RH (RH) 2015 Q1 法說會逐字稿

Good afternoon.

My name my name is Dennis and I will be your conference operator today.

At this time I would like to welcome everyone to the RH first FY15 conference call.

(Operator Instructions)

Thank you.

I would now like to turn the call over to our host, Miss Cammeron McLaughlin.

Madame, you may begin your conference.

Thank you.

Good afternoon everyone.

Thank you for joining us for RH's first quarter FY15 Q&A conference call.

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

Prior to this call we posted a video presentation to our Investor Relations website, www.ir.restorationhardware.com, highlighting the Company's continued evolution and recent performance, as well as the launch of a new business.

Before we start, I'd like to remind you of our legal disclaimer, that we will make certain statements today that are forward-looking within the meaning of the Federal Securities Laws, including the 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 results to differ materially.

Please refer to our SEC filings 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 www.ir.restorationhardware.com.

With that, I'll turn it over to the operator to take our first question.

Adam Sindler from Deutsche Bank.

Congratulations on a very nice quarter and I very much enjoyed the new Modern furniture, a lot of it looks great.

The first question, does the $4 billion to $5 billion in guidance include the impact of Modern?

I know your work with your manufacturers is very important to your process.

Do they have the capacity to handle this, are you going to have to develop new relationships and potentially just how that will impact the balance sheet through inventory?

Yes.

This is Gary.

When we give you our long-term guidance, we have many new businesses embedded into that assumption and so RH Modern is in that assumption.

The vendor base and as it relates to new vendors, most of Modern is scaling on our current vendor base with some new vendors added in some categories.

Excellent.

With respect to inventory, we do expect this year to have inventory flow a little bit different than it has in prior years just because we have a lot of the newness and investment that are coming in the back half.

Whereas in the past we've had a lot of inventory growth in the beginning of the year and work through it, this year we'll have kind of two different cycles of inventory, we will grow inventory ahead of sales at the end of Q4.

Okay.

Then, just secondly on Atlanta you mentioned exceeding expectations, anything specifically driving that?

Or, sort of just taking more share than expected across the board?

I think we're really happy about it, it's just how Atlanta is ramping now that it has been open for several months.

And we're getting into the season where a lot of our investments in outdoor square footage and that category, we are beginning to see traction.

We opened Atlanta, as you know, late in November and now, with thinking about the bet we made in outdoor furniture and outdoor growth and space we gave that to, we didn't expect to see that business really become impacted until the spring, summer months.

Now, as we are heading into this, as we've seen the business track into this we are very excited about how the business is tracking versus our expectation.

The other way to think about Atlanta, is Atlanta was engineered and designed to hold RH Modern.

RH Modern will be another incremental layer of business for Atlanta.

And then the new business we have not yet announced this year, but we will by the time this call -- the next call, will also be affected in a positive way, as that new business gets layered into Atlanta.

We expect Atlanta to continue to ramp and at this point it's ramping ahead of our expectations.

Excellent.

Appreciate it.

Thanks much.

Oliver Chen.

This is Steven McCollum on for Oliver today.

I want to extend our congrats on the solid results and also the Modern announcement.

We were curious on Modern, do you think this will be an incremental customer to RH, or is this going to be like increasing spend from existing customers?

And then piggybacking on the supply chain, is there anything to think about here in terms of longer lead times and then as this business faces the customer, any difference in pricing or the margin profile?

Let me answer the first question, which is kind of two questions in one.

Bring new customers to RH and will it become incremental spend to the existing customers?

I think the answer is yes to both.

If you saw the video, you saw a product aesthetic that we currently don't have and a position in the market that we are not in.

So, we expect this to really open up the aperture of the brand to attract a lot of new customers and in many ways we expect RH Modern to create a new business in general.

It's one thing to say I'm planning a share game and I want to go take some of the share of RH Modern or I want to take some of the share in whatever category.

It's another thing to create a market for a category.

When we look at the Modern market today, or we look at the category, we see all these trends and the ones I talked about in the video, that we believe are going to set up the opportunity to make a market.

If you were shopping for a modern home today and you had to go out in the marketplace and you just built a new home or you bought a home or you remodeled your home in a modern aesthetic and you had to say, I need modern furniture and home furnishings.

Where do I go?

My sense is that you really draw a blank.

It's an even more fragmented market than the one that the core RH interiors business has been competing against.

Because there's no-one that has dominant assortments in any of the categories and then has multiple categories and integrates those categories into a lifestyle point of view.

In the video, we gave you a little teaser of the products that we wanted you to see how unique and different the products are.

I think what's going to be as impactful if not more, is when you see these products integrated into a lifestyle, as you will when you see a 300 plus page Modern book being mailed in the second half, later this fall.

