RH (RH) 0 Q0 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Restoration Hardware Holdings fourth-quarter and fiscal 2012 financial results conference call.

My name is Keith and I will be your operator for today.

At this time, all participants are in a listen-only mode.

Later on, we will conduct a question and answer session.

(Operator Instructions).

As a reminder, today's conference is being recorded for replay purposes.

And, with that, I would now like to turn the conference over to your host for today Ms. Cammeron McLachlan, investor relations.

Please go ahead.

Thank you.

Good afternoon, everyone.

Thank you for joining us for Restoration Hardware Holdings' fourth-quarter and fiscal 2012 financial results conference call.

Joining me today are Carlos Alberini, Chief Executive Officer; Gary Friedman, Chairman Emeritus, Creator and Curator; and Karen Boone, Chief Financial Officer.

Before turning the call over to Carlos, I would like to remind you of our standard 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 financial results press release.

These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ to really.

Please refer to our SEC filings as well as our financial results press release 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 will discuss a number of non-GAAP financial measures, including adjusted operating income, adjusted EBITDA, adjusted net income, and adjusted earnings per share.

These measures adjust our GAAP results to eliminate the impact of certain items.

You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release, as well as a reconciliation of adjusted P&L items on pages 11 and 12.

A live broadcast of this call is available on the investor relations section of our website at IR.

RestorationHardware.com.

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

Thank you, Cammeron.

Good afternoon, everyone, and thank you for joining us.

We have many exciting things to share with you today.

I will start with an overview of our business performance and touch on the progress that we have made on our key operating initiatives and long-term strategy.

Then Gary will provide an update on the RH brand and key product and business initiatives.

Karen will then wrap up our prepared remarks with a discussion of our financial results and our outlook for 2013.

After that, we will open the call for your questions.

We are very pleased with our fourth-quarter performance, which drove record financial results with adjusted net income growth of 24%, and an adjusted diluted EPS of $0.64 for the period, closing the best year ever for our Company.

On behalf of our leadership team, Gary, and myself, I want to thank every member of Team Restore for all the hard work and tremendous accomplishments this past year.

In the fourth quarter, we delivered industry-leading sales growth with a net revenue increase of 30% on top of a 19% increase last year.

Excluding the 53rd week, net revenues increased 23% year over year.

This performance marked our 12th consecutive quarter of double-digit net revenue growth during a time when we have contracted our store base from 95 locations in 2009 to the 71 locations that we had at year end.

In fact, during this three-year period, RH achieved compounded revenue growth of 24% per year, essentially doubling the size of the Company from $625 million in net revenue in 2009 to $1.2 billion this past year.

We believe that this 24% CAGR significantly outpaces the home furnishings market and our peers.

The home furnishings market in the US has grown at a 4% CAGR over the three years, while our sector peers have generally grown at less than a 10% CAGR over the same period.

We believe that it's clear that we are disrupting this highly fragmented marketplace and have been gaining share consistently.

While all of our categories are experiencing strong growth for us, furniture is leading the way, reducing a lower margin mix, but resulting in industry-leading sales results and market share gain.

We are thrilled with this evolution of our business.

We believe that we are creating significant brand awareness and are becoming a destination for furniture nationwide, which should support our goal of sustainable long-term market share gains and margin expansion.

Gary always had a clear vision for the RH brand and our business.

Today, we believe we have the most dominant luxury home collection in the marketplace.

What he and the team have accomplished with the transformation of our assortment is simply outstanding.

What is most exciting to me is the fact that we are very early in this transformation, and we see tremendous opportunities for further expansion in multiple product categories.

The home furnishings market is very large at over $143 billion in the US alone, and we represent less than 1% of that market today.

The expansion of our assortment has enabled us to drive significant growth.

But less than 20% of our current assortment is displayed in our retail galleries today; less than 15%, if we include our Baby and Child products.

The bottom line is this.

Today, we have an assortment with revenue potential that could be more than three times as large as our business today, but the assortment is trapped in our undersized real estate portfolio.

The real estate transformation into our full line design gallery concept is the key to unlocking the value of our assortment, and it remains our highest priority.

Our first three full line design galleries showcase a larger percentage of our assortment and continue to outperform our expectations.

Our LA and Houston galleries have achieved store demand comp growth in excess of 25% since their first anniversary.

Our new full line design gallery in Scottsdale, has delivered store demand growth in excess of 90% since its opening last November.

And it continues to gain momentum each month.

Both LA and Houston are delivering annual sales per selling square foot of over $1500 while Scottsdale is tracking at over $1000 per square foot.

The increase in profitability in these markets is up anywhere from 80% to 300% in the first year of operations.

We recently opened our newest full line design gallery in the former Museum of Natural History in Boston.

This gallery is our best expression of the RH brand to date and represents the next evolution of our customer experience.

While we are excited to open last weekend, the recent events in Boston have been devastating to our team, to the city, and to our country.

We want to express our sincere sympathy and concern for all those impacted by this terrible tragedy.

While the Boston gallery was temporarily closed following this event, it has now reopened for business.

We plan to open our next full line design gallery in Indianapolis in a few weeks and we'll be breaking ground in Greenwich, Connecticut, and Atlanta, Georgia, very soon.

We have also identified and are in negotiations for full line design gallery sites in over 20 markets, including New York, Chicago, Miami, Denver, and San Diego, just to name a few.

The next generation full line design galleries will be larger to accommodate our Small Spaces collection, expanded furniture assortments, and Baby and Child products.

The new lease deals will generally reflect more favorable economics as the concept has now been proven.

