RH (RH)

Earnings Call: Q4 2015

← View all transcripts

Mar 26, 2015

Ralph Waldo Emerson believed the world was separated into 2 groups, the establishment and the movement, the latter representing those who would drive progress by presenting new thoughts and ideas. As I reflect on our journey and results of this past year, I'm reminded of Emerson's words and believe that in many ways we too are creating a movement, moving through multiple transformative stages that have defined our brand and redefined our industry. While we believe the ideas of the future don't exist in the past, taking a moment to look back on how far we've come might put where we are going and what we are capable of into perspective. How does a brand called Restoration Hardware that defined itself by selling nostalgic discovery items like an AquaTroll, a shoeshine kit or Auto Bingo transform into RH, the leading luxury home brand in the world? How does a retailer with an average store volume of 2,900,000 grow its average store volume to more than 10,000,000 in the exact same real estate? How does a company with a $20,000,000 market cap, no capital and teetering on the edge of bankruptcy in 2,001, become a company with a market value in excess of $3,500,000,000 in 2015, up 175 times from 2,001 with a strong capital structure and significant growth opportunities. History has taught us that real value is created by those who have the courage to lead rather than follow. We're willing to destroy today's reality to create tomorrow's future. At our core, we are innovators. We obsessively search for opportunities to destroy the current version of ourselves to create something significantly more valuable. It's based on Joseph Schumpeter's notion of creative destruction and what he referred to as leapfrogging. His hypothesis proposed that companies holding monopolies based on incumbent methodologies have less incentive to innovate than potential rivals. They eventually lose their leadership role when radical new innovations are created by firms willing to take the risks. When the radical innovation becomes the new paradigm, the new companies leapfrog ahead of the former leading firms, No different than Apple leapfrogging past Dell, Hewlett Packard, IBM and Microsoft. We believe RH will leapfrog past every current player in the home furnishings industry today. In every area of our business, we are focused on creatively destroying the current version of ourselves to unleash a better one. Our approach is disciplined and systematic. We assess competitors looking for opportunities to disrupt current markets and create new ones where none exist. We like to say we have to think until it hurts, so we can see what others can't see and do what others can't do. We then deploy our human and financial capital where we can drive meaningful change and create maximum value. And while all value creation involves some degree of risk, we search for asymmetrical returns where upside is significantly greater than our downside. Over the years, we have demonstrated that we can test, scale and roll out new ideas predictably and profitably. Much of our success is due to significant infrastructure investments we have made and the unique platform we have built. One such investment is the RH Center of Innovation and Product Leadership, a facility unlike anything in our industry. It's 120,000 square foot space designed to support the creative process from ideation to presentation and has enabled us to increase our productivity by 500%. Despite our results, we are often questioned about the number of initiatives we are pursuing or at the speed in which we are moving. What's often overlooked are the many things we've chosen not to do. And in many cases, it's where others have followed blindly based on the latest strategy du jour. Let me give you a couple of examples. As you can see on this graph, we don't have many Facebook likes compared to our competitors. That's because we don't have a Facebook page. We don't have any Pinterest followers, yet we are one of the most pinned brands in our industry. We also don't have a Twitter or Instagram account, yet our rain room installation at the MoMA was one of the most tweeted and Instagrammed events of the past several years. And our new design galleries in Boston, Greenwich, Los Angeles and Atlanta have become social media stars in their own right. We don't have a blog because we believe it's not what you say about yourself. It's what people are saying about you that matters. We don't have an elaborate digital strategy conjured up by a fashionable digital agency, because we are not a digital company. Digital companies primarily create content, connections and serve up information much like media companies and sell advertising. We are a product company. We are focused on curating the very best product, people, ideas and inspiration and then integrating them to create a point of view that is authentic and distinctively our own. We then present those products across any and all relevant channels and amplify their meaning with an experience and service designed to render them more valuable. So while we don't have a Facebook page, our own blog, a Pinterest board or an Instagram or Twitter account, what we do have compared to our competitors is this, the leading revenue growth in our industry over the past 5 years, the leading comparable brand growth in our industry over the past 5 years the leading earnings growth in our industry over the past 5 years and we are the top performing retail consumer IPO in the past 6 years as our stock is up 70% since our offering in November of 2012. We believe our performance is a result of our focus on creative destruction, on innovation versus duplication and our ability to allocate both human and financial capital to create meaningful value for our shareholders and our customers. Since I'm focused on results, let me also point out some of our highlights from 2014. 2014 was our 5th consecutive year of at least 20% revenue growth and we have averaged 25% revenue growth over that time period. After 4 consecutive years of achieving comparable brand comps of at least 25%, a milestone I'm seeing before in our industry, We achieved comparable brand comps of 20% in 2014 on top of 31% a year ago. Our operating margin increased 150 basis points to 9.3% versus 7.8% last year, putting us in a position to leapfrog the operating margin of the firm Many Point 2 as the gold standard in our industry. Adjusted net income grew 41% in 2014 on top of 83% growth a year ago. And in fiscal 2014, our stock appreciated 54%. We also opened our 1st next generation design gallery in Atlanta, which is being hailed as the most important new home store in our industry. These next generation galleries successfully integrate all of our current concepts: RH Interiors, RH Small Spaces, RH Baby and Child and RH Outdoor and they're designed to incorporate the multiple new businesses we have in our product development pipeline. While many have been predicting the death of the retail store, we've continued to innovate and build a retail experience that defies conventional wisdom that everything is moving to the web and retail stores are a dying platform. We have proven just the opposite, developing new larger galleries that blur the lines between residential and retail, indoors and outdoors, physical and digital and create an experience that cannot be duplicated online. We find it serendipitous that the recent trend of previously online only retailers are now opening physical stores, people like Bonobos, Birchbox and even Amazon. Warby Parker, whose Fast Company Magazine just named the most innovative company in the world for building the 1st great made on the Internet brand is now also opening retail stores. Scott Galloway, Professor of Marketing at the Stern School of Business at NYU and Founder of L2, a think tank for digital innovation, called stores the new black and has predicted the death of pure play. Consulting group, A. T. Kearney, in their recent report titled On Solid Ground, said brick and mortar is the future of modern retailing and it's not physical or digital, it's physical with digital. We have always believed that while the web presents a revolutionary new way to shop, a retail store by far presents the best opportunity for the physical manifestation of a brand. What many online advocates miss is a website is an invisible store. You don't see it in the physical world. The other disadvantage to online only businesses is that a website is completely democratic. The smallest store in the world can appear to be as large as the biggest store in the world online as everyone has the same size storefront. You have to click through thousands of pages on a website to get the same impression you can achieve by spending a few minutes in a retail store or in many cases just driving by. So while many have assumed our strategy was misguided, we believe transforming our retail stores will prove to be the single best investment we make. As we look forward to 2015, there are several innovations and initiatives I would point you to. The first is the opening of 4 new next generation design galleries. This fall, we will open RH Chicago, the gallery at the historic 3 Arts Club RH Denver, the gallery at Cherry Creek RH Austin, the gallery at The Domain and RH Tampa, the gallery at International Plaza. Ranging from 45,000 to 65,000 square feet of indoor and outdoor selling space, you really have to see these new galleries to truly appreciate how revolutionary the shopping experience is, how uniquely they position and differentiate the RH brand and the ongoing potential for disruption and market share gains. The second innovation I would point you to is the evolution of our source