And, I think when you see that, and you see the store or any of the floors, you're going to see an entirely new business, it's almost like it didn't exist.

It's almost like, in some ways, before the iPod there was no MP3 business, right?

Before smartphones there was no smartphone business.

People had cell phones but the smartphones created a whole new category.

As we look at these big trends and architecture, how the millennials live, the aging boomers and want to stay youthful and the impact from the antique markets and the reproduction markets was very influenced, quite frankly, by the estate sales and generations that pass, right?

All these things coming together at one time, I believe, create an opportunity to create a market, right?

But if all those things happened, and no one provided a complete shopping experience, the market could be smaller.

I think with the combination of all the trends and what we are doing and what we are launching is going to create a whole new market.

Ben, with respect to the question of supply chain and lead times, as Gary mentioned, because a lot of the vendors are on our current platform, we certainly have some new ones.

We don't really expect a significant change.

I will say that any time we add newness, sometimes there can be hiccups along the way if something that we have, it's a runaway train and it's doing really well and takes us a well to get caught up and catch up with that demand.

So there could be those issues with some of these products, but nothing out of the ordinary and different than are typical newness that we introduce.

With respect to pricing, it's pretty much about the same, there's certain categories at a little higher and lower.

On the whole, very similar to our core business.

Okay.

Thanks very much.

Very helpful detail.

Thank you.

Budd Bugatch.

I, too, love the Modern.

I've had a little experience with that.

Congratulations on the new category and the new products.

Just a question, a little bit piggy backing on the supply chain.

Do you have enough distribution capacity to handle it?

Do you need to do anything more on that?

What additional load will you be putting on the vendors?

You said you want to extend terms, I think in your part of the presentation, Karen.

We are adding 1.5 million square foot DC and northern California in the coming months, actually it's opening this summer.

That was planned partially for Modern, both to keep up with the growth we have in the core business but also knowing that Modern was coming.

So, we should be very good on supply chain capacity for a while.

With respect to AP and vendor terms, that's something that we've been working on and working with our vendors.

In the past, when we've worked with really small vendors, we sometimes do deposit terms with them or we pay in advance the PO.

As we've grown with them, we have been working with many of our vendors to try and extend those so that as we grow, they grow with us.

We kind of all benefit and we get a little bit more leverage off of the AP base.

So, you end the year typically around 60 days.

Averaging a little bit above, a little bit of below.

The first quarter usually coming around 80 days.

Where do you think you'll wind up the year in terms of payables?

What's the goal at the end of the year?

We are not going to commit to that yet just because we saw, haven't finished all those negotiations with the vendors, it's not something that we want to cram down their throats and then have them really hurt.

We do consider them our partners.

So, it's not something that I can commit to at this point as far as a specific number.

We have certain internal goals that we will work towards, but it really depends on that partnership with those very important partners in our business and how we can make sure that they're still going to be fine and able to most importantly get us the product.

And if they need more support in the short-term versus long-term, with raw materials and stuff, then that's how we help and make sure that we are growing together and most importantly, again, is making sure we have the product to get to the customer.

So that's something that's certainly a goal for us, but we won't jeopardize that relationship in getting that product.

I would just keep it simple and just think about it from the perspective, right way to think about this, as we scale our business, both RH and on our artisan partner vendor partners side, we both have bigger more profitable business and we have much more flexibility as it relates to working capital.

So, I think you'll see us, over the next couple of years, be able to be much more efficient with working capital and it's going to be because our vendor base is also scaled with us.

The benefits that you would get with scale, you should assume that we will get those kind of benefits.

Gary, would that be both on the inventory efficiency side and a little bit on the payable extension side?

Both?

Absolutely.

Both sides.

One last question and I will turn it over to others.

You mentioned, I think, the extension of art out of I just think the New York facility, the New York operation into the RH Modern facilities.

Can you talk a little bit about what your thought process is on that?

Yes.

We think the contemporary art platform that we built, the online platform and the one gallery we have a New York, as we think about Modern and we think about the art business, we've always seen those as merging together.

The Modern business, in that way it's going to be displayed and presented, it creates a natural integration point, which will give us more points of distribution at retail for the art business, long-term.

Very interesting to see how you execute that.

Congratulations on the quarter.

Best of luck going forward.

Thank you so much.

Jessica Mace from Nomura Securities.

Congratulations.

My first question is on the new outdoor collection.

I was wondering if you could give us some feedback on how it's doing, especially as it contains some more modern and contemporary elements, what kind of response you're seeing from the consumer and how that should help our expectations for the new business?

Yes.

Very, very happy.

The outdoor business has been our fastest-growing category so far this year.

Obviously we've made investments there with product expansion and we teased it a bit with some of the RH Modern collections that initially we were going to hold for the other book and we thought, let's integrate it, let's get some early reads.

