RH (RH) 2017 Q3 法說會逐字稿

Good day. My name is Ken, and I will be your conference operator. At this time, I'd like to welcome everyone to the RH Third Quarter Fiscal 2017 Q&A Conference Call. (Operator Instructions) Thank you. I would now like to introduce Cammeron McLaughlin, RH Investor Relations.

Thank you. Good afternoon, everyone. Thank you for joining us for RH's Third Quarter Fiscal 2017 Q&A Conference Call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Karen Boone, President, Chief Financial & Administrative Officer.

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 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) And our first question comes from Steve Forbes from Guggenheim Securities.

Maybe just start with a high-level question, right, given the current outlook for corporate tax rates. So Gary, if you can -- maybe if you can just discuss your willingness or general thought process around the idea of investing margin into the business, right, in a lower tax environment to drive share over the long term. Would you accelerate the rollout of home delivery or hospitality initiatives? Or are you really committed, right, to that kind of margin outlook that you provided at the Analyst Day and would not, right, proactively invest margin to the business in the environment that we may see?

Sure. Well, thanks. That's a good question. I -- the way we think about the operating margin guidance for next year is that is inclusive of investing pretty aggressively into the continued enhancement and redesign of our supply chain, including home delivery. So would we consider investing faster depending on the tax law? I think, depending on where it all lands and what gets passed, I think we'll evaluate it more specifically then. I think it'll obviously open up some optionality for us to consider things. But as I think about next year and I think about the guidance that we've given, we're very committed to that guidance, and that guidance is inclusive of some pretty significant investments in continuing to redesign and enhance our supply chain, including home delivery.

And then a quick follow-up here. Can you just remind us how many next gens are in the plan for '18? And then maybe also a high-level question, right. As you think about the evolution of brand awareness, right, and how differentiated the RH brand is from the cohort here, are you guys starting to have discussions, right, about a scenario where you can have even a larger footprint, right, than that 60 to 70 store current goal, right, and maybe penetrate cities or counties that may not necessarily house a legacy store today as brand awareness continues to evolve? Or is it still too early as you think about that?

Sure. Let me take the first one and concur with Karen. Next year's...

Next year, we have 3 in the plan for sure, and there's -- and then there's a smaller billboard gallery as well in the Napa Valley, so 3 of the larger and 1 smaller in Napa Valley.

Sure. And then as we think about the evolution of kind of brand awareness and having a larger footprint than 60 to 70, I think when you're -- as I think back in my career, whenever you're successful with the brand and a business and you continue to improve it and evolve it, you generally, over time, see a bigger market than a smaller market. And I think that's happened to us over the years at RH, and I think it will continue to happen to us. I was in a conversation with one of our investors the other day who was commenting on some friends of theirs that had been into our Palm Beach gallery and had -- went there for, I think, lunch or dinner and then came out wanting to redo their bedroom and other parts of their home. And the comment was that these new retail experiences that we're beginning to unveil in the marketplace have the opportunity to create a real tipping point in the perception of RH as a brand. And I think for those of you that were at our Investor Day in Palm Beach, and you had a chance to look at just 50 yards away from where we built the current new expression of our brand, was the legacy expression of our brand hidden in kind of the center, no real dominance, not a very impressive shopping experience and that the new physical expression of the brand is such a leapfrog. It's almost hard to believe that the company that runs the current legacy stores is the same company that's creating these dramatically different and enhanced shopping experiences. So I think we're going to find that tipping point. And the people that maybe don't think about shopping RH today and maybe don't perceive us yet as a luxury brand or don't quite perceive the breadth and depth of our assortment and the design services that we're investing into and the capabilities we have and the experience we can offer, I think when that really gets known, I think our market is going to get bigger, not smaller, and there's going to be a meaningful tipping point as we really continue the positioning of the brand in these new next-generation galleries. So -- and if I look back at the history of my career, whether it was early days at The Gap or Williams-Sonoma, and I remember when I first joined Williams-Sonoma and I think we had 48 Williams-Sonoma stores. And the discussion there was I think we can have 60 or 70. And that was as big as anybody thought it could be. And I think what does Sonoma have today, 250 stores. I don't think -- I remember my first conversation with Chuck Williams and Howard Lester. We -- the most we can have is 60 or 70. And so I -- that just happens to be the exact number we're saying about RH now. Do I think RH is going to have 250? I don't think so, not the size and scale that we're building. But do I think that there's markets that are not on our target list today that are not included in the 60 to 70, that as our brand becomes more successful and the brand awareness is higher and the understanding of the assortment and the services that we offer? I think -- of course, I think the market will get bigger than maybe what we see today, and I think that's a natural evolution of a growing brand or business. I think if we were sitting here with Phil Knight at the same stage that we're at today and said how big could Nike be, I don't think Phil or anybody in that team would have seen it. I know nobody saw it at The Gap and nobody saw it at Williams-Sonoma or Pottery Barn. And if you ask me 10 years ago what we were trying to do, we were trying to build a $1 billion brand that could make 8% to 10% operating margins. And clearly, we've blown by that. So I think that's just a natural evolutionary process that evolving and growing businesses go through. You just -- the market grows. You kind of create a market if you're really building the brand correctly.

