RH (RH) 2014 Q3 法說會逐字稿

Good afternoon, my name is Kyle, and I will be your conference operator today.

At this time, I'd like to welcome everyone to the RH third quarter fiscal 2014 Q&A conference call.

(Operator Instructions)

Ms. McLaughlin, you may begin your conference.

Thank you, and good afternoon, everyone.

Thank you for joining us for RH's third quarter FY14 Q&A conference call.

Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Karen Boone, Chief Financial and Administrative Officer.

We hope you've had an opportunity to view the video presentation posted to our investor relations website prior to this call which highlights the Company's continued evolution, recent performance and outlook.

Before we start, I would like to remind you of our legal disclaimer that we are making 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 press release and video presentation issued today.

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 press release issued today for a more detailed description of the risk factors 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 may discuss 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.

A live broadcast of this call is also available on the investor relations section of our website at ir.restorationhardware.com.

With that, I'll turn the call back to the operator to take our first question.

(Operator Instructions) Matt Nemer from Wells Fargo Securities.

Afternoon, thanks so much for taking my questions.

First I wanted to ask about the strong growth in the online channel.

Obviously, stores are critical to those sales, and it only really reflects where sales are completed.

But does it change the way you think about allocating capital, and do you think there is a need to significantly increase your digital investment over the next few years?

Hi, Matt, this is Gary.

We have significant plans to continuously upgrade our digital presence, as I think any retailer would in today's world because you are just going to have -- the Web part of the business is going to become more and more important and we believe more significant.

But the real key to our growth there is, you have to remember, we are consistently merchandising beyond the four walls of the store and sizing our assortments to the potential of the market versus limiting those assortments to the size of the store.

If you think about the books we mailed last year at roughly 1,600 pages and the books we mailed of this year at roughly 3,300 pages, and the fact that we can't expand the store assortments in the legacy stores.

So you are inevitably going to have much faster growth on the direct side of the business, as well as that being turbocharged by the continued evolution of technology and the consumer interface constantly getting better.

We are completely agnostic to where the sales go, but believe we are investing wisely to build the right multi-channel platform to capitalize on the opportunity to enhance our market share.

Okay, and then, just, secondly, on the gross margin, it doesn't look like you needed to dip into the [merch] margin in Q3 to drive sales.

Is there anything that you see in the current environment in terms of promotional activity that would cause you to need to do that?

And is it possible that the Q4 gross margin could, in fact, be a little stronger than what your guidance implies, or does the pre-opening cost headwind really limit that?

Let me take part of that and I will have Karen take part of it.

First, I'd say that since 2008 and 2009, I think there's been a permanent change to the promotional environment in retail in the United States.

That promotional environment, I think many of us thought would change post that time, but it really hasn't.

We're in a constant promotional environment, and the way we think about our business, and how we focus on winning is we focus on the top line and the bottom line in an integrated way, and all the lines in between those, the middle of the P&L.

We use every lever we need to maximize market share and profitability for the Company.

We will guide directionally, but we will fight the fight daily in the business and make the decisions we need to, whether it is in gross margin or SG&A, to win the fight.

I would say the key is to stay focused on our top line and our bottom line growth, and our goal is to always grow our bottom line faster than our top line.

But the middle of the P&L, they are all levers for us to use in a way to win the fight.

Understood.

And with respect to Q4 growth margins, we're still tracking exactly what we guided on the last call which was that 50 to 100 basis points of improvement on the half.

So you are exactly correct that the Q4 guidance does imply less gross margin expansion than we've seen and that is due to other things outside of the merch margin category, so retail pre-opening ramp we talked about, the pre-opening costs with the new West Coast DC that is going to open in early Q1, and then less shipping efficiencies than we see as we anniversary some of the good things that have been happening.

So still great things happening in all three buckets, but just not the same leverage that we've seen.

And that is intentional, I would say.

Yes, it is playing out exactly as we had intended and as we had previously communicated.

Perfect.

Thanks, and happy holidays.

Matthew Fassler from Goldman Sachs.

Thanks a lot, good afternoon.

First of all, love this format, thank you for doing it.

My first question relates to the cadence of openings for next year, if you can talk about the drivers of that cadence, particularly the second half of the year dynamic, and whether that four openings you are looking for today represent the max you'll do, or sort of the minimum that you think you will get open in 2015?

I think today, Matt, that is directionally what we plan to open next year in 2015, but I think that, that number will build year-over-year as you look out into our plans.

But these are big, complex developments where -- we don't play in the middle of the mall anymore.

If you think about our real estate strategy, we are either an additive new anchor or mini-anchor, and so you have a landlord developer having to basically develop a new pad for us, or we are developing something off the center or in a lifestyle center, or we are taking a historical building and doing an adaptive reuse.

All three are very different than most retailers that are playing in the middle of the mall where you are basically taking a storefront, building a storefront, and then filling in a box.

These are complex development deals, they have long lead times.