Landlords have embraced our new galleries with high enthusiasm and are currently offering RH leases as an anchor tenant for some of the best retail shopping centers in the country.

We believe that we can structure this these types of anchor tenant deals in a number of locations throughout the country, and we expect these leases to result in a more predictable timing, higher developer contribution to our build outs, and lower rents, all of which should drive higher profitability and minimize execution risk.

The combination of our improved performance in the new galleries and better deal economics should result in improved returns on our invested capital above what we have previously expected.

This is an important fact, as most of our capital spend over the next several years will be directed toward the execution of our real estate transformation, and we are in the very early stages of this process.

We remain confident that these galleries will allow us to drive sustainable growth for many years to come.

We recognize the importance of investing in our operating infrastructure and platform to support our rapid sales growth.

During the year, we made good progress with our key initiatives in this regard.

First, we executed on our inventory strategy and closed the fiscal year in a much stronger inventory position.

We are very pleased with our vendors' ability to scale and meet the growing needs of our business.

During the quarter we improved our in-stock position, which contributed to better customer service, lower back orders, and higher deliveries.

These trends are also positively impacting our business in the first quarter of this year.

Regarding our supply chain infrastructure, we are on track to open our fourth DC, near Dallas, Texas, and expand our existing Ohio shelf stock facility.

In addition to providing increased capacity, we estimate that the addition of the Dallas DC to our furniture network will reduce the average transit time to our customers by 25%, enabling us to reach a higher percentage of our customers even sooner.

The Dallas facility will also have our new customer service call center, allowing us to reduce our reliance on outside providers and support our growth in an efficient and cost-effective manner.

We have also made progress with our in-home delivery initiative.

With the recent conversion of the Houston market, we now have six insource hubs which give us more control over the quality of the customer experience, while also yielding lower returns and damage rates.

In 2012, we delivered 38% of our furniture through our insource hubs, up from 19% in 2011.

By the end of 2013, will have eight insource markets and almost 50% of our furniture deliveries will be controlled through our internal network.

We have never been more confident in the strategic direction we have chosen for our Company.

We have a disruptive and powerful business model that we believe will drive significant market share gains and support our financial growth for many years to come.

We believe we have dominant product assortments and exclusive products across our categories, and are offering tremendous value and superior service.

We have significant real estate opportunities with very attractive lease economics.

We have made investments in our infrastructure that we'll continue to leverage as we grow.

Each of these attributes positions us for strong topline growth, operating margin expansion, and improved ROIC.

I'd like to turn now the call over to Gary.

Gary?

Thank you, Carlos, and good afternoon, everyone.

As mentioned in the press release, our ability to innovate, curate, and integrate new products, businesses, and experiences has driven our industry leading results and will continue to distinguish us in the marketplace.

Our growth in 2012 and, indeed, our growth since 2009, was driven by a combination of new products, new categories, new businesses, and the re-conceptualization of both our retail and direct platforms.

We believe we are building not only an innovative and proprietary product offering, but also completely -- a completely new platform or ecosystem to experience our collections.

Both these factors are producing industry-leading sales per square foot in our galleries, and with continued refinement, will also produce what we believe will be one of the most compelling and productive multi-channel experiences in retail.

As Carlos mentioned, with only four of the top 50 markets having been converted, many of our new and developing businesses have been just introduced and others being launched this spring and into the future.

We are at the very early stages of our growth story.

Most recently, our growth was driven by new collections and finishes in furniture, lighting, and textiles, coupled with an expanding Baby and Child offering and the introduction of Small Spaces.

Looking forward, this spring our collection will be presented across six sourcebook titles, totaling over 1600 pages, and represents the most dominant and authoritative assortment in luxury home furnishings market.

Our Interiors and Small Spaces books include the addition of new furniture collections and finishes, the expansion and presentation of color across our upholstery furniture and textiles collections, and dramatic new lighting.

The new furniture, which includes an antique taupe and white painted finishes, we believe will open up an entirely new market for us.

In addition, we are introducing two new businesses this spring -- RH Tableware and RH Objects of Curiosity, which we believe represent significant long-term growth opportunities for the Company.

Each of these new businesses are being presented in their own distinctive catalogs and represent what we believe is an underserved market from an aesthetic point of view.

As we have traditionally approached new businesses, the product for each of these will be tested in direct and rolled out at retail over the next several quarters and into next year.

Our newest business, RH Contemporary Art, has acquired the Rain Room by rAndom International, arguably one of the most admired pieces of modern art in recent history, as evidenced by the 3 to 5 hour wait times while in exhibition at the Barbican in London during the past several months.

We were actually the first in the world to purchase the Rain Room, and it will make its US debut in collaboration with the Museum of Modern Art in New York.

The exhibition is part of EXPO 1 and will be presented in a freestanding structure in the parking lot adjacent to MOMA, bordering the entrances on 53rd and 54th Street.

The launch will coincide with the opening of the Frieze New York Art Fair this May and will be on exhibition at the MOMA until August.

Clearly, this association adds credibility to our position as a new entrant into the world of contemporary art.

We plan to open our first freestanding RH Contemporary Art Gallery in the Chelsea art district in New York City and be live with our online platform this fall, post the exhibition.

With that, let me now turn over the call to Karen.

Thanks, Gary, good afternoon, everyone.

I will first take you through some of the financial details of our fourth quarter and 2012 performance, and will then provide our outlook for both the first quarter and 2013 full fiscal year.

First, as Cammeron mentioned, we had several unusual and nonrecurring items that we've excluded from our adjusted earnings in the fourth quarter and full fiscal year.

These adjustments include the items we discussed on our third-quarter earnings call as well as a charge from an anti-dumping exposure related to purchases from a supplier in China dating back to 2011.

