RH (RH) 2016 Q4 法說會逐字稿

Good afternoon.

My name is Chantel, and I will be your conference operator today.

At this time, I would like to welcome everyone to the RH Fourth Quarter and Fiscal 2016 Q&A Conference Call.

(Operator Instructions) Cammeron McLaughlin, you may begin your conference.

Thank you.

Good afternoon, everyone.

Thank you for joining us for RH's Fourth Quarter and Fiscal 2016 Q&A Conference Call.

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

Prior to this call, we posted a video presentation to our Investor Relations website, ir.rh.com, highlighting the company's continued evolution, recent performance and future outlook.

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.rh.com.

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

(Operator Instructions) Your first question comes from Oliver Chen with Cowen and Company.

Regarding the inventory for the year ahead, what quarter will that be a source of cash?

And are there any parameters about the magnitude in terms of the opportunity there to drive cash?

And as we do model net working capital, are there any puts and takes we should think about on the net working capital in terms of use of cash?

And our second question was the details on back-end optimization where you feel like you have the biggest opportunities and how that will factor into either top line in terms of traffic or comps and margin opportunities.

Sure, Oliver.

I'll take the inventory question, and then Gary and I will tag team on the network optimization.

On the inventory, we've said that inventory is going to be a source of cash this year, which implies it's going to go down actually versus last year.

We're not giving a lot of color on timing and cadence, with the exception of the fact that we've said that a lot of our SKU rationalization efforts are going to be in Q1 and into the first half, so you should see some good progress there, but part of that's also versus where the inventory levels were last year.

So it's one of our key initiatives this year.

It's something we're very focused on.

And we'll continue to provide progress updates, but we're not really giving details by quarter at this point.

And then with respect to working capital, we've talked about the fact that we're trying to make progress in the past on vendor terms, and that's something that -- it's something that we'll work in concert with our inventory.

When the inventory goes down, AP is not necessarily going to go up in that way, so that could be an offset.

No other items really of note to point out there though.

Then on the network optimization...

Yes, can you repeat -- you had quite a few questions in that 1 or 2 questions, like I heard about 6 or 7 of them, so maybe if you could repeat the question again.

Yes, I was just -- I was curious about the back-end optimization in terms of the opportunities you see there and how that will interplay with just the sales and margins and what kind of strategic improvements and how that links to what kind of opportunities you have on the income statement.

And Gary, hospitality seems like a game changer.

It would be great to have your thoughts on how that will also evolve to impact the core, too.

Sure, sure.

I think we've communicated all year this past year, that we believe that there was an opportunity to redesign our supply chain network and simplify the business which we believe will have a meaningful impact on the ability to get lower inventories and reduce working capital in the company while also increasing in-stocks and optimizing our inventories and our customer experience.

Secondly, the other big opportunity we've articulated is really around the home delivery experience.

And the belief is we believe by taking more control of that experience than less control and using our own customer-facing people, in many cases, it can greatly enhance that experience.

I would characterize our business today, if I stand back, I'd say we really -- we're in the process of transforming the brand from call it a mid-upper tier brand to a kind of a luxury brand experience.

And we've made significant progress on the product side, on the customer experience front-end side in our galleries with our Source Books and online.

But our home delivery experience is really still architected the way it was 10 years ago.

And while we're making some small steps of progress, I think you'll see us take some big steps.

And we have a -- we have a pilot that's just beginning here in the Bay Area where we're taking full control of the delivery experience from the people to the trucks to the entire in-home experience which I believe we should be taking more control than less control.

So we think those both can be significant -- significantly impact the business in multiple ways, both from a top line point of view by improving the experience, from an asset turnover point of view and working capital point of view and a return point of view and then the ability to simplify the supply chain network and operate the business out of fewer facilities versus more facilities.

We told you we were able to forgo building a planned distribution center that was going to open in 2017.

That's saving the company a meaningful capital investment in '16 and '17 as well as significant operating cost.

And you'll see us -- I think we've got still a long way to go, but big opportunities here to really move the needle financially for the company and enhance the experience in a significant way for the customers.

And just lastly on hospitality, it seems like a game changer.

And how do you see that like impacting the core business?

And are your -- do you have thinking along the lines of hotels?

And how do you brainstorm about how do you continue to evolve the luxury brands across a paradigm of touch points for the consumer?

Yes.

You've seen our first effort from a hospitality experience in Chicago.