We believe we have got the pipeline full to be able to achieve our plans, but this is not something you will find out mid-year that a new deal came up and we can get it built in 16 or 26 weeks.

These are one year to a year-and-a-half builds and a year-and-a- half to two-year development deals.

Got it.

And then, if I could follow up on the openings, I'm trying to reconcile the four openings with the square footage number, Karen, that you talked about on the video.

Can you give us the rough size enough, so whether they're going to be closings, as well as some of the smaller boxes alongside these openings?

Yes, so, Matt, you are exactly right that there are four that we talked about on the call, or on the video.

The Chicago and Tampa markets are more in Q3 and then Denver and Austin are Q4, so we talked about them being back half.

What's changing, or what might play between the 30% and 35% is what we might do with some of the 7,000-square-foot legacy locations.

Some of those are still in play.

For example, if we wanted to take one of them and put another concept, or maybe, such as Baby & Child.

As we have those planned, we will continue to communicate those to what we do with some of the closings, et cetera.

And then, in addition, other markets that are coming up for lease, whether we decide to renew them or let those sales (inaudible).

The delta between 30% and 35% is final square footage size of those four, as well as what we're doing with some of the small legacy locations.

Yes, I would add to that, there will be some flexibility and fluidity that we have to manage to.

For instance, we have a plan in each market, where we want to open, and then how many of the legacy stores will close and consolidate into the new store.

In some cases, we may be offered a development deal from a landlord in a specific legacy market or mall or shopping area that we plan to close, and we may be offered a development deal to do a new next generation gallery at favorable economics that when we look at the market our returns will be greater than if we had decided to just do one.

Those are, there's lots of different discussions happening today.

It will be market-by-market, store-by-store, and there will be fluidity.

So we may have plans to close a store today and that plan may change based on the development deal we are offered.

We may keep the existing legacy store open and then develop another store, or we may close more than we think based on the transfer rates and the economies of scale of the big stores.

And we are learning and testing and getting smarter every month and every year here.

There will be a little fluidity within this because of those factors.

Got it.

Thank you so much, guys.

Brian McGough from Hedgeye Risk Management.

Great, thank you.

Hi, everybody.

Hi, Brian.

I have a couple questions about Atlanta, specifically.

It's an amazing store, it's unlike anything I've ever seen and anything, I think, you have ever operated.

I am wondering, as I look at stores you've opened in the past like Houston and a couple of others that have really big ramps in the first year, and it has arguably been because the stores have been a lot smaller than they probably should have been, which is why I think you're growing the size of the Houston store.

So here is the store in Atlanta, and I am just wondering how you gauge if it is actually according to your plan, really?

It is its own, it's like, what, four or five stores in itself, and you haven't really had anything like it, so how do you tell if it is working or not?

Sure, Brian, that is a good question.

With each one of these endeavors we are in uncharted waters to a degree, as you are pointing out.

In some ways, it's no different than going from a 1,600-page collection of source books to a 3,300-page collection of source books.

It's all based on math and bridges.

And it's funny, I had analysts and investor say to me a couple quarters ago that, gee, Gary, you are talking about more about the science of the business than the art of the business, and I asked them to please clarify what you mean art, because I said our business is all about math, and it's all about creating the right equations and formulas that allow us to transfer our logic into the future and build a bridge of what we think will be because almost everything we are doing hasn't been done before.

You can't guess at it.

There's nothing artful about it.

It is a lot of math to get there.

Let me just give you a little background on Houston or [Bed] Boulevard where a lot of the learnings were, and the math that we're extrapolating going forward.

In each of those markets, we know based on taking a legacy store from 7,000 feet of selling to roughly 20,000 feet of selling what the math looks like.

What the math looks like in year one, what the math looks like in year two and in year three.

So we have an assumption that the stores will open based on a Houston or LA model, and what will be the increase in year one, what will be the increase in year two, what will be the increase in year three.

We have that math based on the square footage that would be comparable to a Houston.

Then what we do is we have a bridge on the other square footage that has assumptions based in new businesses or categories or category lists, based on category expansions.

For example, if you took Atlanta and you thought about -- okay, the legacy Atlanta store -- if we had built Houston what would we expect the lift to be in year one, year two, year three.

Now let's take the square footage above Houston and what are we using that square footage for?

Part of the square footage is an expansion of the core businesses and the core category.

We have a math for that.

Then we know that the square footage, we have an expansion of the square footage for Baby & Child that is entering the market.

We have math for that.

Then we have assumptions -- and the math for Baby & Child is an easier assumption because we have some examples of Baby & Child.

The math around small spaces, which we have a floor of, has to be new math.

So that's even more assumption based, but still, we have numbers from a direct point of view that point us through, with the productivity of small spaces in each market.

Then we take an assumption based on the introduction.

Now each of these businesses in each of these categories, there is a maturity and ramp curve to each of them.

When all of a sudden, you put in a new business like Baby & Child and you enter that market, or a small space, there is nobody waking up in the morning saying, hey, honey, we need Baby & Child furniture, or we need small spaces furniture.