Further details regarding all these adjustments have been included in our press release.

We are extremely pleased with our fourth-quarter performance.

Total revenue for the fourth quarter increased 30% to $398 million.

Retail sales during this period increased 22% to $210 million.

And our comparable store sales increased 26%, and this was on top of the 22% comp store sales growth we experienced last year.

We also operated fewer stores with 71 galleries open at the end of the fourth quarter versus the 74 we had open at the end of last year.

Our direct sales increased 41% to $188 million, on top of a 23% increase for the same period last year.

Topline growth across all of our channels was primarily driven by the expansion of our assortment, as we saw strong performance in the new black and brown furniture finishes, lighting expansion, and new items in our Small Spaces and Baby & Child collections.

Adjusted gross profit in the fourth quarter of fiscal 2012 increased by 26% and reached $148 million.

Adjusted gross margin decreased to 37.3% from 38.5% last year, due to increased shipping costs and a reduction in product margins based on changes in product mix with higher furniture sales during the period, partially offset by improvements in our occupancy costs.

Strategic pricing on both new furniture introductions and existing collections has allowed us to take market share, but is resulting in lower product margins.

Increases in our furniture sales also resulted in higher shipping costs.

We believe that the value we offer through our competitive pricing is resonating with our customers and is contributing to significant market share gains.

During the fourth quarter, we also continued to see occupancy leverage despite new costs related to the expansion of our Baltimore furniture facility and a full quarter of pre-opening rent for our Boston gallery without the corresponding revenue.

Turning to expenses, our total adjusted SG&A expense were $107 million in the fourth quarter versus $83 million in the prior year.

The increase in SG&A dollars was primarily driven by increased employment costs, the majority of which related to variable store and distribution center labor, which was in line with our sales growth, as well as increased advertising and catalog costs related to our expanded page count and circulation.

As a percentage of revenue, adjusted SG&A expenses decreased by 40 basis points to 26.9% versus 27.3% of net revenues in the prior year.

This decrease was due to increased leverage on fixed payroll and other corporate expenses, partially offset by increased advertising and catalog costs.

Adjusted net income for the fourth quarter increased 24% to $24.2 million, up from the $19.5 million in the prior year.

Adjusted diluted EPS was $0.64 during the quarter, with the 53rd week accounting for approximately $0.04 of our Q4 adjusted EPS.

This performance closes out our best year ever for the Company.

In 2012, our net revenues increased 25% and reached almost $1.2 billion for the year, surpassing a significant milestone for our business.

Comparable store sales on a 52-week basis increased 28% on top of the 25% comp growth in fiscal 2011.

Direct revenues also increased 30% on top of the 27% increase last year, with our direct sales in 2012 representing 46% of our overall revenue.

Full-year adjusted gross margin as a percentage of revenue was 36.9%, a decline of 30 basis points from last year.

Similar to the fourth quarter, this decrease was driven by changes in our product mix, strategic pricing, and higher shipping costs, and was partially offset by occupancy leverage.

Adjusted operating income increased 40% during the year with adjusted operating margins expanding to 5.8% from 5.1% last year, as we continued to leverage our overall occupancy costs and SG&A expenses.

We are extremely pleased with our progress this year, especially when we consider all the investments we have made in our infrastructure to support growth, our new businesses, and in our real estate transformation.

Adjusted net income for the year increased 43% and reached $37.7 million, or $1.01 per diluted share, based on approximately 37.2 million diluted shares outstanding.

Turning to the balance sheet, inventory levels at the end of the year were $353 million, up 44% from last year.

This increase was in line with the inventory strategy we had outlined previously as we worked to improve our in-stock positions, reduce back orders, and drive higher sales.

Through the third quarter of 2012, our sales growth had outpaced our inventory growth.

And as Carlos mentioned, inventory receipts in the fourth quarter allowed us to close out this year in a much stronger inventory position.

And it positively impacted our performance as we've begun the 2013 fiscal year.

With respect to our credit line, we ended the year with $82.5 million outstanding on our $400 million credit facility.

Following our IPO in November, we utilized a portion of our proceeds to make payments of $75 million on this facility and fully repaid our $15 million term loan.

Our total capital expenditures for the year were $49 million, representing investments in both new galleries and infrastructure to support our growth.

Let me now address our guidance heading into 2013.

We are very pleased with our fourth-quarter trends, which have accelerated in the first quarter and remain strong, even when our spring sourcebooks will be in homes a month later this year.

We continue to see very strong consumer demand for our products, including our new furniture offering, lighting assortment, and Baby & Child products.

Based on our current trends, we expect to grow revenues between 28% and 31% to $280 million to $285 million for the first quarter.

We expect gross margin trends in the first quarter relative to the prior year to be consistent with our fourth-quarter performance and expect SG&A trends to improve considerably.

We are assuming a 40% tax rate for the quarter and net income in the range of a loss of $1 million to breakeven.

We are providing first-quarter diluted EPS guidance in the range of a loss of $0.02 to breakeven, which assumes 38.8 million diluted shares outstanding.

With respect to the full year in 2013, we expect revenue growth to be between 19% and 22% and reach $1.42 billion to $1.45 billion.

Our fiscal 2013 revenue outlook represents growth of 21% to 24% on a 52-week basis.

As we think about quarterly revenues, the majority of our spring sourcebooks will be in homes in the second quarter of 2013.

While we expect this change to benefit our second-quarter business, based on the amount of newness this season and our past purchasing patterns, we anticipate this shift will impact our third-quarter business in an even more meaningful way.

