Earnings Call: Q3 2016

Dec 10, 2015

Good afternoon. My name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the RH Third Quarter Fiscal 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. And I would like to turn the conference over to Cameron McMossland. Thank you. Good afternoon, everyone. Thank you for joining us for RH's Q3 fiscal 2015 Q and 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, ir. Restorationhardware.com, highlighting the company's continued evolution and recent performance. Before we start, I would 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 statements about the outlook for our business and other matters referenced in our press release and video presentation issued today. These forward looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward looking statements in light of new information or future events. Also during our call today, we may discuss non GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non GAAP financial measures and a reconciliation of these non GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir. Restorationhardware.com. With that, I'd like to turn it over to the operator to take our first question. Our first question comes from the line of Peter Benedict with Robert Baird. Hey, guys. Thanks for the question. I guess my first question just quickly just looking at the Q4, you've got the revenue guidance up obviously, but the earnings guidance was held. Just curious what was what's affecting the flow through there relative to your previous expectations? That's my first question. Yes, this is Gary. Let me try to take that. I think that the way we think about the business is every quarter, especially Q4, always requires some level of recalibration versus our plan. And that's because the environment is forever changing. The economic environment, the competitive environment, consumer trends preferences, so many things. And we believe our success is based in our ability to improvise, adapt and win. And winning to us, if you stand back and as we've articulated, I think in past conference calls in past quarters, is about 2 things. It's about gaining share and optimizing earnings. It's about 2 lines in the P and L, the top and bottom ones. And as we've said, every other line is a lever and creates optionality and opportunities to win. So when we have looked at recent data and said, what's different? What are we seeing and what are we learning and how are we improvising and how are we adapting and how are we going to win? There's a few things that are different and there's some new data that's affecting our thinking. Some of the things that are created kind of inside the company that we have more control over, shorter term and longer term, some outside the company that we're evaluating and figuring out how to adapt our plans accordingly. So there's a few things that are different from last year. I think Karen alluded to some in her script, but in the video. But one, I think we've mentioned that our circulated pages in the spring books are down year over year and pretty meaningfully so. And I don't think we've communicated this before, but if you just stack the spring books last year versus the spring books this year, you'll notice that the pages are significantly lower and the circulation was slightly lower this year. And our data indicated that we could significantly reduce our pages circulated without meaningfully impacting our top line. So we had in the spring versus a year ago, 60% less circulated pages. That's a meaningful move. And as we've watched it throughout the quarter, our sense is the new data would suggest that as the books from last year built, our ability to comp that build the way we thought, we were a little off in those projections. So we've got a bit of pressure that you saw at the end of Q3 and some projected pressure into Q4 depending on how the newness comes in with modern and so on and so forth. And that's the next point I'd make is the majority of our newness this year is tied to modern and teen versus a year ago. So you've got significantly more newness kind of building earlier in the year, a lot less circulated pages and less circulation in our attempt to optimize our model. And we are always, as you guys know, testing and evolving our source book strategy and our marketing strategies here in trying to find the most optimal way to go to market with our business. And so we have a difference in the newness cadence year over year. And then our modern book, I think if you I think we started the year telling you guys we're going to launch a modern book that was going to be in about the 300 page range. And then I think we told you it was going to get the 400 or 500 page range and it ended up at 5 44 pages. Yes, 5.40 pages. And because the book came together and many good ideas came together somewhat late and we thought they were very important. We delayed the book a few weeks against our forecast internally. And then because the book was significantly bigger, it took a couple of weeks to kind of get through the printer and get through the mail system. So we lost about a month in general from where we thought the books were going to be. So that was different and that kind of affected our top line trends, especially coming out of Q3 and early in Q4. And then there's a few, what I call, macro regional factors that I think are important ones. And I don't think you've ever heard us talk about the weather before, and I'm not going to talk about the weather. But there are some meaningful things that I think everybody has to have on their radar today because they're the kind of things that could shift your business and change economic conditions and you could place bets incorrectly if you're not careful. And here's the things that we're seeing and the data that has changed from path 1 to Q3 and we see the trends in Q4. In areas where the economy is more dependent on oil and natural resources, such as Texas, such as Canada, and you can even throw in there Miami and parts of Florida because they're affected by South America. And I don't know if we've communicated this before, but we ship a third of our business in Miami is shipped to South America. And I'd say an even greater amount of our business in Miami and in parts of Florida is influenced by South America because not all the product we sell to South America leaves the country. A lot of it is people buying homes in Miami and condos and so