Earnings Call: Q1 2016

Jun 11, 2015

Thank you. I would now like to turn the call over to our host, Ms. Cameron McLaughlin. Madam, you may begin your conference. Thank you. Good afternoon, everyone. Thank you for joining us for RH's Q1 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 as well as the launch of a new business. Before we start, I'd like to remind you of our legal disclaimer that we will make certain statements today that are forward looking within the meaning of the federal securities laws, including 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 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. Ir. Restorationhardware.com. With that, I'll turn it over to the operator to take our first question. And our first question comes from Adam Sandler from Deutsche Bank. Good morning, everyone. Congratulations on a very nice quarter and I very much enjoyed the new Modern Furniture. A lot of it looks great. First question, does the $4,000,000,000 to $5,000,000,000 in guidance include the impact of Modern? And then I know your work with your manufacturers is very important to your process. Do they have the capacity to handle this or you're going to have to develop new relationships and potentially just how that will impact the balance sheet through inventory? Yes. So I'll take this. It's Gary. When we give you our long term guidance, we have many new businesses embedded into that assumption. And so RH Modern is in that assumption. And then the vendor base and as it relates to new vendors, most of modern is scaling on our current vendor base with some new vendors added in some categories. Excellent. With respect to inventory, we do expect this year to have inventory flow a little bit different than it has in prior years just because we have a lot of the newness and investment coming in the back half. So whereas in the past, had a lot of inventory growth at the beginning of the year and worked through it, this year we'll have kind of 2 different cycles of inventory. So we will grow inventory ahead of sales at the end of Q4. Okay. And then just secondly on Atlanta, you mentioned exceeding expectations. Anything specifically driving that or sort of just taking more share than expected across the board? I think we're really happy about it. It's just how Atlanta is ramping now that it's been opening has been open for several months and we're getting into the season where a lot of our investments in outdoor square footage and that category is now we're beginning to see traction. We opened Atlanta as you know late in November And now and with thinking about the bet we made in outdoor furniture and outdoor growth in space we gave that to, we didn't expect to see that business really become impacted until the spring summer months. Now as we're heading into this as we've seen the business track into those months, we're very excited about how the business is tracking versus our expectations. And then the other way to think about Atlanta, Atlanta was engineered and designed to hold RH Modern. So RH Modern will be another incremental layer of business for Atlanta. And then the new business we have not yet announced this year, but we will by the time of this call, this is quarterly called and the next call, will also be affected in a positive way as that new business gets layered into Atlanta. So we would expect Atlanta to continue to ramp and at this point it's ramping ahead of our expectations. And our next question comes from Oliver Chen. This is Steven Zekone on for Oliver today. I want extend our congrats on the solid results and also the Modern announcement. We were curious on Modern, do you think this will be an incremental customer to RH? Or is this going to be like increasing spend from existing customers? And then piggybacking on the supply chain, is there anything to think about here in terms of longer lead times? And then as this business faces the customer, any difference in pricing or the margin profile? Let me answer the first question, which kind of 2 questions. And 1, new customer bring new customers to RH and will it become incremental spend to the existing customers? I think the answer is yes to both. I think if you saw the video, you saw a product aesthetic that we currently don't have in a position in the market that we're not in. So we expect this to really open up the aperture of the brand to attract a lot of new customers. And in many ways, we expect RH Modern to create kind of a new business in general, right. It's one thing to say I'm playing in a share game and I want to go take some of the share of RH Modern or I want to take some of the share in whatever category. It's another thing to create a market for a category. And when we look at the modern market today or we look at the category, we see all these trends that are and the ones I talked about in the video that we believe are going to set up the opportunity to make a market. If you were shopping for a modern home today and you had to go out into the marketplace and you just built a new home or you bought a home or you remodeled your home in a modern aesthetic and you had to say you walk in the morning say, I need modern furniture and home furnishings, where do I go? My sense is that you really draw a blank, right? It's an even more fragmented market than the one that the core RH Interiors business has been competing against, because there's no one that has dominant assortments in any of the categories and then has multiple categories and integrates those categories into a lifestyle point of view. Now in the video, we gave you a little teaser of the products that we wanted you to see how unique and different the products are. I think what's going to be as impactful if not more is when you see these products integrated into a And I think when you see that and you see it's And I think when you see that and you see the store or any of the floors, you're going to see an entirely new business. It's almost like it didn't exist. It's almost like in some ways before the iPod, there was no MP3 business, right? Before smartphones, there was no smartphone business. People had cell phones, but the smartphones created a whole new category. And as we look at these big trends in architecture or how the millennials live, the aging boomers want to stay youthful and the impact from the antique markets and the reproduction markets, which are influenced quite frankly by the estate sales and generations that pass, right. All these things coming together at one time, I believe create an opportunity