You obviously saw some collections there and we are very pleased with the initial response.

It gives us a good indication as to how the consumer's going to react to this new aesthetic.

I think the other thing we saw, were we -- if you look at the cover of the current interiors book and the opening spread and you look at the cloud sofa, and some of the new -- we called it the crystal halo light fixtures, the big hoop fixtures and stuff, we see that that book with some of the product to get reads in test and we're very, very happy with the early response to -- early response to that aesthetic and some of those test in both the outdoor book and the interiors book.

They both bode well for the fact that there is a customer out there that wants a more contemporary modern aesthetic and we think it's going to just really open up the opportunity of the brand.

Great.

Thank you.

My second question is on the Source Book and the timing this year.

If you could give us maybe a little bit more color and how that should help shape our expectations about the second quarter?

In addition, on the cost side, maybe how the Modern Source Book in the fall should guide our expectations around advertising savings in that period?

The cost part of it, and the ad cost is all baked into our model and our guidance that we provide to you.

One of the ways to think about the timing of the goods this year, versus last year, last year we mailed all 3,300 pages bundled together at one time, all in the first half.

This year, when you look at the newness, more than half the newness is tied for the year.

More than half the newness for the year is tied to RH Modern and another new business category that we'll be announcing shortly.

So, more than half is coming in the second half of the year, more than half the newness.

So, you've got some timing in Q2 where you had all the newness coming in, in Q2 last year.

So, we're up against that.

Even though some of the books were in early, like outdoor or Baby & Child mailed separately.

You've got a little bit on the Interiors book, where you've got some earlier deliveries than a year ago, you're still up against -- if you're thinking about a bridge, you are up against all the newness hitting in that quarter and beginning to ramp and we don't have all the newness this year in that quarter.

So, that puts a little bit of pressure on demand and some of the revenue in Q2.

Then, as we come through into Q3, and into Q4, you have this -- these new businesses hitting with more than half of our newness for the year and figure you are going to have a big step up.

Great.

Makes sense.

That's very helpful.

Thank you.

Daniel Hofkin from William Blair & Company.

Congratulations, great results.

Just wanted to ask a little bit of a follow-up on the books and just first question would be, how you felt about the little bit earlier flow and also some of the mailings were separated a little bit like outdoor, for example, how you felt that worked this year versus the timing last year?

And then, I have a follow-up question related to the stores.

We were very happy with the decisions we made.

Yet, I would also just coach that and say that we are going to learn from the data and continue to make adjustments.

We get smarter every time, every season and every year we do this.

We think we pulled the right levers, we think we can do it even better next year.

That there will continue to be opportunities.

As you think about the flow in the books.

Okay.

In terms of, as you think about the demand related to versus the books revenue if you will, the revenue that you actually book versus just initial orders.

How is that flowing versus your expectations?

In other words, earlier to earlier book shipments ought to lead to earlier demand, but doesn't necessarily show up right away in actual revenues, so just curious how that impacts itself the second quarter?

You talked about the newness being heavily concentrated in Q2 last year but just curious how that other dynamic --

The way I think about it, is based on our results in Q1 and based on what we know Q2 to date and I will let Karen build on this, how we are performing today is ahead of our expectations.

Which gives us confidence in how we build that bridge then to Q2 and marry that up with our expectation for the incremental revenues and profitability that the new businesses will create.

That's why you saw us increase guidance for the year and increase guidance by more than our beat in Q1, just based on the underlying data and trends we have in the core business.

Then, add that to what our expectations for the new businesses and the newness that we'd add, which is relatively formulaic in how we think about newness and incrementality.

I would say that your specific question on demand and timing and how it's different versus this year than last year, we always with the newness, tend to have demand ahead of the actual shift build in revenue and that's no different than it's been in any other year.

What is very different this year, is very much and so much of the newness, last year all of it was in Q2 and this year a lot of it is going to be in Q3.

Where you would expect -- when you're landscaping the back half of the year, demand might be nice in Q3 when we launch these, but you won't actually see a lot of that revenue shift until Q4, so it's just a heads up on the rest of the fiscal year.

If I could sneak one last one in, just regarding overall store performance.

I have to assume with this level of comp you're seeing kind of the same strength across most of the openings the last several years, interested in that general comment as well as New York flatiron, specifically.

Thanks.

I think we had communicated that the New York store was the one store that had performed lower than our expectations.

And as we added square footage there, and we believe that is really due to the fact that the only time we had meaningful square footage expansion without changing the location and the customer is seeing a different physical environment.

So, our view on that one, and it's really the only outlier, is that the customer didn't recognize a change in the business.

You've got to actually come in to the store and then realize, oh my gosh, you have two more floors, as opposed to seeing a significantly different physical expression of the brand and that attracting new customers.