book strategy. As we continue to test and learn, we believe we can meaningfully improve the productivity of our source books. This year, we will be mailing our outdoor books separately and earlier than a year ago. We are launching 14 new outdoor collections this spring and believe some of our new modern and contemporary collections will open up the brand to new customers. From homes to hotels, beaches to balconies, pool sides to patios, we have the most comprehensive collection of high quality outdoor furniture in the country and expect meaningful growth from this category in 2015. We have also consolidated some of our source book titles, densified our pages and we'll be testing mailing depth by title. We believe we can drive increased revenues while reducing advertising spend and further expand on our operating margins. The 3rd initiative I would point out is the continued innovation in our supply chain. We are opening a new West Coast facility this spring. We continue to in source our home delivery hubs. We've made meaningful improvements in how we flow and deploy inventory. And we will roll out our final mile home delivery system this year, all of which should lead to improved fulfillment, lower back orders, reduced stops per delivery, lower returns and damages, and an improved customer experience and increased profitability. Lastly, we plan to launch 2 meaningful new businesses this fall, each with their own source books. These new initiatives will serve new markets and both should be incremental to our current business. As I reflect on this past year, there is another point I would like to make. Every now and then a friend or family member will ask me if they should buy our stock. And I always ask them the same question, are you a trader or an investor? Because as you know, there's a big difference. Traders look for short swings and bet on short term movements or outcomes. Investors, on the other hand, generally focus on value creation over a longer horizon. Investors have a bias for building versus betting. They tend to be advocates versus adversaries and realize that building great businesses and brands takes years not months or quarters. We too are investors. We deploy human and financial capital where we believe we can create long term lasting value for ourselves and our shareholders. We make investments like we own 100% of this business and it's the last place we will ever work. We don't believe it's wise nor possible to measure those investments in days, months or quarters that can be affected by short term episodic events. We also know that every investment we make or plan we develop is some degree of wrong. The key to our success at our age is having a portfolio of investments that in aggregate have asymmetrical returns, that there is significantly greater upside than downside and we have developed plans that are positioned to protect the enterprise in the event of an unforeseen downturn. Therefore, we encourage you like we do our friends and family to only purchase our stock if you are an investor, if you have a long term view and want to be part of building a meaningful enterprise. Let me end with a few thoughts that are at the very core of everything I've spoken about today. It's the essence of why against all odds, we are still here. Why an irrelevant money losing brand selling nostalgic discovery items with a market value of $20,000,000 went on to become one of the most innovative and fastest growing luxury brands in the world with a market value in excess of $3,500,000,000 It goes beyond what we have done, but rather who we have become. We have become a team of people who don't know what can't be done. A team of people who don't work for a company, but rather a cause. A team of people who are defined by our values and beliefs, those things we live for, would fight for and die for. A team of people who believe in leadership versus fellowship, innovation versus duplication and are driven and determined to define next practices versus best practices. What's most important is who we are, how we think and what we believe in. That's why we will continue on a path of creative destruction and leapfrog every other business in our industry. As I mentioned last year, we are like a $1,900,000,000 start up in the very early stages of a highly evolutionary business moving through multiple transformative stages that will define our brand and more importantly redefine our industry. History has taught us that real value has been created by those who have the courage to lead rather than follow, who are willing to destroy today's reality to create tomorrow's future. We like Emerson are passionate about creating our own path and leaving the trail. Thank you for joining us. The many transformative changes that we have made in evolving our business model are leading us down a clear path towards significant shareholder value creation. As we step back and reflect on our performance in fiscal 2014, there are several meaningful financial achievements we are proud of, including posting our 5th consecutive year of net revenue growth in excess of 20%, delivering 150 basis point expansion in our operating margin, reaching 9.3% for the year achieving a 41% increase in adjusted net income, quality earnings growth that was primarily driven by 110 basis point expansion in our gross margins, reporting adjusted diluted EPS of $2.36 well ahead of our original outlook of $0.14 to $2.22 with the 4th quarter representing our 8th consecutive quarter either meeting or exceeding our earnings guidance and the significant strengthening of our balance sheet in fiscal 2014, successfully executing a $350,000,000 0 percent coupon convertible notes transaction with terms rarely, if ever, achieved in our industry. Our recent achievements demonstrate how far we have come and how much our business model has evolved in our short time as a public company. Looking back at the transformative changes we have made and the current strength of our business, we have even more confidence in achieving our long term goal of reaching $4,000,000,000 to $5,000,000,000 in North American revenues with a mid teens operating margin. First, I want to touch on the evolution of our growth strategy. At the time of our IPO less than 2.5 years ago, we believe there was a significant opportunity to unlock the value of our product assortment by displaying a greater amount of our offer in larger format stores. At that time, our real estate strategy was to open stores that were an average of 21,000 square feet in approximately 50 markets. Today, we believe we have an opportunity to open next generation design galleries in the top 60 to 70 markets, representing more than twice the square footage of our plans at the time of our IPO. Today, landlords view RH as an anchor tenant in some of the best centers in North America, enabling us to secure economics previously unattainable by a specialty retailer. Today, our real estate pipeline is strong with 9 leases currently signed for 20 16 and beyond and an additional 25 locations that have been identified or in advanced negotiation. 2nd, I want to discuss the significant impact our real estate transformation is having on our long term revenue outlook. Just over 2 years ago, our plan contemplated that the average 21,000 square foot full line design gallery would generate $18,000,000 in retail sales or nearly 2 times that of the legacy store in that market. Today, we believe that our next generation design galleries will average 45,000 square feet and generate $30,000,000 in retail sales, approximately 2 to 4 times the legacy store volume in each market. Our first next generation design gallery, RH Atlanta, The Estate at Buckhead, is our first gallery to incorporate all of our current concepts under one roof: RH Interiors, RH Small Spaces, RH Baby and Child, and RH Outdoor. It has also been designed to accommodate several new businesses that are in development, including RH Kitchen and many more, which will be announced in the near future. We are very pleased with the initial results and the direct lift we are seeing in this market has been one of the strongest thus far. The combination of the sales volumes these next generation design galleries are expected to generate, coupled with the corresponding direct lift that we experience in each market and the continued expansion of our product offering, allows us to see a clear path toward generating $4,000,000,000 to $5,000,000,000 in total in total company sales once our real estate transformation is complete. 3rd, we've become more disciplined than ever in our approach to deploying capital. We go through a rigorous process that's designed to focus on investments into strategies that drive the greatest financial and strategic value. We are mindful of the need to invest in building an infrastructure that can support our long term growth while delivering a luxury service experience. This is an area of particular focus as we believe there is significant opportunity to improve our service experience, leading to increased sales and lower costs. You will hear more about our initiative to elevate our quality and service experience as we get further into the year. We've been more measured with the pace in which we roll out our larger format galleries for three reasons. 1, the reality is our real estate strategy is unlike anything seen before in specialty retail. This is not a simple cutter rollout. Each new gallery is a complex development deal requiring principal to principal relationships and negotiations, shopping center expansion or reconfiguration and complexities that can be very costly without a measured and disciplined approach. 