to create a market, right. But if all those things happened and no one provided a complete shopping experience, the market could be smaller. I think with the combination of all the trends and what we're doing and what we're launching is going to create a whole new market. Then with respect to the question on supply chain and lead times, as Gary mentioned, because a lot of the vendors are on our current platform, we have certainly have some new ones. We don't really expect a significant change. I will say that anytime we add newness, sometimes there can be hiccups along the way of something that we have, we a runaway train and it's doing really well and it takes us a while to get caught up and catch up with that demand. So there could be those issues with some of these products, but nothing out of the ordinary and different than our kind of typical newness that we introduced. With respect to pricing, it's pretty much about the same. There are certain categories that are little higher, a little lower, but on the whole, it will be very similar to our core business. Okay. Thanks very much. Very helpful detail. Thank you. Sure. Our next question comes from the line of Budd Bugatch. Good afternoon. How are you? That was a new one. Thank you very much. I too love the modern, got a little experience with that. So congratulations on the new category and the new product. Just a question, a little bit piggybacking on the supply chain, do you have enough distribution capacity to handle it? Do you need to do anything more on that? And what additional load will you be putting on the vendors? You said you wanted to extend terms, I think, in your part of the presentation, Karen. Yes. So we are adding a one 500,000 Square Foot DC in Northern California in the coming months. Actually, it's opening this summer. So that was planned for partially for Modern, both to keep up with the growth we have in the core business, but also knowing that Modern was coming. So we should be very good on supply chain capacity for a while. With respect to AP and vendor terms, that's something that we've been working on and working with our vendors in the past and we work with really small vendors. We do sometimes we do deposit terms with them or we pay in advance to the PO. As we've grown with them, we have been working with many of our vendors to try and extend those so that they as we grow, they grow with us, we kind of all benefit, we get a little bit more leverage off of the APB. So you end the year typically at around 60 days, somewhere averaging a little bit above, a little bit below and the Q1 usually coming around 80 days. Where do you think you'll wind up the year in terms of payables? What's the goal at the end of the year? We can't we're not going to commit to that yet just because we haven't finished all those negotiations with the vendors. It's not something that we want to cram down their throats and then have them really hurt. We do consider them our partners. So it's not something that I can commit to at this point as far as a specific number. We have certain internal goals that we will work towards, but it really depends on that partnership with those very important partners in our business and how we can make sure that they're still going to be fine and able to most importantly get us the product. And if they need more support in the short term versus long term with raw materials and stuff, then that's how we help and make sure that we are growing together. And most importantly again is making sure we have the product to get to the customer. So that's something that's certainly a goal for us, but we won't jeopardize that relationship in getting that product. Yes, I would just keep it simple and just think about it from the perspective. The right way to think about this is as we scale our business, both RH and on our artisan partner, vendor partner side, we both have bigger more profitable businesses and we have much more flexibility as it relates to working capital. And so I think you'll see us over the next couple of years be able to be much more efficient with working capital and it's going to be because our vendor base is also scaled with us and the benefits that you would get with scale, you should assume that we will get those kind of benefits. Gary, would that be both on the inventory efficiency side and a little bit on the payable extension side, both? Is that how you would Absolutely. Yes, both sides. Yes. Okay. One last question and I'll turn it over to others. You mentioned I think the extension of art out of I just think the New York facility or New York operation into the RH Modern facilities. Can you talk a little bit about what your thought process is on that? Yes. We think the contemporary art platform that we've built, the online platform and the one gallery we have in New York, we think as we think about Modern and we think about the art business, we've always seen those as merging together. And that the modern business in the way it's going to be displayed and presented, it creates a natural integration point, which will give us more points of distribution at retail for the Arc business long term. It will be very interesting to see how you execute that. Congratulations on the quarter. Best of luck going forward. Thank you so much. Our next question comes from the line of Jessica Mace from Nomura Securities. Hi, good afternoon and congratulations. Thanks, Jessica. Esther. My first question is on the new outdoor collection. I was wondering if you could give us some feedback on how it's doing, especially as it contains some more modern and contemporary elements. What kind of response you've seen from the consumer and how that should help our expectations for the new business? Yes, we're very, very happy. The outdoor business has been our fastest growing category so far this year. And obviously, we've made investments there with product expansion. And we teased it a bit with some of the RH Modern collections that we initially we were going to hold throughout for the other book and we thought like well let's integrate it, let's get some early reads. So you obviously saw some collections there and we're very pleased with the initial response that gives us I think good indication as to how the consumer is going to to react to kind of this new aesthetic. I think the other thing we saw where we if you look at the cover of the current interiors book in the opening spread and you look at the cloud sofa and some of the new halo light fixtures, the big hoop fixtures and stuff. We