And our next question comes from the line of Oliver Chen from Cowen.

We had a question regarding the merchandise margins. What was some of the main rationale for the strength? And over a longer time horizon, how do you see merchandise margins evolving? And second question, Gary, was about your thoughts on the evolution of breadth versus depth in your inventory planning and how you're thinking about the assortment and making sure that you're thinking about what's right for breadth versus depth just to optimize ROIC and turns, and yet stay innovative and relevant to what customers want.

I'll take the first one. This is Karen, and then we'll turn it over to Gary. On the merchandise margins, the 460 that we were up for last year, they're -- we are still lapping some of the SKU rationalization and other items from 2016, so I wouldn't necessarily take that plus 460 and carry it into future quarters or even next year but that 36.9%, that 37% or so margin, you can see, based on the guidance we have given for Q4, that we do feel quite comfortable with that. And then as we head into '18, we've given you guys some indication of that 170, 220 basis point improvement to there. So we do feel very comfortable that we're getting back to those prior highs that we've had in that 37% range. Longer, longer term, we see even further opportunity and upside beyond that.

And yes, let me take the question about the evolution of the breadth and depth, the assortment and how do we balance the breath versus the depth and what's best for innovation, I think, was your question. I think about -- one, I'd say think about 2017 as kind of a reset year in many ways, right? If -- we articulated that 2017 was a year of execution, architecture and cash, that we were going to be focused on executing our new membership model, architecting a new operating platform and optimizing cash flow by increasing revenues and earnings and decreasing inventory and capital spending and that we were going to have no new businesses introduced outside of hospitality introduced in 2017, right? And so that's not a long-term view. I would say, someone asked me the other day, "Gary, how do you think about 2018?" And I said, "Look, 2018, to me, looks a lot like 2017. I think it continues to be the year of execution, architecture and cash." I think we've -- we see a lot of opportunity in fine-tuning, executing our core business. We're in early stages of architecting what I believe will be one of the most innovative and optimized operating platform in our space of retail. And the focus on optimizing cash flow is important because of the current structure of our balance sheet and the risk we took on in buying basically half the company back. So 2018 will look a lot like 2017 but slightly different because we'll be farther down the path and our focus will now kind of shift back to our natural tendency of building growth. I think it's one of the core strengths of this business -- or this team and one of the things that we've demonstrated that we can do well. So as you think about the reset, we've -- it was important for us to reset the supply chain and redesign the supply chain because it was -- in its previous design, it was going to be a highly inefficient kind of capital usage, and we thought we could build a much more capital-light model and capital-efficient model by rearchitecting the supply chain. We avoided building a fifth furniture DC in Savannah, Georgia. We stopped moving forward with that project, and then we've now rearchitected the supply chain and are moving to a 2 DC network. And some people have asked, "Well, can you still grow the assortment with that 2 DC network?" and we can. We've got a lot of room to grow on the new platform. We're doing some things that are very innovative that, quite frankly, are new revolutionary ideas in how to think about DCs and inventory turns and just using the supply chain in a very new and innovative way that I don't want to talk too much about and give away too much to our competitors. But you'll see us -- we've got a whole assortment, architecture that has many new business opportunities within RH that we're going to be focused on. And previously, we had -- we also have other business opportunities outside of the core RH brand that we believe we can grow and be dominant in the home space. I think our tendency today is to kind of stay focused on the RH brand. We think that there's so much opportunity here and hence, really, the announcements around the office of the President with Sandra, who initially joined us as President of new business development and I think has communicated to me that she's so excited about what we're building here in RH and see so much opportunity in RH. It's like her comments to me is like, "How can I help?" Like, there's so much opportunity to grow this business. And I think augmenting our merchandising and creative leadership and having both Eri Chaya and Sandra at the helm gives us just huge capability and great leverage in that area. And I think you'll see us start to bring on new growth vehicles within the core RH business. There's multiple ways that we believe we can expand the assortment and open up the aperture of the brand and reach new customers and open up new markets. So you'll see us start to accelerate that in 2018, and we'll be accelerating that on a new significantly more efficient and optimized operating platform. So we think it was really good for us to kind of take that breather for a year. And as we get into '18, you'll start to hear us talk about what's next and how we plan to continue to accelerate growth going forward.

Okay, Gary, and just a final question. On the platform and thinking about the platform that you're building, what are your thoughts on the opportunities for -- through the lens of customer engagement and what you want to accomplish there and (inaudible) through the lens of M&A versus organic development as you look -- as you've done the successful Waterworks deal and how you think about the extendability and the aperture and the capabilities of the brand?