2, we are learning a tremendous amount with each of the first new galleries and want to ensure we have the time to make adjustments and perfect the model so we can maximize the returns over the long term. 3, these are 18 to 36 month development deals and it is difficult to predict what complications might arise due to tenant relocations, department store approvals, incremental parking requirements or local permitting issues. Despite the fact that our real estate transformation will take longer than previously anticipated and 2015 will be a bridge year with square footage growth at the low end of our range, we are confident we can achieve our long term target of 20 percent plus revenue growth once our development pipeline ramps in 2016. Furthermore, despite our focus on even larger format stores than planned at the time of our IPO, our next generation design galleries will require less net capital per gross square foot to build and generate a higher return on invested capital than initially contemplated. We assumed that our build outs would cost roughly $2.50 in net capital per gross square foot and we expected that the average payback would be 20 months. Today, we expect to spend 20% less per foot and are planning an average payback period of 12 to 18 months. If we were to include the lift in direct sales that we experienced in each market, that payback would be even faster. The transformative changes have occurred in almost every area of our business. We have further evolved our product development and vendor collaboration processes, made transformative changes in our supply chain and continued to evolve our source book strategy over the last few years. These changes coupled with our continued market share gains have allowed us to see significant operating margin expansion. Putting it into perspective, we ended fiscal 2014 with operating margins of 9.3 up 3 50 basis points in 2 years. In fact, just over 2 years ago, we were targeting a 10% plus operating margin in our long term model once our real estate transformation was complete. Today, we expect to achieve industry leading operating margins in excess of 10% in fiscal 2015, putting us further along the path toward our long term target of operating margins in the range of 15% to 16%. Let me remind you how we get there. 1st, we expect gross margin expansion of roughly 300 basis points, driven by retail and DC occupancy leverage of approximately 200 basis points and approximately 100 basis points from merchandise margin expansion and shipping efficiencies as we gain further pricing power, see improved vendor pricing and benefit from the efficiencies of our home delivery in sourcing initiative and optimization of our shipping model. Within SG and A, we see 300 to 400 basis points of improvement in our long term model. We expect to see advertising cost leverage of at least 200 basis points as we leverage our ad spend in each market as we roll out our next generation design galleries and as we further optimize our source book strategy. In addition, we expect to see 100 to 200 basis points of other SG and A improvement as we leverage our fixed corporate and other G and A expenses with the higher sales volumes contemplated in our long term model. The final point I would like to reflect on is the current state of our balance sheet and our path toward free cash flow generation and higher returns on invested capital. 2 years ago, our long term real estate estate transformation was being funded by short term borrowings. Our only source of liquidity was through our asset base line of credit. Today, we are confident we have the liquidity to withstand any economic downturn or other event. The $350,000,000 0 percent convert allowed us to pay down our line and has also provided tremendous leverage and flexibility in negotiating our next generation design gallery leases, ensuring we optimize the capital construct and unit economics of each and every deal. We also expanded the availability of and reduced the fees and borrowing rates on our line of credit. Furthermore, we feel even more confident in how we've been able to manage our working capital and our ability to generate free cash flow. We continue to see a near term path to becoming free cash flow positive and expect to reach this important goal within the next 12 to 24 months. We are proud of all that we have accomplished and are well positioned as we enter fiscal 2015. As I mentioned, 2015 will be a bridge year for RH with revenue growth targeted in the mid teens and then reaccelerating to the low-20s as the real estate transformation begins to ramp in 2016. For fiscal 2015, we expect net revenues to grow in the range of 14% to 16%. Our ending lease selling square footage is expected to increase approximately 27% in fiscal 2015 with all of that growth coming in the 3rd 4th quarters. As I referenced earlier, our plan to enhance productivity of our source book coupled with continued gross margin expansion give us great confidence in achieving operating margins in the 10% plus range this year. While 2015 will be a bridge year as it relates to our top line growth, we expect our earnings growth to exceed our long term target as we are planning net income in the range of $125,000,000 to $131,000,000 up 28% to 34% and delivered diluted EPS in the range of 2.95 dollars to $3.10 representing growth in the range of 25% to 31% from fiscal 2014. In summary, we have never been more proud of our performance or more confident in our outlook. We are exiting 2014 with even more optimism about the opportunities that lie ahead. We will cross both the $2,000,000,000 sales and 10% operating margin marks in 2015 significantly faster than we communicated at the time of our IPO just over 2 years ago. We continue to demonstrate that we have the fastest growing and one of the most profitable businesses in the home furnishings industry. We see a clear path to achieving our long term goals of $4,000,000,000 to $5,000,000,000 in net revenues with mid teens operating margins, and we expect to reach free cash flow positive in the next 12 to 24 months. As Gary mentioned, we are in the early stages of one of the most exciting and compelling transformations in all of retail, and we plan to continue on our path of creative destruction, leapfrogging past everyone else in our path. We would like to thank every single member of TeamRH, both our people and our partners around the world. Thank you for your commitment to our cause and as Ralph Waldo Emerson described, for being part of our movement. Good afternoon. I'd like to welcome everyone to the RH Fourth Quarter and Fiscal 2014 Q and A 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. Cameron McLaughlin, Investor Relations, you may now begin your conference. Hi. Good afternoon, everyone. Thank you for joining us for RH's Q4 and fiscal 2014 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 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 will turn it over to the operator to take our first question. And your first question comes from the line of Adam Sandler with Deutsche Bank. Your line is open. Yes. Good afternoon, everyone. Thanks for taking our questions. I guess, obviously, sort of the biggest question here is the revenue slowdown that we're looking at for 2015. If you could maybe help us understand what is driving this? It does seem to imply a pretty significant slowdown in the brand comps as well. And obviously given that you're saying 2015 is a bridge year, but then then sort of as you think about this longer term, getting back to 20% next year. But if we take and this is I guess a 2 part sort of near term, help us understand. But then longer term, if we could help understand sort of the maybe disparity, if you will, between longer term guidance of $4,000,000,000 to $5,000,000,000 once the network is fully built out versus the 20% CAGR, because 20% -ish, even below that CAGR would get you to the $4,000,000,000 change in just several years from where you ended 2014? Which question do you want me to start with? If you could just start with the near term please would be great. Sure. Well, let me talk about the way we think about our 2015 revenues and why they should accelerate in 2016 is twofold. 1, all of the new real estate opens in the back half of this year. While 2015 will only receive a partial benefit from those new galleries, 2016 will have a much greater benefit as they roll into the next year. And then 2, our development accelerates, our store development pipeline accelerates in 2016 with current plans to open 7 new next generation galleries in the following year. So really 2016 gets the benefit from the new stores. And if you think about the stores that opened this year that roll into 2015, we really only had one of these big stores Atlanta that opened this year, right, that rolls into 2016 rolls into 2015. So that's why we see this as a bridge year. I think the additionally as we kind of mentioned in the press release and video presentation, we have 2 new yet to be disclosed businesses opening in the second half of this year. We believe those businesses will ramp throughout 2016 as we add a second more and more informed mailing of each of those source books. So you've got 2 factors really. You've got the later openings this year and then you've got those 4 stores really rolling into 16. You've got the 2 businesses that we will be disclosing in the next quarter or 2. And those will ramp in the back half of this year and then be fully realized in 2016. Okay. That makes sense. And then just on the longer term, if you could help us think about the guidance of sort of a longer term CAGR of 20% versus the $4,000,000,000 to $5,000,000,000 in sales once the network is fully built out. Appreciating that you're opening you're ramping openings in 2016. Should we expect acceleration from that