And also communicating to existing customers, oh my gosh, something is new at RH, let me go check them out.

So, you won't see us do an expansion like that again.

Got it.

Thanks very much.

Best of luck.

Matt Nemer from Wells Fargo Securities.

Line is open.

Why don't we go on to the next question.

Neely Tamminga from Piper Jaffray.

Gary, just wondering if you could help us a little bit on RH Modern, very intrigued with what we're seeing on the video.

The pricing, can you talk to us a little bit about the pricing, and just the skew complexion a little bit?

For shopping Modern out there and obviously your modern is a very different interpretation of modern that we think of, other mid-century modern designers like Ames and Nelson and Herman Miller, et cetera.

How is your pricing going to compare with some of those traditional sort of thought of modern designers?

And then maybe relative to what you also have existing in the assortment?

That's my first question.

Sure.

The pricing advantages and the disruptive pricing models that we've had in the core business, will be the same in the Modern category.

I think versus the price points that you see in the modern market, or to the trade, we are going to be a significant value and we're going to have I believe, overall, a very disruptive pricing position in the marketplace.

And then, if you think about the marketplace, as it is, there really is no fully assorted, fully integrated modern concept that exists.

Anywhere in the world, quite frankly.

You have people that -- whether it's B&B Italia or other ones, that they have upholstery and then they might have a few lights, a couple of items here where you've got -- even Design Within Reach, it'd say, is a very item driven business.

You walk into one of their stores and it's very much not a lifestyle.

It's presented like an item business, also.

You'll see this business presented in a fully integrated lifestyle, in a model that's very similar to the core RH business in the Interiors business.

So, think about all the learnings and everything we've accomplished with RH and then creating a mirror image brand that is targeting the modern segment.

And because, I think, it will be like nothing else in the world, I think it's going to create an entirely new market.

So I think you're going to have a lot of people that are buying Modern today that are having a hard time buying it and finding the price points very high, and the value equation very low, because the lack of synergy and scale that exists.

So, that's going to create, I think, that's going to great market share gains for us, there.

Just as importantly, I believe, is it's going to create a new market.

It's going to motivate people who maybe weren't thinking about furnishing their home or buying new furniture furnishings.

I think it's going to inspire people to purchase, just like it's no different, I believe, that all of RH's growth over the last several years has not all been market share gain.

I don't believe that really high growing companies are just taking market share.

I think the ones that are really performing at a high level are doing two things.

They're taking market share and they are creating a new market.

Can you speak a little bit to the pricing relative to your existing assortment?

Similar to slightly higher, in some cases.

Okay.

One more question on the assortment.

The complexion -- for whatever reason -- when I think of modern, I think of an assortment that would actually skew more towards accent pieces, chairs, decor versus straight up sofas.

So, is there something in the margin implication too, of RH Modern, if you skew -- if I'm right -- if you skew a little bit more off side of the traditional, so that that piece is from a rate basis?

Why would you think that?

(laughter) I don't know.

I just do.

Why would you think people that live in a modern home don't have sofas?

I think they do have sofas, but for some reason I think it's aesthetic that has more of aesthetic pieces too, accent pieces.

I could be totally off on that.

Just wondering if there's a margin implication here.

I think there is a little bit of a more minimalist view in a modern home right, in that each piece is a thing of beauty.

There is less clutter and so on and so forth.

I think categorically, you need places to sit.

You need sofas, you need chairs, you need dining chairs, you need dining tables.

You need beds, you need bedroom, you need case goods, you need lighting.

You need ceiling lights, table lamps, floor lamps, you need rugs.

I don't think that the assortment is going to be meaningfully skewed any differently.

You need bathrooms, it's not going to -- whether you have a classic home with a classic aesthetic or you have a modern aesthetic, you've got all the same number of living rooms, dining rooms, bedrooms, bathrooms, outdoor space, so on and so forth.

Everything has a different aesthetic and point of view, it might be presented in a more minimalistic way.

That's how I think about it.

All right.

Thank you.

For Karen, on inventory, the elevation of inventory because of the newness, how should we think about that spread patterning through the balance of the year?

It will grow a little bit in Q2 just like it normally does for the spring and then it will work through the spring inventory and then we'll make some additional investments in the Modern and other newness that we are having.

It will grow a little bit more in Q2 then it will dip, and then it will grow a little bit more in Q4.

Remember, this is just the very beginning of Modern.

This is going to be our first book, our first freestanding store, our first retail presence on floors.

We are going to get so much better than what you see in this first book.

The pipeline of development behind this and the excitement and enthusiasm, in the designer world, the artisan world, all the people that contribute to us building this platform and this collection of product.

The pipeline is every bit as exciting, if not more exciting, than what you're going to see when we come out of the gate.