We're going to go to RH because we haven't made ourselves aware in their buying cycle.

Remember, this is a long lead buying cycle here.

Our presence in the market, and that is why we look at a three-year curve on these things, three-year ramp.

Each year we should capture a bigger percentage of the market as we have top line awareness around the new businesses and the new categories that we have expanded into the space.

That is how we think about the logical math bridge, and we do that on every category, whether it's rugs, which Karen talked about in the video, we're adding rug galleries, whether it is linen pantries, whether it is tabletop, and all of the sub-categories of the business.

In the future, we have talked in the past that we expect to launch RH Kitchen.

RH Kitchen will be in these galleries and there is a bridge to RH Kitchen.

There is a bridge to many other businesses in categories we haven't talked about publicly yet, but we built these stores to accommodate all the product extensions and category extensions and new product and categories that we have planned for the future.

I think about these businesses, and we think about the math bridge actually looks out over about seven years because we've got a product pipeline that has about seven years of ideas right now, if that makes sense.

Yes, yes.

One other point on Atlanta, or one question is, I have to think that any property developers who you could be working with in the future, if they haven't already seen Atlanta they probably will be seeing Atlanta.

If there are any who have seen it, what have they told you, and how could this help your economics down the road?

It is transformative to our economics and our deal structure and the enthusiasm and excitement around our brand, as is Los Angeles and the Melrose store.

That is why I mentioned on the video, you have got to see it to believe it in both of those stores.

Personally, I have invested over the last several years hundreds of hours in the design and development of those stores.

You think if there was anybody who would expect to know how it would feel when they showed up, and know what it would feel like and be like it would the me.

And I would tell you in both locations, and in Los Angeles and Melrose, on Peachtree in Atlanta, both stores, both galleries, were beyond my expectation, beyond my imagination.

I think that is happening in the development community.

People have seen presentations, they have seen pictures, they have seen renderings.

They see pitches from everybody, so our pitch may be better.

Our pictures and renderings might look better, but until you've seen this, until you've seen it, you can't really quite appreciate the level of quality, the level of design, the level of innovation, and I would say the level of separation of this concept from everything else in the marketplace.

That's how we talk about it internally.

What is the degree of separation between our business and everybody else's business from a customer point of view.

The amount of separation, I think we've just leapfrogged ourselves here.

Houston in and of itself, for people who had never been to Houston, there are developers that go to Houston today and they are awe-inspired and overwhelmed and then they want to do a deal with us.

Atlanta is almost three times the size of Houston.

It is three times more intelligent than Houston because we are three years smarter than we were when we built Houston, and designed and developed Houston.

The impact on the development community, I think, is going to be exponential.

That's a great answer.

Everybody, thank you very much.

Aram Rubinson from Wolfe Research.

Hi, there.

Thanks for taking my question.

Well, that was original and interesting, so thank you for spicing up our day.

Had a question about your customers, and, I guess, in keeping with the video, an art and a science type of question, but on the art side, can you tell us about your customers and their willingness to follow you, id est, are you making subtle changes in design to make sure that the customer is going to follow you beyond a single aesthetic?

And then on the numeric side, can you tell us about your sales growth, how much is coming from existing customers versus new customers to help validate that?

Thank you.

Sure.

Again, you say the art side, that always baffles me because the art is the final touches here.

But, again, the logic and the math is what leads us to where we want to go.

We say internally that we do not have an aesthetic, okay, a specific aesthetic.

We have a point of view, and we curate those products and ideas that we love and then we integrate those products and ideas that we love.

And through that integration, we present a unique and authentic point of view regarding our brand and our business.

And so if you just start with that idea, that methodology that we take, we don't go out and look for any specific aesthetic.

We go out and we look for product and ideas in categories and we look for things that inspire us that we love.

And as anything in this world, we are in an evolving world, so there are things we love, all of us, not just us here, are constantly evolving.

We are in a world that is constantly evolving, we're in a world that is constantly changing, there is new ideas and new choices each and every day.

We are curating from an ever-evolving world which has an ever-evolving aesthetic, and we are choosing those products and ideas and people and inspiration in a constantly evolving world.

By definition, we will be a constantly evolving brand.

This is not a brand -- I talk internally sometimes and I can say this publicly because they don't exist anymore, those of you that have been alive long enough know about the Bombay Company.

The Bombay Company was English inspired, reproductions of English American furniture and antiques.

Their whole business idea was based on an aesthetic.

That's not what we do.

If you really sit down and look at our assortments, we have interpreted and updated classics, we have updated and reinterpreted modern furniture.

We have things inspired from mid-century modern to English antiques to Italian to Spanish Baroque.

We've got a little bit of Asian influence.

It's going to be constantly evolving and constantly changing.

The key is the integration of it all, and does it reflect, is it edited well enough to have a specific point of view that is of the moment, and it is current, and what we like to say is fresh yet familiar.

