. Thanks, guys. Good luck, Carlos.

I think you asked also about the continuity and how we plan, as I transition out. I think as Gary made very clear, that the Company, and Gary specifically, is leading this charge on planning. We are developing a strategy for the transition, and we're going to be working together on this.

The great thing here is that we have an amazing team. And, frankly, every member of the team really operates very autonomously. And Gary and I, we've spent a lot of time together. So, we are both fully up to speed on what is happening in every one of these areas. And I, frankly, do not anticipate, like I said in my remarks, that the Company will miss a step.

But we will be working together on this. I'll be here through the end of January, and even beyond that. It's just a great thing that I will be on the Board, so I'm not going too far.

Yes. I'd just build on the fact that you guys should expect us to look for the best talent anywhere in the world to fill this role. If you think about the Company and the positioning today, and our, probably, ability to attract top talent, I think we are in a really good position. We've got a lot of growth and runway ahead of us. This is a new and exciting and developing new Business and new model.

And we will exhaust all resources, and we will continue to build a team. And from multiple ways, not just Carlos's replacement. But throughout the Organization, we are continually upgrading and building a world-class organization.

Okay. Thank you.

Matthew Fassler from Goldman Sachs.

Carlos, obviously, best wishes to you going forward.

My first question does relate to the recruiting process. You two obviously had a very unique relationship -- have a very unique relationship, and unique structural relationship as co-CEOs. So, Gary, I will direct it to you. As you contemplate replacing Carlos, how do you see the structure of the management team evolving as you bring in the next person or people to step into Carlos's shoes?

Sure, Matt. I think that it's going to be dependent on two things. One, we are going to take some time -- as we do every year, by the way -- to assess the Organization, where our strengths are, where our opportunities are. How the Organization is structured for where the Business is going. We will be going through a process to do that. And so, our needs will be driven by that, and will also be driven by the talent.

I don't believe, personally, that you just identify a slot, and try to find someone to fill a slot. It's a combination of: What are the needs of the Organization, and what is the talent and capabilities of the individuals, and where can they make an impact? Is this one person, two people? Is it a combination of things here?

I will tell you this: We will get the best talent that we can in the industry. I think our calling card is as good as anybody's. So, I wouldn't focus so much on just how we think about this in a like-for-like swap. It's really: What are the needs of the Business going forward, how do we find the best talent, and how do we keep building a world-class organization?

A second question: You mentioned to scaling back a couple of the newer initiatives. Can you talk about what you might slow down? And also, obviously, if there are costs associated with those that are no longer going to be in the plan, how beneficial is that to the P&L in the short run going forward?

Matt, I wouldn't say this really affects the long-term vision and view of the Company. What it does is it obviously affects the more shorter-term, near-term decisions and investments we will be making, just because of time and focus, and specifically, my time and some of the other key leaders' time in the Business. This is a brand-new, recent development with Carlos. We haven't -- went through the process yet.

I think the things that we've slowed down would be obvious. We haven't talked to our teams yet. It wouldn't be prudent for me to be making public announcements about what levers we are going to pull. But I think people will be wise enough to think: Geez, which ones might you put on a slower fuse, and where might you slow down investments? They would be the ones you'd assume.

And then, finally, just a real quick one on the financial side. Obviously, the gross margin began moving more so in the right direction this quarter. If we think about the moving pieces underneath, and just some directional quantification, if you could talk about the moving pieces between occupancy, shipping, mix, et cetera, what direction some of those moved in. Mix, in particular, which I don't think you discussed, Karen, in your earlier comments.

Thanks, Matt. On the margin side -- if you know the three main levers -- on the product margin, they were still lower than last year. As I mentioned, that it is continued furniture expansion. So, when you see our Q, you will see that furniture continued to grow, and our furniture penetration continues to grow. So, that does have a mix effect.

The transportation impact, though, of that, based on some efficiencies we are seeing, and how we view transportation margin with some of the recent increases in our flat-rate shipping and just other optimization, was not as significant as we've seen in prior quarters.

And then, within occupancy, we did see a deleverage in DC occupancy for the first time in quite a while, with Dallas and Ohio, with that full quarter of those rents. We've talked about that was coming. And then, retail occupancy just continues to leverage, and that's exactly where we expect it to continue to move in the future. And even more so when we get more of the Full Line Design Galleries online.

