RH (RH) 2017 Q4 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the RH Fourth Quarter and Fiscal 2017 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 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) Your first question comes from the line of Steve Forbes with Guggenheim Securities.

It's John Heinbockel in for Steve.

Guys, maybe touch upon -- you mentioned learnings in recent galleries that have led to the new prototypes.

So maybe what are some of the key learnings particularly as it relates to merchandise curation?

And then when you think about the use of the new prototype, does that alter in any way your thinking about what the ultimate size of The Gallery footprint you need to cover the U.S.?

Sure.

This is Gary.

I'll take that.

As you know, we started developing these new larger galleries in 2010.

So we're 7 years into it.

And over those 7 years, we continued to innovate and evolve quite dramatically as a business and a brand.

As it relates to the breadth and depth of our assortment, the business extensions and -- our brand extensions and new businesses have been added to the brand.

So if you think about this, we've continued to evolve this as over a number of years, including adding hospitality.

So what we've done over the last couple of years is really been able to study productivity, study space investment and now design a gallery that we believe will yield the most productivity and integrate all of the businesses in a single footprint.

So this -- while the square footage looks smaller and it is, it will have no less assortment, particularly it's just a much more efficient design.

So it's probably the most efficient presentation of all the businesses.

And our view today is as we look at the majority of the markets, that this will be the best expression of the brand in a majority of the markets, and it also simplifies it for our organization to execute and roll out.

The stores all will have the same presentation, the same goods presented.

And the biggest question becomes do we want to put the integrated F&B component of the business in The Gallery or not in The Gallery.

One of the big breakthroughs for us was really RH West Palm, where we had not yet tested a restaurant on a rooftop.

And quite frankly, that was not our initial intent.

And if you read my shareholder letter, we've designed that store much smaller initially.

Then baby, child, teen became real -- Design Ateliers became real, we added a whole back section to that gallery.

And then once we did Chicago and we saw the response to the F&B component of the business, the only place we could actually put a restaurant was on a rooftop.

And honestly, we were worried about it because on the fourth floor of the rooftop, you couldn't see it from the ground, we didn't know if it would work or not, and it is our highest-performing hospitality experience.

And again, you saw my comments, it's tracking to do in excess of $7 million in its first year.

And it draws people -- what we like is it draws people up and through The Gallery.

So we really like the courtyard, really like how -- in Chicago, and how that creates energy in the middle of The Gallery.

But we really like how the rooftop restaurant pulls people all the way up through The Gallery so -- and exposed them to a lot of products as they're walking through.

So there's so many things we like about the components.

It took really the best of the things we've learned over the last 5 to 7 years, and now it's been working for the last couple of years, integrating it into what we think is the ideal prototype.

And we don't foresee any huge big changes.

We've got a lot of brand extensions, some new businesses, but nothing that will shift the footprint dramatically.

So we think this puts us in a position to be a lot more efficient with our time, with our capital, and we're going to have a much better return on capital.

So think about the first 15 of these as an ongoing experiment over the past 5 to 7 years.

And now we're pretty locked in on what we think will serve the majority of the markets in a tremendous way.

There is nothing cutback in this gallery.

It's a fantastic experience.

So that's really how to think about it.

It's no less productivity we're planning.

It's just a really efficient design and expressing the best of what we've learned.

And then just as a follow-up.

You think F&B will be in what percentage of the new prototypes?

Not sure yet.

So I don't want to commit to anything, but I'd say probably the way we're thinking about today, probably about 1/3, maybe more.

Your next question comes from the line of Matthew Fassler with Goldman Sachs.

The first question I want to ask relates to the relationship between hospitality and the membership program.

So with hospitality, you seem to have a successful somewhat more high-frequency draw to the stores than you had in the past.

Can you talk about whether you expect this to impact membership, whether there's a way to tie membership into hospitality?

And whether you've seen membership trend different in the stores that have the element of hospitality today than from some of the other galleries?

Yes, I don't think they really tie together.

I think that we have a dynamic F&B experience that is clearly driving incremental traffic into our galleries.

And if you stand back and think about shopping for furniture, right, going to a furniture store, and how often people do that, it is massively infrequent, right?

It's massively infrequent.

I mean, most people might go to a furniture store every 5 or 10 years, and it's driven by a real need.