even, given that you did mention 9 signed for 2016 and then 25 identified or in advanced negotiations? Or is there sort of a number where you'd like to cap yourself just so you can make sure you execute properly on all these because they're not cookie cutter? Yes. Well, they're not right now, our plan is for 20 16 to have 7 of the next generation design galleries. As we look into 2017, could that ramp? I mean, it could. I think that what I'm hearing is you're asking the question as you're modeling this out, you're saying, hey, if you grow 20% a year, you're going to hit this $4,000,000,000 to $5,000,000,000 The way you think about the $4,000,000,000 to $5,000,000,000 in the real estate is that is just one of our initiatives, right? So the real estate transformation is one of our initiatives that tied together with our expanded product offer, right, gets us to $4,000,000,000 to $5,000,000,000 once we have transformed the real estate in North America. Beyond that, there's strategies here to continue to drive the product offer in multiple new ways that we have not disclosed. And there is business. So we believe that we can continue to grow the business in the 20% plus range for the foreseeable future based on the strategies that we have and the initiatives that we have in our pipeline. But you have to kind of look at the real estate as just one of the things we're doing, right? Got it. That's very helpful. Thank you so much. Yes. And your next question comes from the line of Matt Miller from Wells Fargo Securities. Your line is now open. Good afternoon, everyone. Thanks so much. Two questions. First, on Atlanta, can you provide any additional color on the early performance relative to that 12 to 18 month payback forecast? And you mentioned that it's the direct lift is one of the stronger lifts among your new format stores. I'm curious what factors might be driving that? And then secondly, in terms of the new concepts, do you have any more detail on the timing of RH Kitchen and the other concepts and whether or not they're included in your revenue guidance? Or would that be upside to your revenue guidance? Thanks. Yes. Yes. Let me try to take those. Karen you can add some color if I miss anything here. But as we said, we're very pleased with the early reads from Atlanta and we expect the sales in Atlanta to further accelerate as we introduce the new businesses we plan to launch in the second half of this year and then additional new businesses that we have planned for 2016. So one of the things when you step back and you think about these new stores that we're building, we built them for the future pipeline that we have in progress, right? So we didn't build them for today. We built them for tomorrow. So Atlanta is the first store to include all of our current businesses, RH Interiors, Small Spaces, Baby and Child and Outdoor. Additionally, there'll be 2 new businesses introduced in the second half of this year, both core to RH. So both will be within the home realm of the business that relate to the RH business. We think both open up entirely new markets and are significantly incremental to what we're doing today. So there are categories that we don't serve today. And those categories will be launched in a catalog and they will be then inclusive in these next generation design galleries, right? So Atlanta will benefit and continue to ramp in the second half of this year and then will continue to ramp further in 2016 as it benefits from those new businesses for the full year and it benefits from new businesses that will be added in 2016. We have announced Kitchen. We have not announced the date that we're launching Kitchen. Kitchen is not one of the 2 businesses that we will be launching this year. So I can end that speculation because we've already I've already gotten e mails from people that says, is one of the 2 businesses kitchen. And so we probably should have made that more clear. So kitchen is not kitchen is taking us a little bit more time as we are approaching the kitchen business in a fundamentally different way than anybody has in specialty retailing. So and we're very excited about it. We just have to do more work to be able to execute kitchen at the level we expect to. But the 2 new businesses that we are launching, I think I mentioned on the call, one of them I believe represents our finest work ever and might represent one of the biggest market potentials that we've addressed with a new category, a new business. So and the second one I think is also significantly incremental, but one I think is a game changer. We're not ready to talk about it yet, because we want to talk about it when we can show it to you fully visualized and you will hear more about it on our next call. So if you think about Atlanta, we're very pleased where Atlanta is tracking based on the categories in the business that it has in it today. We have expectations that it will further accelerate in the second half as it gets 2 new businesses, right, which the square footage is designed to take. And it will continue to accelerate in 2016, And then I would just add all the metrics internally, And then I would just add all the metrics internally are on track. The direct lift you mentioned, why is that happening? I think it's just if anyone's been there or seen it, it's just we've often said that these stores serve as somewhat of a billboard. And so I think the impression that you get even just driving by that thing it versus being kind of hidden in the mall in 7,000 square feet, the advertising sort of the marketing that we get from the brand just from having that store physical presence, it's no surprise that it's driving the direct lift, but at the same time we're very pleased that it's been as strong as it has been. And with respect to all of those payback metrics, just as a reminder, none of the direct lift is factored into those. That's kind of crazy because it's not in that 4 wall contribution. Yes. I would say and let me just maybe back up and give color on all the stores and it might short circuit some of the answers as we go. We've opened in the really in the last 12 months, 4 stores, Greenwich, New York Greenwich then we had an expansion of New York. We opened Melrose and we opened Atlanta. They're all very different. And I think it's important to note that as you think about the business and the indications or reads you should take from each of them. Greenwich was really a full line a basic full line design gallery. So Greenwich was more like a Houston or our initial LA or our Scottsdale store. So it was about the same square footage expansion as those and it only has the core RH business and then had an expansion of the RH excuse me, the RH Outdoor business. The New York expansion and by the way, we're very happy with Greenwich, exceeding our plans, very excited there. The New York expansion is the one store we've been disappointed with. And let me tell you why we believe that has not played out to be up to our expectations. This is the only store that did not relocate to a new location. So what we did in New York is we added 2 floors above an existing floor and a half. We closed the basement and we then went up 2 floors. So we expanded our square footage and we had an expanded assortment of our interiors business and we put some outdoor on the top floor in New York. That store has not gotten the we expected. So we're disappointed with that. What's the lesson there? The lesson is it's the only one that did not go into a new location and does not have there is no physical change from the exterior of the store. So we believe that just expanding the store in its space without changing the facade or changing the presence of the store is a key lesson for us that the customers don't know enough's changed, right? You can't see it from the outside. Melrose on the other hand is in and of itself is another kind of store change. So Melrose replaced one of our first what we called full line design galleries, right? So we opened in L. A. In an ex Williams Sonoma home location that was a temporary location for us. We had signed the Melrose location. We knew it was going to take several years to develop and build and we didn't want to wait in L. A. To have an expanded assortment of our business in the market. So we picked up the Williams' home location. When Williams' home when Williams' home closed those stores, we were able to build that out, remodel it, put in a courtyard and present our brand. We were very happy with the lift. We learned a lot. But we already had a store in development. So Melrose represents just a better version and bigger version of a full line design gallery. It's not a next generation design gallery. It does not have baby and child. It does not have small spaces. So it's just a bigger version of a full line a bigger version of a full line design gallery. And we're very pleased with the results in Melrose. Atlanta, as I said, is the 1st full line design gallery. So that's the only one that represents the new model. And we're very pleased with the early results in Atlanta. And we're very excited to continue to feed that footprint with the businesses that we've developed in the pipeline that are designed for all these larger stores. Thanks so much for all the color and good luck this year. Yes. And your next question comes from the line of Jessica Mace with Nomura Securities. Your line is now open. Hi, good afternoon. Hi, Joanna. My first question, if you could just clarify on this bridge year for 2015. Is it fair to say that the dynamic is solely related to the timing of opening stores? And or could you tell us if there's any change in what you expect in your comparable sales growth? Well, it's from our internal plans, it has everything to do