on and so forth and we're furnishing those homes. So when we look at the kind of the areas that are affected by oil and then also doubly so with Canada and South America, you're affected by exchange rates, right? If you're looking at your spending power, if you're Canadian, if you're South American versus U. S. In exchange rates, you're meaningfully less wealthy. You're getting a lot less value for your dollar year over year. So when you take just those three areas, when you take the Texas market, specifically Houston, which is being impacted the most, when you take kind of the Miami market and you take the Canadian market, which are all very important markets for us. In the first half of the year, they were pulling down total company sales a little under 2 points, okay. And at that point, we knew it was a drag and it wasn't mean that those markets were 2 points lower. Those markets were meaningfully lower. They are pulling the whole company down a little under 2 points. In Q3, that accelerated to 4 points. And that's meaningful, right. It's not just meaningful, but I'd say it's meaningful to anybody who's thinking about what the U. S. Economy ought to look like and how we ought to think about it. It makes me think, hey, should we be calling Yellen and the department is saying, let us tell you what we're seeing. Because those things from my point of view, and I don't mean to make anybody panic, but it's important that how we look at those, these are important markets and markets that are connected to other markets. Miami is connected to New York, so on and so forth. A lot of the investment that's happening in Miami is connected to New York. So we sit here and we say, wow, one, it was dragging down the company 2 points, now it's dragging down the company 4 So what do you do about that, right? Do you just swallow? Do you just say, just button down the hatches? Or do you say, how do you play the game differently? And how do you win in changing conditions, because you can either be a spectator and be on the sidelines and just report that that's happening or you can decide to get in the game and be a participator and do something about it, right. And we have a bias for action in this company. We're not good spectators, but we're really good participators. And so we think that that's a dynamic that has to be watched and that's a dynamic that has to be reacted to, assessed and reacted to. And so we've changed our game plan because of some of those things. And then the other thing that we've seen and look, I think we all today the great thing about email is we all have access to customers and we can promote and much more flexibly and much more cheaply than ever before. The other thing is you can really see what your competitors do and You don't have to walk every mall to see what posters they put up in their windows or what they're doing, right. And all the analysts on the call and investors on the call, I'm sure you all have some sort of tracking that says what are people doing this year and what people doing last year and our promotions up year over year and so on and so forth. And look, many of you guys all pointed out last week that RH ran a big promotion. Got it. We weren't trying to be shy about that, by the way. But one of the things that's happening is, we track all of the competitors' promotions and we know what everybody is doing just like you do. And we've noticed that there has been an uptick in competitive emails year over year and you have to be you have to look at the details to really get it sometimes because if you're discounting emails, you're going to miss it. If you're just looking at the generalities in the emails, you're going to miss it. And many of the people in our industry today are sending multiple emails and there's multiple messages and there's multiple promotions being stacked on promotions. And when we look at the data internally, it is the most promotional environment we've seen meaningfully so. And it doesn't matter if you're looking at what and by the way, and then there's new players that are bringing a whole new dynamic to the marketplace. Tell the team like, look, I don't care if it's who it is, whoever is selling goods in our case, right, that's coming in, whether it's an online player, you can't ignore someone like Wayfair today. They're doing big volume. They're not making money, but they have cash flow. And the last thing you want to do is you want to let yourself get Amazoned by somebody. We're not going to allow that to happen. We're going to figure out how to play the game to win. If you look at the promotions from everybody from Ethan Allen to Our House, to Pottery Barn to West Elm, and you can say are they all who's the direct competitors, who's not? At holiday time, if you've got stores in retail districts or retail malls and there's thousands of people in those malls and you're not doing something to maximize share, then you're a spectator. And so we've noticed a more aggressive promotional stance from all of the people I've mentioned. And we've stood back and said the combination of all these factors I've articulated, whether it's we pulled back and circulated pages and so on and so forth. And by the way, a lot of good things have happened here. I'd start with the headline, operating margins in RH in the Q3 up 180 basis points over last year. Find me another person in our sector that can say that. So there's a lot of good news here. But if you want to know the details of how we're playing the game and how we're playing to win, there's a lot of moving part and I'm just giving you some headlines. There's many other things. There's a 1,000 moving parts in a company like ours and you're always looking at every piece of it and every line and every lever and every opportunity. But when we step back and we kind of take it all into context, we say, how do we want to play the game? That during Q4, when mall traffic is seasonally high and our home furnishing peers are aggressively promoting their business, We're making moves to optimize both our top and bottom lines and to take share, period, right, and to optimize earnings, period, right. How it landscapes and Karen kind of alluded to the landscape maybe differently, Quite frankly, as the CEO of this company, I'm kind of indifferent how it landscapes. What I care about is what is the outcome and what's going to create the most value. And our belief is taking share, okay, our competitors