And what we worked long and hard at there was trying to seamlessly integrate a hospitality experience into a retail environment and not just as -- there's -- we're not the first people to put a restaurant or food and beverage in a retail store, it's -- that's been around for as long as I can remember when my mom would take me to a department store when I was a kid and they'd have a restaurant or a café.

I think what we've done differently and where we're kind of leapfrogging that previous experience that might be out there today is, in many cases, the hospitality experience was disconnected from the retail experience.

And you might have walked through a shoe department to get to a restaurant or went to the top floor and the business -- the restaurant had nothing to do with the retail experience, it just happened to be convenient.

And that was something we weren't really interested in.

Just having a porthole that walks into a -- walks from a retail store into a restaurant is I think no different than stepping back out into a street or a shopping center and walking into a restaurant.

For us, it was really taking the idea of home, the business we're in, and saying in a home, in your home, you would be hospitable, right?

You would have people into your home.

Probably one of the first things you do is you offer them something to drink, you might offer them something to eat, you'd make them feel welcomed in that experience and you'd try to connect with them.

And that's really what we're trying to do.

And I think what we've done really well, and we're the first ones to really do, is integrate the hospitality experience into the retail experience where it's completely seamless.

And there's really no barriers, and there's really an interactive play between the consumer, whether they're shopping in the store for home furnishings or they're eating in a café or interacting with us at our coffee bar pantry or having a glass of wine, that you're really immersed in the brand and you're immersed in the ethos of our design esthetic, our lifestyle, our sense of quality, our sense of design in every aspect of that interaction.

And look, the response we got in Chicago has been tremendous, way beyond our expectations.

And I've had people joke around before -- I think I showed a video in the last -- a little film clip in the last video that showed people lined up around the block a year after we opened and kind of a quick time where they were filing into the store.

And people asked me, "Well, did you set that up?" And we didn't set it up.

And you go to Chicago any weekend even if it's snowing, and there's a line every Saturday and Sunday.

And I think it's not -- do we have great food?

Do we -- we absolutely do.

And we created a great experience.

But there's something magical that's happening there that I think we're on to that gives us so many -- so much more optionality as we think about -- if we think about our business and our brand, where our business can go, what kind of real estate locations we can go to, what kind of destination we can be, the dependence on the brand for mall traffic or shopping center traffic, we've learned so much in Chicago that we believe is the first steps that even -- revolutionizing our physical experience even further in the future.

So we're quite excited, and that's why we're making an aggressive investment this year, we ramped up the whole hospitality organization that I talked about on previous calls led by Brendan Sodikoff, who's joined us as President of RH Hospitality.

So our focus is going to be on expanding that experience that we launched in Chicago into multiple new galleries, I think -- what is it?

4 of the 5 in '17.

And many of the galleries we have planned for '18 and '19 will have integrated hospitality.

And I think we'll just get better at it, and we'll learn more as we go.

As it relates to the questions around, "Are you doing more in hospitality?

Are you opening hotels?" And I've had a lot of people ask me and say, "I've heard you're opening a hotel." And I've told them no.

And then they ask, "Well, I hear you're opening a boutique hotel." And I've said no.

And I guess I'll just leave it there.

So if something does come to fruition, it won't be a hotel and it won't be a boutique hotel, but it will be something that will be equally revolutionary if we decide to step into a new category.

Your next question comes from Matt Fassler with Goldman Sachs.

I've got 2 quick questions, I'll ask them at once.

First of all, can you talk to us about your plans for merchandising holiday at retail next year given some of your learnings from this past fourth quarter?

And then secondly, if you could kindly run through the cadence of mailings here in 2017 relative to last year, and how we should think about that as we model out the cadence of the year from a sales and expense perspective?

Sure.

As it relates to holiday, we're still in the planning stages and aren't ready to unveil our plans there yet, Matt.

We did get back more business than we thought last year, and we think there's an opportunity this year.

And as our plans come together, we will share them with everyone, so not too many comments on holiday at this time.

Okay.

And on the mailings for '17?

Yes.

Mailings for '17, we just communicated that we -- our outdoor book is in the mail -- was in the mail the last 2 weeks, and now it's substantially in home.

And Modern will mail late in the spring, and that will be the second mailing to Modern.

And at this time, we do plan to mail an interiors book in the fall.