We expect net income to grow between 35% and 43% to a range of $51 million to $54 million in fiscal 2013, also assuming a 40% tax rate.

We are providing full year diluted EPS guidance in the range of $1.29 to $1.37, which assumes 39.5 million diluted shares outstanding.

With respect to inventory levels, we are planning to close the year with inventory growth commensurate with our planned sales growth.

In the first half, we are planning inventory levels higher than our sales growth in line with our recent efforts to improve our overall in-stock position.

We plan capital spending to be between $95 million and $100 million, excluding [spend] allowances, and over half the spend will be invested in our real estate transformation with the remaining spend invested in infrastructure, including our supply chain and other initiatives.

In closing, we are extremely pleased with our record performance this year.

We delivered industry-leading revenue growth and increased earnings at an even faster rate, driving operating margin expansion.

We remain confident in our growth strategy and ability to consistently deliver long-term revenue growth in the mid-to-high teens and earnings growth of approximate 20%.

With that, I would now like to open up the line for any questions.

Thank you.

(Operator Instructions) Lorraine Hutchinson, Bank of America Merrill Lynch.

Good afternoon.

My first question was around gross margin.

I know there's a lot of mix shifts going on with the increase in the furniture penetration.

How should we think about that over the long-term?

Should we continue to see that decline on a multiyear basis given the focus that you're placing on furniture?

Or are there offsets that we can look for in the out years to offset that?

Yes, Lorraine.

How are you?

Let me take that.

Let me start by saying that we are very, very excited and thrilled with the evolution that the business that has taken, and how we continue to gain market share in the business that is so critical to our long-term strategy.

And I'm talking about furniture, specifically.

You are correct.

That business has impacted our mix negatively.

We are modeling our long-term with a very stable margin.

We do see that the trends are somewhat similar in the first quarter, as Karen indicated, and that would impact our first-quarter margins as well.

We have seen some promotional activity and we believe that we have a winning formula with a very strong, dominant assortment and very exclusive products.

So we feel that, long-term, we will have pricing power.

As you know, at the core of our strategy, we want to win, disrupt this marketplace and continue to gain market share.

And I think we are doing just that.

The great thing about the model is that we do see operating margin leverage as we further lever our cost structure and infrastructure in SG&A overall, and occupancy with the new deals that we are seeing.

So we feel that we can continue to drive these marketshare gains, remain very competitively priced and continue to win in the marketplace.

Yes, this is Gary, Lorraine.

Let me build on a couple of key points is, we are going to start to see growth from new businesses, particularly tableware, objects, and art, as those businesses start to grow.

You'll see a stabilizing of the furniture growth in the product mix.

The other thing that we are seeing is, with the growth in furniture, it's leading to better pricing with our vendor base.

So there are efficiencies that our vendor base has that are being passed along to us, so that will be a positive as we start to get into the later half of next year -- excuse me; this year.

And the other thing to consider is Baby & Child is now just starting to reach a level where our orders are getting to a scale that we're going to start to get leverage in our buying in Baby & Child.

And so that business, because it was in its infancy, was somewhat of a margin drag and that will start to normalize and lift up margins also.

Great.

And then on your new store opening cadence, what's a good run rate for us to think about longer term?

How many of these do you think you can digest in the course of a year?

And is $100 million a good CapEx number to use as a run rate?

Yes.

Let me address that, too.

We are very excited about what we are seeing in terms of the [entry sales] that we see the landlords are taking with our new full line design concept.

I think that there is a big opportunity here to grow the square footage in a pretty significant way -- probably even more than what we originally thought, because when you are concentrating on some of these shopping retail centers with anchor tenant deals, there is an opportunity to grow much faster than if we are just looking for one building here or there.

Now, of course, there is going to be opportunity for single buildings like the ones that we found in Boston or the post office building in Greenwich, but this gives us a model that will enable us to go grow significantly faster.

In terms of the number of units, it depends on the complexity, but we have been modeling our long-term growth with numbers anywhere between five and 10 locations.

I'm talking about 3 to 5 years out.

And CapEx?

In terms of CapEx, if you think about that type of number, considering that we are going to be building locations that are larger than what we have built so far, just to accommodate the expansion of some of these product categories, as I mentioned in my prepared remarks, you have to think that this $100 million will be probably spent in a different way.

There is a considerable amount of spending this year for infrastructure from [around the] supply chain.

We are opening a new DC and we are expanding one in a pretty significant way that is very costly, but which we do not anticipate that we will have that type of investment every year.

So -- but I think of the $95 million to $100 million in terms of overall capital, it's a good annual run rate.

It doesn't necessarily mean that we will spend exactly that amount every year.

There could be some years where we may spend more than that, but I think the $100 million range is a pretty good benchmark.

Great.

Thank you.

Thank you.

Matthew Fassler, Goldman Sachs.

Thanks a lot, and good afternoon.

Congratulations on the holiday season.

The first question I'd like to ask relates to a little more detail on the impact of some of the emerging businesses on the fourth quarter.

I know that some of them hit the sourcebook and the stores thereafter.

Any color you could give on what the early reads are on their impact on the business?

Sure, Matt.

You're talking about the books that are just now being dropped?

Well, I guess I'm talking about some of the new initiatives, Gary, that impacted Q4.

Yes.

Well, if you stand back and think about it, right, we have multiple business investments that we believe will lead to longer-term growth and leverage in our operating margins.

But that were -- that provided deleverage, right, in the last couple of quarters.

And so, specifically, those are Tableware, Objects of Curiosity, and fine art, where we have no sales being generated, but we have teams working on building those businesses.