Is it fresh, yet is it familiar.

When things are neither fresh nor familiar business usually isn't good.

If there are only one of the two, business is probably good, not great.

When you hit fresh yet familiar, it is usually when you develop the biggest net and the biggest economic net for an idea.

It's interesting, because people say, well, the RH look, the RH look is nothing but a filter of our point of view of what we love today, what we believe is relevant today.

It will be reflective of what we will be next will be what we are excited and passionate about next, but it is not limited.

It is a point of view and a brand point of view that is ever changing and ever evolving and growing.

And you will see even more evidence of that in the first quarter of next year because we have some revolutionary new ideas that will come.

One of them is the most exciting thing, I believe our most exciting evolution and idea that we have ever had.

What is that?

You will see it when it is unveiled.

Seriously, I'll make this point.

I usually, I'm usually the worst to tell a secret to because if I am excited about it I tell the world about it.

I learned my lesson, I don't know if it was a conference call a year or two ago, we were a newly public Company, we just beat the estimates by the biggest we have ever beat it.

We raised second half guidance by 17%.

I talked that all these new things we were doing, and I think everybody panicked and thought we were doing more than we should, and I think we also eliminated a source book mailing and whatnot.

I thought our stock was going up $10 and actually it went down $10.

And I said, you know what, we are now taking the Apple approach.

And I think it comes back to what I said in the video, you have to see it to believe it.

I think it is hard for people, for us to talk about things that we are so intimately involved in that we can see that we are working on, and then tell you about something that we've never even showed you and expect you to get excited about it or understand the logic about it.

You will see in our ideas when we unveil them, and then they will make sense and they will be logical, and I think you will get it.

And as opposed to frightening anyone, I think we will inspire more people that way.

Thank you.

And any way to get a number, Karen, on the mix between (inaudible)?

We don't disclose those metrics, traffic ticket, et cetera.

We do track them and we are pleased with how we are performing, but that is not something we disclose publicly.

And the same with new customers, you are not talking about?

No, neither.

Well, thanks, again, for being refreshing.

Okay, thanks, Aram.

Jessica Mace from Nomura Securities.

Hi, good afternoon.

Hi, Jessica.

My first question is a follow-up on the process of the real estate transformation, and you alluded to on another question about being three times smarter than you were when you opened Houston.

Given the lead times in these development deals, can you talk about how you have been able to apply the learnings from previous openings, and maybe some of the changes you expect to implement as you tweak your evolution in the future?

I would look at Atlanta.

If you visit Atlanta and you walk Atlanta, and maybe the best thing to do is fly to Houston, and go to Houston and walk Houston, then go to Atlanta and walk Atlanta and I think you will see it.

It is all right there.

You will see the space allocation to each of the businesses, the expanded core, the addition of Baby & Child, the addition of small spaces, the organization and flow of the businesses, the expansion of our interior design efforts, the expansion and integration of outdoor space, so they are all visible.

They are all out there to see.

If they are not obvious to you, then they are probably not obvious to the customer and they are probably not good enough.

Understood.

My second question is about the path to positive free cash flow in the 12- to 24-month horizon.

Is there any color you can give us, or near-term capital requirements you are expecting, or internal benchmarks that you can achieve in order to be positive?

We were kind of vague on the timing, the 12 to 24 months on purpose because we do not have a specific, we have many different levers we're pulling with everything from inventory to capital, but also just as we continue to grow and our earnings expand, the cash flow we're generating with our business and the real estate deals we're seeing, all of that is going to come together and we expect to, again, achieve that important goal in the next 12 to 24 months.

The internal metrics we're tracking all the time, but we're not probably going to get into a lot of that process on the call today.

Great.

Thanks for taking my question.

Thanks, Jessica.

Adam Sindler from Deutsche Bank.

Yes, good afternoon.

Thanks for taking my question.

I wanted to switch topics for a minute and talk about the new credit program, the RH Finance.

Just maybe what were some thoughts around rolling that out given that you do typically have a much higher income customer?

And then, secondly, just because you have a higher income customer probably more sensitive to security of things of that nature, which steps you have taken to help minimize the impact of breaches and things of that nature?

And then I have a quick follow-up.

Sure, I will take that.

What we are trying to do is make our brand as accessible as possible, and while the top of our customer list that would be a very true characterization, does not need credit.

I think there are people and customers who are maybe shopping other places that if they could stretch and shop at RH they would, and the ability to open up credit and provide the kind of credit people need to make large purchases and have a monthly payment system should open up the aperture of the market.

I do not think that happens immediately because we haven't had credit before.

So I think as we have credit available, as customers are interfacing with our brand -- I use the example, if we all stand back and say, how many people buy a car with cash in the world today, and how do people make a monthly payment?

And if the car industry, if we all had to buy cars with cash, they would probably sell a lot less cars.

And by having the ability to have monthly payments, I believe, allows the market to open up.