with the later development of the real estate and the real estate coming on later. And so I mean just to be clear, we don't expect this company to continue to comp at 20% to 25% forever. And that's never been an expectation. So we the real estate is essential to continue to have the 20% range revenue growth. Understood. And then if you could provide any further color on the performance of the gross margin expansion and the SG and A performance in the Q4? And maybe just some of the timing for the significant benefits you expect to see in 2015? Sure. So for Q4, our gross margin was actually right in line with what we had kind of been talking about for the whole last half of the year. We had talked about the half having 50 to 100 basis points expansion. Our actual was 90 basis points gross margin expansion in Q3 in Q4 that was 30 basis points, which was right where we kind of had talked about. And then SG and A was also kind of similar. We had said we expected modest deleverage and the biggest drivers within SG and A, we were flat in Q4. We had some deleverage in advertising as we've been talking about with the expanded page count and that basically offset some of the great leverage we had all across the rest of the P and L with a lot of our fixed G and A costs. So that's kind of the story and the color on Q4. With respect to 2015, just in general that operating margin expansion that we're talking about, we expect the majority of that to come from SG and A leverage this year. The biggest driver being advertising leverage, which Gary mentioned some of the optimization we're going to be having with our source books this coming year. But we do expect to have some modest gross margin expansion in 2015 as well. Great. Thanks very much. Okay. Thank you. Your next question comes from the line of Matthew Fassler with Goldman Sachs. Your line is now open. Thanks a lot and good afternoon. The question I want to ask tries to relate the direction of operating margin to your store opening trajectory. So your incremental margins are likely to increase nicely in 2015 as revenue growth slows a bit to your plan and the operating margin expansion stays somewhat similar. Is any of that reflective of less new footage? And I guess the other question related to this, as you look out to 2016, is there any reason why incremental margins would change at all from where they're going to be this year? In other words, should you be able to get good operating margin expansion a year out even as the rate of average footage growth accelerates? Yes. We would expect the operating margin to continue to expand. Yes. And one of the big drivers there, Matt, is related to the real estate transformation. The occupancy leverage that we're getting with these new deals is really significant. So we have this legacy portfolio that's highly productive and leveraging. And as these new stores come on, those are such superior economic deals than we've seen that that occupancy leverage is going to continue. Yes. And then let me just build on that. I think if you study the slide that Karen puts up that shows the path to the 15% to 16% operating margins to get to the mid teens. There's really a couple of key things and a way to simplify it. If you take the real estate transformation and you say, take any market and say, we are going to meaningfully increase the sales in that market. And in that market, we also expect to have occupancy leverage not only in that market, right, but we'll have occupancy leverage across the greater company because we're increasing sales. The other thing that happens is when you have a significant increase in sales, we're not planning to increase advertising in that market to drive those sales, right? So those sales happen as a result of the real estate transformation. So advertising leverages significantly in each of those markets, right? And so you've got 2 big levers and then you've got the other levers of those incremental sales across the entire infrastructure of the company. Again, what's very different here than I think of than many other businesses that are growing is we've spent years years years building this assortment. Remember in the typical market less than 10% of our assortment is displayed at retail. So we've built the assortment. We have more things coming, right? But we've built the vast majority of assortment. And now by opening these new stores, we will get the sales and the leverage, because it's not like we're building the assortments as we're trying to drive the sales. We've already built the assortments. So we just have to unlock those assortments into the marketplace. We will by transforming the real estate that will meaningfully lift the sales in every market that will drive down occupancy, that will drive down advertising costs and it will drive down overall SG and A across the company and across the board. Great. Thank you so much for that. Appreciate it. Thanks, Matt. Your next question comes from the line of Peter Benedict with Robert W. Baird. Your line is now open. Hey, guys. A question just on the operating margin. Thanks for the color on the year and how you're seeing gross margin SG and A. But if you think about the Q1 kind of implying flattish maybe up a little bit and I understand that the revenue is a little lighter there. But as you go across the balance of the year, you're obviously guiding to a lot more operating margin expansion. I mean the revenue growth rates implied over the following 3 quarters aren't materially higher than what you've got in the Q1. So I'm just curious, other than just sales leverage, are there any other puts and takes, Karen, we should be thinking about in terms of what's maybe pressuring the early part of the year, but that may fall off of the back half? Yes, sure. So Q1, if you just think about what Q4 looked like, just roll that forward to Q1, because we expect the same thing. We expect the modest gross margin expansion, but the ad cost. So our books mailing once a year have pretty much a 1 year cycle. So when we double the page count and we have the deleverage in ad cost in Q2, Q3, Q4, it's just going to continue into Q1 until we lap that and have the benefits of our some of the optimization we're having with our next year in 2015 the coming books. When those optimization efforts hit in Q2 that's when you'll start seeing the ad cost leverage. So in Q1 you still have a little bit of the deleverage that we saw throughout the year. Now that really helped in another year with very little square footage growth to drive a lot of our sales and the great things that happened in our business. But in Q1, you're not going to see the same level of operating margin expansion as we will in Q2 with Q3 and Q4 in 2015. Okay. That's perfect. And then just thanks very much for that. And then just as we're thinking about 2016, I think Gary you said maybe 7 of the new design galleries coming online. Do you think any of those come early in the year? Are they do you think the timing would be more spread as best you can tell at this point? Or should we be thinking back half of the year for the 16 openings as well? Yes. I would say it's still going to be weighted back half, but we may get a couple of them open in the first half. But these because they're all big development deals, they're just really hard to gauge. We actually just until several weeks ago thought we had 8. And then one of our major landlords had an issue with moving a critical tenant that they needed to move and the store gets pushed by 6 months into the following year. So I wish these could be simpler and more predictable, but they're not. And in many ways, they're in retail, because even different than a department store where you're just looking for a pad. They've got pads for department stores and you've got a simple build. These are they have to make the room for us or find the room for us, right? Or we have to find a building that works. So we're confident in getting them all done. But as we're doing them, I think we're learning and we're learning about the complexities. And while it's rolling out a little slower than we might have originally anticipated, I think the benefits from that, I think we're smarter. We're making we're learning lessons. We're making a lot of good changes and continuing to tweak these and make them more productive. So and I think we'll still be able to hit our long term targets here. I think in this 1 year and this bridge year, we would have hoped this year would have been more like 7 or 8 stores and it wound up being 4. Understood. Thanks for the color. Yes. Your next question comes from the line of Oliver Chen from Cowen and Company. Your line is now open. Hi. Congrats on a solid finish to a great year. We had a question related to the inventory needs over the next year. How should we think about the magnitude of cash outflows? And is there a delta with the new concepts? And then also Gary, you mentioned quality and service as a theme. How will that interplay with your with the financials in terms of margins or how you see traffic and awareness building? And finally, I just wanted to ask you a little bit about supply chain and supply chain feels like a great long term opportunity as well as ongoing and how that may intersect with the customer experience? Thank you. Okay. I'll start with the inventory one. And that one is very similar to what we have been saying is this business does require a nice in stock position. So we will continue to make inventory investments to make inventory investments to make sure that that strategy to improve our in stock and make sure we're not having high back orders continues on that path. We were really happy with the investments we made last year. It actually was one of the reasons we were