see that that book with some of the product to get reads and tests and we're very, very happy with the early response to first early function that aesthetic in some of those tests in both the outdoor book and the interiors book. So they both bode well for the fact that there is a customer out there that wants a more contemporary modern aesthetic. And there is we think it's going to just really open up the aperture of the brand. Great. Thank you. And then my second question is on the source book and the timing this year. If you could give us maybe a little bit more color and how that should help shape our expectations about the Q2. In addition on the cost side, maybe how the modern source book in the fall, should guide our expectations around advertising savings in that period? Yes. Well, The cost part of it and the ad cost is all baked into our model and our guidance that we provide to you. One of the ways to think about the timing of the goods this year versus last year, last year we mailed all 3,300 pages bundled together at one time all in the first half. This year when you look at the newness, more than half of the newness is tied to for the year. More than half the newness for the year is tied to RH Modern and another new business category that we'll be announcing shortly. And so more than half is coming in the second half of the year, more than half the newness. So you've got some timing in Q2 where you had kind of all the newness coming in Q2 last year. So we're up against that, right? So even though some of the books are in early like outdoor or baby and child middle separately, you've got a little bit on the imperious book where you've got some earlier deliveries than a year ago, you're still up against the if you're thinking about a bridge, you're up against all the newness in that hitting in that quarter and beginning to ramp and we don't have all the newness this year in that quarter. So that puts a little bit of pressure on demand and some of the revenue in Q2. But then as we come through into Q3 and into Q4, you have these new businesses hitting with more than half of our newness for the year, and so you're going to have a big step up. Our next question comes from the line of Daniel Hofkin from William Blair and Company. Good afternoon. Congratulations. Great results. Just wanted to ask a little bit of a follow-up on the books. And just first question would be how you felt about kind of the little bit earlier flow and also some of the mailings were separated a little bit like outdoor, for example, how you felt that worked this year versus the timing last year? And then I have a follow-up question on related to stores. Yes, we were very happy with the decisions we made. Yes, I would also just couch that and say we're going to learn from the data and continue to make adjustments. We get smarter every time, every season and every year we do this. So we think we pulled the right levers. We think we can do it even better next year that there's continued there will be continued to be opportunities as you think about the flow in the books. Okay. And in terms of kind of as you think about the, I guess, the demand related to versus the book's revenue, if you will, the revenue that you actually book versus just initial orders, how is that kind of flowing versus your expectations? In other words, earlier book shipments ought to lead to earlier demand, but doesn't necessarily show up right away in actual revenues. So just curious how that should how that impacts itself the Q2. You talked about the newness being heavily concentrated in 2Q last year, but just curious how that other dynamic Yes. The way I think about it is based on our results in Q1 and based on what we know Q2 to date and I'll let Karen build on this, but how we're performing today is ahead of our expectations, which gives us confidence in how we build that bridge then to Q2 and that marry that up with our expectation for the incremental revenues and profitability that the new businesses will create. So that's why you saw us increase guidance for the year and increase guidance by more than our beat in Q1 just based on the underlying data and trends we have in the core business and then add that to what are our expectations for the new businesses and the newness that we'd add, which is relatively formulaic in how we think about newness and incrementality. I would say that your specific question on demand and timing and how it's different this year than last year, we always with newness tend to have demand ahead of the actual ship sales and revenue and that's kind of no different than it's been any other year. What is very different this year is, as Gary mentioned, so much of the newness, last year all of it was in Q2 and this year a lot of it's going to be in Q3. So where you would expect when you're landscaping the back half of the year, demand might be nice in Q3 when we launch these, but you won't actually demand might be nice in Q3 when we launch these, but you won't actually see a lot of that revenue shift until Q4. So it's just a heads up on landscape in the rest of the fiscal year. And if I could just sneak one last one and just regarding overall store performance, I have to assume with this level of comp, you're seeing kind of the same strength across most of the openings in the last several years, interested in that general comment as well as New York Flatiron specifically. Thanks. Yes, I think we had communicated that the New York store was the one store that had performed lower than our expectations and as we added square footage there. And we believe that is really due to the fact that the only time we had meaningful square footage expansion without changing the location and the customer seeing a different physical environment. So our view on that one and it's really the only outlier is that the customer didn't recognize a change in the business. You had to actually come into the store and then realize, oh my gosh, you have 2 more floors as opposed to see significantly different physical expression of the brand and that attracting new customers and also communicating to existing customers, oh my god, something's new at RH, let me go check them out. So you won't see us do an expansion like that again. Got it. Thanks very much. Best of luck. Thank you. Thank you. Our next question comes from the line of Matt Nemer from Wells Fargo Securities. Mr. Nemer, your line is open. Let me go on to the next question. Our next question comes from the line of Mili Tamyaga from Piper Jaffray. Great. Good