And how many people might have to drive a Ford or a Toyota because of credit, and they look at a monthly payment that they say, hey, you know what, I'm going to stretch up and I'm going to get a BMW.

I think the consumers always want to buy and associate themselves with where they want to go.

All of us purchase that way, we're all victims of a material world, and the things that we acquire in the places that we live are reflections of who we are and how we've established ourselves, and is a reflection of our success in the world.

That is why people buy luxury brands and buy things at ridiculous prices because they can differentiate themselves.

And I think that you've got a consumer that is always in a quest to rise to their highest level and differentiate themselves, but it's all within a bandwidth of what they can afford.

And so the ability to allow more accessibility to our brand, especially as we roll out small spaces, which is also an ability, not only from a size point of view to access our brand, but from a price point of view because the goods are smaller, the goods are more accessible from a price perspective.

And that actually -- sorry, yes, please, Karen, go.

Go ahead.

No, please, please.

I was just going to say also this isn't a new program.

If you look at high ticket purchases, and this is a very similar program than the one offered by Home Depot and Lowe's, mattress companies, this is really just extension of our current platform.

So this was with our existing credit card provider.

This isn't something that we did in-house ourselves.

It is a pretty plain vanilla program that, again, we're using a reputable third-party.

So your credit question, I think, the credit in this day and age, that is a risk to our retailers.

I don't think it's anything that is new.

We have offered these credit programs before.

We don't think this increases our risk anymore.

Great.

And then, actually, my follow-up to that was sort of, as you move into Baby & Child and as you have moved into small spaces that does seem to be someone who doesn't own a house, or maybe owns a smaller house, or may be younger in age, the exact reason is to -- this was sort of the thought process behind offering the RH Finance, to try and draw that customer in and then convert them longer term.

Is that the right way to think about it?

I think that is the right way to think about it, and I think it is not just people that don't own a home, I think there's lots of people that own a home and they can't really afford to furnish that home today.

That next level of spend, if it's thought of more like -- you think about how everybody buys a house today, you don't really buy a house based on the price of the house.

You don't really even buy a car based on the price of the car.

You buy a house and you buy a car based on the monthly payment, and what is the monthly payment you can afford.

So if all of a sudden you transition the perception of someone furnishing their house from, gosh, it's going to cost me $40,000 to $70,000 to do this house, to where it is going to cost me $1,200 a month that is a completely different perception and a way to make the brand accessible.

We're just, we're trying to make our product accessible to people that want our product.

All right, perfect.

Thanks so much, I appreciate it.

Congrats on the quarter.

Peter Benedict from Robert W. Baird.

Hey, guys, thank you.

Just a quick one here, Karen, what do you think -- what kind of distribution center footprint do you need to support that longer-term plan that you guys articulated in the video?

We have the newest one coming in 2015.

We've been saying that we may need to add them every 18 to 24 months so this is right in line with that.

As we begin to expand more, our sales come more from sales footage growth as opposed to assortment growth, our inventory will get more efficient.

So that is something that could stretch that 18 to 24 months to 24 to 36 months, but that is something that we will continue to assess.

This next DC is over 1 million square feet, so this one should keep us in good graces for awhile.

Yes, I would piggyback on this point, it's an important distinction when you think about our model versus other models.

When you grow a business horizontally, as we refer to it, and we're broadening our product offer, that's the most inefficient way to grow a business from an inventory point of view because were adding new products and new categories that we don't have history on, and we haven't been able to optimize that inventory.

So if you just think about our growth this year versus last year, the page count going from 1,600 to 3,200, we didn't expand square footage by double, we expanded our assortment in a meaningful way.

And we had a lot of new things and you're never going to optimize your inventory.

Your investment cadence from a distribution point of view and an operational perspective are not going to be optimized.

When you start to grow vertically versus horizontally, when you start to grow through unit growth, that's when you move from an under optimized model, growth model, to a more optimized growth model which is what most people are used to looking at in retail, 99% of the stories in retail look like that.

Somebody develops a box that looks like this, they carry those things, they have got 30 stores, or 50 stores, and they think they can have 300 or 500.

A really easy model.

You can think about inventory turns and inventory optimization in a real vertical sense versus a horizontal model which is the model we've had to get to where we are today.

As we have been trapped in these legacy stores it's from a cash and a return on investment point of view because you have a big capital workload, and an under optimized investment in inventory.

When we start growing vertically and we start using square footage, the model shifts and then you start to get a model that will be highly optimized.

I would anticipate in the future that the inventory turns and the optimization in this model from not just an inventory point of view, but a cost point of view will look very different in the future, which is reflected in the long-term potential of the Company, as Karen laid out in her presentation.

No, that's helpful.

That leads me partially to the next question which, 100 basis points of merch margin, shipping margin improvement kind of implied over the longer term here, what role does mix play in that?

Do you guys envision the furniture mix being roughly where it is today, higher, lower, when we get to that end point?

We're not disclosing that for competitive reasons, but we would take all the pieces and assumptions you would take in building our model.