able to navigate some of the port issues in the back half of 2014 having made some of those investments. And then we will make investments for the product, the newness in some of the product categories that Gary talked about. So on the year, we do expect to continue or we hope to grow inventory slightly ahead of sales, very similar to what we did actually the last 2 years. So that really won't change and we won't see significant improvement in turns until we start to grow more of the square footage and start to kind of optimize some of those inventory investments and have a little less newness and more growth by square footage as opposed to offer. Okay. Thank you. Great. Let me try to pick up your other two questions. I think one was related to the theme of quality and service and how that will impact the P and L. I think we believe as we position this company at the luxury end of the market and position the brand there that there's an opportunity to continue to elevate our service and elevate the quality experience that our customers get. And we're making multiple investments and we'll continue to and they all have pretty good return timing. So let me just talk about some of them. 1, you've heard about our push into design services. We're finding out that as we invest into offering a very high quality level of interior design, The payback on those investments is very quick and it differentiates us in the market. And a lot of people today, it's interesting, a lot of people say they have free design services and but not many people have really certified and qualified interior designers on staff or people that are qualified to go in and do somebody's home. Many times, I think other people out there that are in the industry that say they have design services are taking some junior person who may be as good at visual merchandising and letting them into somebody's home and try to give them advice on how to design a home. Or other people may have people who think they're good at decorating and they call them an interior designer. We're building a world class kind of interior design platform. And we believe we have the credibility to do that, because I think if you look at the execution in our galleries, we execute as well as world class interior design platform. Galleries, we execute as well as world class interior designers the way we present in our stores. But we think there's opportunities to elevate the service to add installation services to be more full service like an interior designer. The question is at what point do you charge for that service? And how high do you take that service before really it doesn't make sense to do it for free. So there's we're doing a lot of work around interior design services and believe we can elevate that effort over the next several years. Some other things that we're focused on is the continued in sourcing of our home delivery hubs. I think I've mentioned in past calls that our bias is to have more control than less control and to have more control of every aspect of our business all the way to the customer. So we continue to make investments and to take control of our supply chain based on that final delivery. And that kind of piggybacks onto another key investment we're making and a system that we're rolling out this year and that's our new Final Mile system. I think we've mentioned this before, but it's a new scalable state of the art delivery and scheduling platform that provides visibility to all aspects of the delivery cycle and enhances the customer experience through improved inventory accuracy and scheduling efficiency. Today, we're dependent, especially where we have third parties on systems that don't give us full visibility that we don't we have communication gaps and visibility gaps throughout the system and we lose efficiency and it impairs our ability to deliver world class service. And it's also more costly. So we think that there's significant opportunities as we roll out Final Mile, which should be fully rolled out by the end of this year and will be seen we believe big impacts and payback on that investment. The other thing we'll be implementing this year is a sales force customer relationship system management system. And it's really the leading customer relationship management solution that will provide a single view of the client for galleries at all of our stores and our client service centers. It elevates the customer experience by enabling associates to service clients faster and more accurately with seamless access to order product and other key information and including the customer's lifetime value. So we can we can see the lifetime interaction and value of this customer. And today we don't have that, right? So we're still today operating kind of in the dark ages from customer relationship management point of view. So when we roll out this Salesforce system, this is going to leapfrog us ahead. We're also we have some other things that we think will just improve the operational performance of the company and execution of the company. Well, first let me finish on the supply chain. The last piece is our new distribution center in Northern California. We talked about this. It's a new 1,500,000 Square Foot DC in Paterson, California. It's the next planned step in our long term growth of our network. And it's really a next generation kind of distribution center. Each one of these we get smarter, we get better, we execute better, we take learnings from those and we can then take those learnings into our existing centers. But all of this gives us the ability to continue to grow the company and gives us enhanced flexibility. So we're building a network that we believe gives us the ability to grow and the ability to be flexible and to accept new businesses and new ideas and not have a supply chain that locks it in. And then the other investment we're making is into a new Oracle Financial System. We have a planned replacement of I think it's what do we have? Lawson. It's an aging financial system. Very aged. Yes, very aged. And this is really state of the art Tier 1 solution from Oracle that will give us better data, better reporting and better information throughout the organization and be able to manage our financials better and be able to manage the business better. So a lot of investments that will all of these will help us raise the level of quality, service and execution throughout the company. And so I think that kind of ties into the supply chain question also. Yes. That's really, really helpful. It sounds like really great infrastructure developments. And Gary just as a follow-up, where are you with lead times roughly? And is there a way to dimensionalize what the big opportunity is on that overall kind of lead time picture as you look to efficiently match supply and demand? Yes. We're doing a lot of work there. Ken Denae, our Chief Operating Officer has recently taken over inventory management. He is a new leader in that area of the business. I think we have more intelligence, more energy and passion behind inventory management than ever in the history of our company right now. And these guys are working all the way up the supply chain and really creating interfaces with our vendors at a level of really sophisticated companies. So you'll hear more about this. I mean there's many things we can talk about here, But it's kind of the next step of evolving this company. We've been able to position ourselves where we are today because we have brought a product to market that really didn't exist. In many cases, we created a new market, right? I've always said that furniture of this quality has never been made in these quantities before. So we're building a new railroad. And initially, it was a lot of muscle and hard work and investment to kind of scale this in the early stages. Now we're in a position where we're making more meaningful investments, system investments on both sides with our vendors and internally here and connecting those and building a kind of a supply network and a supply platform that we think will be very unique in our industry. So all of that should help us with lead times, help us with inventory flow. The way we're systematically placing orders now all of it will I think will get better. And the other thing I'd think about as you think about our company, remember our business and I said this a few times before, our business has been growing horizontally not vertically, meaning we've been expanding our product offer and expanding meaning we've been expanding our product offer and expanding into new products, new categories, new businesses. That is always less efficient, right, because you have so much newness. As we start to shift and again, shift not meaning that we're not going to have continued newness and new businesses and categories, you just heard me talk about the fact that we have 2 new ones that we're going to introduce this year and we have another one next year, possibly 2 next year. So that will continue to happen. But as a percentage of our total assortment, it becomes a smaller percentage. And then as you think about the vertical growth we will shift to, we will start opening stores, new and bigger stores, right? Our square footage will grow. So the square footage is about growth coming from the existing assortment, right? So that's where you start to get leverage on the inventory and you start to have much more predictable your business becomes more predictable, your turns get faster and you have a much better use of and returns on that working capital on that inventory. But how we've been growing the company has been the least efficient way from an inventory point of view, because when you grow horizontally and you have the percentage of newness we