afternoon. Gary, I was just wondering if you could help us out a little bit on RH Modern. I'm very intrigued with what we're seeing on the video. The pricing, can you talk just a little bit about the pricing and just the SKU complexion a little bit? So for Shanabi Modern out there and obviously your Modern is a very different interpretation of Modern, but we think of other mid century Modern designers like Ames and Nelson and Herman Miller, etcetera. How is your pricing going to compare with some of those traditional sort of thought of modern designers? And then maybe relative to what you also have existing in the assortment? That's my first question. Sure. Sure. The pricing advantages and I think the disruptive pricing model that we've had in the core business will be the same in the modern category. I think you're going to versus the price points that you see in the modern market or to the trade, we're going to be a significant value. And we're going to have, I believe, overall a very disruptive pricing position in the marketplace. And then, as position in the marketplace. And then as you think about the marketplace as it is, there really is no fully assorted, fully integrated modern concept that exists. I mean anywhere in the world quite frankly, you have people that you got to whether it's a B of the Italia or other ones that they have upholstery and then they might have a few lights, a couple of items here that where you've got even design within reach, I'd say is a very item driven business. You walk into one of their stores and it's very much not a lifestyle. There's it presented like an item business also and you will see this business presented in a fully integrated lifestyle and a model that's very similar to the core RH business and the interiors business. So think about all the learnings and everything we've accomplished with RH and then creating a mirror image brand, right, that is targeting the modern segment. And because I think it will be like nothing else in the world, I think it's going to create an entirely new market. So I think you're going to have a lot of people that are buying modern today that are having a hard time buying it and finding the price points very high and the value equation very low because the lack of synergy and scale that exists. And so that's going to create I think that's going to create market share gains for us there. But just as importantly, I believe, is it's going to create a new market. I think it's going to motivate people who maybe weren't thinking about furnishing their home or buying new furniture furnishings. I think it's going to inspire people to purchase just like it's no different than I believe that all of our agents growth over the last several years has not all been market share gain. I don't believe that really high growing companies are just taking market share. I think the ones that are really companies are just taking market share. I think the ones that are really performing at a high level are doing 2 things, they're taking market share and they're creating a new market. So can you speak a little bit to the pricing relative to your existing assortment? Yes, sorry. Yes, I'd say similar to slightly higher. Yes, assortment? Yes. I'd say similar to slightly higher in some cases. Okay. And then one more question on the assortment, the complexion. For whatever reason, when I think of modern, I think maybe of an assortment that would actually skew more towards accent pieces, chairs, decor versus straight up sofas. So is there something in the margin implication too of RH Modern if you skew if I'm right, if you skew a little bit more outside of the traditional sofa type pieces from a rate basis? Well, why would you think that? Why would you think that? I don't know. I just do. Why would you think people that live in a modern home don't have sofas? No, I think that they do have sofas, but I don't know. For some reason, I just think it's the aesthetic that has more of like aesthetic pieces too. I don't know an accent pieces, but I could be totally off on that. Just wondering if there's a margin implication here? Yes, I think there's probably a little bit of a more minimalist view in a modern home, right? And that each piece is a thing of beauty and there's less clutter and so on and so forth. But I think categorically, you need places to sit. You need sofas, you need chairs, you need dining chairs, you need dining tables, you need beds, you need bedroom, you need case goods, you need lighting, you need ceiling lights, table lamps, floor lamps, you need rugs. And I don't think that the assortment is going to be meaningfully skewed any differently, right? You need bathrooms, you need like it's not going to whether you have a classic kind of home with a classic aesthetic or you have a modern aesthetic, you've got all the same number of living rooms, dining rooms, bedrooms, bathrooms, outdoor space, so on and so forth. It's just everything's just got a different aesthetic and point of view and might be presented in a more minimalistic way. That's how I think about it. All right. Thank you. And then for Karen on inventory, the elevation of inventory because of the newness, how should we think about the spread patterning through the balance of the year? Thank you. Yes. It will grow a little bit in Q2 for the just like it normally does for the spring and then it will we'll work through spring inventory and then we'll make some additional investments in the modern and other newness that we're having. So it will kind of it will grow a little bit more in Q2, then it will dip and then it will grow a little bit more in Q4. Yes. And I'd also just say, piggyback is that, this is just the very beginning of modern. This is our going to be our first book, our first freestanding store, our first retail presence on floors with a core. We're going to get so much better than what you see in this first book. Like the pipeline of development behind this and the excitement and enthusiasm in the designer world, the artisan world, all the people that contribute to us building this platform and this collection of product. I mean, the pipeline is every bit as exciting, if not more exciting than what you're going to see what we come out of the gate. And if you think about this, most people launch a new catalog, like with this 64 page catalog or an 84 page catalog, and it's like a launch of a new business. If you think about most businesses out there, I don't know, pick whatever ones you want to that are home furnishings based catalog. My