So we would say that the model is reflective of our plans today.

Okay, fair enough.

Thanks very much, guys.

Budd Bugatch from Raymond James.

Hi, guys.

This is Bobby filling in for Budd.

I appreciate you taking my questions, and congrats on a very good quarter.

Thank you.

Most of my questions have been answered, but just two quick ones real quick is, one on the mix between furniture a non-furniture, did that change significantly this quarter versus some of the quarters in the past?

There was a little bit, about 1 point or so, and that has been our 10 Q which will be filed this afternoon or tomorrow.

So it is about 150 or so basis points of lower furniture versus a year ago.

Is that something that you expect to continue going forward and is that surprising in any way?

Again, it is not something that we disclose, it is based on competitive reasons.

We don't want people to know how we are thinking about growing our business in a specific way, but, no, it was not a surprise.

All right, fair enough.

And then, to follow up on the inventory question previously, when does the product assortment, Gary, for you, get to a level where you feel comfortable with and we can start to expect inventory growth to slow down below the total revenue growth?

If you look out in the business and your long-term trajectory?

What is your definition of comfortable?

Well, I'm just kind of glancing at the above inventory growth above revenue this quarter.

How big do you see, or how big do you want the product assortment to go?

I think I want to see this Company continue growing and gaining market share at an exponential rate versus the competitive set.

Again, the strategies that will support that growth, again, if you're looking at history and you look back, it's pretty easy to look at that and say, this is how we gotten to where we are.

As you look forward, I think we've given you some indications and directionally how we plan to grow, in some cases more specifically than others, but we have the big real estate transformation.

And as Karen said, we have probably the most exciting product pipeline in the history of the Company as we look out over the next five to seven years.

So I hope there doesn't come a day when we don't have any new ideas.

I would just add to that that we do feel very comfortable with the inventory growth.

It's been actually a great thing for our business and making sure that our back orders are getting out of control and it's a good experience for the customer.

So very similar to the cadence of inventory growth versus sales growth that we saw in 2013 is what we are tracking to this year, such that by the end of the year, the sales growth will be more line with the inventory growth.

So that is, gain, what we're expecting this year.

And I don't mean to -- my prior comments about the product assortment, really what we're talking about is as we have more unit volume and more of those full line design galleries we will be just be more productive with inventory, that doesn't mean we are going to stop innovating with respect to product.

I would also piggyback on that.

There was, again, if you're just looking at a business based on conventional wisdom, you would say your inventory growth should be in line with your sales growth.

That's not necessarily the right answer.

Again, if you're growing the business horizontally, there's no way your inventory growth is going to keep up with your sales growth or you are going to under optimize the business.

You have to -- from an inventory point of view, you really have to be looking ahead.

You can't just be looking at today.

I would say -- I would not be surprised if our inventory grows faster than sales during the period that we're expanding the business horizontally and we're adding new businesses and new categories because we will not, those businesses and categories and products will not be as optimized as the core of the business.

Once we've had 12 months to look at a product, once we've had our vendor base be able to manufacture a product for 12 months they are more efficient.

Once we've seen the selling characteristics of that product, of that category for 12 months, then we can start to optimize.

But in the first year of any new introduction, any new product, any new category, you are going to be under optimized.

The way I'd think about the retail industry is, if a company is just growing vertically they have got a better chance to optimize their inventory and their inventory, they might get leverage on their inventory because they are getting better.

If a company has been growing like we have, horizontally, expect inventory to grow slightly faster than sales, otherwise we're not going to optimize the business and the market.

There's no way we could.

You would need some kind of computer algorithm that would be exactly right, and all we know is on any product, any new product or any new category, our inventory bet is going to be some degree of wrong.

We are either going to be over bought or under bought, and so we operate in a bandwidth.

But that bandwidth and that investment on new product, we are going to have to over invest and be slightly under optimized, so that is how you should think about our Company.

Once the real estate square footage becomes a bigger part of the story than the assortment expansion expect leverage in our inventory.

Until that point, don't expect too much leverage in our inventory.

In fact, there may be cases when our inventory is going to grow faster than sales and that is not a bad thing.

But don't look at it like a typical model because you'll miss.

Thank you, I really appreciate the detail.

That answers my question, and best of luck going forward.

Thank you.

Daniel Hofkin from William Blair.

Good afternoon.

Just a couple quick questions, first on thinking about the store growth, so roughly four of the significantly expanded galleries expected to open 2015, is that, would you say that's a range that you'd be comfortable with thinking about sort of beyond next year, as well?

Is that sort of what you think is the right responsible number where you're not over committing and you're making sure you're capturing the best deals in the right locations, or would you expect that to gradually move up in absolute terms over time?

That was the right number for 2015 for exactly the reasons you've articulated.

That's exactly how we think about it.

How do we get the right deal, how do we optimize that investment?

And remember, these deals, once we plant this flag it is planted.

This is not a retail concept where we're taking mall space and we can flip in and out of a mall.