I think, today, I think -- look, I think Waterworks was a once-in-a-lifetime opportunity, right? I mean, Waterworks was, by far, the best brand in the bath and kitchen space and at the high end of the market and in many ways, helps render the RH brand more valuable through its position in the market and through its relationships with architects, interior designers and their engagement in the building process of the homes. So to me, that was a very rare once-in-a-lifetime opportunity, and we thought it was important to capitalize. And quite honestly, if you sat here with me 15 years ago and looked at the merchandising architecture and strategic architecture for the company, Waterworks was on there. So I waited a long time for the opportunity to work with the talented team there, and we're just really excited about that kind of opportunities that presents long term. That being said, today, I would say our bias is for internal organic growth. We have -- again, if you saw our merchandising architecture and the number of opportunities that are before us, we -- they're almost kind of endless, right? It's like someone asked, like, "When do you think you might buy another business or another brand?" And not that I want to ever close the door to optionality. We treasure optionality, and we treasure trying to see all the possibilities that we can make the best choices. But someone asked me the other day when do you think like you might buy another brand or do another thing. I said, "Probably not this lifetime." If I look at the opportunities that we have in front of us, they're so meaningful and robust. And when you really start to think about RH internationally, we'd like to say we're building brand with no peer in North America. I think that's amplified. If you looked at it internationally, we just spent a lot of time in London, in Europe and studying the market and looking at opportunities, locations. And we look at the amount of business we -- our customers ship over to those countries. We just think that there's a huge opportunity to the brand. We have lots of people approaching us, knocking on our door about expanding the brand in the Middle East, expanding the brand in China, expanding the brand in South America, expanding the brand in Mexico. And I think we've said no so many times. It's funny. It's -- if you say no enough, at some point, the deal looks so good, it looks tempting. But as we study other brands that have grown internationally, it almost seems that all the great ones tend to try to reacquire their brand over time and get control back. And so we're not in a big rush. We think we're just so focused on growing in a quality way, and building quality into the brand and having more control than less control. We think control is an important word. Control of the brand is really important as we look out into the new and developing retail marketplace where people with less control of their brand and their distribution network are going to get price competitiveness and actually, brand erosion. It's hard enough to execute a brand when -- yourself. When you start giving it to somebody else and -- you got to be really careful about how much money they'll pay you to get control of your brand. Well, hell, we've been -- I've been here 16 years. Now I've been building this brand for 16 years. Most of this team, many of them have been here with me more than 10. And yes, of course, they'll pay a lot of money for this brand who had 16 years to do it, try doing it themselves. So -- and I don't think anybody will be able to copy us anytime soon. So just our general sense when we think about M&A and -- versus organic development and growth is that I just think we're going to be doing this a long time internally. And I don't want to say never. And if another Waterworks opportunity comes up, will we look at it? We look at everything. But today, if I had to place a bet on what will RH look like in 5 years, it will look like an even more exciting and dominant brand in the luxury home furnishings marketplace and probably doesn't need to be augmented by outside M&A.

And our next question comes from Daniel Hofkin from William Blair.

Just some of the longer-term guidance that you shared at the Analyst Day and kind of comparing that with your 2018 revenue growth outlook. You've just touched on some of it, but I'd be curious, going from the 8% to 9% kind of comparable weak growth next year to the 8% to 12% longer term, over, I think it was like a 10-year period on average. What would you say would be the main things? Would it be additional store growth domestically? Would it be international? Would it be brand or product extensions? What do you think are some of the biggest areas that would help you think about that a little bit higher, longer-term range relative to 2018?

Sure. Well, it's 2 things that have really been growing the business over the past several years, right? It's -- our 2 key value driving strategies are the continued expansion of our product offer and the transformation of our real estate, right? And like I said, the brand architecture, the growth -- the kind of the growth platform that we see today to continue to expand the RH brand through product and through services, we think, looks really robust and again, probably take us, at least through the rest of my career, probably longer to kind of do that. And so we see real growth coming from that part of the business. And we see real growth, obviously, coming from the transformation of our real estate. On top of that, I think you think about what international could offer to the business. I mean, we were just -- Dave and I and the team were over there in London, and we were looking at a gallery in London. It wasn't really about a gallery location in London. It was really about the launch of RH international, right, because one gallery in London with our direct platform and capabilities really reaches, for the most part, a lot of key wealth in Europe because everybody interacts with London, right? And so whether business from Moscow, business from the Middle East, business from Paris and other parts of Europe and London itself, right, which is a very robust retail environment, so that becomes an important third leg. But I think back to the point we talked about earlier is, is the brand awareness the tipping point of the brand. I'm kind of amazed that the early numbers out of West Palm. It's -- I've always been a little nervous about that market. If I look back when we were initially doing that deal, the store was -- the gallery there -- legacy gallery was a modest, I'd say, "middle of the road" gallery. And it -- over the last several years, while we've been putting this transaction together, building the gallery, it's comped up nicely. But you really look at it and say, like, okay, how big is Palm Beach, right? Like, how big can we -- how far can we draw from -- how do we think about our business here? And what's interesting about that is just that the early response is so good and so strong, it's made us think about, again, the tipping point, right, when people see you differently and see the brand differently and really see the brand for what it is and the services that we offer today, particularly in Interior Design and the ability to do someone's home. We just had a -- I know we talked at our Investor Day about it. What was it, a $500,000 or $600,000?

$560,000.