And we'll start seeing sales in Tableware and Objects of Curiosity in the next -- well, we are actually seeing starting sales now because we just brought it up online.

The books are just starting to get into homes.

And then Small Spaces and Baby & Child, where we have significant work being done on the assortments, but you've got businesses here, when you think about it, that they are in their infantile stages.

Even Baby & Child, we have such a small retail presence but we have a full assortment.

I mean, we opened 7000 sq.

ft.

of selling in Santa Monica, California, and needed every bit of that.

And actually, it is performing quite well.

We've got industry-leading dollars per square foot in all of our Baby & Child locations that we have.

So when you think about starting to roll that out in retail, you're going to get big leverage there.

Same thing with Big Style, Small Spaces.

The Small Spaces category is -- think about it as a start-up catalog.

It was really in its first year.

We are testing, refining, we are optimizing circulation, optimizing page count and density.

You're going to see good leverage there.

And then the third thing I'd mention is, we made circulation investments to test the depth of our file in the second half of last year.

And we knew, as a private Company, we wanted to get a feeling for how big that market looked and made some investments that now we will start to optimize that circulation.

And I think you can -- we would expectations of better leverage from an advertising point of view going forward.

And, Gary, if you think about Big Style and Small Spaces, in particular, which I realize is very much emerging but still did have a presence for a number of months during last this year fiscal, any read on its promise and its contribution in the quarter that we just saw?

Yes, we are very enthusiastic about the reads on it, very enthusiastic.

In fact, as Carlos alluded to, we are going to size up the box on our new design galleries to incorporate a retail presence of Big Style, Small Spaces.

Yes.

Second question, just on real estate, I realize that demand growth is a relevant metric, I guess.

It encompasses direct and other things.

But if you kind of take maybe a more traditional metric, just same-store sales and the retail box for the galleries that you have cycled, namely LA and Houston, can you give us some color on how those numbers tracked?

Yes, that's actually what Carlos is referred to, Matt, is basically the demand at retail.

Yes.

Normally, you would see complete correlation, Matt.

And the main reason why I talked about demand is because we were comparing to a much smaller type of business.

So really, if you don't do it based on demand, you would get skewed on the delivery of product.

Shipments, yes.

At the beginning of that.

So same-store sales is pretty much tracking the numbers that I spoke about for each of those locations.

And to be clear, that demand growth is same-store demand, right, for the store.

So it's basically written business, if you will, as opposed to (multiple speakers)

Exactly.

Exactly.

Exactly.

(multiple speakers).

And that's a clean retail number.

That's a clean retail number.

Got it.

That's great.

And then my final question --

And actually, Matt, let me just add that if you add the impact that these galleries have in each of those markets, in our direct business, which was something that we were not counting on when we've made those decisions to invest in these full line design galleries, the impact is significantly accretive to each of those markets as well on the direct business.

Great.

And then my final question.

Karen, you spoke in your commentary on Q1 about SG&A trends improving considerably.

I just want to make sure that, are we thinking about versus the fourth quarter run rate versus the fourth quarter year on year?

In other words, do you expect to see a lot more leveraging Q1 than you saw in Q4?

I just wanted to get clarity on what precisely in that (multiple speakers).

It's the latter.

Yes.

It's the leverage.

We see the leverage in Q1 being better compared to what we saw in Q4.

Great.

Thank you so much, guys.

Thank you, Matt.

Daniel Hofkin, William Blair.

Good afternoon.

Very nice quarter.

Thank you.

Hi, Dan.

I guess just to follow up a little bit on maybe the intermediate term on the gross margin.

You know, you talked about the first-quarter outlook.

It sounds like that's kind of going hand in hand with the stronger sales, particularly in furniture.

As you get out to the year as a whole, do you expect the gross margin drag to be smaller than in the first quarter alone, given that you were sort of --

Yes.

Completely.

That's exactly what we expect.

We see opportunities as we go into the second half of the year for a significant improvement over the trends that we saw.

Not necessarily up year-over-year, but you are saying a smaller rate of degradation.

Right.

Yes.

Got it.

Okay.

And then --

Meaningfully smaller; a fraction of.

Got it.

And then I guess just on the real estate front, maybe if I could just ask about the Chicago market.

I noticed a couple of the locations -- the smaller locations have closed.

Is that just sort of in preparation for an eventual large-format gallery?

Or what's sort of the specific strategy there, if you can share that?

Yes.

Dan, this is very similar to and consistent with how we have approached every market.

You know, every time that we decide to close a location, it's based on that one investment position.

And so if we decided to close it because there was a significant return opportunity in every case.

But that being said, you are absolutely right.

We are searching for the appropriate location to represent us in that market.

And it's a big market for us and a great opportunity for a full line design Gallery.

And we have been negotiating and talking about one specific location that we are very excited about.

Great.

And then, I guess my last question relates to the new store performance.

Is there anything you would call out in terms of -- you know, is it certain classifications; certain collections of furniture that are driving especially good upside so far in the, I guess, the three newest stores?

You know, what I would say is -- and I think it's something that we said before.

If we continue to confirm every time that when the product is displayed at retail, we experience that [sale lift] in the 50% to 150% range, and that is consistent.

And, of course, these full line design galleries are displaying much more of our assortment, and that is how we are seeing that significant lift.

And that has been completely consistent in every one of these locations.

We have been really surprised in a great way with that Scottsdale just delivering some amazing numbers.

And we continue to build -- you know, the two locations in Beverly Boulevard and in Houston, just continue to really accelerate relative to the rest of the fleet if you exclude full line design galleries, even on the second anniversary.

So it's all great.

Like Gary said before, we do see an opportunity to really represent more of the assortment and we know that that's the way to win.