have, every inventory buy that's new is some degree wrong, right? It's either overbought or underbought. It's never right. The vendors it's the first time the vendors are making it. So they're not efficient yet. And it takes a really a good year to really start to optimize any new product or category investments or business investments that we make. So we're still cycling through all of that newness of last year. But each year, the newness becomes a smaller percentage And each year, we will be ramping up the square footage growth and the percentage there. And so the business model will change here. It will become a lot more efficient from an inventory and working capital point of view. Thank you. Thanks for sharing all those details. Appreciate it. Your next question comes from the line of Ryan Macauff with Hedgeye. Your line is now open. Great. Thank you. I appreciate you guys taking my question. So I hate to waste my air time here on like a nitpicky numbers question, especially with having you on Gary. But one thing is on the square footage growth rate for the upcoming year. You had mentioned in the video Karen how it looks like you'll be coming in at around 27% and that's down from the low 30s call it that you had previously given. I've gotten about a dozen emails already asking what's going on there. And I guess I'm wondering as far as the size of the stores being added, I'm assuming those haven't changed. I'm wondering if maybe there could be any slippage by a month or 2. Just as you had mentioned, you're dealing with local landlords and just a different group than Amalie. And then lastly, I guess, I'm wondering how many or how much of that could be driven by fewer legacy stores being closed, which are maybe staying open for maybe in the back half of the year when you open up these new concepts that you had hit on Gary that you'll have real estate available in order to show your new stuff? Yes. So you're exactly right. Our original target was 30% to 40%. We kind of started to ratchet that down throughout the year as we did see some slippage. There was one full line design gallery specifically that was going to be in Q4 that bumped into 2016. But in addition to that, there's 2 things going on with the legacy stores. One is, we originally planned to end 14 at about if you go back, we originally at the beginning of this year said we're going to end this year at 7% and we ended at 10%. Part of that is some of these legacy stores we thought we might close. When we opened Greenwich, we thought we closed Westport, but we kept Westport open. So there's been a few of those where in our original plan there was a few other legacy locations this year that we were going to close that we didn't. So that having a higher base this year makes the growth next year smaller. And then there's a couple of other small stores here and there in our plan. And for example, baby and child is not in the Greenwich market. It's not in a lot of these markets where we have what we would call the 1st generation full line design gallery. If there's not a baby and child expression, we still want baby and child in that market. So the play between some of those smaller ones, we might still have 30% square footage growth. Right now, our best estimate is 27%, but I would say if anything there's upside to that and now I want to miss 15%. Great. That's all I needed. Thank you very much Karen. Thanks, Frank. Your next question comes from the line of Daniel Hofkin from William Blair and Company. Your line is now open. Good afternoon. Just to go back to the, let's say, the plan for next year as you're seeing it at around 7%. Do you feel just big picture similarly confident about all of those opening next year? Or is there like a number where you'd say, okay, these are highly likely and then there's 1 or 2 that have a little potential flex just so we can have a sense for kind of a confidence interval? That would be my first question. Yes. I think I would say today we feel very confident about those 7. And I would just I hate to qualify anything, but they're big development jobs. So could something move? It may, but we also have some other opportunities where something might come forward. So we think we've got the pipeline well positioned. We believe 7 is the number we will hit next year. And that's how we see it today. And I would just add that whether it's 7 or 6, the way if there's a store that was going to be in December, we're going to have demand for that store, but it's not going to ship. It's not going to have a big meaningful impact on revenue next year. There's what I think is the important thing is to know that all the stores that are the stores that we're adding this year in 2015, all the stores we're adding in 2016, we have a lot in the pipeline already for 2017. We're kind of hustling like there's been a lot of work done on the real estate trends. We have 9 leases signed and a lot more deals that we've identified and it's moving along. We're extremely pleased with the economics we're getting in these lease deals and the locations we've been able to secure. So I think just making sure if you're looking out in 12 months trying to be laser specific this is going to be a harder one to model. But I think the long term growth in that 20% revenue and the operating margin expansion we expect from this strategy is quite strong. Yes. And I think that I think one of the points I made on the last call is we manage the business to optimize the earnings and the performance, right? And this year honestly and I know people are really focused on the revenue slowing. Could we beef up the revenues and spend more to drive more? And we could. We believe that the way to optimize the earnings of the company this year, right, is that the crossover for the optimization and is to pursue the plan we're on. And what we don't want to do is become victims to short term kind of thinking, right? And say, hey, let's try to jack up the revenues and spend more ad cost and temporarily have higher revenues and not optimize the earnings of the company. I think what we're building here is a really durable business, right? That will stand the test of time and that will dominate its market. And whether something moves between quarters or between a year here, from our point of view as long term shareholders and my point of view as the largest shareholder is not the right way to think about our business. The right way to think about our business is are we constructing something that's durable and is lasting value that will dominate its marketplace and win. And I would tell you today, I'm pleasantly surprised that we're guiding operating margins in the 10.3% to 10.6 6% range. I don't believe anybody had us modeled in the mid-10s. And I believe our guidance looks as good as anybody else's guidance in our industry today. And I don't think anybody would have thought we'd ever get here, right? And by the way, the other thing I'd say is that since we've been a public company in the 2 years that we've given you guidance at the beginning of each year, we've materially beaten the earnings guidance that we've given you. Has our top line moved around up and down? Absolutely. And is this stock volatile? Absolutely. It's traded between $55 100 right? And that's why I made the point about traders versus investors, because we manage this business like investors. We manage this business like it's the last place we will ever work and we own 100% of the company. And we believe we'll build the best company the home furnishings industry has ever seen with the best model and it will be the most durable business that we have. And I think this is is going to be a great long term investment. But I tell you, look I got it. The stock goes up and down, makes us all feel good or bad short term. But I think what we say here is we have to look beyond these bumps and we have to make decisions to build a great enterprise and that's what we're doing. So whether it's 7 or 6 next year, whether the sales are 14 to 16 this year and accelerate and we have a business today that is going to have a mid-10s operating margin that's growing faster than anybody in the home furnishings industry. We have the most exciting new strategy. We have the most exciting new stores that the retail industry has ever seen. And this is going to be a big win. It may not happen exactly to everybody's timing, if you think about this over the shorter term. But over the longer term, this is a place where we believe it's the right place to invest if you're a long term shareholder. No, that's great. And I mean it's clear that at least in terms of whatever delays there are, it's largely related to if not totally related to factors not related to the internal store performance or the website performance. The other just very quick question is, are you explicitly in your guidance for the remainder of the year assuming the kind of recapture related to the port issue that you have talked about? Or is that potential upside if you will? No. We have it in our guidance. We characterized $10,000,000 to $12,000,000 There may have been other loss demand that we didn't characterize because we could have given you a higher estimate and talked about what we might not get back quite frankly of the $10,000,000 to $12,000,000 that's what we believe will shift from Q1 to Q2. And I'd also say that in the back half of the next year where we've got 2 new businesses launching, I would believe that we're on the more conservative side versus aggressive side in how we're planning and forecasting those sales, a really aggressively from an annual perspective, right? That's how I think about this, if you look at history here. Much appreciated. Thanks. And your next question comes from the line of Wolfe