If you think about this, most people launch a new catalog, with a 64 page catalog, or an 84 page catalog, it's like a launch of a new business.

If you think about most businesses out there, whatever ones you want to that are home furnishings based catalog, my team's saying don't start naming them, but think about it.

Just stand back and think about it.

Most of them are 64 pages to 120 pages and they're kind of item businesses and they have a little bit in each category.

We are coming out with 300 plus pages.

A separate web experience, a 15,000 square foot store in LA.

This is going to be a real business.

That's just the beginning.

This is just the beginning.

I would expect the page count in this book to ramp.

The retail presence, we will invest more space, not less.

I am more excited about this than any new thing we've ever done and I would say our organization is, too.

That doesn't mean we've lost any enthusiasm to the core business.

But just as a new business opportunity.

Because when we sit back and we look at the trends and we look at what's happening out there, and you look at the influences of architecture, product design, how people are living, the millennials, I just bought a modern house in LA.

I think it is going to be a unique and transformative time in the industry and I think we're going to lead this timing.

And this shift.

Best of luck out there.

Thank you.

Aram Rubinson from Wolfe Research.

I thought the video was terrific.

Two questions.

One, Gary, on the video, you use the word luxury maybe three or four times and I'm curious.

I think you believe that is a bit of a limiting term.

If we were to think over time in terms of architecture, are we going to be going up higher inside of that $4 billion to $5 billion to achieve it, are we going to be kind of dipping down into more of a mass?

How do we think about where you'll be in that good, better, best pyramid to get to the $4 billion to $5 billion?

I think that's a good question, Aram.

When we think about the $4 billion to $5 billion, that's really North America and that's as we're positioned today.

That's not doing anything to move the positioning of the marketplace and we really like the luxury positioning that we are establishing in the marketplace.

Because the spend by the wealthy and affluent customer is meaningfully and exponentially greater than when you go down market.

So, it's not that we don't think, long-term, there's opportunities to do other things and create other businesses that will take our expertise, our case level style and capabilities and think about other markets, but that's not in any of our numbers when you think about that $4 billion to $5 billion.

The $4 billion to $5 billion is really triggered by two things.

It's triggered by the expansion of the product offering that we know of today, and we think we're relatively conservative, like could RH Modern, in and of itself, take $4 billion to $5 billion up?

Yes, it could.

Will we commit to that today?

Not yet, we have no data, yet.

And I think we're relatively conservative with how we're positioning RH Modern and how that will open up the aperture of the market.

So, the $4 billion to $5 billion is really based on the continued product expansion and what we know today that we're working on that is in our pipeline, and the real estate transformation in North America.

That gets us to $4 billion to $5 billion and mid-teens.

Beyond that, there is international opportunity, that we think -- I think all of you know, we hired a head of international new business development, Doug Demos and he's been traveling the world, meeting with potential partners, looking at real estate, looking at opportunities and putting together the international blueprint for growth for RH.

We think the business we built today is -- it will be just as dominant in internationally as it is today in America.

We are very enthusiastic about it.

We're just trying to be smart about capital allocation and where do we put the next dollar and where do we get the return.

International, thinking about how we scale international, how much capital it takes to build the infrastructure, what does it really take to break into a new market, do we do it ourself, do we JV it, do we franchise it, do we license it?

We are building that blueprint and want to be really smart and say how are we going to generate the best returns?

Based on what we know about our business today.

Beyond that, we think that there's other business opportunities and other things that we are looking at working on, that we haven't talked about that might address new markets, new categories and other things.

$4 billion to $5 billion is just to help everybody think about the current business and the model in North America.

It gets much bigger when you take it outside North America and then there's other incremental businesses and things we're working and developing for the long-term, that will continue to fuel growth long-term.

I had a second.

I'll ask it.

But if you feel like we've spent too much time, you can just move on.

You've got a long product cycle.

You've been in the business now, last six or seven years with your new look and design.

Can you characterize the relationships that you have with your customers, are you seeing repeat business the way you'd expect, can you talk about clientele opportunities?

I'm trying to get a sense now that you've seen more years of this business, what you're seeing from a relationship standpoint.

We do.

The buying cycle -- what really drives our business is event buying tied to life stage events.

Someone either buys a home, remodels a home or redecorates their home.

That is -- that category, that life event is a big, big driver to our business.

And then on top of that, when you look at our customer over a five-year period, and you take their biggest purchase week, you see a big peak and then as you look at it on each side of that for several years, you see that fall off, pretty big.

So, we are trying to position ourselves to maximize the market share when people have that meaningful event in their life, when they buy a home or remodel a home, and they redecorate their home.

Back to tie in your point on the luxury customer and how to think about it, the wealthy and affluent customers, and especially the demographic, the higher end of that, generally owns more than one home.