Yes, $560,000 in Tampa, right, that we had, had. And our gallery leader and our team were there and discussed that, and -- but we just had another $500,000 Interior Design job closed in Texas in Willowbrook for a home in Williamsburg. So we're just starting to see these bigger transactions, and I think people are just seeing us differently. And so how do you think about the value of brand awareness? How do you think about the value of that tipping point? Is that worth 2, 3, 4 points a year as you really start to position this brand? We're just at the early stage of these -- of building these design galleries. And so those are the pieces. It's really the continued expansion of our product offer, the transformation of our real estate, the increased brand awareness and growth of the brand. We can always step on the advertising lever if we want, pull the advertising lever farther if we want. Right now we're holding back a little bit. We're testing a few things, but we're really trying to optimize the model. But as we look forward, can we expand the circulation of our books? Can we invest more in print, in digital advertising? Is there other ways to invest in driving brand awareness? So we're early on there. And then international is, I think, going to be a real business. I think it's going to be much bigger than we ever thought.

And our next questioner comes from Matt Fassler at Goldman Sachs.

Delivery, you spoke a lot about delivery at the analyst meeting in West Palm, and our sense is that delivery is misunderstood by many consumers as a commodity. I know that you're stepping up the execution of your delivery effort and insourcing more of it. I know you also have talked about not really believing in marketing per se. But how can you integrate what you're willing to offer the consumer in terms of getting the product to them and then home interaction into the membership message in terms of their expectation and what they can get from their association with RH?

Yes. I think, again, as we execute better, I think there's going to be tremendous word of mouth, and we clearly will continue to talk about what we do and the work we do. And again, it's not that we don't believe in marketing. I say, look, we don't have a marketing department. We have a truth group, right, because our brand is much more about our truth, and our truth is the products we create and bring to market, the way we present those products in the market, the galleries we create, the source books we create, the web experience we create, the service we deliver, the interior design offering and service that we're building. And when you do great work, the world talks about it. So we just have a bias to do great work. And we think that it's more important to invest in our work than invest in talking about ourselves, right? And so just thinking about how we might go through a capital allocation here, right, and somebody goes, like, I'd like $10 million more to put into digital marketing to run more ads or more of this or connect here, and our sense -- or $10 million more for more print ads or $10 million more for more catalogs. And we -- look, the catalog is marketing, but it's really our work. We're putting our work out there. But we don't spend money on social media talking about ourselves. Yet, as you read in our -- in the letter that Instagram, I think, the day before yesterday, just came out with their most -- the most posted cafés and bakeries in the country, right, and our 3 Arts café is the seventh most Instagramed café in the country. Like, a café in the middle of a furniture store, think about that. Like, how many people wake up in the morning go let's go eat in the middle of a furniture store and it's that inspiring that we're going to Instagram it? By the way, I don't know how many -- by the -- it was the end of last year, we had 32 marriage proposals in the café at the 3 Arts Club in Chicago. 32 marriage proposals in the middle of a furniture store. You can't make that up, right? And so it's just our bias to kind of do great work. And I think as we continue to do great work, we will put the work out there. We will talk about the work we do in a direct and humble way, and -- but we're -- we just don't think -- we don't want to go try to chase a bunch of low-quality revenues, right? Like, we want to build a high-quality business over time, and so it's going to continue to get out there. Like when we perfect home delivery, will we talk about it? Yes, we will. Of course, we will. Will you read about it on our website? Will we -- will it be in our source books? Will you hear about it from other people? Of course, no different than our galleries. We talk about the new galleries that we open. We have pretty interesting opening events when we host them. I mean -- so we celebrate our work, but our capital is more focused on doing great work.

A very quick follow-up for Karen if I could. I know that you're largely through the clearance activity, and the merch margins coming up will show that. Can you talk about the role that the outlets played in the quarter from a revenue perspective? And how many of them are still standing?

Yes. So we have about 30 -- well, we have 31 stores right now. I think we'll open one more by the end of the year. And outlet growth was actually, if you look at that 460 basis point up number, outlet was actually a drag within there because revenues were up about $5 million. So that's about 1 point of revenue growth, and the margins were lower than they kind of have been in the past and could be. So we do think that's another area where we'll have better margins in the future when we're not still working through some of the outlet inventory. As far as the number of stores long term, we actually -- although at one point we were thinking we would open these temporary stores and close them down. Because of [some changes] in the reverse logistics model, we're not going to be having outlet inventory sitting in the DCs any longer, so our bias is to turn that more quickly. And as we've been talking about, we're going straight from when it's a return and exchange and it gets dinged or whatever is going to go straight to the outlet, so we need more boxes, more outlet doors to turn through that inventory. So some of those locations, we won't keep. They were temporary, so we might close them down and then open ones up that are closer to our home delivery centers.

And our next question comes from Michael Lasser from UBS.

This is Atul Maheswari filling in for Michael Lasser. So my first question relates to your third quarter comp drivers. So how much of it was really driven by Modern? And what really was the contribution due to your source book? And were there any other significant drivers?

Yes. We don't actually give a lot of detail on the specifics within comp. We just give that 6% comp growth. And then the things that are not in comp is the new real estate, and then outlet was a point, which is noncomp. But we don't parse out the details of the 6%. We continue to be very happy with Modern. So we're still happy -- very happy with that business, still think it's incremental, still think it has a lot of runway to grow, and it's doing great.