can't get it back. Taking share is important. There's a reason why Amazon launched Black Friday before everybody else in the world, right? There's a reason why we launched the promotion we did last weekend. It was to take share that there's consumers, there's shoppers and we're going to try to take share. And so in the sense of that, that's the way it summarizes it. It's kind of a maybe a long piece, but I feel I felt like, look, we knew it was going to be the big question. We the landscaping is different. The numbers may not all add up if you look at it in a traditional way. I think this is not a traditional time. I think this is a very unique and different time. I think it's time where you've got to pay attention to all the details and you've got to worry about everything. So because these are the times when you don't quite frankly, something changes in the economy, something changes in the competitive landscape and you wind up with on the short end of the results. So we think our results are going to be the winning results in the industry. We think our results in Q3 were the winning results in the industry, and we think our results in Q4 will be the winning results in the industry. And our next question comes from Jessica MACE with Nomura Securities. Hi, good afternoon, everyone. And thanks for all the information, Gary. I guess to follow on some of the things you said about the environment. I was wondering if you could maybe give some specifics on what's giving you the confidence in Q4 to increase your revenue guidance range even despite all the factors you named like the oil and the later source book? Sure. Because as of today, we are ahead of Q4. That's why. All right, great. And then just secondly, you gave some good information on the success of the RH Modern standalone store in LA. And I was wondering if you if there's anything you could share about maybe some other plans to roll out formats like that? Yes, we're really early in a lot of the data. I think as I said in my script, the level of innovation we've just unveiled in such a short period of time is really unparalleled in our industry, if you think about the last 3 months, right. We've introduced 2 new businesses, one of which appears to be significantly incremental with the first store. We've opened trending to do $25,000,000 in its 1st year. By the way, that's the first time in my career that's ever happened. I've never opened a new test store that tracking to do $25,000,000 in its 1st year. By the way, the customer doesn't know that much about modern. This is just our initial assortment. This is just our first book that we ran. We are going to learn so much here. The assortment is going to get so much better. The investments we'll make here and the knowledge we'll have here to think that we're doing $25,000,000 in our 1st freestanding standalone store in Los Angeles. And by the way, the store that's 3 blocks away that we thought we'd have some cannibalization in is up more than double digits. To me, it's phenomenal. And when you look at the numbers inside of the stores, we've got a Flora Modern and it's adding at a minimum incremental incrementally in the new galleries, 40 points or more, really, really terrific. So but early, I mean, we're not in stock, it's an initial assortment, Vendors are ramping up. There's so much to learn here. It's so early, but really great news, right? And then we have 4 new distinctively different new stores that are intended to be tests and provide data to enable us to access future opportunities and sharpen our strategic decisions. And so far, every one of them is performing beyond our expectations and gives us great, great confidence about the long term strategy of this company, which if you just take the 2 big pieces I talked about in the video, The expansion of the brand, which is tied to modern and teen and multiple other new things that we have in the works in the pipeline for this year that we haven't for next year that we haven't announced yet and following years. We are, I'd say, from a long term point of view, on track plus, right. And you look now at the 3 new next generation design galleries, all slightly different, all intended to teach us something unique and different, whether it's how we perform as an anchor tenant in a major regional shopping center, how we could perform as a freestanding store, how we perform in a secondary market with slightly lower model and lower investment piece, how we what happens when we add hospitality to one of these big environments, on and on and on, so many new tests. First time we've integrated baby and child and teen into the stores. First time we've integrated Modern into the stores. Yet to put Modern and teen into Atlanta, but now we feel we were already outperforming in Atlanta. You put modern teen in Atlanta, the numbers look different. You look at kind of what's happening with Chicago and you step back and say what's different about Chicago. It's our best performing gallery. I would tell you highly debated real estate deal, probably the most debated real estate deal in the history of our company, in the history of our Board of Directors, right, because people thought like you're going into a residential neighborhood, there's not a retail store for 5 blocks. Are you guys crazy? And we thought like, look, there is an opportunity. It was a good economic deal. We could test to see if we could be a freestanding location. And if we could, we'd be more desirable. We'd have more optionality to places where you go. We'd also be more desirable and more valuable to developers. But I think you just have to ask yourself, what's different about Chicago, right? Like why is it the best performing gallery? Well, there's 2 things, right? 