But I would also just say that one of the things that we've learned here is that we should put our work out in the marketplace when we -- when our work is ready to be put out into the marketplace.

And I don't think -- because of our business, and our business is not necessarily a fashion business like apparel and that we're trying to hit seasons with -- the only seasonal part of our business is really outdoor and the holiday part of the business.

The rest of the business is pretty much seasonless.

And our focus is to introduce our books and put our work into the marketplace when we feel great about it.

And if it takes an extra month or 2 or -- I'm not really too concerned about that, and I'm not really -- I don't want to focus on, "Well, was the book late a month?

Or is it early a month?" Look, I think Apple puts out the iPhone, the new iPhone, when the new iPhone is ready.

And we're going to put our collections out there when our collections are ready, when we feel our work is truly great and is going to move the brand forward.

And if it takes us a little longer to refine the collection, to make the book great, to fine-tune our plans, then it does.

And I don't think that does anything but make the brand better as opposed to kind of rushing to hit a time line and maybe sacrificing quality along the way.

So I think we've learned a lot in the past year.

We've made some moves, gave ourselves more time, invested in the Interior Source Book.

And I think I even made an incorrect comment on one of the last calls, I said if I would have done something better, something differently in 2016, I wouldn't have delayed the spring Source Book because I thought it cost us too much revenues.

Now that I even have more data and I look back, I'm really glad I delayed that book because that book is fresh, it's new, it's exciting, the brand looks cohesive now, we don't have an older dated-looking book and a new modern book.

And while there is some short-term pain and maybe depressed revenues in '16, I think we're going to all be really happy with our performance in '17 and how the brand and the business performs even in light of what surely looks like, if you look at the performance of home furnishings retailers, like a difficult top line environment.

And I guess a kind of a follow-up, there's a fairly narrow revenue range, $100 million from the low end to high end.

Presumably, the base case there for that range is the mailing schedule that you originally discussed, just to be clear on that.

You're contemplating that the books go out at the time that you specified rather than with some variability.

Correct, correct.

Your next question comes from Brian Nagel with Oppenheimer.

So the first question I had -- just with respect to the first quarter guidance to understand the mechanics there, so you don't -- you are telegraphing a pretty significant pickup in sales growth going from Q4 to Q1, but then there looks to be a lack of flow-through on the earnings line on that.

So I guess the question I have around that is what are the drivers behind that better sales growth, how much of it, if any, is onetime in nature?

And then why -- or am I interpreting it correctly, there's not as much showing up in the early (inaudible) something else?

Sure.

So on the top line, 2 things that we pointed out on the video, I just want to make sure they're very clear, is, as it relates to Q1, we do have incremental growth.

This is the last quarter were Waterworks is not the base, so we have 5 points of top line growth from Waterworks.

And then we've also called out that we will have incremental growth from both the outlet business, and we plan to have warehouse sales in April.

So those 2 factors are what are driving some of that top line growth.

The residual...

That's onetime in nature.

That's...

That's onetime in nature that won't -- we'll then anniversary Waterworks in May, the acquisition of that business, and then we don't expect to have similar -- we're still kind of looking at how the inventory optimization efforts work out or what that plan will be, but those are 2 things that are driving outsized top line growth that won't necessarily continue into the rest of the year.

With the outlet and warehouse sales, absolutely, those have a cost on both margins and earnings, so the flow-through on that is not there.

And then we've also talked about the fact that we're having investments related to hospitality and related to some of the supply chain efforts, so those start in Q1.

Yes, this is Gary.

I'd also say, as it relates to the outlet and the warehouse sales, we may have some of that drag into Q2.

We're trying to just optimize the business right now.

We're managing the business for cash.

And so there may be decisions, as we look at optimizing the inventory and designing the supply chain network, to simplify the business and optimize the business for the long run.

We may continue to have accelerated outlet sales in the second quarter also.

Got it.

Well, then if I can just follow up, with regard to the buyback, so you announced the $300 million buyback in late February.

The numbers really suggest you got at it pretty quick, bought it out pretty aggressively, buying back a lot of stock in what seems like the last month or so.

The question I have there is discuss the funding of what's been bought back so far, and how should we think about the pace of buybacks over the balance of 2017.

Yes, so the purchases to date have been funded with our cash and investments on hand.

And we're not really -- other than providing the number of shares we've bought so far, we're not really giving a lot of specific guidance on how much we're going to buy, when we're going to buy it.