Okay. And I have a follow-up question on your guidance for the fourth quarter. So we've seen the holiday spending has been pretty volatile in the past few years. So could you provide a sense of how trends have been recently and whether you're tracking in line or above your expectations at this point in the quarter?

The question is...

Around holiday. So I think...

Yes. Well, holiday, as you know, over the last several years, we've deemphasized our holiday assortment, right? As we've emphasized our positioning as a true interior design platform, the holiday assortment that was kind of the legacy assortment, whether it's stocking stuffers or gifts and knickknacks and even holiday decor, the -- tends -- we believe it detracted from our ultimate goal to position the businesses as really the leading luxury interior design platform in the country. And so holiday has been a smaller part of our business. We added a little bit more than last year a layer of decor and some gifts. Quite frankly, we are always torn when we go through that assortment because it's -- some of it's relevant, and some of it just seems like it just doesn't fit anymore. But we do have a lot of locations that are still in malls. You still have holiday traffic that comes through the malls, and you see you still have a customer that's there shopping for gifts. It fits a lot less in our free-standing larger gallery locations. So we're less impacted by the volatility in the holiday quarter than others. We're not a typical business like most retailers anymore. Our business is not as dependent on that fourth quarter, and you'll see that start to unfold next year as you start to see our operating performance and how it begins to smooth out. Not too unlike the graph that we showed you with our sales pre membership and post membership, but our sales and earnings and our business will have some seasonal movement to it. But we're not banking everything on Q4 like we have in the past in our new models. So we feel confident about the numbers we put out there. I think I've said in my note that we're running the business with a bias for profits versus revenues. We're not going to chase low-quality sales and low-quality revenues. We're going to try to optimize the business. We're focused on kind of maximizing gross margin dollar growth. If you think about our revenues even this past quarter being up 8% with merchandise margins being up several hundred basis points, the way we think about the business and if you just directionally think about the map, 1 point of margin is really worth 2 points of sales when you think about margin dollars. And so when you think about our business being up 8% with several hundred basis points of merchandise margin growth, our gross margin dollar growth is significantly higher than that, right? And so we're not going to let ourselves be victims of the lens that other people might be looking at our business or looking at our stock and short-term momentum players who are in and out or -- I mean, we're sitting with a stock here with almost 50% of the active float short still, right? They're very in our high 40s. It changes week to week. We're positioning the company to win over the long term, and that's how we think about the business. So very comfortable with our guidance for Q4. We're -- we feel very comfortable with the guidance we put out there for 2018, which, by the way, 9% to 10% operating margins would put us at the top of the heap if you look at the people who have had the historical high operating margins in our sector, right? Most of them, their operating margins are eroding. We've set our company up for the long term, and you're going to see operating margins expanding over the next several years.

Our next question comes from Geoff Small from Citi.

First, I want to circle back to your 9% to 10% operating margin target for 2018. And specifically, I was wondering if you can provide some color on the internal, external variables that would allow you to achieve the high end of that range or conclude 2018 at the lower end.

Sure. So we've -- in the guidance that we gave, both gross margin and SG&A, that kind of assumes that growth. Certainly, if something negative happens with the economy, we'd be closer to the low end of the range. We're not really speaking to things that we can't control. We have not factored in obviously some of the benefits that could come from tax rate changes and such, but really, I think some of that depends on level of investment in things like home delivery and hospitality, timing of new stores because when those new stores open, we get nice volume lift and occupancy savings versus our old model. So I think we're focused on all the things we can control. If things go sideways or out of our control, whether macro or otherwise, we'll certainly pivot and make changes as necessary.

That's helpful. And I was also curious what level of revenue your 2 distribution center model can support. And if and when you reach that level, are you planning to open up additional DCs or simply add square footage to your existing locations?

Yes. That's really dependent on how we grow the business, right? One of the things that's a big positive to some of our recent growth and the -- one of the biggest growing parts of our business is our special order business. And our special order business is a business we don't hold inventory, right? We really just crossed off the inventory. So as we continued again to build this as an interior design platform, as you think about interior designers using our platform, as you think about people wanting to have their homes reflect their own unique point of view and style, our sense is our special order business will continue to grow. And we think that there is -- our -- the supply chain that we've just built this is just significantly more efficient for how to position and turn inventory and how we think about it. And so we think we've got ability to grow for several years on the existing platform. And if we needed to expand it, most likely, we're just going to expand the platform itself and just add some square footage in a simple way. So it's not anything that I see in anytime in the future that we're going to have big, significant capital expenditures as it relates to the distribution center network. We'll be making investments in home delivery, obviously, as we go forward. And we simplified that model, and we -- I think -- look, we're going to -- as we articulated, I think, in -- at our Investor Day, we're going to really -- the existing home delivery models that exist are really built for the middle market, and there's really no luxury home delivery networks built out there. The people that are -- play at that level control it themselves, and we think we will either take more control or we will partner with providers to build a whole new level of quality and service that's deserving of our brand from a home delivery point of view. And so we expect to invest in that part of the business, and that's built into our operating model for 2018 and beyond.

Our next question comes from Peter Benedict from Baird.