team is saying don't start naming them, you'll be like, but just think about it, if you stand back and think about it, Most of them are 64 pages to 120 pages and they're kind of item businesses and they have a little bit in each category. We're coming out with 300 plus pages, a separate web experience, a 15,000 square foot store in LA, right? I mean this is going to be a real business, right? And that's just the beginning. This is just the beginning. I would expect the page count in this book to ramp, the retail presence, we will invest more space and not less. I am more excited about this than any new thing we've ever done. And I would say our organization is too. And that doesn't mean we've lost any enthusiasm for the core business. But just as a new kind of business opportunity, because we sit back and we look at the trends and we look at what's happening out there and you look at the influences of architecture, product design of how people are living, the millennials, look at I just bought a modern house in LA. I mean, we all I mean, I think it is going to be a unique and transformative time in the industry. And I think we are going to lead this timing and this shift. Best of luck out there. Thank you. Thank you. Thanks, Nealey. Our next question comes from the line of Arun Rubinson from Wolfe Research. Hi, there. Thanks for taking my call. I thought the video was terrific. Two questions. One, Gary, on the video, you used the word luxury, I think maybe 3 or 4 times. And I'm curious because I think you believe that's a bit of a limiting term. So if we were to think over time in terms of architecture, are we going to architecture, are we going to be going up higher inside of that $4,000,000,000 to $5,000,000,000 to achieve it? Are we going to be kind of dipping down into more of a mass? How do we think about where you'll be in that good, better, best pyramid to get to the $4,000,000,000 to 5,000,000,000 Yes, I think that's a good question, Aaron. I think when we think about the $4,000,000,000 to $5,000,000,000 that's really North America and that's as we're positioned today. That's not doing anything to move the positioning of the marketplace. And we really like the luxury positioning that we're establishing in the marketplace, because the spend by the wealthy and affluent customer is meaningfully and exponentially greater than when you go down market. So it's not that we don't think long term, there's opportunities to do other things and create other businesses that will take our expertise, our taste level style and capabilities and think about other markets. But we don't but that's not in any of our numbers when you think about $4,000,000,000 to $5,000,000,000 The $4,000,000,000 to $5,000,000,000 is really triggered by 2 things. It's triggered by the expansion of the product offering that we know of today and we think we're relatively conservative like could RH Modern in and of itself take $4,000,000,000 to $5,000,000,000 up? Yes, it could. Will we commit to that today? Not yet. We have no data yet, right? So and I think we're relatively conservative with how we're positioning RH Modern and how that will open up of the market, right. And so the $4,000,000,000 to $5,000,000,000 is really based on the continued product expansion and what we know today that we are working on that is in our pipeline and the real estate transformation in North America. That gets us to $4,000,000,000 to $5,000,000,000 in mid teens. Beyond that, there's international opportunities that we think I think all of you know, we hired a Head of International New Business Development, Doug Demos, and he's been traveling the world, meeting with potential partners, looking at real estate, looking at opportunities and putting together the international blueprint for growth for RH. And we think this the business we built today is will be just as dominant internationally as it is today in America. So we are very enthusiastic about it. We're just trying to be smart about capital allocation and where do we put the next dollar and where do we get the return and in international thinking about how we scale international, how much capital it takes to build the infrastructure, what does it really take to break into a new market, do we do it ourselves, do we JV it, do we franchise it, do we license it. We're building that blueprint and want to be really smart and say, how are we going to generate the best returns and based on what we know about our business today. And then beyond that, we think that there's other business opportunities and other things that we are looking at, working on that we haven't talked about that might address new markets, new categories and other things. So $4,000,000,000 to $5,000,000,000 is just to help everybody think about the current business and the model in North America. It gets much bigger when you take it outside of North America and then there's other incremental businesses and things we're working and developing for the long term that will continue to fuel growth long term. I had a second. I'll ask it, but if you feel like we've spent too much time, you can just move on. You've got a long product cycle. You've been in the business now for the last, I don't know, 6, 7 years with your new look and design. Can you characterize the relationships that you have with your customers? Are you seeing repeat business the way you'd expect? Can you talk about clienteling opportunities? I'm just trying to get a sense now that you've seen more years of this business, what you're seeing from a relationship standpoint? Yes, we do. There's the buying cycle, what really drives our business is event buying, life stage events. So someone either buys a home, remodels a home or redecorates their home, That is a that category, that life event is a big, big driver to our business. And then on top of that, so you see when you look at our customer over a 5 year period and you take their biggest purchase week, you see a big peak. And then as you look at it on each side of that for several years, you see that fall off, right, pretty big. And so we are trying to position ourselves to maximize the market share when people have that meaningful event in their life, whether they buy a home or they remodel a home and they redecorate their home. Now back to tying in your point on the luxury customer and how to think about it. The wealthy and affluent customers and especially the demographic, the higher end of that generally owns more than one home, right? So thinking about 2nd and third homes and