A lot of that is dependent upon our future plans, and we'll be continuing to look at that.

We do believe our shares are undervalued, and we'll be weighing that against other alternatives we have to invest in the business.

Your next question comes from Steven Forbes with Guggenheim Securities.

Gary, to start, with 8 next-generation galleries in place and then considering the learnings, right, from the recent RH Modern rollout, has the thought process pertaining to space allocation within the next-generation galleries planned for this year changed at all?

Or should we kind of think about the percentage allocation between modern interiors, Teen, Baby & Child, outdoors, to be similar to what the previous class was?

And then maybe on that as well, where does Waterworks fit into that whole perspective as well?

Yes, good question.

We continue to refine our space allocation model as we learn here.

So I would anticipate that it's going to be constantly evolving as we are expanding categories and expanding businesses and testing new categories in businesses.

So the galleries we're planning to open in '17 will have some adjustments from the ones we opened in '16, as those had adjustments from the ones we opened in '15.

So I would just expect us to keep learning and keep evolving and keep making adjustments that makes the space more productive and the outcome better from a profitability point of view as you think about the square footage.

As it relates to Waterworks, that's a very new partnership right now.

Our #1 goal was to not goof it up, if you will.

And it's a great business, it's a great brand.

And we think our platform can help amplify that brand in many ways.

We're still learning.

We're learning about their business.

We're learning about how we can best support and amplify their business.

And as we have more to report, we'll share that with you.

Okay.

And then just as a quick follow-up, maybe a 2-part quick question here.

So if free cash flow were to [ meaningly ] improve, right, as you've kind of outlined here over the next couple of years, can you just kind of list your prioritization of the use of those funds?

I mean, clearly, I would imagine investing in the business is first and foremost, but as we kind of think about other alternatives.

And then on that as well, right, if you think about a revolving line of credit and the maturation date of it, are you guys in the process of revisiting the -- that debt option as well?

Well, I think the debt option is still pretty far out, right?

You've got a ways for the debt option.

But we're always evaluating our balance sheet, and we're always going to put our balance sheet into the best position to support our business and support the opportunities that we see, so nothing to say right now outside of what we articulated in the press release or in the video.

We feel very good about how the balance sheet's positioned.

We feel very good about the choices we're making today.

We feel very good about coming around against probably what was one of the most difficult decisions I think a retailer in our space has ever made, and that was moving off the promotional cadence of the business on to a membership model.

We're very pleased with that.

And we're going to continue to invest in the business where we believe we have the best returns, so nothing more to report than that.

I don't know if, Karen, you have anything to add.

No, I think we've talked about the real estate transformation being one of the biggest value-driving strategies we have.

So obviously, that will be at the top of the list.

And we have some investments to make in the back end as well that we talked about for this year.

Yes.

Your next question comes from Brad Thomas with KeyBanc Capital Markets.

Just a clarification question for Karen to start.

Could you talk a little bit about what your expectations are for a comparable brand revenue for the first quarter just given all the noise and the growth that you have in non-comp business and how you're thinking about that for 2017 as well would be very helpful.

Yes.

So we don't -- Brad, as you know, we don't give guidance on comp brand growth.

But I will just remind you that the 3 biggest things that are not in there that will drive growth, certainly, in Q1, are -- Waterworks is not going to be comp-ed until the end of May, and then our outlet and warehouse sales we never put in comparable brand revenue.

And then the one thing that will stay outside of comp all year is any new galleries.

So both the 4 that we opened in '16 and the 5 that we're opening in '17, we have a 14-month comp assumption, so that'd be open for 14 months.

So that will -- there'll certainly be some revenue and growth that's non-comp-related to our real estate transformation.

Those are the big pieces.

Got you, Okay.

Well, maybe then as a follow-up, could you talk a little bit about how RH Modern has been performing since you expanded its assortment across your real estate network?

What's the response been?

And what's baked into your guidance as you think about the lift that you might see when you mail the second Modern book?

We don't report RH Modern broken out.

We think for competitive reasons, we're going to kind of limit the amount of information we give around that brand, except for the fact that we -- I believe I said in the video that we think it's going to quickly become a billion-dollar brand.

So we're very happy with it.

We're investing aggressively into the brand, investing aggressively into the square footage and the retail footprint that RH Modern is getting in the marketplace, and we'll invest aggressively in the brand from a Source Book point of view and from a website point of view.