Back in the fourth quarter, I mean, the CBR compares really crater and the guide seems to imply something similar to what you probably did here in the third quarter. So -- and I'd appreciate the bias for profits over revenues. But I'm just curious, is there anything -- any discrete puts and takes that we need to be thinking about here in the fourth quarter that would prevent, I guess, an acceleration in CBR as we think about the fourth quarter relative to the third quarter?

CBR?

Comp -- brand comp.

Oh, okay.

The acronym was throwing him off.

Yes, didn't know what CBR was. But CBR, CBR. Okay. I don't -- Karen, anything we want to add to that or...

Yes. I mean, no -- I mean, I guess, one thing that I would just say is that the holiday business for us just isn't -- you would think that it might accelerate if we had a big holiday business when you go from Q3 to Q4, but that's just not the case for us as Gary mentioned. So I can't think of any reason why it would accelerate. I think it's going to be similar, but I don't know that you would expect a big ramp-up for any reason.

Okay. Then, I guess, shifting over to the supply chain. As we -- if we fast forward to next year, we're on this call, what are the main things you guys think you will have achieved in terms of supply chain reengineering, the home delivery efforts? I mean, obviously, you're going to have the 2 DCs, but just trying to get some guideposts to how we should think about maybe the next 12 months and where we should be sitting a year from now.

Sure. So the biggest 2 things that we have achieved is just the plans, and one is done and other one forthcoming is the closing of those 2 distribution centers. So when you think about the occupancy savings and the fixed cost that's going to come out of the business from that -- and frankly, there's still one other facility that we've kind of spoken about that probably could be another candidate to close down in -- further in '18, so I do think we have a lot of progress that's been made just on the DC network footprint. And then, really, what we've done with reverse logistics and the savings that have already come, and we're 90% through that and frankly, that last 10% are just markets that are -- that's not really an outlet (inaudible) extends or it goes back to a DC because it's right there. So not having all of those transportation and labor charges and touching the goods has been a huge achievement. So those are the big things that we've already done. What's on the come and that we've -- keep talking about is just how we're going to think about home delivery and what that experience is going to be like. So I think that's the biggest thing left.

Yes. I'd say it's home delivery and Phase 2 of the reverse logistics and outlet business. If we thought about our reverse logistics and outlet business and how it's architected today, our outlets are not necessarily architected or in all the right places to optimize that network. So we think there's continued opportunity in savings as we architect the outlet footprint to align with the business and the returns and the most optimal way to turn the product at the highest possible margin and handle it the least amount of times. And then the home delivery architecture, the home delivery business and design of that will, in some ways, emulate and look like the outlet architecture. And that's -- we think there's just huge upside there. So I think the home delivery piece, how fast can we go, where we'll be a year from now, I think we'll know more after the first or second quarter of next year when we start to get the real data on the test market here in the Bay Area and we start to get more clear in the learnings and the opportunity that we see and may tell us to go faster or may tell us we need to learn more and test more. But the early indications in the numbers we shared with you at the Investor Day and just -- we gave you some of the few metrics that we're measuring, just indicate it's a huge opportunity. So we're still pretty early on here. I mean, even if you think about our DC network and you think about how to optimize the parts of the business, how do you really optimize a 2 DC network? If you have goods, what percent of the goods are coming from -- coming into the West Coast? What percent of the goods are coming to the East Coast? How are you moving those goods back and forth? How are you thinking about transportation and the design of transportation? Long term, do we have a bias to control more transportation, right? If we're going to control our own trucks on home delivery in some markets and partner with others, do we control our trucks or partner with others on key transportation lanes in our business and take more cost out of our business? And we have a unique opportunity as you think about our supply chain versus others, right, whether it's -- whether versus the former businesses I ran across the Bay, whether you think about us versus the wayfarers or just other regional players. I mean, we -- our average ticket of our project -- product is significantly higher than everybody's else, right? So we can architect a supply chain, and we have the scale, right? So if you think about the average ticket, you think about the average order, you think about the scale of our business exceeding $2 billion going to $3 billion here soon, we just have opportunities that other people don't have because they're playing a different game, right? And they have to play with a different cost model. If you're delivering a $800 to $1,200 sofa and you're talking about how much quality can you build into delivering that sofa, nothing compared to if you're selling a $4,000 sofa, right? If you just think about that math, right? And that's why we like our model, and that's why we believe with our -- with the market we're focused on and the scale we have, the math says you can do it entirely differently than almost everybody else that's out there, right? And so we like what we see going forward. We like what the math indicates the opportunities will look like, and we like the ability that we have to invest into quality that other people are not going to be able to invest into quality. You just can't invest that much when you're selling an $800 to $1,200 sofa.

My last question is just on the cadence of your source book mailings next year and the circ plan. Are there any changes relative to this year that we should be aware of? And that's my last question.