We are making a significant investment for a long period of time.

So we have to be right.

And we have to be smart.

If it is under optimized, it is under optimized for the next 20 years.

The number that we are opening next year is the number based on making really good decisions and also looking at optimizing the organization, like how much can execute in a really good way?

There's still a lot to learn here, and it's interesting, in discussions with some of our key shareholders [in the basis], how many should we open, how many should be not?

Gary, how are you going to optimize this?

We are, again, getting smarter.

We think four is the right number next year.

The number will be bigger than four the following year, whether it's six, whether it's eight or more, we haven't decided yet.

It depends on the nature of the deals and the rate of investment, but I would assume that every year after 2015 there will be more than four.

Okay, that's helpful.

And then, as far as your supply chain, it sounds like you guys will continue to make investments in your own distribution infrastructure.

Do you feel like there's more catch up there, or are you now more in line with your corporate growth, if you will?

And then the other aspect of that would be, your vendors, I'm sure that is an ongoing focus or challenge, if you will, is to make sure that they can scale with you.

How do you feel like that stands at this point?

Sure.

Let's think about the right way to think about the supply chain is there is two big parts.

We've said, when you think about the supply chain infrastructure that we control inside the Company or have the possibility to control, which is our transportation, distribution, home delivery network that we have been investing in front of that and trying to lay enough track to make sure that the train doesn't go off the tracks here because in a business like this with a complex back end, if you get behind it's very, very painful.

We have been investing there.

As we look at it long term, I think our bias is to control more of it than to control less of it.

As we've learned, as we have in-sourced our home delivery hubs, and we have learned to control, to operate those, we see more benefit than less benefit, and now probably have a view that we want to control more of it than less of it, if not all of it.

In the future, is there a day that 100% of our deliveries in the Company from a furniture point of view we control, and there's probably more of a likelihood that we do, and there may be a few markets out in the middle of nowhere that you just say it makes completely no sense, but you have to argue that from both sides.

Say we're going to be a luxury brand, we're going to deliver really high end product, but we're going to hand it off to somebody who might screw up that customer experience.

There's a certain investment and cost of doing business at the high end in controlling the customer experience that is necessary.

We are rethinking, we are testing our models and trying to find the right place to land, and it may only land that we're going to control all of it, quite frankly, that our customers are too valuable to put the final mile or the final hand off into anybody else's hands but our own.

We haven't come to that absolute conclusion, but I'd say the debate has taken us to controlling more than controlling less.

The key there will be the more we control, the more we will have to invest, but we won't invest unless we think there is a good return.

If the returns don't look attractive, of course, we're not going to invest.

But the investment will precede the return.

You will have this investment cadence that we will have to make and the returns then will be following those investments.

How that looks for the next couple of years is, I think, you'll probably see a pretty steady number, if you will, that relates to that, and then we will get leverage as we start to get the sales, as Karen alluded to, long term.

As far as the product supply chain, there, again, we constantly said that furniture of this quality has never been made in these quantities.

We're building a new railroad, and we are investing human capital and financial capital to ensure we have the best long-term supply chain.

Does that mean we're building factories?

Not necessarily.

Does that mean we might build a furniture factory in the future in North America?

That could be likely because we might want more control of that part of the supply chain.

Again, but we won't do that unless it makes sense from a return point of view and can really, and when we think about returns, we think about returns, investments in multiple ways.

What is the strategic value of that investment, what is the financial value of that investment, and what is the emotional value of that investment?

And the emotional value has to do -- the first two are pretty easy, how does this strategically position us to win.

The second one, financial is the easiest.

What is the black and white returns on this investment.

The third one is the harder one, the emotional value of being able to inspire our customers to want to buy our goods, or build a store that inspires, that changes the perceptions of people to say, I love this place.

You have to think about all of those in concert.

If we think about enhancing the quality of our product in places we can control it we may make an investment to do that.

We may have to make a financial investment to enable a strategic vendor to get to the next level.

We may have to make a human capital investment to help people.

Again, I come back to the point where there's the edges of the P&L, the two edges of the top line, the revenue growth, and the bottom line, the earnings growth.

We focus on how we want to grow those two areas.

And then, in between the P&L how we get there, the lines in between, where we are investing, what levers we're pulling to get the optimum output is how we think about the business, how we think about every part of it, and that's how we think about the supply chain.

I think it is going to be, continue to evolve, we're going to continue to get smarter, and we will become better investors in that part of the business.

We will have better results.

Part of the DNA of this Company is to be forever curious, forever learning, and forever innovating and improving.

And if there's an area that we're not getting better then we're not happy.

That's great.

And then, I guess, finally, and you could choose to answer this or not, it's totally up to you, would you feel comfortable at this point, regarding 2015, just saying, do you think it is a year likely to match your longer-term algorithm of 20%-plus of top line and somewhat better than that on the bottom line?

Our cadence is to unveil our financial guidance at the end of the quarter.