It's an event-driven business that's based on people buying a new home, remodeling a home or redecorating, redesigning their home.

So you've got the dynamic of the industry we're in that has really low frequency of visits, right?

And what we're trying to do is one, when we have a visit, they're long-extended visits, right?

If you're doing your job and you're helping a customer design their home, it's multiple visits, and they're long visits.

And what we're trying to do is really enhance that experience.

So they don't have to leave for lunch, we can offer them coffee, a glass of wine, we can really present a hospitality experience that's more home than store, right?

And that was one of our initial goals.

The second goal was just understanding the business we're in and the customer behavior of infrequency is would we -- because we believe we build pretty inspiring spaces and present goods in a really artistic and inspiring fashion, could we -- by driving more foot traffic, not just foot traffic, but driving the right consumer traffic into our galleries, could we have people come in when they might not have come in, experience The Gallery, sit and experience the restaurant, look around and be inspired by the environment, and say, "Geez, honey, look at that beautiful chandelier, I wish we have that in our dining room." Or as they walk through The Gallery, while they're waiting for table and enjoying a glass of wine and see a living room or a bedroom setting and be inspired by it and say, "Geez, why don't we redo our bedroom, why don't we redo our living room or possibly redo our whole home." Right?

And because I think a lot of us with our -- I mean, it's interesting about the furniture business, but people spend significantly more time obsessing about buying a $3,000 couch than they do $100,000 car, right?

And it doesn't make a lot of sense, but it just is what it is.

For some reason, there's a perception that when I change my furniture, it's for the rest of my life, right?

And so -- and I get it because again, most of us, really, if we just think about our days, we don't really go a lot of places that we see inspiring environments, inspiring architecture, inspiring installation of home products, inspiring interior design.

And so there's nothing that's really exciting us to kind of pull a trigger or to kind of think about that.

So we believe by having people come into these galleries that are massively unique in the industry, right, architecturally and from an installation point of view and interior design point of view, and be inspired and then say, "Gosh, I wish our home look like this." I mean, the biggest comment, I think I've said it before when we first did the first few galleries, like all the way back to Houston, was when we got feedback from our clients and customers and we ask our teams, like, what are people saying?

The #1 comment people were saying is, "I want to live here." Right?

I've been in this business for almost 40 years, and I've never heard anybody say they wanted to live in a retail store, right, until now.

And I think there's something to that.

So getting people to come in to these environments, feel inspired, be in a place that makes them say, "Gosh, I'd love to live like this." And we think it's highly important, that was always a goal, and that's the most important piece of hospitality, trying to tie it into membership or make things -- it's like there's so many people that through loyalty programs and other things that are doing so many meaningless things with points and this and that, like who the -- did it really affect anybody's behavior?

I don't know.

I get so much of that marketing stuff coming at me.

We don't want to complicate membership.

We really don't.

It's simple, and it's working, and it has smoothed out our business and allowed us to build -- and allowed us to begin building an entirely new operating platform that is going to leapfrog this company's operating performance, like, we're not...

Your next question comes from the line of Michael Lasser with UBS.

My first question is on the memberships.

How did the memberships trend in the last few months?

And to get to your longer-run sales growth estimate of $4 billion to $5 billion, what do you have to do from a membership perspective?

How many memberships could be inherent in achieving that long-term outlook?

Yes, we don't even think about it that way.

So the simple way to think about getting to $4 billion to $5 billion is thinking about our real estate transformation and some modest product expansion, and that gets you there.

And what about how recent membership trends?

Because I think you mentioned in your letter that 95% of your sales are coming from your membership.

So it would be helpful to have context on how that's been trending?

Yes, it's the same.

It's been similar, that way for several months, so it hasn't really changed significantly.

Okay.

And then as far as some of the tweaks to your outlook from what you've previously provided, can you give a sense for what's changed today versus a few months ago, both on the top line and then on the margins as well?

Specifically, what part of our outlook?

So revenue growth is going to be a little bit lower, margins are a little bit higher, why is that?

Yes.

So we've said that we're going to restrain ourselves from chasing low-quality revenues as many are in the industry and really manage the business with a bias for earnings versus growth right now as we're building the operating platform.