1, the gallery is located in a residential neighborhood, not in a retail district or center. I don't think that's why it's the best performing gallery, okay? But the second thing that's really different, the gallery has our first foray into hospitality with the 3 Arts Cafe, right, which happens to be just on its own a highly successful F and B operation. With the annual volume, everybody said don't tell anybody this, but it's tracking, I'll tell you, with an annual volume tracking to do $5,000,000 per year. There's not a name on the outside of the building. We didn't advertise the restaurant. The restaurant closes at 7 to 7:30 at night because we got a curfew agreement with the neighborhood. We don't everybody said you can never be successful, you don't really serve dinner. We're not serving hard alcohol. That was a big debate. Everybody says you can't have a restaurant without hard alcohol. It's a third of the business. Yet you saw the picture of the line outside, right, line outside every weekend. And just as a standalone, we've got a $5,000,000 restaurant. I think the questions to ask are these, Is the restaurant successful because it's in an inspiring store? Or is the store successful because it has an inspiring restaurant that's driving more traffic? Or is it both? And we've created a unique and highly accretive experience where each amplifies the other and you've got a whole new layer to the strategic view of what design gallery performance can look like long term. So there's from my point of view, there's so many things that we're learning. We've got so many new tests. But in all from a strategic view, it couldn't look any better today. From a tactical short term view, right, is every Q4 a war? Absolutely. Do you have to in this business, can you not pay attention to all those little things and you got to be ready to fight the fights, you got to be into the details. And if you want to win in Q4, you got to be highly engaged and you got to be willing to improvise and to adapt. And so that's the whole thing in a nutshell. I'd say, look, we won in Q3, landscaped a little differently, earnings were a little better, top line is a little softer. I think you got a flavor of why the top line was softer and what we're doing about it in Q4. So in Q4, top line might be a little higher, right? Flow through might be a little different. But the thing I'd focus on is 2016, right? Because I sit here and I look at the team and I say, guys, we launched Team, we're really happy, okay. We've launched Modern, I've never seen anything like it, okay. I've never seen anything come out of the gates like this ever, okay. Never opened a $25,000,000 store, I mean, in 1st year trend. And then I look at the performance of these new galleries and the dynamic of hospitality, the dynamic of having Modern in these stores, baby child team and think like do we add hospitality to other galleries, is there another lift? I think strategically in 2016, you think about the 50 to 60 months against 20 months, you think about what we got into the pipeline and other things we haven't announced yet. I think we strategically today are the best positioned we've ever been at any point in time in our history. Your next question comes from Daniel Hofkin with William Blair and Company. Good afternoon. Thanks for all the color so far. As it relates to kind of the 3Q upside on earnings despite the revenues and then 4th quarter different flow through, is merchandise margin a key swing factor there because of what you're seeing in promotion or is there something else in terms of like other expenses that are maybe the timing is shifting a little bit? That's my first question. Yes. So in Q3 on gross margins, this is Karen. Hi, Dan. Hi. We gross margin was right about where we thought it would be. And overall on operating margins, we're really happy with the expansion. A lot of that was coming from the advertising leverage that Gary talked about. On the gross margin there's a couple of different moving pieces. We did kind of talk about that we had these non comp warehouse sales that are mixing in a little bit lower, but our the improvement in our core margins was quite well. So we're very happy that our core business is performing like we want it to. We did have higher shipping costs and deleverage in the new DC, but we continue to see leverage in the rest of our supply chain network and retail occupancy. And when we head into Q4, as Gary mentioned, we are going to be playing the game a little bit differently. We do expect to have some pressure on product margins with the promotional activity, but we still expect to see good leverage in retail occupancy and those things. We will have higher shipping costs. That's the overall we think that negative gross margin of 50 basis points is going to accelerate and have further deterioration in Q4, but overall still expect obviously you can see in our guidance really good operating margin leverage in the Q4 and then to round out the year. Can you quantify kind of what you're thinking about in terms of the gross margin for the Q4? Yes, we think it will be about 100 basis points in total for all those factors. The 2 biggest being a little bit increased promotional activity and higher shipping costs. Okay. And then as it relates to were there any executional aside from clearly the bigger book and everything, but was there anything that you felt like it sounded like maybe you felt like in hindsight you cut back too much on circulation, but anything else that looking back, obvious things that you would have wanted to do differently? Yes, I'd say we probably were too aggressive with circulated pages in reducing pages circulated in certain categories and certain areas, certain products. And the good thing about that, we can increase pages circulated really easy, right. So I'd expect that you see a reverse of a trend of that next year. And we've got good data to tell us where to focus our efforts and how to think about circulated pages and circulation growth. But we thought this year was a year where we had enough data to say we can let's try to optimize this model a bit. Let's find out what's the operating margin look like, because we've been evolving here, we went from only 10 books a year to 2 books a year, 2 books to 1 book, books that were 200 pages to books that were 300 pages. I mean, it's like we've been innovating at such a pace that the ability to kind of continue to take the data and continue to learn and continue to optimize, it's just in our nature. So you'll see us continue to evolve and learn. And I don't think you ever get it 100% right by the way. But is this directionally right? Are we a company that's going to perform significantly better than anybody else in the industry this year year over year? Do we have the highest earnings growth of any of our peers? We do. And so when we look at the top line, the bottom line, the operating margins, how we're going to perform this year, we feel very, very good about it. I think from quarter to quarter because we have so many tests, so many things that we're doing, yet we're very scientific about by the way. This