Great. Thanks, everybody. Appreciate it.

Peter Benedict from Robert Baird.

Carlos, obviously, congratulations. You will be missed. But best of luck.

Karen, just going back to the revenue commentary on 2014, you guys talked about acceleration throughout the year. Are you thinking acceleration versus where you are coming in this year? Or just that you take the first quarter as your base, and then it accelerates from there? That's the first question.

No, what we are trying to get across is: In my remarks, I mentioned that for 2014 we do feel confident that we are going to meet those long-term financial goals. And for revenue, that's revenue in the low-20%s.

But we are trying to give you a sense of: It might start off more slowly in the beginning part of the year. And, as Gary mentioned, when we drop all that newness in the book in the Spring, it does take -- with those pages, it takes customers a longer time to get through it. Then we have to ship it and deliver it. So, it will ramp as we go and move through the year. That, coupled with the Full Line Design Galleries that are coming online in Greenwich and Melrose and Atlanta.

So, think about that long-term growth in that low-20%s target. But the beginning part of the year will be lower, and the back part of the year will be higher.

Right. And you add New York expansion to that.

Exactly, yes.

That makes a lot of sense. Thank you.

And then the next question: Your CapEx this year will be roughly double what it was last year. But your D&A is growing just 2%. So, help us understand: As we look out over the next year and change, how D&A starts to ramp, and what maybe the longer-term capital requirements are for the Business on an annual basis. Thank you.

I'll take the capital requirements first. That is largely dependent on the timing of the real-estate expansion, and when we start the spend of those. So, you will see it ramp quite a bit in the 2015 year, and even the latter part of 2014 as we start building for that future growth. We are not ready to give any sort of band for 2014 and beyond. But just know that our capital requirements will continue with the execution of the real-estate transformation.

Then, on depreciation, the reason why you haven't seen that -- you will see the bigger numbers -- so far, the $70 million or so, so far, Q3 year to date. But if you think about the timing of the depreciation, it's lagged because a lot of those were just construction in progress. The DC investments, in particular, none of those assets were placed into service until the late part of the Summer. And then a lot of the real-estate build right now isn't going to be placed into service until we open up Greenwich and Atlanta.

So, you are always going to see the capital growth ahead of the depreciation. (multiple speakers) And, again, we will give more -- as we finalize the capital plan and timing, we will give more clarity on depreciation, and how you should think about that as a percentage of sales and the growth, again, once we have that capital plan.

Got it. Thanks. Sounds good.

Neely Tamminga, Piper Jaffray.

Carlos, you will be missed on these calls. But we do wish you all the best over here at Piper.

Gary, if you could talk -- I fully appreciate wanting to just bring on the world's best talent to your Organization. I do believe you guys have the calling card to do so. But could you highlight, in your mind, what some of, maybe, the key attributes that would maybe be more important to you, as I think about the landscape and the opportunity for you guys? Is this a really strong operator from a real-estate perspective? Is this going to be someone who understands international growth maybe better than the average bear? Or is it about digital? If you could expand a little bit on that.

And I have just one other follow-up. Thank you.

I think the priorities would be the first two that you spoke to: operating, financial leadership. I think both Carlos and I are equally well versed from a real-estate point of view, and have both led real-estate areas, and have co-managed the real-estate aspect of the Business on all these new deal developments.

And our model here is very unique. There's really -- no one's done this model. It's not an easy one to pull out.

We feel very good about our team in place from a real-estate store-development point of view. But the real key will be a lot of the qualities and skills that Carlos has brought to the Organization, and as well as we assess the needs of the Organization looking forward as we continue to grow. We look at international, and we look at other pieces How do we think about that?

I'm not ready to comment on all the details in the job description today, as you might expect. But you'll expect us to do all the right work and conduct the right kind of search and build the right kind of Organization.

Okay, that's helpful.

And then, in terms of the Spring Source Book, just a technical question. When do you guys plan on dropping that book? And how does that compare to 2013?

And then the innovation, Gary, outside of the Spring Source Book for all the other micro books that you've had out there, how should we be thinking about the innovation outside of the Spring Source Book throughout the balance of the year?