And as we've gotten into this, and as we've gotten into rearchitecting and being able to build this new operating platform, we see so much potential.

We see just incredible opportunity to have an operating model that distances this brand, separates this business and brand from any other model in our industry meaningfully.

And the opportunity to stay focused on that and to get that work done is so incredibly valuable that I've made a decision to not introduce any new businesses or product -- or brand extensions this year.

And we have many in the pipeline.

And I don't know, 1 month ago, guys, 1.5 months, we were offsite.

We were doing our planning, and as we keep peeling this back, we just see so much opportunities, this is once in a lifetime to build.

It's hard enough to kind of -- to reset and rebuild an operating platform in a business that's running.

I mean, it just rarely ever happens.

And it takes the leadership of the entire cross-functional leadership of every part of this company to sit together in an integrated fashion, collaborative and integrated fashion and rebuild the company from the ground up and rethink everything that we're doing.

And so we think it's the best investment of the human capital, and the financial capital of the company is to focus on that.

And I think we need another year, and so we just pushed everything out and said, there'll be no new businesses.

That's why 2018 is again the year of execution, architecture and cash.

And I think it's going to be the best investment we've ever made.

I think we'll look back and say, "Boy, that time and that effort made all the difference."

Is it -- just to clarify, the difference in the top line and the bottom line is more about delaying some of the launch of the new business lines rather than pulling back on some of the promotional activity that you've mentioned?

No, no.

We don't really have promotional.

I mean, we've always said, we're not just going to chase low-quality revenues.

But yes, it's just pulling back basically.

So on the revenue -- this is Karen.

It's exactly as Gary mentioned.

It's both New York, and it's new businesses.

But on the bottom line, I think as you probably noted in his letter and in the press release, we are seeing just tremendous benefit from the work we've done so far with architecting the operating platform.

All the things we said last year about what we thought what's going to happen with reverse logistics and with closing 2 DCs, we're seeing all of that and then some.

It's actually even been more profitable than we expected.

So that's where you're seeing much better -- we took that 9% to 10% operating margin to 9.2% to 10.2% even though we have $50 million lower sales in that top line target in our 2018 guidance.

Of course, net income also has a tax benefit.

But even just the operating margin is better because of some of the gains we're seeing from all these operating platform and rearchitectural works that we're doing.

Your next question comes from the line of Curtis Nagle with Bank of America.

So I guess just going back to the 4Q gross margin.

You guys put up just terrific results again.

And just out of curiosity, I mean, what drove it so materially higher?

And I guess, just what changed from last time we spoke in December?

It was not that long ago and did look like it was materially higher.

Sure.

So part of that was just kind of being cautiously optimistic at the time about whether we were going to achieve all of those savings.

Again, our gross margin does have occupancy, so we had savings from the DC closure and not having rents.

But also just reverse logistics because transportation is up and gross margin was better.

But the biggest thing, almost the entirety of the beat and a lot of that 390 basis point expansion is product margins, and that's really just cycling last year's SKU rationalization, the outlet drag, all of that not happening this year.

And as Gary mentioned, not chasing those low-quality sales.

We're pretty happy with our sales.

We're still smack in the middle of our guidance and with such good gross margin expansion.

So a lot of things have been going really well based on a lot of the work we've been doing.

Terrific.

And then just I guess a follow-up on that.

So it sounds like the DCs are now closed.

I guess, are you guys now operating on the new supply chain model?

And I guess, what could you say about early operations, early earnings -- or learnings, I should say?

And yes, how do you feel that's going?

We have 2 of the DCs closed, and we're just again in the early stages of architecting this new model, right, including the DC network redesign.

And so there's more to come as we're working through this.

Whether it's the DC network redesign, the redesign of our reverse logistics and outlet model, we're still in the mid-stages of that.

And then reconceptualizing home delivery, which we have an early test happening in a market and still doing a lot of work and a lot of math around that.

So we've got several more years of work to do here.

I think we've got another solid year of design and architecture, right, and just really understanding everything that moves and measuring everything that moves and understanding what all the optionality is and just how to think about it differently.

I think what I've learned, I'm a guy that grew up at The Gap, so I grew up in apparel, and then I went to Williams-Sonoma and selling housewares, and then stumbled into a Pottery Barn business, and we tested and started selling furniture.