is none of it is back of the envelope. We're in here debating and reviewing these things and we have a lot of data that we're looking at. But you're never going to be 100% right on any of these. The key is, are you strategically right on most of them or all of them? And I'd say strategically right now, we're right on almost all of them. And that's why they feel more confident than ever before. Your next question comes from Bob Yagatch with Raymond James. Good afternoon, Carrie, Cameron and Gary. Thank you for taking my questions. This is Bobby filling in for Bud. Two quick questions for me. Karen, I was hoping for a little bit more color on the gross margin buckets for Q3. Can you help us parse out a little bit from how much was shipping, how much was from the DC and maybe a little color on how much was from the outlet sales? Yes, I'll just give order of magnitude. The non comp warehouse sales was the biggest drag, then higher shipping costs and then the deleverage from the new DC. So I'll give you order of magnitude. And then on the flip side, the improvement in the core product margins, excluding those outlet warehouse sales, was the bigger thing than even some of the leverage in the supply chain network for the existing DCs and in our retail occupancy, part of that just being it's a lower quarter. Okay. I appreciate that. That's helpful. You talked about at the Analyst Day starting to flex your shipping payment. You mentioned there was some room in there to help offset some of the shipping headwinds. Have you guys started to look at that or started to flex the cost yet? We haven't done anything in a meaningful way. And for others that we do think there's a lot of if you look at us competitively versus our peers, we are extremely competitive with the shipping we offer. We don't have a lot of surcharges or really many surcharges at all and our shipping program is just highly competitive. We think over time there's ways to optimize that. We don't have restocking fees as our peers do. So I think we're the leader in that space as far as the bargain to the customer, but is there a way to get in that? Sure. And with UPS, I think it's been widely known that they were increasing their parcel rates. We were able to negotiate some great benefit and how that was going to impact us and delay some of the impact of that and have taken up our UPS rate table slightly on a couple of the bands. Okay. Thank you. And then lastly for me, when we look at the Q4, it's great to hear that's already it's ahead of plans today. But when we think about the markets that you guys talked about, the Miami, the Houston markets that are facing the drag, what does your guidance imply for that drag in the 4th quarter? Is it staying the same as the Q3 at 4 percentage points? Or do you expect it to deteriorate a little bit more? It's about basically the same as it dragged in the Q3. And we have a good read so far kind of how it's trending versus the Q3, so far 4 or 5 weeks in. Thank you. That's very helpful and best of luck. Thanks, Bobby. Your next question comes from Brad Thomas with KeyBanc Capital Markets. Yes. Hi, good afternoon and thanks for all the color already. My question was going to be around Modern and I was hoping you could give us an update on how maybe from a tactical standpoint you'll start to get the product in more stores given how favorable the initial response is. And perhaps as we think after 2016, maybe you can give us a little bit more color on what kind of a lift it might be able to provide to the business? Yes, the first obvious one that Gary talked about on the video was that we do or I can't remember when we talked about this, but we do actually plan to get it into Atlanta. So that store is doing quite well and it doesn't yet have Modern and Teen. And then there's a handful of additional legacy stores where we think there could be a vignette and some space in those. But the bigger thing is the space that will be allocated in the new full line design galleries as we roll those out in each and every market. There's space as we've kind of long said, those galleries were being designed for what's on the come, not just the existing product offers. So modern has been part of that playbook and it has a nice home in the design of all those future galleries. And then I think we're going to we're not going to necessarily quantify the exact lift for 2016 just yet, but we do feel really good about based on the early reads, both in the markets where we have a real estate presence and the direct response that we're seeing. We think that's going to be even more meaningful as we get better in stock in Q4 and into 2016, where we think that's going to be a really nice driver for growth in the years to come. That's great. Thanks, Karen. And then with respect to the galleries, it's really a diverse and different type of store you're opening in many of the cases here. I was wondering how much you're able to apply the learnings from 2015 here to something as soon as 2016? And with all this that you're learning, how this makes you think about maybe the pace that the company grows at? Yes, I think that's something that we learned, I don't know, I'd say 2, 3 years ago, when we thought we were going to be opening 10, 15 at one point, we were out there saying we were going to open double digit number of galleries each year and we quickly learned that there's so much to kind of learn as we test different pieces, everything from how to structure the deals with percentage rent break points to just other different factors within those deals on the lease side. But then the execution, we've just gotten better and better on how we merchandise the stores and have a plan going ahead and then the the product offering the space allocation. And then even with this latest crop, as Gary mentioned, we have a smaller sort of mid tier market. We have a non sort of traditional retail mall location and then we're anchoring them all. So I think we're every single time we do it, we're testing and that's and then some things like the F and B experience, those kind of things we can apply pretty quickly, but that's sort of why we've backed off from the 10 to 15 and started kind of going at a more measured pace, because so that we can incorporate all those learnings. And thus far, we can there's even certain things we learned in Atlanta that could already be incorporated. There's things that we learned from Chicago that went