So we're at very early stages, we just launched 18 months ago, and we learned a lot.

We think you'll see the second book that we mail will be a significantly optimized book.

And we're getting smarter with how we're merchandising it at retail today, what collections, and had optimized the floor space and the allocation.

So think about it as -- it's a very new business, it's in an early start-up stage.

We're going to learn and test and grow and evolve very quickly.

But the early indications and the early numbers in RH Modern, the way it's trending today, would tell you that this is going to be a significant business for the company.

It's opened up an entirely new market for the brand.

Your next question comes from Janet Kloppenburg with JJK Research.

A couple of questions.

Given the outlet business, the revenue expected from that in the first quarter and maybe some carryover to the third quarter, just that we should we expecting compressed gross margins in the first half and then a nice uptick in the back half, or how should we be thinking about that trend in the back half in particular?

Also, it sounds like the interior book is doing very well, Gary, the fall book.

And I wondered if you could talk a little bit about the success there and if there's some learnings there as you go into the fall season with the new book that is being launched.

And just lastly, with the in-home delivery objectives, I'm wondering if that -- what pressure that puts on margins, if any, in fiscal '17 and how much it might help in fiscal '18.

Okay, Janet, I'll start with the gross margin.

We're not giving guidance on gross margins, but I'll just say that in Q1, just as a reminder, last year, we had some of those temporal factors that we've been talking about all last year were really heavy.

And Q1 was the period when we had the customer accommodations related to RH Modern.

So that's something that we anniversary this year.

So even though we have some negative gross margin impact certainly, and the flow-through is not what we would like on those incremental sales, the gross margins in Q1 will be benefited by not having some of those issues from last year.

And then again, we'll continue to give a little more color as the year goes on with margins, but not providing formal gross margin guidance for the balance of the year.

So on the interiors book, I'll turn it over to Gary.

Yes, we're very happy with the interiors book and the early reads on how it's building and expect that book to continue to impact the business all the way throughout the year.

As I think we -- as you know, we mailed it somewhat late in the year last year and it got in -- a vast majority of the books got in too close to holiday we felt, so we knew that the ramp was going to come later.

And the ramp has come and it continues to build.

I'd say I piggyback on that point with saying don't forget and don't overlook the investment we made into RH design services and the rollout of Design Ateliers and the doubling of our design team in the field organization.

We believe that's going to have a significant impact on the business short term and long term.

We're building bigger orders, they have longer tails to them.

Those customer relationships are more sticky over time and more valuable over time.

So we feel very good about that investment as well.

But the key investments we made, whether it's the redesign of the interiors book, the investments we made in RH design services and the Design Ateliers, we believe are going to impact the business throughout this year and years to come.

So we feel very confident about this.

Right.

And on the in-home deliveries, Gary?

Yes, I don't if I have anything else to say except that we will -- we'll make the necessary investments to deliver the kind of quality experience that a customer would expect at the level of the brand that we're building.

So there will be investments there, we will communicate with you as we make those investments.

Right now, we're still at a learning and a testing stage, but we feel very confident we can make a big impact there.

And my sense when we stand back and look at it, while there may be a significant investment, there's going to be a significant opportunity from driving increased revenues, reducing returns and damages, all the things that you would expect as you improve performance in that part of the business.

And you're happy with the renewal rates on the RH membership program?

Yes, we're very pleased with how membership is evolving in the business.

And as we look at early renewal rates and customer acquisitions, they're all on target, all within our plans.

So we feel great about membership, and we feel great that we were able to hold hands, if you will, and march into hell for a heavenly cause.

I think there -- I tell people who've never worked inside a retail company.

From the outside, you look at a retail company and things can look beautiful, the stores look beautiful, the displays look beautiful, the interactions can be great.

Behind the scenes of most retail companies, it's chaos because you're running a business that's many times is week-to-week, month-to-month, promotion-to-promotion.

And you see it keeps getting worse in our industry, right?

I mean for the first time ever, I saw promotions for St.

Patrick's Day, 17% off, right, on the 17th.

I mean I'm like, how many more promotions can people make up?

And how many more cornball ideas can there be?

And how much more chaos can be created?