Research. Your line is now open. Hi. Thank you for taking the call. This is Cody Ross filling in for Aram. So you have given increasing importance to generating free cash flow. What are you guys doing to drive that results? And what types of goals are you guys aiming for? Is there a working capital to sales goal that you guys are aiming for or an accounts payable ratio? Any color on that would be great. Thank you. Yes. I would just say that that is one of the higher priorities for me. And I think we feel pretty good that we have our eyes on the prize. We've talked about that 12 to 24 months. I guess 3 months has passed, so I should take it down by 3 months on each end. But I think we feel very good about it. There's initiatives across the board in the company, everything from some of the inventory stuff we're doing to how we're managing the source books to how we're managing vendor terms. All the working capital line items are kind of being worked on. We're not going to go disclose any specific internal targets. But I would just say we feel very confident that that important goal is kind of around the bend. Great. Thank you. And just one quick follow-up on that. Are we in any way seeing a slowing or sacrificing of growth in order to help drive free cash flow at all? No, absolutely not. I think the benefit of some of the real estate strategy is how much the landlords are willing to contribute on the capital front. But what the convert allowed us to do and I alluded to this on the call is, there are certain instances where it doesn't make sense financially for the unit economics of a specific deal to take their capital. If the returns they require on that capital hurt the deal and make the 4 wall contribution and the occupancy not as good for the long term, we now have the flexibility to use our own capital where it makes sense or to use their capital where it makes sense. So we're really balancing the free cash flow goals with that long term operating margin target in check. So I think it's been a really nice way for us to balance and make sure we're really optimizing each and every deal. Great. Thank you very much. I appreciate it. Thanks. And your next question comes from the line of Lorraine Hutchinson from Bank of America Merrill Lynch. Your line is open. Thank you. Good afternoon. With the 2 new businesses launching in the back half, should we expect incremental catalog or advertising spends to be coming through to support that business? Yes. And those are in our guidance. Okay, great. And then Timing will be a little different. Yes. Yes. I think what I think I alluded to in our prepared remarks on the video that we're decoupling some of the books this year. We're decoupling outdoor, decoupling baby and child based on our learnings. And these two new businesses we are decoupling from the big mailing, right? So the way our books will flow and hit the marketplace will be different than a year ago. And I know it's early on the outdoor launch, but you mentioned modern and contemporary furniture there. Have you gotten any reaction to that? The books are just getting in home this week. This week? Yes. Okay. And then lastly, Karen, on the port issue, are you seeing congestion in the East Coast where most of your deliveries were diverted to? Or is there some other delay that's coming through? No. The biggest thing for us is a significant portion of our imports do come through the West Coast, but we really I mean back in April of 2014 and almost a year ago we put mitigation plans in place. So we were not that heavily and of course things slowed down, but we diverted a lot of our goods through the East Coast ports. We took that reliance from over 80% on the West Coast down below around 50% and increased our weeks of supply to kind of manage through that. So we were pretty we navigated pretty well through the end of 2014. In February, things started slowing even more and all the congestion. So really for us, it's just some of the receipts that $10,000,000 to $12,000,000 for us is receipts that we thought would land in the latter part of the quarter in Q1 that are now going to shift into Q2. So, of course, is there some loss demand? Sure. But for us, we're characterizing it more of a shift versus a significant loss. And we don't I mean, of course, we have canceled when we have back orders and things on special orders that are taking too long. But so far, we feel pretty good that that's just going to come in Q2 and shift. Great. Thank you. And your next question comes from the line of Cristina Fernandez with Telsey Advisory Group. Your line is now open. Hi, good evening. In the past, you've talked about revenue shifting to retail from direct as the new stores open. With the learnings that you've seen from the last couple of stores, do you still think that's the case? Or has the consumer behavior changed that perhaps direct will be the main driver going forward? No. We retail as we open these new next generation galleries will be the majority of the driver. There will be times that for example, when we launch these 2 new businesses this fall, those will be the majority of the business will be all direct, right? Because besides Atlanta, we won't really have a presence of those businesses at retail until we open Chicago, Tampa, Denver and Austin. So we will continue to grow and offer new businesses and new collections. It depends what the ratio of the next generation stores are, right? So as the ratio of the next generation stores becomes bigger, you'll see the business shift more towards retail. On the other hand, we also believe that there is just behavioral changes that are happening in society as technology accelerates and we have faster devices and mobile devices and you can shop any which way and just as we all develop new habits, right? And we're comfortable with new channels and ways to shop. So there's an underlying shift that is moving towards direct. But remember, I mean, 90 percent of all retail sales are done in retail stores today, right? Only 10% is done in direct. So we're unusual being fifty-fifty. And so we like the way we're positioned, but retail, we still believe is the most important channel going market. And I would just add just because I got to bang this drum that for us, as a reminder, very little is cash and carry in the stores. A lot of it's being shipped from the distribution center. So we really our retail galleries are a showcase. They're a showroom. They're an opportunity for people to come in and interact and look at the product. But we absolutely know that people go home and then order from the comfort of their living room. So we don't really think there's a huge difference in our profitability. The brands are synergistic with the channels are very synergistic and move together. So we don't really care where they order, because of course we want to maximize all of our profitability. But if they order in the store or they order online, a lot of times they're going to the store that it's still getting direct. So it's not so we don't focus a lot internally about trying to drive it to one channel or the other. We work on making sure all the channels are maximized and that our retail experience is making all that product is available for them to consume in the best way. I think Karen makes a really good really great point. At the end of the day, we really look at the productivity in the marketplace. We look at the capital we deploy in a market with a combination of our investments into 1 of the new into a gallery, into our advertising, through our source books, and our electronic marketing and so on and so forth. I mean, I think the fallacy that you hear today and it kind of surprises me is all these companies want to talk about well their direct business is growing faster and this is happening and the direct channel is their most profitable channel. Well, it all depends on how you're allocating costs. I don't know how you make more money when sales shift from retail to direct, right? Because your occupancy cost doesn't go down. Your overhead doesn't go down. So I think there's a lot of companies that are out there. In fact, it goes up in some cases. You're seeing in certain people that are now just getting into the direct business and everybody is all excited because they're growing their direct business and they're missing their earnings, right? Because they're finding out that it's expensive to handle the goods, to ship the goods and so on and so forth and fulfill the goods. And so it's honestly, I think there's a lot of old math and old thinking that's in the industry. At the end of the day, you've got to build a platform that can serve the customer wherever they want to shop that presents your brand better than anybody else. And it doesn't it shouldn't matter where the customer transacts at the end of the day. Look, if all of a sudden we're when virtual reality comes to everybody's homes in so many years, I just came back from the TED conference, right, and where virtual reality is going. We're going to be sitting in our homes being in a different world. You could be probably in 4 to 5 years, you can be in a restoration hardware three dimensionally, right, sitting in your living room. Should we care if they place the order in a store or from their couch? No. We shouldn't care. And I haven't seen one retailer yet that has said, oh, look our direct business makes more money and we're growing that faster. I haven't seen their earnings grow, but they talk about it a lot. I haven't seen one yet. So we look at the business holistically as a multichannel platform and we look at it by market and how do we maximize our revenues in each market and maximize our profitability in each market.

• Earnings release
• Annual report