into Tampa, just as we learn, we immediately apply it. Great. Thank you very much. Your next question comes from Oliver Chen with Cowen and Company. Hi. Thank you. Karen, we had a question on the revenue growth and kind of the comp versus total revenue spread. So for Q4, will it trend in terms of the low single digit spread? And then as we think about the dimensions of that comp, is it going to be mostly conversion and traffic led in terms of the comp on traffic versus ticket? So we don't guide comp nor do we really disclose traffic and ticket. We kind of always say that so far every single quarter that I've been here for the last three and a half years, we always generally see growth in traffic and ticket, which for us is average order value and number of orders. So I will just say those trends are positive. We expect them to continue to be so. On the comp versus non comp or total revenue growth, I should say, versus comp, that 3 point spread that we saw in Q3 was a little bit higher because we had the warehouse sales that I mentioned that we moved from Q4 to Q3. So that dynamic both had an impact on our margins, but it also made at least about a point of that growth is probably attributed to that and we won't have that recur in Q4. That said, the performance of the new galleries continues to just be quite strong and we're very happy with that and that's more of the volume in those new stores ships in Q4. We expect what had been a really small delta between those, it will stay in the 2 to 3 point range. The thing I want to make sure continues to be clear is that just when some of those new stores start to have great performance in the non comp bucket, things like Melrose getting into the comp bucket, Atlanta getting into the comp bucket, you're never going to have that many stores in the non comp bucket in any given year at any given quarter. Okay, thanks. That's really helpful. And then when we do monitor and we do think about how you're strategically executing on promotions and what's the best way to do this in a brand appropriate manner? Is it within certain categories or is it going to tend to be a whole store in terms of how you would like that to evolve over time? And Gary, in the video you mentioned home and hospitality. As the brand continues to evolve in terms of lifestyle, how does hospitality fit into the bigger picture? And what do you think about art and hotels and clothing in terms of how you're thinking about what RH means? I think that it's take the hospitality part, we'll talk a little bit of the other question. But I think when you think about building stores that are in the 50,000 to 60,000 square foot range and creating a destination, creating a sense of hospitality, it's no different than bringing somebody into your home, right? If somebody is going to visit your home, we've said we want to blur the lines between residential and retail and create spaces that are more home than store, if you will. Well, if you're going to have somebody into your home, of course, you're going to offer them something to drink, possibly something to eat and create a more engaging experience. And to us, it's about how do you create destinations that people can be immersed in the lifestyle, can experience it, that want to sit with it longer, that maybe we'll discover ideas or products. And I think that that's what we're seeing today in Chicago. So as I think about other things, they're just the things that complement that, I think, are pretty intuitive. We've integrated contemporary art into our modern stores. If you think about things, people may be responding to the fact that WWD ran an article on and focused on apparel. That was, by the way, an interview we did in our Modern Gallery when we opened. And it was supposed to be about RH Modern and somehow the writer decided to make about apparel when she told us it wasn't going to be about that. And I think everybody knows that we have a view that maybe long term there could be an opportunity in that side of the business. It's nothing that's on the front burner. It's nothing that we're even remotely working on with any effort right now. So I wouldn't think about that. I think about how you think about hospitality where when all of a sudden you take a store like Chicago and it's the least traffic store and all of a sudden it's the best performing store. I think there's something to learn there about hospitality inside a retail store and how it can be integrated and how it can be drive traffic at we are at the trend we're on today, which is trending to about $5,000,000 a year in the hospitality side in Chicago. We're feeding about 450 to 1200 people a day. Much of that traffic is incremental. And we think that, that is providing a real synergy to the experience in Chicago. And there's really something to learn there that we think is which we think is possibly a big opportunity when we look at it. Okay. And on the promotions front? All of it as far as promotions and kind of doing it in a brand appropriate way, I think we try to always do it in a brand appropriate way with whether it's our emails or kind our in store marketing. You don't see a lot of things on the street. You don't see I think we try and keep the messaging clear. But for us, we're very consistent with our promotional events that we run and we don't often deviate from those when we do and even going a little deeper than we do, we see a great response. So, we have a lot of high quality interior designers who work on projects for folks who have deep relationships with their customers and clientele. So I do think we have a way to execute in a way that is brand appropriate. Yes. And I think you have to ask yourself what's brand appropriate in the world of promotions, right? Like we are in a promotional environment in the world. I think it's kind of a permanent state of being. And I think it doesn't matter what where you are in the economic chain, people want value. And when you especially when you're buying high ticket. So I think it's here to stay. I think everything that we do is brand appropriate. I mean, you don't walk by our stores and see big sale posters in the windows. You don't see big sale signs anywhere. You don't see a source book that's focused on price, right. You don't see ads that are focused on price. It's really focused on design and we think about our business from a design, quality and value point of view. But you have to win on value, make