how we play in that life cycle and how we capture that share is really key. The services that deepen the relationship and create an ongoing repeat customer, whether it's again another event like they bought a second home or when they moved, the deeper relationship is built around a lot of ways. 1 is what's the general service we gave them and the experience they have and that's affected by the new galleries. I mean think about most of our business over the last several years has been driven out of all these little mall stores, right. The perception of our brand has been shaped by a completely different business that was opened in small mall stores, right. And you about the new experiences that we're building and how those experiences will shape the perception of the customer will create a net when people wake up in the morning, 3 years from now somebody decides to move or remodel their home, I think they're going to think completely differently about us in a couple of years than they do today. And just as they think completely different about us in any market where we've done one of these new bigger galleries. So we think that's highly important. Then things like interior design services and the investment we're making there and the different level of service and what you're going to see evolve. I mean, I'd invite you and anybody else to come to our new store in Chicago when we opened Chicago and Denver. We have some these next generation galleries are going to have design ateliers and a whole section of department that looks like you walked into an architect or interior design offices and set up with all the samples and swatches and all that capabilities and technology to support a different level of interior design services and that's a big investment. You'll see us move that forward. You might even see us long term get into architectural services where we can help them products, but how do we move from creating and selling products to conceptualizing and selling spaces. And so when you hear about other new businesses that are coming in, we've talked about RH Modern open, I mean, not RH Kitchen before and we've been working on developing a kitchen concept that we believe will be able to when we launch that business transform your whole kitchen, not just sell your pots and pans and knives and forks and things like that. We'll be able to transform your kitchen. And so there's going to be levels of services, product categories and then the overall positioning and presentation of the galleries and walking into that experience that I think is going to continue to transform the brand, continue to build a deeper relationship with customers and continue to open up the brand to new customers who don't even think about it today because their point of reference is a 6 1,000 square foot store in the mall. And the last time they were in that store, they bought stocking stuffers 7 years ago. So the opportunity to create a forced reconsideration of this brand through the real estate transformation, additional new services, additional new businesses and categories we're going to continue to introduce. I just think we're still at such an early stage of this transformation. Mean, in almost every market, we have a little mall store that was built for an entirely different company. Thank you for that answer. Our next question comes from Lorraine Hutchinson from Bank of America. Thank you. Good afternoon. It seems to be a lot of focus in the market on a simple new store productivity calculation. And I was hoping that you could just discuss the lift that you're seeing in the direct business in the markets where you have transformed the real estate into a design gallery. Yes. We have seen a lift in every market where we've opened one of the new larger format galleries. Atlanta has been no exception to that and has even been on the high end of the range that we've seen. But one of the most key things about the new store productivity is we've kind of tried to make sure everyone understands a few things. 1, when we have closed stores in a market and or just in general in that same period and in Q1 and Q4 of last year, basically since we've had Atlanta open, we do have 3 stores in the non comp base that have a 0 this year and there was revenue last year. So 3 of those stores are just a drag on that number. The other thing we've tried to make sure everyone understands is the ramp period, both from a demand to ship sales, but also just the way Gary described, we do expect these stores to ramp and with Atlanta specifically, making sure you have time for all the categories to have their time in the sun, whether it's outdoor or holiday or all those things that are part of the core assortment and we're especially we're investing significant square footage and for the books to be in home. So in Atlanta, when you're there and in a market and no one knows it's there yet and once we get the books in home, which raises further awareness of the brand, those are all that contribute to the brand. Yes. And I would say, piggyback on what Sharon is saying, because this is an important point to understand in how we measure our business. We really are looking at the market lift, right? Because the consumer behavior is going to continue to change. And there's a lot of people, I believe, in the retail business today that are making very poor strategic long term decisions because they're not they don't understand the just the consumer behavior shift because of technology, right? I mean, today, we look at it and we go, we make an investment into transforming the real estate in a market, whether it's LA, Atlanta, you name it, Scottsdale, Arizona, whatever that market is. What the retail lift is today versus what the direct lift is today is going to change, okay? The devices are going to get better. The speed on all the devices is going to is going to get better. Consumer behavior, whether they again, whether they order it online or order it in the store and what that dynamic is, I think if you worry about that dynamic, you're going to miss the business opportunity and you're going to make bad decisions for your business long term. I said in my video, where a lot of people, 10% of retail sales exist online today. Do I think it's going to be 20% down the road? Of course, I do, okay. But the fact is it's only 10 today. So that says the retail stores are really, really important. But when it becomes 20, it's because devices are better, interactivity is better And all of a sudden, whatever market, LA, New York, Atlanta, you