Yes, it is a bit early, we will provide full guidance for next year on our next call.

We're going to stay on that cadence.

Fair enough, guys.

Well, best of luck, great job on the quarter.

Thank you.

Thank you.

Lorraine Hutchinson from Bank of America.

Good afternoon.

You spoke on the last call about a decision to set your floor sets later after the later catalog drop.

How did that go, and how was the cadence of the quarter versus your expectations with the later book?

I think it's, if you look at our results, Lorraine, they would indicate that our results came out slightly above our expectations, which would have said that the things that we thought would happen, happened.

Okay, so you are happy with that decision?

Yes.

Yes, we are happy with our results today.

Our adjusted earnings are up 56% in the quarter.

Our revenues up 22% and our comps are up 22% against, I think, 39% last year.

If you take 22% and 39% and hold that up against anybody else in the industry, I think that looks really good, and it is something to be proud and happy about.

Yes.

And then, Karen, any help with the size of some of the stores for next year, and the structure of the deals, whether it's build to suit or straight leases?

Nothing to share yet at this point.

Most of them will probably be build to suit, but we're still going through all of the accounting.

It's actually a quite complex analysis, so we will share more details on those leases as we get a little bit closer.

But the size, at this point those markets, they are about in that same target range when we had the new target of 45, but the final plans and specific square footage, again, as soon as all of the plans are finalized, we will give you the exact square footage.

But right now they should all be in that rough ballpark.

Great, thank you.

(Operator Instructions) Brad Thomas from KeyBanc Capital Markets.

Thanks for taking my question, squeezing me in here.

Just a couple of quick ones here on the source books, I was wondering, as all the dust settles here from the doubling of the page counts in the spring source book what you could share in terms of your learnings and how you might be able to build on that success next spring?

Sure.

Well, we're very happy with the results and the results are in line with what we expected.

But, again, within that, there's a whole lot of things that did better than we thought and a lot of things that did worse than we thought.

Again, whenever you are in uncharted waters you are going to -- so many of your assumptions are going to be some degree of wrong, wrong to the plus and wrong to the minus, and the key for us here is to say when you calculate all those pluses and minuses and try to forecast forward, were we directionally right?

We were directionally right.

Again, if you look at our business growing 22% up against 39%, those are by far, by far, the best numbers in our industry.

No one close.

So while there's a lot of people, a lot of sideline critics saying like, oh my God, you mailed the monster book, this is not smart, it is stupid, it is not going to work.

Again, we try to look at the top line of the business and the bottom line of the business, and the investments we make in between those and do they get a result that we like.

We like the result.

Now, as anything in our business, think about it, we opened Houston and LA.

They had the best numbers our industry had ever seen, the highest productivity the industry had ever seen, and the best economic four-wall model, I think, in the history of home furnishings retail.

We're not building those anymore.

Should you expect us to mail the books the same way, organize the same way next year?

Of course not.

We've never done that for two years in a row.

We've never done the same thing as we did last year, ever.

Expect us to learn and to do things differently, and I think we're very excited about our plans for next year from a direct point of view.

We're very excited about what happened, what we just did, but we're even more excited about what we just learned and what were going to do next.

Great.

And with respect to the holiday mailing, the holiday book and the Baby & Child, the page counts on those were both up.

How important are those catalogs or those source books to this fourth quarter, and how has the initial response been?

Of course, Baby & Child is highly important to the overall position of the brand, so it's an integrated piece of the brand.

The holiday part of the business, we're not commenting on the fourth quarter.

But the way to think about holiday, and I think what we are learning and, again, the best place to get those lessons is in Los Angeles and in the Atlanta store.

As you look at where we are going and how we're trying to position ourselves as a design authority in the marketplace, the holiday business, I believe, strategically will be less and less relevant to our brand.

And in some ways it is almost distracting to the long-term positioning of RH as a design authority.

When you walk into these new galleries and you see stocking stuffers and things like that, and different nostalgic gift items, and so on and so forth.

You just say to yourself, does this render the brand more valuable or less valuable?

Does this enhance our positioning as a design authority in the marketplace and leader in the marketplace or does this distract from it?

Is it additive, is it dilutive.

My sense strategically is holiday is right now in those new galleries rendering us as less of an authority, less valuable and it's dilutive.

I think we will keep evolving holiday.

I think there will be parts of holiday that will probably be less meaningful, and we will intentionally evolve it in a way that -- to a place where it really should be in concert and in harmony with the long-term positioning of the RH brand as a design authority in the world.

Very helpful.

Thanks so much.

Thank you.

All right, well, thank you, everyone, for joining us today.

Thank you.

I hope all of you had a chance to watch our video prior to the call.

If you haven't, I would encourage you to do so.

We are very excited about the strategies, as you can tell, and pursuing our long-term vision, and we look forward to talking to you after the quarter and giving you our views for not only our performance then, but our views into 2015 more specifically.

Thank you and have a wonderful holiday.

This concludes today's conference call.

You may now disconnect.