no mistake. So you have to first win on design and you have to win on quality and then you have to win on value in that order and you have to win on all 3 if you want to have a customer. So there's constantly be different perceptions of what that value equation is. And we're going to always be evolving and always again playing to win. So but I wouldn't let one incremental promotion in the 4th quarter change the way people are going to feel about RH, right. I think about it more is RH's numbers at the end of the day better than the competition? Are they taking share? And are they growing earnings faster? And is this going to be a more valuable company? That's what I'd be focused on. We just beat our Q3 numbers that were on the street. We just guided up in Q4. We just told you we have exciting new businesses that we launched that are performing ahead of our expectations. And the new galleries, which by the way, many people couldn't wrap their head around the new galleries we were going to open a year ago, are the most exciting things in retail today, I believe. And they're all performing over our expectations. I mean, those are the headlines. Thank you. Really, really helpful. Happy holidays. Best regards. Thank you. Thank you. And your next question comes from Lorraine Hutchinson with Bank of America Merrill Lynch. Thanks. Good afternoon. I just wanted to follow-up on the out of stocks and modern and ask when you thought you'd be back in stock and if you think this will be a gating factor to the early success of modern in the first half? Yes. Look, it's going to build as we go. We've got a lot of new product, some existing vendors, some new vendors. With anything new, there's going to be a ramp up period. There's some things that are going to go right, some things that are going to go wrong. So we think the in stocks are going to improve every week and we'll continue to ramp and continue to be in better and better stock. I'd say despite the fact that the in stock position is not great today, the demand is outstanding. And you can only anticipate it's going to get better as our vendors ramp and everybody starts to get some time under their belt here with this new business and we continue to execute better. So but with any new business of kind of this size and scope, you're going to have a ramp up period. We're not making apparel here, right. This is much more complicated in making furniture. And let me just clarify, it's not that we were in and then we were out. It's really just a build of getting some of those initial products. So it's every week we get kind of more of the initial runs of things. And we certainly want to be conservative with how we buy the inventory. So some of it we started off with low buys or a lot of it we started off special orders so we could read and decide what to stock. So that percentage of in stocks will continue to improve gradually into the Q4 into all the through Q4 and then into the 2016. Yes. And then look, the best sellers in a new business are always going to sell out. And you're going to always have to respond and catch up with those. And we've got our share of those. So but I'd say it's kind of nothing that we don't have experience with, right. We've grown this business through the expansion of our brand. I think we've proven that we know how to do this. And we know look, the good news is supply chases demand. The most important thing in our industry is can you create demand. If you can create demand, you can get supply. The bigger issue is when you can't create demand. Thank you. Thanks, Frank. And your next question is from Michael Lasser with UBS. Good evening. Thanks a lot for taking my question. Gary, longer term, what gives you confidence that some of the exogenous factors that impacted the business in the Q3 and into the Q4 are not more longer lasting and not more just unique to this period? Does it put the longer term margin outlook at risk if the company has to be more responsive to the promotional environment and some macro factors, even as it's launching a lot of new products? I think that we've proven that we can navigate through those changing factors. I tried to put the factors into perspective with how we're playing the game and how the factors a lot of these factors have been there. Some look like they've gotten worse. But generally, I'd say, you've got to look at it both ways, right? We're being affected by certain things now. Oil is at the lowest price in and I can't remember when oil is at these prices. So that's there. At some point, you anniversary these things, right? So there's always pluses and minuses that you're navigating through in your business here. And there's always certain markets that are going to over perform underperform. But there's certain things that are happening today that I think everybody's got to deal with. And I think, again, whether it's how we're dealing with it, how competitors are dealing with these different factors, I think the key is, can you be honest? Do you see them? Are you creative enough? And can you think about how to navigate through whatever economic landscape in a way that you're going to take share and that you're going to win. And I think if you go all the way back to 2,008, when the economy blew up and if you think about where we were then and where we are now and how we performed in the worst economic downturn in history, I don't think we're facing anything like that. But we outperformed everybody by a long shot. I think the key is like is this company positioned strategically to win? Do we know how to win in the short term tactical moves that you have to make? And do we have a strategic framework here that is going to continue to build distance between us and other people that's going to continue to disrupt markets and take share? And look, I don't mean to make anybody too worried about this stuff, right? But sometimes maybe I tend to be overly transparent because look, we've got shareholders and supporters on the phone and I think it's important how we're playing the game. We can speak less about stuff and pretend like everything's just always great. I don't think that's the right way to build partnerships. I mean, I think we're we tell you when things are working, we tell you when things are not working, we tell you when we make changes, we tell you when the changes are working, we tell you when the changes are not working. And in aggregate, I'd stay focused