All right.

Thank you very much.

Thank you, Dan.

David Schick, Stifel Nicolaus.

Hi.

Good afternoon, and congrats on the quarter and the continued strength.

And I think I have to just, for sake of comedy, there is something profound about Baby & Child being in its infancy, right, that we talked about.

We like to think that it's poetic.

I think we've got our title starting to form for the note.

So if we could go -- sort of think on a comp basis, you've got a lot of comp drivers, but how much is new customers -- you know, you talked about growing your catalog a little bit, but new customer versus existing customers growing their business with you?

If you could talk about that, and then sort of overlaying as well transaction count growth versus the size of the transaction, or you know, it's per transaction, or however you think about it?

Clearly, we are selling more to our existing customers and as we expand the assortment and we move into new categories, so we would expect the majority of Tabletop to sell to our existing customers we who haven't been in that category.

Same with Objects of Curiosity.

Same with where you are seeing the growth in outdoor or Baby & Child or even in our existing furniture lines.

I think the addition of Small Spaces starts to open up a new market and makes our brand even more accessible.

And that's why we are so excited about the Small Spaces concept into a retail format because, if you think about it, you've got a couple of ways to make the brand more accessible.

One is, we make the product smaller.

There's less input costs into the product, so it's going to have a lower retail, but also shipping it here, you get more in a container so that gives you a low retail.

So we are not taking any quality or any design out of the product.

But by sizing the product differently, we believe that's going to open up the market, not just from a youth point of view, but from an accessibility point of view.

So we start to see how that is opening up the market.

And then the other key part here.

One of the hardest ways to grow a business is just through a direct channel as far as awareness, right, because the deeper you circulate, the more expensive it is.

And it's hard to hit those targets.

The best way, once you have a proven format, is to put that assortment into the retail channel and make it accessible and make it visible.

So the biggest opportunity you have here for new customer acquisition is really by transforming the real estate and opening the new galleries.

And that, by far, is going to be the biggest deal in this Company.

I mean, we are going to see really good growth.

We are excited about Tabletop.

We're excited about Objects.

We are excited about many of -- whether it's expanding our rug business with Ben Soleimani, or that -- the shade and window blind business.

And we have many more bullets loaded in the gun that you'll hear about coming down the pike.

But the big deal here is that, as Carlos said, if you really looked at this assortment, if you look at the six titles, 1600 pages, and you put that assortment into the retail marketplace, it changes everything.

And that is the key.

You know, we have spent years building this assortment.

We have spent years editing it, figuring out how to present it in the direct channel.

And now we have proven that we can put it into the retail channel and see returns that are multiples of our current real estate locations at an occupancy cost level that is significantly lower than our current locations.

And the other thing I did say, and I want to reinforce what Carlos said.

The fact that -- and this just happened in the latest quarter -- that we have now found ourselves in a position to actually cut what's called anchor tenant deals.

For someone like Carlos and I, who have spent our careers paying mall rents, and this is nothing against our landlords who rent any of the shopping centers that might be on this call, but we -- this completely changes the game for us.

It changes the game for us from what we had previously thought were going to be the rents we were going to be paying in the model, which was going to give us a great return.

And now we are seeing significantly different rent deals which allows us to size up the box and put sales Big Style, Small Spaces out there, to put Baby & Child out there, and not in 2000-square-foot footprint, but in a 6000- or 7000-square-foot footprint, to add more categories and more of our assortment in the marketplace.

And do it on significantly less rents and significantly bigger tenant improvement -- tenant allowances.

We thought we were going to have to go off the mall to get these kind of real estate deals.

The fact that we can stay in the mall -- the fact that you're going to soon hear about a location where a Saks Fifth Avenue is vacated and we are taking a Saks Fifth Avenue and facing the street, and many other locations like that, completely changes the game for us.

So we couldn't be more excited about what's going to happen here as you think about the accessibility and the impact and how customers are going to perceive the brand.

You thought we were excited about Houston.

Wait until you see what is coming next.

Well, thank -- just to -- that's very helpful for me to think about it.

It sounds like you're saying the business today is being driven by more -- really more your existing customers growing and what they're buying.

And it's mixing towards a more even mix you grow your footprint and accessibility.

Is that the right way to think about it, then?

If we grow our footprint I think we are going to (multiple speakers)

I mean, change the -- (multiple speakers) yes, change the (multiple speakers)

(multiple speakers)

The one thing I would add to that, David, is that, you know, like Gary said before, you know, we made a significant investment in the circulation and went significantly deeper this past year.

And so we are talking to new customers as well and we are seeing that the impact on the return on that investment is very desirable.

And on the comp, you might as well hear from all of us.

This is Karen.

On the comp, the other thing I would add is toward the latter part of 2012, we saw an acceleration in the impact that our interior design service at having on our comp, where we are now having more and more designers in our stores.

We closed the year with 39 designers in 25 of our galleries.

And those individuals are so much more productive.

And they have a longer relationship with these customers, and more and more customers are coming and shopping for multiple rooms in their home over time.

So we are really pleased with that initiative.

And by the end of 2013, we expect to have these services available in all of our galleries.

So we think that is going to be a good driver for comp in the future as well.

Thank you so much.

Anything you would share, then, on average transaction size growth or is -- anything like that, any metrics?

Not at this time.

We are not going to show those.

Okay.

Thank you.

Neely Tamminga, Piper Jaffray.

Great.

Good afternoon.

And let me also add my congratulations to the team.

Thank you, Neely.

You bet.

So I just wanted to get some just clarity around, particularly the Big Style, Small Spaces and Tabletop.