So, thinking about second and third homes and how we play in that lifecycle, and how we capture that share, is really key.

The services that deepen the relationship, and create an ongoing repeat customer, whether it is again, another event like they bought a second home or when they moved, the deeper relationship is built around a lot of ways.

One, with the general service we have them and the experience they had and that's affected by the new galleries.

Think about most of our business over the last several years, as been driven out of all these little mall stores.

The perception of our brand has been shaped by a completely different business that was opened in small mall stores.

You think about the new experiences that we're building and how those experiences will shape the perception of the customer, will create a net when people wake up in the morning, three years from now somebody decides to move or remodel their home, I think they're going to think completely differently about us in a couple of years than they do today.

Just as they think completely different about us in any market where we've done one of these new bigger galleries, we think that's highly important.

Then things like interior design services and the investment we're making there and the different level of service and what you're going to see evolve.

I invite you and anybody else to come to our new store in Chicago when we open Chicago, in Denver, we have these next generation galleries are going to have design ateliers and a whole section and department that looks like you walked into an architecture or interior design offices.

And set up with all the samples and swatches and all the capabilities and technology to support a different level of interior design services.

That's a big investment.

You will see us move that forward.

You might even see us long-term get into architectural services, where we can help them think about their space differently and how to create a different kind of space.

We like to talk internally about not just creating and selling products, but how do we move from creating and selling products to conceptualizing and selling spaces.

So, when you hear about other new businesses that are coming, we've talked about RH Modern -- we talked about RH Kitchen before and we've been working on developing a kitchen concept that we believe we'll be able to -- when we launch that business, transform your whole kitchen.

Not just sell you pots and pans and knives and forks and things like that, but be able to transform your kitchen.

So, there's going to be levels of services, product categories and then the overall positioning and presentation of the galleries.

And walking into that experience that I think is going to continue to transform the brand, continue to build a deeper relationship with customers and continue to open up the brand to new customers who don't even think about it today, because their point of reference is a 6,000 square-foot store in the mall.

The last time they were in that store, they bought stocking stuffers seven years ago.

The opportunity to create a forced reconsideration of this brand through the real estate transformation, the additional new services, the additional new businesses and categories we are going to continue to introduce, I think we're still at such an early stage of this transformation.

I mean, in almost every market we have a little mall store that was built for an entirely different company.

Thank you for that answer.

Lorraine Hutchinson from Bank of America.

Seems to be a lot of focus in the market on a simple new store productivity calculation and I was hoping that you could just discuss the lift that you are seeing in the direct business in the markets where you have transform to the real estate into a design gallery.

Yes.

We have seen a lift in every market where we've opened one of the new larger format galleries.

Atlanta has been no exception to that.

It has even been in the high-end of the range that we've seen.

One of the most key things about the new store productivity is we've kind of tried to make sure everyone understand a few things.

One, when we have closed stores in a market and where we're just in general in that same period, and in Q1 and Q4 of last year, since we've had Atlanta open, we do have three stores in the non-comp base that have a zero this year and there was revenue last year.

So, three of those stores are just a drag on that number.

The other thing we've tried make sure that everyone understands is the ramp period, both from a demand to ship sales but also just the way Gary described.

We do expect these stores to ramp and with Atlanta, specifically, making sure you have time for all the categories to have their time in the sun, whether it's outdoor or holiday or all those things that are part of the core assortment and we're investing significant square footage and for the books to be in home.

In Atlanta when you're there and in a market and no one knows it's there yet and wants to get the books at home which raises further awareness of the brand, those are all things that contribute to the ramp.

An important point to understand is how we measure our business.

We really are looking at the market lift.

The consumer behavior is going to continue to change.

There is a lot of people, I believe, in the retail business today, that are making very poor strategic long-term decisions because they don't understand the consumer behavior shift because of technology.

Today, we look at it, we make an investment into transforming the real estate in a market, whether it's LA, Atlanta, you name it.

Scottsdale, Arizona.

Whatever that market is.

What the retail lift is today versus what the direct lift is today, is going to change.

The devices are going to get better.

The speed -- and all the devices are going to get better.

Consumer behavior, again, whether they ordered online or ordered in the store, and what that dynamic is, I think if you worry about that dynamic, you are going to miss the business, the business opportunity and you are going to make bad decisions for your business, long-term.

I said in my video, a lot of people -- 10% of retail sales exist online today.

Do I think it's going to be 20% down the road?

Of course, I do.

The fact is, it's only 10% today.

It says that retail stores are really, really important.

When it becomes 20%, because devices are better, interactivity is better, and all of a sudden whatever market, LA, New York, Atlanta, you pick it, and all of a sudden, the store business might shift and the store business might flatten.

The store business might go down.

But the direct business goes up.