Yes. We are -- as you know, if you followed us for the last 8 or 10 years, it's like -- I mean, we are constantly evolving our source book strategy because the market keeps changing, right? As more business shifts to direct, as more business shifts online and plus, we -- as we change the cadence of our -- or just the character of our business from a business that was a more typical retailer with a big holiday assortment that had a big peak in December, if you look at the furniture business and furniture companies, December is not a very big month at all. It's actually when everybody goes on vacation. January is a big month, right? And so the character of our business is changing and is different, and therefore -- and the real estate's different. And so the source books are going to continue to evolve. We're going to continue to test things, whether it's the size of the source books, whether it's the bundling of the source books, whether it's breaking out parts of our business into their own source book, whether we have a lighting book, a rug book, a linens book, separate books to build category dominance and other things like that. And then even like when we mailed the books -- and there's -- those of you who followed us a long time, we used to mail 10 to 12 books a year, almost monthly. And then we had the radical change and then went to 2 books a year, and everybody thought we were crazy. And then we went from 2 books a year to 1 book a year. Do we go back to testing 2 books a year? Do we test -- like if you think about our business just short term, right, like, the nature of the furniture business being really kind of a big business in January, do we test some books? And do we have plans to test books at different times of the year? Do we put some books out into the marketplace in January to see how that works as our business continues to change and evolve, sure. We're just going to continue to test things all the time. Sometimes you're going to notice them. Sometimes you're not. As we have key learnings that are worth sharing, we'll share those with you, right? But if we shared ever test and every change in this company, it would -- everybody would be further confused about what we're doing, right? We're already so unconventional, and define conventional wisdom, with almost all of our moves, whether it's big stores or still milling source books and when everybody's moving to digital and going upmarket when people were going down market. And you'd think about most of the things we're doing are relatively unusual, and it's because we do test a lot of things. We are constantly curious and critical of our own work, and we're going to constantly test things. So I guess, I just told you to don't be surprised if you see some source books floating around in January. Right?

And our final question is from Janet Kloppenburg, JJK Research.

A lot of my questions have been answered, but let me just see if I can summarize, Gary. We don't know how the delivery upgrades will unfold next year. You'll be testing them and you'll give us an idea, maybe, at the end of the -- well, maybe in the end of the year, the fiscal '17 call or first quarter end. Is that how I should be thinking about the timing there?

Well, I think we'll be talking about it all next year. Just like we've been talking about the architecture and evolution in our distribution -- supply chain redesign and the distribution center redesign and the reverse logistics redesign. And I feel now our efforts are shifting to the home delivery part of the business and architecting that. And we'll be testing things, and we'll be working through it. And as we learn, we'll continue to improvise the gap and overcome, right? So...

Yes. And I'm just wondering, like, what -- how should we think about that high-quality delivery, the touch point with the customer? What impact should that have on operating margins? I mean -- and have you contemplated in that 9% to 10% outlook?

Yes, yes. (inaudible)

So should it be a bit of a pressure to operating margin because you're providing this higher level service? Or how should we think about that?

We think, long term, it'll be accretive to operating margins. So we think we've got plenty of -- plenty -- we're contemplating our plans as it relates to the investment in testing, in architecture, and we're going to learn as we go. The -- look, delighting our customers and having furniture stick, right, and reducing returns and exchanges and also, augmenting the selling experience, right, like -- I mean, think about it. We get to go in our customers' homes. We actually -- they open the door and let us in. That just seems like an enormous opportunity to me. Like -- so maybe we don't just send in the delivery team. Maybe we send in other people with them. Maybe we create a different experience. Maybe there's a selling opportunity in the home, right? And so -- and while we're reducing returns, reducing exchanges, reducing cancel rates, solving problems in the home, right, if there's an issue with a piece of furniture and ability to adjust it or fix it, right, as opposed to now if it's handled by a third party, a call goes into the customer service center, I mean, it just transfers -- it almost goes into the black hole that gets dealt with over days and sometimes weeks as opposed to minutes, right? And so we're just going to get a lot closer to the customer. We're going to architect the back end for the business we're running today -- architect home delivery for the business we're running today, not for the business we were running 15 years ago, right? So...

Okay. And Gary, when you set our your revenue range for next year, I know you have a lot of ideas about new concepts or extensions of RH's concepts, and I'm assuming that there'll be some new launches during the year. Or is that a wait and see as well?

It's a wait and see, I think, more likely than less likely. I mean the team's all here shaking their head. So if you had a little web cam in here, you'd see everybody shaking their head, yes, yes, of course, we are. So we like to make sure we get things right. People say, well, when's that going to be ready. When -- say what -- when it's right. When it's right, we'll launch things. So we've got a few concepts we've been working on for years. (inaudible)

Yes. Well, I mean, it's exciting to think that 1 or 2 of them may emerge next year. And just lastly, Karen, I think you said right now you have 3 stores that you're thinking about opening for next year or maybe have deals in process or signed on. Are those structured as sale leasebacks? Or are those more of the traditional rent structure deals?

So those are the traditional rent structure deals. The first -- now we have opportunity to do sale leasebacks of ones that are in the pipeline, but we've up all the capital for those -- I mean, [like] the landlord put up some, but we've put up capital. The ones that we talked about at Investor Day where it's kind of a developer funded, we don't actually put the capital. The first one of those wouldn't be until at least probably 2019.

Okay. But there would be an opportunity to transition these leases over time to that structure.

Well, the new deals are going to move more towards that structure. David (inaudible)...