on what is our performance and what is the outcome and then what's the strategic framework of this business look like. And I've I'll tell you what I said before, I've never felt more confident about where this company is positioned and what our outlook looks like than I am today. And then my quick follow-up is, as you raised the guidance for the Q4, was that all in response to what you saw from the promotion, from the increased promotion? Or was it based on the performance of the new design galleries and the launch of modern? It's a combination of everything, right? You've got brand new business, I mean modern books got in, majority of modern books got in mid November, right. So you've got that business ramping, you've got in stocks coming in, you've got stores that just had modern, you've got when it's that boulevard open, these stores just got modern and you've got that business ramping, you've got teen ramping, you've got new galleries opening. Every week or 2, we were opening some of these new stores. And so it's a combination of all those factors and all those trends and where we are quarter to date that gave us the data to say how do we see the quarter based on how we're going to play the quarter. Understood. Have a good holiday. Okay. Have a great holiday. Thank you. Your next question comes from Matthew Fassler with Goldman Sachs. Thanks a lot. Good evening and congratulations on getting it all done. I know it's a very busy quarter for you. My first question both of my questions actually relate to Modern. Can you talk about the Modern customer, the customers actually buying and engage in that brand and what the overlap looks like between your legacy Restoration Hardware customers? Do you feel like you're engaging a new cohort here? Is this a loyal customer from the past just coming back and shopping, monitoring? Anything you're learning about how this might be extending the customer base? I know it's early days, but presumably have some data. Yes, the early data would tell us that it's opening up an entirely new market. It's bringing in new customers and it's accretive to our current core customers, meaning that they're finding things in the assortment that they like that they can integrate into our current assortment. And so I think we're seeing it hit on multiple levels and that's why we're seeing the early response that we're seeing today. That's great. And then if I could follow-up, you gave some numbers, I believe in the video about the lift that you're seeing in stores that are getting modern. If you could talk about just what that cohort is right now and essentially what the modern presence at retail looks like today? Obviously, you have Beverly Boulevard, you have the new galleries. Where else have you brought it in? And when you put some of those numbers up there, what kind of store base did that refer to? Yes, Matt. So the way to think about it is where we've opened new galleries in Chicago, Denver and Tampa, if you take those 3, where and the way we think about the business, right, we start in each of those markets, we have a legacy store that was doing trailing 12 month volume of X. And then we've got an internal model that says, look, the core business based on showing more of the core business, based on showing the categories by showing the outdoor business on the roof, so on and so forth. We have math that says that the number ought to go from X to Y, right? And whether it's baby, child, teen, so on and so forth. When you look at modern, right, and you try to isolate the core business and where the core business should be performing to how our data has told us it will. And then you look at Modern and how incremental it is off that base legacy store. So if you took the base legacy store in Tampa, Chicago or Denver, Modern is adding 40 points or more of incremental volume on top of the base legacy store, right. And that's incremental to the lifts we would have expected in all the other businesses and categories, whether it's expansion of core, outdoor, baby child, teen, etcetera, etcetera. Great. I appreciate the color. Thank you very much. Your next question is from Oliver Wintermantel with Evercore ISI. I just had a question, excuse me, on inventories. Been talking about the cadence of inventory for the year and really nothing's changed. We continue to expect to have year over year inventory growth ahead of sales growth in Q4 mostly because of the of cadence of newness last year with all the newness coming in the spring, receiving it, selling through it and then a lot of our chunk of newness coming in the fall and just kind of not really a good compare year over year. We do expect to have higher inventory growth and sales growth, but that delta right now that we have 10 to 25, that 15 point delta will certainly narrow by the time we get to the end of the year. Got it. Thank you. And I just want to go back quickly on the gross margin side. I think on the Q2 call, you said that a gross margin deterioration would be higher in the Q3 than the Q4, but today you said that's a little bit higher in the Q4. I just wanted is it just is promotional the big difference there or what is driving the difference? Yes, that is the biggest difference. Got it. Thank you very much. Thanks. And we do have time for one final question. And our final question for today comes from Matt Namer with Wells Fargo Securities. Good afternoon, everyone. I've got 2. The first is, given the success of food and beverage in Chicago, do you have time to integrate hospitality into the 2016 vintage of stores? And would you potentially retrofit stores like Atlanta? And then secondly, Karen, how does the Austin store opening a little later than expected impact the Q4 guidance? Thanks. Yes. So as it relates to hospitality, we do, Matt. We're reviewing plans and opportunities right now. And we also have opportunity to add hospitality to the existing galleries that we've already opened. And then with respect to Austin, very similar to Atlanta last year, although it was Austin was scheduled to open in Q4, just like Atlanta last year, you see more impact demand more than shipped because we would have had some volume in there, but it's not hugely significant. There's something there, but I think everything we see with the modern ramp and the new stores and kind of early reads in the quarter to date, we feel good about the guidance even with Atlanta pushing to 20 16. Great. Thanks so much.