The books are a combination of books. You've got an interiors book, an outdoor book, a baby and child book, small spaces book. We announced that we will be launching a leather book, a rug book, and others. And we've got some new ways of thinking about the Organization and the presentation of those books that we are not prepared to comment on for competitive reasons right now.

But I think when you see the collection of books together, how they're going to be presented and how they're going to be mailed, you're going to think it's pretty innovative and revolutionary. We think it's a significant upgrade to how all of our categories are being presented, and how all of our lifestyle approach to the Business is being presented.

What was the other question?

When are we planning to drop the book.

The books will be dropped exactly -- right now, they're planned exactly as last year. It's second half of April in-home begins. Because these books are so big, they start to roll out over the course of, I think, four to six weeks.

Five weeks.

We're going in-home exactly the same time we went in-home last year.

Thank you very much. Best of luck out there. Happy holidays.

Matt Nemer of Wells Fargo.

This is Omair on for Matt. Can you discuss what the response has been to the recently introduced product categories of tableware and objects of curiosity versus, maybe, your internal expectations? And then, given the higher margins in these categories, was there a benefit at all to gross margins in the quarter?

We are happy with all the early reads of the new businesses. They are very small still, comparatively, to the categories that we've been historically in. And, as I think I've mentioned on other conference calls, there is a ramp-up time of building top-of-mind awareness. And there is an importance of getting a critical mass of these assortments into the retail stores, which, in our legacy real estate, we don't have that much room to really present a full tabletop department and some of the other categories.

You will see these ramp over time. You will see that the margins will grow as we have more scale and buying power here. But the way to think about all of these categories is they will all converge into the much larger next-generation Full Line Design Galleries, where they will have, really, a bigger and more proper presentation impact.

Got it. Okay. And then, on the five Full Line Design Galleries that are currently open, you mentioned some of the metrics regarding those. Can you dive a little bit further -- maybe discuss the differences between traffic and ticket? And just contrast the Full Line Design Galleries maybe versus the legacy stores?

Yes, we have not prepared to give much more granularity. We feel that we are giving a lot of details on this new Full Line Design Galleries, as it is. And the idea here is: We believe that this is important. So, we want to give you that type of visibility

But let me say that these new locations are just a very powerful business model. We are seeing significant efficiencies relative to the legacy locations. We are seeing higher average order value in these cases. We are seeing an opportunity to provide, greater even, customer interior-design services.

Overall, the productivity that we are seeing, in spite of the much larger space that these locations have, I think, is just a testimony to how powerful this new formula is. And we are very, very happy with the continued comp growth that we are seeing in these locations, in spite of the huge growth that we see in the first year out of the box. And then continue to comp at a faster rate than the rest of the fleet, is pretty powerful, I think.

Got it. Thank you, everyone, and good luck, Carlos.

Janet Kloppenburg from JJK Research.

Congratulations on a great quarter. And congratulations to you, Carlos.

I was wondering if you guys could talk a little bit about your promotional activity during the third quarter year over year? I know you anniversaried your pricing strategy change. But I was wondering: It appeared subdued to me. And I'm wondering, given the strength of your assortments, if you have some leeway in terms of pricing now and going forward?

Also, Gary, I was a little bit confused about the introduction of so much newness -- excited, but a little confused. Does that mean that you cull some older product, life cycle product, out of the books? Or are the books becoming larger? Are you segmenting the books in a different way than you had before?

Perhaps you could help me understand what's happening in terms of the total SKU count. Thank you.

Sure. Let's start with this: Promotional activity year over year -- it was very similar. I know some people count exactly how many emails we are sending versus a year ago. In some cases, there may be more email contact because we also had more categories and had more businesses with baby and child, and outdoor, and the core business and other introductions. But there's no meaningful difference in our promotional cadence year over year.

Actually, almost identical.

Yes, absolutely identical.

As it relates to the newness, I don't think the newness should confuse you. From a percentage point of view, it's pretty typical to what we've been doing the last couple of years. The way to think about it is that we've said we are going to have a leather book; we are introducing RH Leather. We are going to have a rug book: RH Rugs. So there's meaningful catalogs that we are putting into the mail that are dominant assortments in those categories.