Gary, is there currently right now in all galleries -- all 73 or so of them, representation of some form of the edit of this product in stores, or just the 25-ish or so?

I mean, I'm just trying to get a sense of where it is (multiple speakers).

You know, Small Spaces and Tabletop, there is no assortment out there.

There's a little bit in the second floor in New York for -- (multiple speakers) yes, in the basement.

Like, there's basically no representation of Small Spaces in the Company.

And then, also, Tabletop, the book is just getting ready to drop and the product will be rolling out to retail stores over the next several months.

And as it is tested and we get more clarity how it's performing, we will make bigger investments into the retail presentation.

By the end of the year, would you expect at least maybe 10% of the galleries to have some form of an edit or 10% of the product to be in all the galleries -- something to that affect?

Not in Small Spaces.

In Tabletop, I would say, by the fourth quarter we will be in all galleries with Tabletop.

Okay.

Excellent.

Excellent, excellent.

Okay.

Cool.

Thank you for that clarity.

And then, just a couple more questions here.

On outdoor furniture, I know that Minneapolis is not the center of the world, but I am currently staring at a snowstorm today.

Just wondering, and somewhat emblematic of what we have seen across at least the Midwest for most of the spring, could you comment as to how outdoors performed for you guys?

And then whether or not Q2 contemplates -- or Q1 and into Q2 contemplates some sort of acceleration in that business for pent-up demand?

Just help us understand the importance of outdoor.

Yes.

Two things.

One, our outdoor business is positive year to date and we are happy with the performance of outdoor.

The -- One of the things that -- it's -- if you think about our limited retail space, a lot of it deals with not only the time when we drop the book, but when do we switch out indoor product off the floor and put outdoor product on the floor in our retail stores.

And we have been studying that art, if you will, carefully.

And we have purposely left indoor product on the floor longer this year because we believe we have a better arbitrage in that.

And so we are just now going to start -- you're going to start seeing some outdoor furniture on the floor in the retail stores.

But we are excited about our assortment.

We think we have one of the coolest new collections.

Our Aspen collection, which you'll see in the front of the book and across the magazines, designed by Soren Rose from Copenhagen, is I think one of the most innovative outdoor collections.

It's really viable for mountain homes in places like Aspen and Sun Valley and lake cabins and things like that.

And we've done a lot to outdoor and expect a very good season.

And what I would add is, I think you have probably heard the comment that Karen made that the books are dropping later than they were a year ago.

And that also includes outdoor.

So the fact that the business has been tracking so strongly relative to a year ago with that change in our strategy, I think is pretty meaningful and significant.

That's an excellent point.

Thanks, Carlos.

And then, I just have two follow-up model questions for you, Karen.

First, did you specifically give -- unless I missed it, did you specifically give where that circulation plan is this year relative to last year?

I know you guys made a significant investment in last year, but what is the 2013 circulation plan?

We are not sharing the specifics of that.

I just will say that we do kind of optimize that and see leverage in 2013, but we are not really guiding to a specific ad cost or numbers or percentages.

Okay.

And then in terms of depreciation, did I miss that number?

Have you given some sort of depreciation guidance for this year and for the quarter?

We didn't give that, but I'll just say planning it roughly similar to what we saw in 2012 would be a good estimate.

Similar -- you mean by rate or the actual whole dollars?

Could you clarify just a little bit?

The rate.

Okay.

Thank you very much and good luck, you guys.

Thank you, Neely.

Matt Nemer, Wells Fargo Securities.

Afternoon, everyone.

Sorry for the background noise.

So I just wanted to follow up on the full line design galleries that you're making larger in terms of Small Spaces and Baby.

, offset by the anchor tenant deals that you're getting.

How does that impact the returns and the payback on this next batch of stores versus the math you provided in the IPO?

Well, when you think about the next batch of stores, we have a couple of deals that we did prior to some of the things that we learned recently.

But all are what we call our accretive deals versus our current performance and the performance of the current fleet.

So, if you think about things like Greenwich and Atlanta and so on and so forth, some of the deals that are in the pipeline, I'd say those are models more towards the guidance that we gave at the IPO.

And then, many more of the deals that you're going to see happening, obviously with the expectation -- with the exception of things like New York and some major metropolitan areas where -- you're not going to go into a mall in Manhattan.

But we expect the majority -- vast majority of the deals going forward to be accretive to the expectation that we laid out at the IPO.

You know what I would add, Matt, is that there were a few things that were very different when we were doing the roadshow when we talked about this topic.

And I think the good news is that all the changes are more positive and beneficial.

So the first one is, the fact that at the time we had some expectations about the performance of the full line design galleries, which we have been exceeding pretty handsomely, actually, in the ones that we have.

So that is definitely impacting our returns in a positive way.

The second one is that we have anticipated or planned that our total occupancy costs were going to be similar on a per square foot basis to what we were paying.

That's the way we modeled our financial plans.

And what we are seeing now is with these anchor tenant deals, that we can see a pretty significant improvement over what we were paying.

So that is the second big thing.

Combined with the capital utilization which we, again, think that could be a big positive.

The fact that we are dedicating more space to this category, as Gary mentioned, it's all good news.

We see, based on our experience in Baby & Child, you know we -- Gary mentioned the Santa Monica location.

I mean, it's delivering some pretty impressive performance.

And we know that every one of the markets where we are planning to open a space for Baby & Child are markets that are doing very well with the direct business for Baby & Child, so we already have a test.

We know what to expect, and it has worked in every market where we did open Baby & Child.

And we believe that Small Spaces is a big opportunity, as Gary said.