pick it. And all of a sudden, the store business might shift and you store business might flatten, the store business might go down, but the direct business goes up. Should you care about that? I can't control technology and how technology is going to change our lives, okay. But what I can control is our assortments and the presentation of our assortments in the marketplace and be completely agnostic to how the customer transact. I mean, I remember that it's like it'd be like in the old days, when we used to go to banks and there would be tellers and then all of a sudden there was ATMs, right? And you could have been sitting there going, oh my God, the teller business is down, the teller business is down. Well, no shit, excuse me, but people are going to ATMs, of course, the teller business is down. Well, in retail, before there was the Internet, if you weren't in the catalog business, they had to buy everything in your store, right? There's now another channel. There's and that channel is evolving transact or where they do? Not at all. Should I build smaller retail stores stores because they're transacting differently and then have a worse presentation physical presentation in the marketplace? I think that kind of strategy is idiotic. I really do, because people want to things and people want to interact in a three-dimensional nature. And that's why we're ambivalent to where they transact. And that's why I make my point about it's not about the Internet. The Internet is a channel. It's going to change things. It's going to shift things. But retailers that are kind of trying to shrink to greatness, I think they're missing the whole point. I mean, look at Warby Parker, look at Bonobos, look at all these people have started online. Now Warby Parker is on the cover of Fast Company Magazine, it's the most innovative company in the world. Why? Because they were the 1st built on the Internet brand that all of a sudden decided to do retail stores. I mean, they're the most innovative because they're doing retail stores. I'm not trying to take that away from Warby Parker, but think about that, right? They're building retail stores. Retail stores are always going to be important. Otherwise, by the way, if anybody's been to an Ipic theater or movie, again, what's happening with the movie industry and movie theaters, why the hell would anybody go to movies? You can watch any movie you want at home, on your iPad, TV, so on and so forth. We're social creatures. We don't want to sit alone at home all by ourselves. Nobody we're not going to see a future ever, I believe, where people are sitting at home all by themselves doing everything on online. I think people think that like good luck. Your strategies can really miss. I think the physical experiences in the world are going to be even more important than the online experiences, because we are social creatures. And I think the retailers that have the very best physical experiences in the world tied with the very best virtual and digital experiences in the world. Is it one thing and win? It's not one or the other. It's physical and digital. That's the world. But I think so many people spend too much time in their models and their businesses trying to get like how much is in the store and how much is online. The key is how much of the market are you getting? What's your overall growth? Right. Like some people say, our direct business is up this and it's the fastest growing division, our direct business is the fastest growing division. Who cares? Of course, it is. It's like that'd be like saying the teller business is up, the teller business, I have 50 of the ATM business is up, the ATM business is up and I'm running the ATM division. What do you do? What is the Bank of America's business versus Citibank's business? That's what's important. That's how people ought to think. I haven't seen an app yet that lets you sit on a couch. So it seems like the strategy is right. Yes, great point on the direct list. Thank you. Just maybe one more for Karen, if I could. The port impact, did that play out as you expected the $10,000,000 to $12,000,000 hit in the Q1? And will that revenue be recognized in 2Q? Yes. It's a great question. We actually, at the end of the day, when we looked at all the orders, we actually were able to move through a lot more of the receipts and things picked up in April. So that 10% to 12% impact that we originally estimated was only about half that. So we were able to get things through. Now when we look at the transit times for currently right now, they're still a little bit slower. So there's a modest impact that could shift to Q3 from Q2. But overall, it was only about $5,000,000 impact that's actually flopping to Q2 and a little bit of it's probably going to even move forward to Q3. So not a huge impact on Q2 one way or another. Thank you. Our next question comes from Peter Benedict from Baird. Yes. Hey, guys. It's Justin Clay Brown on for Pete. Thanks for taking the questions. Karen, I wanted to ask about the Q2 guidance and how you guys are thinking about gross margin directionally as you lap the strong performance last year, whichever I recall was helped by the softer 4th July promotional event? Yes. The biggest thing, for Q2, just headline is the kind of significant change in the newness introduction. So I'll start with the top line and just reminding that when you think about Q2 this year versus last year, even though the books are home in home earlier this year than last year because over half of the newness is being introduced in the second half, the sales composition is just a little bit different. We do expect to see modest gross margin leverage in Q2, partially because of that friends and family event last year, but also just because of what we're seeing just in trend. So we do expect to see modest gross margin leverage in Q2 and then even into the second half. Okay. And then just one of the update on some of the supply chain initiatives, specifically the in sourcing of the furniture delivery hubs. Can you guys just remind us how many markets have been in sourced? Maybe what percentage of your furniture deliveries do you control today as compared to either last year or a few years ago? And then just as a part of that question, when you in source these hubs, the benefits more, I guess, financial in nature or are they customer facing? Thanks. Sure. We in sourced 1 more hub in the last quarter. So with that, we're about 50 8% of our deliveries are in sourced and we expect to have one more by the