And I would just tell you that the one thing that nobody probably really understands in the value that's going to created, not only is this going to streamline and simplify our business and improve so many things operationally in the business from suppliers to our supply chain and all the way through, but just the reallocation of our time, right, our ability to think, our ability to kind of step back and see the bigger picture and see the bigger moves that can be made and play a much more strategic game, the difference between playing chess and playing checkers, right, and seeing the moves ahead and being able to make the big moves that are going to really have an impact on our business long term, it's -- I can't even tell you how different it is for this team in how we're navigating today.

And I could tell you, I can almost guarantee you there's not too many people -- there can't be anybody that would ever want to leave here and go back into the chaos that exists in a typical retail business that's on a promotional cadence.

I mean, I know I never would want to go back.

So we feel great about membership, and we feel like our performance is going to demonstrate that it was the right decision for our shareholders.

Your next question comes from Michael Lasser with UBS.

First, if the temporary items cost you $1 of earnings last year, could you size what you think the temporary items that are going to impact your business this year will be?

Yes, we're not doing that this year, Michael.

We're -- it's all reflected in our guidance.

I think there are certain things that we're still working through.

As Gary mentioned, we have a pilot for the home delivery, how that ends up in our P&L.

You'll notice we have a wider range on our earnings.

Part of that reflects the investments we're making, and we want to maintain some optionality on what those -- how those play out throughout the year.

So does that mean you would push them deeper at the [ potential ] expense of your profitability if you're sort of satisfied with the results?

We want to maintain optionality depending on how those results are and what we think we need to do to get the results we want on our back-end service experience.

So we don't know exactly how much it's going to cost.

There's things that we're testing.

And depending on the results of those tests, we'll roll them out accordingly.

Yes, I think if -- look, a lot of the initiatives we have right now -- you have to invest before you get returns, right?

And so whether it's the investments we're going to make in the supply chain network design, the investments we're going to make in home delivery, investments we're going to make to architect decision data throughout the organization that's going to amplify the quality of our decisions and the speed of our decisions throughout the company, the investments we're going to make to have a metric-driven quality process in our company.

There's -- we wouldn't make those investments unless we thought there was going to be returns that would be -- that would have a hurdle rate that would be worth investing to.

So we feel good about all the things that we're going to invest in.

Whether we speed up the investments, it depends on the magnitude of the returns, right?

You'll see us invest more aggressively where we think there's going to be greater returns, where we think they're going to have -- some may take longer to materialize, but that's true in any part of our business, whether it's new business, new category, new product, new system, new service all through the business.

So we're -- look, we believe we're going to be a long-term growth company.

We are an investment platform.

And we think we keep getting smarter, and we're going to be better allocators of capital as we go forward.

And so we believe the returns are going to get -- continue to get better.

But there may be some times where there's lumpiness because we decide to invest more aggressively into something that we think is going to have a greater long-term impact or opportunity.

But I think as I articulated in the past, we're going to invest like we own 100% of the company.

We're here for the long run.

We're not going to play a quarter-to-quarter game, we're going to play for multiple years and a long-term view and no different than the decision investment we made moving from a promotional to a membership model.

These are long-term decisions.

Okay, that's helpful.

My second question is based on your first quarter sales guidance and your full year sales guidance, it looks like you're embedding either that your brand comp remains stable or equal or potentially even decelerates as you move over the course of the year, despite the fact that the comparisons will get easier, and you'll have more Design Galleries mature, you'll roll in Waterworks and you'll have all of these Source Books be a little bit more mature.

So how should we think about that?

That's more of a function, Michael, of the items I mentioned that are in Q1 for sure.

And we're not sure how much outlet and warehouse sales we'll have through the year based on what we want to do with our inventory, how much we want to accelerate some of those efforts, with what we want to do with our DCs.

And then again, Waterworks will come up against itself in May.

So you have 2 items that are sort of anomalous on the growth front in Q1 that won't necessarily continue into the back half.

I wouldn't say that we're necessarily implying a deceleration, but I would say we're being sort of cautiously optimistic as we think about the retail landscape.

But the outlet sales are not in the comp, is that correct?

Right.

And again, we haven't given any guidance for comp.

We only give revenue growth guidance.

Your next question comes from Peter Benedict with Robert W. Baird.

Yes, guys, it's actually Justin Kleber on for Pete.

I just wanted to first clarify the comments regarding the DC that was originally planned for 2017.

Has this been pushed out to 2018?

Or have your inventory optimization efforts and some of the back-end work allowed you to delay this facility for the foreseeable future?

The latter.