So we haven't redone the numbers in terms of what to expect, in terms of return, but it's going to be better all around.

Great.

That's helpful.

And then, just secondly, in terms of services, you mentioned that you ended the year with 39 designers.

Where can that number go by the end of this year and just over time?

Does that go into the hundreds or just give us a sense for how big that fleet gets?

In order to be present in all 70 galleries, like Karen mentioned, you'll be looking at a number in the 90s.

Okay.

And then, lastly, I know it's pretty early because it hasn't been online that long, but any early read on Tabletop and just early read from what customers are kind of talking about and blogging about?

Thanks.

Yes, and you know it's too early.

And the books are really in home yet.

And we went online with the books and we have gotten some -- the comments are positive, like in -- generally there are.

I mean, people are enthusiastic about it.

That's great.

The first few transactions around Tabletop, we are seeing people buying not just items, but buying full collections -- outfitting a second home.

We are very, very encouraged by it.

I think if you take our Tabletop book and you try to take other -- look at anybody else who's got tabletop in a catalog, and just put them side-by-side on a table, I think it is a completely different presentation and assortment of how tabletop is represented anywhere in America today.

And we happen, [biased], think it's better.

Our people are excited about it and we are positive that -- relatively positive that we are going to happy with the outcome.

I think that you could say the same thing with Objects of Curiosity.

If you say to yourself, where do you buy product like that; where to present it in a way that you can understand it, does that category even exist in the marketplace today, I would argue that the category is not really merchandised anywhere in a meaningful way and that we are almost creating a new category with Objects of Curiosity.

And I don't know if you guys have gotten the books yet or if you have seen them online, but, again, these are businesses.

When you think of Tableware and Objects of Curiosity, these are products that our customers need and want.

Right?

You know, need and want.

You need to finish accessorizing your home.

You need tabletop in every one of our customers' homes.

And they want the level of quality, the level of taste, and the level of style that we provide.

We have proven that in other categories.

So logic says, survey says, should work.

But we don't have any real numbers to get out there and get too enthusiastic, so this is our tempered enthusiasm.

Thanks for that detail and congratulations on a great quarter.

Yes, thank you.

Peter Benedict, Robert Baird.

Hey, guys.

It's actually [Justin Claiborne] on for Pete.

Thanks for taking the question and congrats on the quarter.

Just in terms of the books dropping later, was that an internal decision on the part of you?

Or is there some other rationale behind it?

Is it just lead times associated with the new assortments or something else driving that decision?

It's a combination of things (laughter) that we felt that there was optimal way to maximize our business and lots of efficiencies in the way we did it.

So -- but listen, we learn all the time here, right.

So we are constantly fine-tuning and tweaking.

And, like I talked earlier about the arbitrage between indoor and outdoor furniture, there's a lot of things you can fine-tune here in the direct business, in the direct model and this is one of them that we are testing.

I would add that this was a strategic decision that we are very happy with the decision we made.

Let me put it that way.

Okay.

Thanks.

And then, Karen, just on the gross margin, going back to the fourth quarter, could you discuss the impacts from product margins, supply chain costs and occupancy, maybe perhaps in basis points or at least relative magnitude?

Yes, we are going to -- when you think about those three components that we've been speaking about in the past, the product margin, the shipping costs, and occupancy costs, the product margins and shipping costs are impacted by the mix.

And they really do vary based on the timing of new product introductions and seasonality.

We are not going to be giving the same level of detail that we've given in the past, down to the basis point by each area.

And then the occupancy cost leverage is going to fluctuate from period to period.

And in Q4, as I mentioned, we did have investments.

And, frankly, in 2012 and then going into 2013, we expanded our -- we'll actually have a new Baltimore furniture facility and we expanded that another 600,000 square feet in Q4.

We have an Ohio shelf stock facility that we are expanding coming in the 2013 year, and another DC in Dallas that we are opening that really are critical investments to support our growth, and a lot of the growth that we see coming and being sustained.

So the timing of those investments are going to change the timing of the occupancy leverage that we see over time.

For Q4, specifically, again, we don't want to get into a lot of the details.

But I will say that the product piece of that was less than what we saw earlier in the year in Q3 and then the occupancy was less.

So the magnitude that you saw in some of the earlier quarters with big swings one way and big swings the other way, we still have some of those offsetting factors, but they weren't as great.

Okay.

Appreciate the color.

And then, just lastly, on any closings we should expect throughout 2013?

I think you only have the one full line design gallery planned in Indianapolis, but just any visibility on additional closures?

Yes, well, as you know, we closed the two Boston locations that we had this year, right.

That happened in the first quarter.

So when you think about store activity, that is going to impact and that.

And depending on when we open Greenwich, that could trigger the closure of the existing location or not.

We are still thinking about those things.

We also closed one store in New York in January.

All right.

Thanks, guys.

Best of luck.

Thank you very much.

And, ladies and gentlemen, that is all the time we have for questions today.

I'd like to turn the call back over to Carlos Alberini for some closing remarks.

Well, thank you.

So in closing, we are very confident and excited about our strategy.

We have a disruptive and very powerful business model and we believe that we will continue to drive market share gains.

In addition, we believe that we are in the very early stages of our real estate transformation.

And we see significant opportunity to unlock the value of our assortment, which I think is absolutely dominant in the marketplace.

We have invested in our infrastructure to support future growth and we are well positioned for operating margin expansion as we look into the next few years.

Thank you all for taking the time this afternoon and we look forward to sharing our progress with you next quarter.

Have a great evening.

Ladies and gentlemen, that will conclude today's conference.

Thank you very much for joining us.

And you may now disconnect.

Have a good day, everyone.