Sure. I mean, one of those would be [we know] there's an opportunity to do, and we'll give you guys more details on those as we have them. But at this point, the 3 that are open, I mean, 2 of them, we've been talking about for Portland and Nashville are early in the year and then New York obviously. So those 3, we've been talking about for some time, Portland, Nashville and New York. And I don't -- at this point, we don't have plans to do a sale leaseback on those, but of course, things could change. If we have an opportunity to monetize, we will evaluate that opportunity.

Okay. And just lastly, Gary, your vision for hospitality within the new galleries, will you strive to have some sort of hospitality venue in each of the new gallery openings? Or how do you think about that? And what's included in the operating margin guidance?

Yes. I think there's going to be more than less. It's not going to necessarily be able to be everywhere, and it'll -- in some ways, might be determined on

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and the volume opportunity we think we have in the market. I mean, some of these -- the ones you just saw were actually kind of bolt -- last-minute bolt-ons, right? We were under construction in Toronto. We were under construction in Palm Beach, and they did not have the hospitality design. And so when we saw that success and the reaction to Chicago and we saw the lines around the block in the weekends and we saw the performance of the overall gallery, right, the impact that we believe hospitality was having on the traffic and then the incremental sales of the gallery, we quickly pivoted and said where could we add hospitality to. So in Toronto, we took kind of the front loggia of the store, the store terraces back on the mall-facing side, and we built a courtyard café. And we kind of figured out how to integrate it and how to do it. And then in Palm Beach, the only place we could do it is we said could we put it on the roof, and so we delayed that opening for several months and had to beef up the steel to be able to put a -- the structure on the roof to handle it. And what's great about both of those, to tell you the truth, is we now have -- we have the Chicago location, which has an interior courtyard café. We have the Toronto location that now has an exterior street-front-facing courtyard open café, right, under a skylight, and we now have a rooftop café, an F&B experience. And so we have a test of all 3. And what's really exciting to us, I mean, it's almost kind of bewildering a little bit. I mean, we, in Chicago, I mean, benefited I think because we've got this great historic building. We've got this incredible central courtyard that we put a steel and glass structure over. We had a -- it's a great passageway with vaulted ceilings. We created a wine vault, and it's just a great neighborhood. And we partnered, and Brendan Sodikoff, who joined us as President of RH Hospitality, is a very well-known restaurateur in Chicago, and we knew we would be benefited by that. And so we, quite frankly, didn't know exactly what to expect when we went into Toronto and how that would play out. When we went onto the roof in Palm Beach, would anybody come? Would anybody know there's a restaurant and wine vault and barista bar up there? And quite frankly, if you look at the numbers, the numbers are really comparable to the initial weeks and months in Chicago, which was a phenomenal success. So I mean, hats off and really, bravo to the team that Brendan has built because, I mean, he is an obsessive -- he is obsessive compulsive about quality and execution. I mean, he's one of the deepest thinkers I've met in the hospitality space not just about -- he doesn't really operate as a chef anymore. So he does the direction, obviously, for all the menus. And as his team says he's still a great chef, but he's just such a great operator and team builder. So I mean, when I think about the fact that we just kind of opened 2 restaurants in a very short amount of time in 2 cities that nobody expected us to have a restaurant, I don't know how well -- I don't think that many people knew Brendan in Toronto or Palm Beach as a restaurateur, yet we've got packed cafés and wine vaults and active barista bars. And if you go to Yelp, and the team is holding their hands up, like 5 stars, 5 stars, like if you go to Yelp and you look at Palm Beach, like we're -- it's all 5-star ratings. It's going to -- it's unbelievable. So we're just really excited about this opportunity, and I think you'll see it. We're designing them into more than less. Portland, we did not have the space or capacity to get hospitality into Portland. In Nashville, it is the first built from the ground up version of Chicago. So we designed that to have the central courtyard restaurant, wine vaults, pantry, and it has a lot of the characteristics of Chicago and flows like that. And then New York will be our second rooftop restaurant. We're building an amazing rooftop park. It's like a 12,000 square foot rooftop park with this beautiful glass box in the middle of it with a beautiful skylight on the roof, and it's got views of Freedom Tower in downtown New York. And I joke around with the team. I say it's going to be the modern-day Tavern on the Green. I really do believe it's going to be like this destination in New York because it's so wonderful, where you get to, in New York, eat in the middle of a beautiful park and have views of downtown. And by the way, the great thing about Meatpacking District, you don’t have a lot of high buildings, so we have all this natural light that hits our building, hits our rooftop, so we think that one's going to be spectacular. So we're (inaudible)...

Yes. And it looks quite beautiful, so I'm anxious to see it.

This does conclude our Q&A session for the day. I'd now like to turn the call over to Gary Friedman for closing remarks.

Great. Well, thank you, everyone, for your continued interest in our journey here. We're extremely excited about the outlook for our business and our future, and we could not be more proud and appreciative of, really, the passion and the persistence and the work and effort that our team of people and partners around the world put into kind of bringing our vision and our values to life each and every day and as we continue our quest to be one of the most admired brands in the world. So thank you, and we look forward to talking you after the holidays.

This does conclude today's call. You may now disconnect. Thank you very much for your participation.