Should you care about that?

I can't control technology.

And how technology is going to change our lives.

But what I can control is our assortments and the presentation of our assortment in the marketplace and be completely agnostic to how the test work transacts.

I remember, it would be like in the old days, when we use to go to banks and there'd be tellers and then all of a sudden there was ATMs.

You could have been sitting there saying, oh my god, the teller business is down, the teller business is down.

No (expletive).

Excuse me but are going to ATM's, of course the teller business is down.

In retail, before there was the Internet, if you weren't in the catalog business they had to buy everything in your store.

There is now another channel.

That channel is evolving faster than anything.

Technology is changing our lives massively.

Should I care where they transact or why they transact where they do?

Not at all.

Should I build smaller retail stores because they are transacting differently?

And then have a worse presentation, physical presentation in the marketplace?

I think that kind of strategy is idiotic, I really do.

Because, people want to see things and people want to interact in a three-dimensional nature and that's why we're ambivalent to where they transact.

That's why I make my point about, it's not about the Internet.

The Internet is a channel.

It's going to change things.

It's going to shift things.

But retailers that are trying to shrink to greatness I think are missing the whole point.

Look at Warby Parker, look at all these people that started online.

Now, Warby Parker is on the cover of Fast Company magazine at the most innovative company in the world.

Why?

Because they were the first built on the Internet brand that all of a sudden decided to do retail stores.

The most innovative kids are doing retail stores?

I'm not trying to take that away from Warby Parker, but think about that.

They're building retail stores.

Retail stores are always going to be important.

Otherwise, if anybody's been to a theater or a movie, what's happening with the movie industry and the movie theaters?

Why the hell would anybody go to movies?

You can watch any movie you want at home on your iPad, TV, we are social creatures.

We don't want to sit alone at home all by ourselves.

We're not going to see a future ever, I believe, where people are sitting home all by themselves doing everything online.

I think people that think that, like, good luck.

Your strategy is going to really miss.

I think the physical experiences in the world are going to be even more important than the online experiences.

Because we are social creatures and I think the retailers that have the very best physical experiences in the world tied with the very best virtual and digital experiences in the world are the ones that are going to win.

It's not one or the other.

It's physical and digital.

That's the world.

But, I think so many people spent too much time in their models and their businesses trying to get how much is in the store and how much is online.

The key is, how much of the market are you getting?

What is your overall growth?

Some people are saying our direct business is up this and it's the fastest-growing division, our direct business is the fastest-growing division.

Who cares?

Of course, it is.

That would be like saying the teller business is up.

The ATM business is up, the ATM business is up and I'm running the ATM division.

Woop-tee-doo.

What is the Bank of America's business, versus Citibank's business.

That's what is important.

That's how people ought to think.

I haven't seen an app yet that lets you sit on a couch.

Seems like the strategy is --

Great point.

May be one more for Karen, if I could.

The port impact, did that play out as you expected, the $10 million to $12 million hit in the first quarter and will that revenue be recognized in Q2?

Yes.

Great question.

Actually, at the end of the day when we looked at all the orders, we actually were able to move through a lot more of the receipts and things picked up in April.

So that $10 million to $12 million impact that we originally estimated was only about half that.

Were able to get things through.

When we look at the transit times currently right now, there is still a little bit slower, so there's a modest impact that could shift to Q3 from Q2.

Overall, it was only about $5 million impact that's actually flop into Q2 and a little bit of it's probably going even move forward into Q3.

Not a huge impact on Q2 one way or another.

Thank you.

Peter Benedict from Baird.

It's just an Justin Clayborn on for Pete.

Gary, I wanted to ask about the second-quarter guidance and how you guys are thinking about gross margin directionally, as you lap the strong performance last year which, if I recall, was helped by the software fourth of July promotional event.

The biggest thing for Q2, to headline, is the significant change in the newness introduction.

I'll start with then topline and just reminding that when you think about Q2 this year versus last year, even though the books are in home earlier this year than last because over half of the newness is being introduced in the second half, the sales composition is a little different.

We do expect to see modest growth margin leverage in Q2, partially because of that friends and family event last year.

But also, just because of what we're seeing just in trends.

We do expect to see modest gross margin leverage in Q2 and then even into the second half.

Okay.

Just wanted an update on some of the supply chain initiatives, specifically, the in-sourcing of the furniture delivery hubs.

Can you guys just remind us how many markets have been in-sourced, maybe what percentage of your furniture deliveries do you control today as compared to either last year or two years ago?

As a part of that question, when you in-source these hubs are the benefits more financial in nature, or are they customer facing?

Thanks.

Sure.

We in-sourced one more hub in the last quarter.

So, with that, we're about 58% of our deliveries, are in-sourced and we expect to have one more by the end of the year, such that by the end of the fiscal year it will be at about 60% of delivery we'll control.