I'd say it's for the foreseeable future, certainly not in -- I wouldn't even say in '18.

So within that long-term $4 billion to $5 billion revenue target, how many more DCs do you envision needing to reach that level?

I think a lot of that depends on how much progress we make this year.

We do think that with the SKU rationalization efforts and some of the duplicative inventory that we had at too many DCs, we'll be able to reassess that and kind of revise the plan.

But certainly, we're a lot better off than we were even at this time last year as far as how we were thinking about our long-term plans and space and capacity needs.

Okay.

And then just as it relates to kind of the back-end platform and what you guys had going on, what areas are, I guess, most in need of improvement in your view?

And who's leading these initiatives?

Is it internal folks?

Or are you guys leveraging outside expertise?

Yes, we -- look, we believe great companies are architected from the inside out, and that's the only way you build next practices, otherwise, you just have best practices.

And so what we articulated in the video and our press release is we are cross-functionally architecting the entire operating platform.

And so we're breaking down silos within the business, and we're spending time -- and that started with the appointment of the co-presidents last year and began to break down the silos in the business and began to look at the companies as one holistic business model and not just individual functions.

So more to come on this, but I think what we're doing is we're seeing big moves that a lot of times people don't see when they're just looking at it inside a silo or just looking at the distribution network from a distribution point of view.

But when you look at it from a business model point of view and you consider the entire business, you see things that you couldn't have seen.

And in my past, I've only seen it done the other way.

I've only seen it designed and implemented in a silo.

And a lot of times you have optimization in one part of the business and you deleverage other parts of the business and you play whack-a-mole.

So we're taking a different approach, it's going to take more time, it's going to take more effort, it takes cross-functional integration and leadership and collaboration to do it.

And we think we're going to design a model that nobody's ever seen before, no different than the assortment we've developed that nobody has on the planet, the galleries that we've designed that nobody has in the world, the hospitality experience that we've designed that's unlike anything in our business.

We believe we're going to build an operating platform that's unlike anything in the industry.

And we're going to do it from the inside out, we're going to design it ourselves, and nobody will be able to copy it.

So more to come.

We're excited about it.

And I'm personally leading the effort, just so you know -- what I'm really excited to do.

Your next question comes from Adam Sindler with Deutsche Bank.

First question, Karen, I think in the past, you had spoken about that as you leverage or you anniversary Grey Card, you're expecting potentially about a $20 million delta in revenues in 2017 versus 2016, including some benefit from Grey Card itself and then from lapping the extended selling cycle.

Is that still an appropriate estimate?

Yes, that's in the ballpark.

And just to be clear, the $15 million is kind of one of those items from last year, and that's purely just the deferral of membership revenue that will flop into this year.

The incremental amount is what we expect for new members and renewals.

Perfect.

And then on some of the initiatives from 2016, I know in the past, you've spoken about wanting to use design services more, the integration of Waterworks helping you become one of the only companies that truly can address the entire home.

As you look at some of the data, can you talk about maybe what you've learned from those 2 things and how many percent of orders are using design services, maybe what percent of orders are using Waterworks?

Yes, just on those 2 would be great.

Yes, those aren't things that we've traditionally disclosed nor do we plan to start, we'll just say that we -- you'll see that our efforts are only going to continue in expanding the Design Ateliers and the design services, and that should be an indication of that it has, in fact, been successful.

Your final question comes from Cristina Fernández with the Telsey Advisory Group.

Gary, I wanted to go back to the back-end system.

In the video, you talked about this being completed in 2019.

Can you talk about I guess the major phases over the next 3 years?

And should we think about the investments being front-end loaded or pretty similar over the next couple of years?

I don't think we can really articulate all of that right now.

I'd say, a lot of it is -- a big part of it is just time allocation by the leaders in the company, to tell you the truth, to architect and align around the strategies to uncover the big opportunities and simplify.

I think that so many people talk about systems as the solution to problems.

Generally, what I've learned in my career is when you -- if you don't take the complexity out of the business and simplify the business, and if you try to take a complexity and you then try to solve it with a complex system, you create a double complexity.

And that usually doesn't work very well.

All the companies I've ever been involved with and studied, most of the time, when they're launching a big system or they're opening a new facility, something drastically goes wrong, and that's because they haven't first simplified it.

And our effort here is going to, first and foremost, simplify our business and then support and amplify that simple solution with simple systems.