We also have been working on other categories that we are not inclined to comment on due to competitive reasons. I think you are going to probably see us speak less about things. You realize, in today's world, everybody is listening and everybody's reading your transcripts. So, we don't need to give our playbook out to anyone.

But you can expect that the product will be presented in an enhanced, and more dramatic and focused, way than it has in the past. We are always going to be looking at: How do we look at the space allocation, the organization, the categorization, the lifestyle aspect of it, and how it all integrates.

I think this Spring -- it's a big step forward in the total cohesive presentation of the entire brand. And I think you will see that, and I think customers will see it; they will appreciate it. The interior-design community will be, I think, excited about it. Our people will be excited about it.

But from a newness point of view, really think about the newness in Fall would have been percentage growth that would have been normal to historical standards. And Spring would have been normal to historical standards. It's just that you're now taking Spring and Fall, putting them together, and mailing them at once. So, you have a bigger percentage lift year over year for the entire year.

The way we think about it, and why it's important when you think about the Source Book piece, which I know spooked everybody last quarter, that we were going to eliminate a book, and you say: Gosh, you're going to eliminate a book, they must not be able to keep up the top line, and so on and so forth. And I know people -- it seemed obvious to say: That hasn't been done before. The sales must -- how are we going to maintain the sales growth?

And, really, what we said to you was very similar, as we tried to tell you about gross margins within the -- it's hard to look at our Business quarter to quarter because we have shipping changes and delivery changes. But if you look at our Business sometimes half to half, is a good way to think about it. And especially when you think about the Source Book impact and the newness. We were up, as Karen said, I think, 35% --

34%.

-- 34% in the first half of the year on a like-week basis. And in the second half of this year, without a Source Book, with pulling out all that newness and the re-mail of the entire assortment, we are going to be up 35% to 36%.

35% to 36%.

-- 35% to 36%, so you -- (multiple speakers)

With an identical promotional calendar.

With an identical promotional calendar. And you say -- you probably wouldn't believe that, right? But again, if you had to make that bet. But we had a lot of data that said that was going to happen. And that we could run this Business in a completely, more efficient cost structure than before.

Our Business has changed dramatically. We are much more of an event business, much more of a furniture and serious purchase and lighting business, and rug business, so on and so forth. Now what you have is you have the newness just got pushed from Fall into Spring, and now you've got, instead of 400 to 500 pages of newness and innovation, you are going to have 800 to 1,000 pages. Last year, I think we mailed 1,612 pages, in total?

Yes.

So, you've got a meaningful amount of page-count expansion, newness, and enhanced presentation that's going to be happening year over year. And that gives us a lot of confidence, based on what's happened historically, that our Business is going to continue to grow at a healthy rate. We will continue to disrupt the marketplace, and take market share. We will continue to look more dominant. And I'd say that the book strategy -- think about it in a similar way to the new store strategy: fewer, more dominant expressions of our brand in the mail -- fewer, more dominant expressions of our brand in the physical retail space.

Okay. (multiple speakers) Just as an interpretation then, the level of newness not only includes existing categories, but it may include new and expanded -- expanding some categories, as well as adding new categories.

And my last question is: Is that the primary time that newness will be introduced? So, from here on in, as we go forward, the newness to the assortments will largely be reflected in the Spring Source Books?

That's the right way to think about it, Janet. That's the right way to think about it. (multiple speakers)

It's an interesting way to --

We'll have other contacts, and some other things that we might do seasonally. With the digital and electronic marketing, we've got abilities to introduce newness in new and different ways, and we will be testing things, and so on and so forth. But that will be the primary way to think about the model, yes.

Okay. Great. That's very interesting. And good luck for the holiday.

Ladies and gentlemen, due to time constraints, we are concluding the Q&A session. I will turn the call back to Mr. Friedman for closing remarks.

Great. Thank you, everyone. We know it's a day of big news, and a lot to digest. We appreciate all of your time and support of the Business.

Again, we are going to dearly miss Carlos on a daily basis. But we are excited that he's going to continue as a part of our team at the Board level. And we are as excited, as committed as ever, to build the next great, innovative and admired brand in retailing. So, thank you very much, and we will talk to you soon.

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