And your question on whether it's cost or customer service facing, it's both.

So, we do think that there is a better customer service experience and then there's some cost-benefit.

We are at the point now where we've done a lot of the big markets.

So, the immediate leverage that we get from controlling some of that in the cost efficiencies, those big markets are behind us.

Now, we still see ancillary benefits with the customer experience, but even other things like returns and damages and shrink and other things just from controlling more of the inventory.

And then again, all of the customer benefits that come from us having more control over those folks and who is interacting with our customers.

Thanks, guys.

Best of luck.

Cristina Fernandez from Kelsey Advisors

Gary, on the video you alluded that should open more RH Modern standalone stores besides the one planned for LA.

Can you speak about how many of these you have and just in general, how are you thinking about standalone stores for some of these concepts like Baby & Child and the one dealer concept that's going to be announced in the fall until you bridge the gap for transforming the real estate that you currently have?

Good questions.

Specifically, let's talk about LA and talk about the logic and why there's going to be an RH Modern standalone store in LA.

We built Melrose, it's not one of the next-generation design galleries.

Melrose does not have all the square footage and we knew when we were moving to Melrose, we kept our location on Beverly Boulevard because we knew were going to need the space for RH Modern in that marketplace.

Also, in that marketplace, we have a freestanding baby & child store.

Because we don't have the room in Melrose.

There is going to be combinations here, where we will -- where the brand may be aggregated under one roof and there's going to be some places where the brand is disaggregated into separate pieces.

And, separate standalone.

My sense is, we are going to continue to evolve.

We're going to learn more.

If Modern in and of itself, in a freestanding location, deserves to be freestanding long-term, then we will adjust our approach.

Today, we've said we have a floor that's going to be dedicated, just take Atlanta, for example.

We have three floors of the interior business, on floors one, two, and three, today, that's showing basically our core interiors assortment and category presentation in the store that was rugs and window treatments and other categories.

Floor four is small spaces and floor five is Baby & Child.

In that store, it was always thought of in design that RH Modern would be on the third floor.

Then, the other business that we are announcing is engineered to take half of one of the floors in the business.

As we learn and grow, today, we have some Baby & Childs that are freestanding, and we have Baby & Child now in Atlanta integrated.

Whether it's Baby & Child, Modern, the new business that we are talking about, other categories of the business, we will continue to test and experiment, which is the best way to optimize the business, not just from a revenue point of view, but from a profitability point of view.

There could be a decision at some point to say, hey, Baby & Child, with is own storefront, is more optimal than Baby & Child on the fifth floor.

We have plenty of things in the pipeline that we could use the square footage for.

Same discussion around Modern.

That's why you are seeing different tests.

The great thing about the big stores, is the real estate deal, the financial construct of those deals gives us really a long-term advantage and a pretty low cost overhead structure for stores of that size.

So, we have lots of flexibility how to use that square footage.

We'll continue to test and learn and use the square footage in the most optimal way and augment with additional square footage outside of the big box, if we believe that's right and appropriate.

Final question comes from Matt Nemer from Wells Fargo Securities.

I had a quick follow-up on Modern.

You mentioned that the prices would be, you think, will be disruptive in the market.

I'm curious about speed to delivery.

My impression is that some of the high-end specialty folks that you talked about earlier have very long lead times, it's almost a custom business.

How do you think you'll compete on speed?

That's a really good point, Matt.

It is very much a custom business.

On the Modern side, and the lead times, the wait times are a real disadvantage for the people in the marketplace today.

We are going to compete on speed just like we would our current business.

When we're launching, we're being relatively conservative on inventory that's how and where we are buying.

I'm sure we're going to be wrong in a lot of it.

100% of the first buy is going to wrong, we're going to oversell some stuff -- overbuy, underbuy and so our lead times and our delivery won't be optimized in the 6 months or 12 months.

After that, I think, you think about it, it's going to be a huge competitive advantage versus how the marketplace exists and operates today.

Just one quick follow-up.

Do you have a roadmap this year for changes to the website and the digital experience I know that's something you've been thinking about making some changes to?

I'm just wondering if we should expect anything big this year, more fine-tuning?

Thanks.

Some things will be bigger than others.

I think we have a long-term strategy and we'll continue to evolve and change the website.

The launch of the Modern site is going to include some new features.

Nothing that I would say is massively revolutionary.

It's going to continue to evolve and be better and we'll continue to focus on it, on leading and not following.

Great.

Thanks so much.

Thank you, everybody, for your time today.

We're very, very excited about our future and the year ahead and our future ahead.

Appreciate your time and attention and support.

Have a great day.

Thank you.

This does conclude today's call.

You may now disconnect.

Thank you.