And when I've been involved in projects like that, those have worked very well.

But -- and when you see that -- I think when you see what we're going to do in this kind of first year and -- or what we already began doing last year and our efforts this year from a supply chain network design, a big part of that is just simplifying it, quite frankly.

I think I've articulated that our previous strategy was compounding distribution centers.

And we had 4 furniture DCs, on its way to 5, on its way to 6. Our fifth one would have been open this spring, our sixth one, I think, was going to be open late in '18 or early '19.

And our view, as we looked at that, the complexity of running a furniture business that has high average ticket, low velocity and is SKU-dependent, it's already a complicated business, it's already very difficult.

And by putting it in multiple DCs, you just compound the complexity of that problem.

And so the simple solution is to be in fewer facilities, right, and you simplify everything.

And that might mean you might have a little bit more transportation cost, it might mean that you have an extra day or so of delivery time.

But when you look at the offsets of the working capital investment you had to make, the capital investment you had to make to build out the platform, the people investment you had to make to manage such a complex inventory -- you think about our business this way: if you just took a furniture business, you said, "Okay, here's my assortment.

I've got it in one DC." Now you have to -- you're planning your sales, you're planning your replenishment, you're replenishing one location, you're staying in-stock in one location.

The moment you duplicate that inventory in a second location, you've now doubled the complexity of your business.

You have to now write orders for 2 locations, you have to be in-stock in 2 locations.

And in many cases, you almost got to double the number of people managing that.

Now turn it to 3, now turn it to 4, now turn it to 5, now turn it to 6. It's just compounding complexity.

And I've learned, in all my years in this industry, people go, "Oh, we'll fix that with a system." And I've never seen anybody fix complex problems with complex systems.

That usually becomes what I call a double complexity.

And I can't even say what I -- what I say that results in, but it's not a good outcome.

And what I've observed in the best businesses and the best companies I've studied is the ability to simplify and to architect a very simple solution, and then amplify that simple solution with systems and execution.

But it takes -- to be able to solve these kind of problems, it takes looking at it cross-functionally, it takes deep collaboration cross-functionally so you can see everything.

Otherwise, companies play whack-a-mole.

They fix something over here and they make something worse over there, and you get long-term deleverage.

You get companies that tell you year after year after year, "Oh, we're making all these investments, and we think operating margins are going to go up." And for some reason, the operating margins don't go up.

And sometimes, they go down.

And that was -- by the way, that was happening to us.

You look at our inventory and our return on invested capital, the inventory bloat in our company was unsustainable.

And we believe we're building a supply chain with a supply chain strategy that was too complex, and it didn't -- by the way, it was done by outside experts.

We had all the right outside people, they all studied this.

And by the way, none of them had ever architected a national furniture business.

Why?

Because there hasn't been any, especially at the high end.

So that's why we believe we have to do it ourselves, and we have to do it from the inside out.

We understand our business better than outside people do.

If there was great examples of high-end luxury level national supply chains, show them to me.

It's a very fragmented industry, and no one's done it.

And you've got some examples on the lower level and lower end that's nothing like the customer experience that we want to build.

So a lot of this is doing it ourselves, and a lot of it is first being able to simplify it.

And that's what we're doing, and that's what we've done.

And you'll see some pretty significant outcomes in 2017 because of simplification.

And the simplification is going to lead to much better execution throughout our organization.

And as we simplify and architect the right platform, we'll then amplify that with the right systems.

But this isn't coming in with a lot of consultants trying to take our complex problem and trying to solve it with a complex system.

That never works.

So sorry for the long rambling answer, but we couldn't be more excited than -- about the opportunity that exists today on the operating platform side of the business.

Okay, that's helpful.

And one more, and a different topic if I may, on the marketing side, you talked about higher advertising expense this year.

Is that just due to the Modern book, just having the additional book this year?

Are you making any changes to the circulation or digital marketing or any other areas?

Yes, that's just really a function of last year, we really only had one book and it was late in the year.

And then this year, we have the book -- kind of the fall book last year wrapping into this year, plus Modern plus another book in the fall.

There are no further questions at this time.

I will now turn the call back over to Gary Friedman.

Great.

Well, thank you, everyone, for your interest in our business and in our brand.

We're very excited about the year as we look forward into 2017 and beyond.

And we look forward to talking to you at the next quarter.

Thank you very much.

This concludes today's conference call.

You may now disconnect.