end of the year such that by the end of the fiscal year, we'll be at about 60% of deliveries we'll control. And your question on whether it's cost or customer service facing, it's both. So we do think that there's a better customer service experience and then there's some cost benefits. We're at the point now where we've done a lot of the big markets. So the immediate leverage that we get from kind of controlling some of that and the cost efficiencies, Those big markets are behind us. But now we still see ancillary benefits with the customer experience, but even other kind of things like returns and damages and shrink and other things just from controlling more of the inventory. And then again, all the customer benefits that that come from us having more control over those folks and who's interacting with our customers. All right. Thanks guys. Best of luck. Thanks, Jeff. And our next question comes from the line of Cristina Fernandez from Telsey Advisors. Hi, good afternoon. Gary, on the video, you alluded that you could open more Irish modern standalone stores besides the one plan for LA. Can you speak about how many of these could you have? And just in general, how are you thinking about standalone stores for some of these more concepts like Baby and Child and the one the other concept that's going to be announced in the fall until you bridge the gap to transforming the real estate that you currently have? Yes, good questions. So specifically, let's just talk about LA and talk about the logic and why there's going to be an RH Modern standalone store in LA. We built Melrose, it's not one of the next generation design galleries. So Melrose does not have all the square footage and we knew when we were moving to Melrose, we kept our location on Beverly Boulevard because we knew we were going to need the space for RH Modern in that marketplace. Also in that marketplace, we have a freestanding baby and child store because we don't have the room in Melrose. So there's going to be combinations here where we will where the brand may be aggregated under one roof and there's going to be some places where the brand is disaggregated into separate pieces, right, and separate standalone. My sense is we're going to continue to evolve. We're going to learn more. If modern in and of itself in a freestanding location deserves to be freestanding long term, then we will adjust our approach. Today, we've said we have a floor that's going to be dedicated. Just take Atlanta, for example, we have 3 floors of the interior business on floors 1, 2 and 3 today that's showing basically our core interiors assortment and category presentations in a store like that with rugs and window treatments and other categories. Floor 4 is small spaces and floor 5 is baby and child. So in that store, it was always thought of and designed that RH Modern would be on the 3rd floor. And then the other business that we are announcing is engineered to take half of one of the floors in the business. But as we learn and grow, we today we have some baby and childs that are freestanding. We've got and we got baby and child now in Atlanta integrated. Whether it's Baby and Child Modern, the new business that we're talking about, other categories of the business, we will continue to test and experiment, which is the best way to optimize the business, not just from a revenue point of view, but from a profitability point of view. So there could be a decision at some point say, hey, baby and child, which is on storefront, is more optimal than baby and child on the 5th floor. And we have plenty of things in the pipeline that we could use the square footage for. And same discussion around modern. So and that's why you're seeing different tests. The great thing about the big stores is the real estate deal, the financial construct of those deals gives us a really a long term advantage and a pretty low cost overhead structure for stores of that size. And so we have lots of flexibility how to use that square footage And we will continue to test and learn and use the square footage in the most optimal way and augment with additional square footage outside of the big box if we believe that's right and appropriate. And our final question comes from the line of Matt Nemer from Wells Fargo Securities. Good afternoon. Can you guys hear me okay? We can, Matt. Hey, Matt. Okay, great. I just had a quick follow-up on modern. You'd mentioned that the prices would be you think will be disruptive in the market. I'm curious about speed to delivery. My impression is that some of the high end specialty folks that you talked about earlier have very long lead times. It's almost a custom business. How do you think you'll compete on speed? That's a really good point, Matt. It is very much a custom business on the modern side and the lead times and the wait times are a real disadvantage to the people in the marketplace today. I think we're going to compete on speed just like we would our current business. Now when we're launching, we're being relatively conservative on our inventory best and how and where we're buying it. So I'm sure we're going to be wrong in a lot of it. I mean, 100% of the first buy is going to be wrong. We're going to oversell some stuff under overbuy, under buy. And so our lead times and our delivery won't be optimized in the 1st 6 months or 12 months. But after that, I think you think about it as it's going to be a huge competitive advantage versus how the marketplace exists and operates today. And then just one quick follow-up. Do you have a roadmap this year for changes to the website and the digital experience? I know that's something that you've kind of been thinking about making some changes to it. I'm just wondering if we should expect anything big this year or more fine tuning? Thanks. Some things will be bigger than others. I mean, I think we have a long term strategy and we'll continue to evolve and change the website. And so the launch of the modern site is going to include some new features and so on and so forth. But nothing that I'd say is kind of massively revolutionary. I mean, I think it's going to continue to evolve and be better and we'll continue to focus on leading and not following. Great. Thanks so much. Thanks, Matt. Thank you. Well, thank you everybody for your time today. We're very, very excited about our future and the year ahead and our future ahead and appreciate your time and attention and support. So have a great day. Thank you. This does conclude today's call. You may now disconnect. Thank you.