And the next thing you know, we've got into the furniture business.

And as I think -- and then I came to RH, right?

And then this was a business that was, when I got here, it's 52% discovery items, knickknacks and things like that, and I think we were about 24% furniture at the time.

So when I look back in my career and I think of my experience at Williams-Sonoma, Inc.

and at Pottery Barn, and I think of my experience here, I realize that no one's really built a national supply chain for furniture.

Or maybe there's been some private companies, like Ashley or some companies that that's all they did for their life and people don't really get into the insides of it.

But most companies, when they build a supply chain, they hire 1 of 4, 5 consulting companies.

The companies come in with their best practices, and they give you their view, and they do their model, and then companies generally execute against that.

And that's been my experience at Williams-Sonoma, and that was my experience in the early years at RH, right?

And in the fact, we use the same consultants at Williams-Sonoma, and we kind of got the same thinking in supply chain.

And Sonoma's supply chain, think about it as a lot different than ours.

Ours is a much higher percentage of furniture.

We really become a serious furniture business and big ticket, big items.

So furniture is high ticket, low velocity business, and it's -- like I say, it's very difficult because in my days at The Gap, you had men's and women's, tops and bottoms and accessories.

Everything folded at the same size, everything went into the same sized box and nothing broke in transit.

Everything here comes in a different sized box, and almost everything except bedding and some of the textiles can break in transit and get massively damaged.

And it's a completely different business with completely different math, right?

And so what I realize is everybody's kind of doing the same thing, and nobody is really doing anything different, and nobody's really ever scaled the national supply chain.

The furniture business historically was built in our -- kind of our regional model, right?

It was kind of regional family-run businesses, the power players in California, in Florida, in the Northeast, in Texas.

And I realize it was regional because once you get national, it's very difficult from a supply chain and execution point of view and a cost point of view.

And so what we're doing is just really challenging all the conventional wisdom, all the assumptions, and we realized that the math is entirely different when you look at it and when you challenge it.

And so we're doing it ourselves without any consultants, without any people that have never done it, except done it for someone else, right, and we're doing it from the inside out.

And that's what's taking the enormous time from -- cross functionally from the entire leadership team, right?

And so I just think we're going to do it better than anybody else because we're thinking about it at the detailed level that nobody's ever went to.

And I think we're going to wind up with just a completely unique and differentiated operating platform.

But we're still learning as we go.

The good news is we're more and more excited about it.

I mean, look, people know -- look, my reputation is on the creative merchandising side, conceptualizing new businesses and growing businesses.

And this is what I've done my whole career.

So it's probably a little odd for everyone to go like, Friedman is focused on execution, architecture and cash, right?

And I got 90% of my time focused on rebuilding this operating platform because I believe it's going to be such a huge unlock and such a huge leapfrog.

So we need more time.

And it's not that -- I wouldn't say 90% of the time, kind of like, I don't know, 70% of my time.

But we're still focused on the product.

We're still going to have really exciting product.

We've got a worldwide team, of the best designers and artisans in the world.

So -- but we're going to have the best operating model in the world when we're done.

And I don't think in our lifetime, anybody will ever try to do this.

Your next question comes from the line of Bobby Griffin with Raymond James.

Two quick questions from me.

One, on the gross margin improvement that's implied next year and the forecast of 260 to 340 basis points.

Is it mostly for merchandise margins?

Or is it from the work with the supply chain and the outlet?

Can you kind of help us understand the buckets there?

Sure.

It's about -- I'd say 3/4 of it is product margins, and the rest is primarily DC and a little in some transportation.

Okay.

And then the transportation is just a redesign of the outlets?

Or are you getting different rates from a transportation contract standpoint?

Yes.

No, it's a redesign of the entire supply chain, right?

So it's the DCs.

It's the outlets.

It's the reverse logistics.

It's a lot of things.

Exactly.

And that's even offsetting.

There is some nominal just increases in the industry we're seeing, which is freight, both the ocean contract, UPS for our parcel business.

Those are actually going up.

So this is kind of more than offsetting some of those increases.

Okay.

That's very helpful.

I appreciate that.

And then just lastly a quick modeling question.

Can you just update us on the cadence of the source books introductions this year and how we should think about those in our model?

Yes.

We are going to test a second drop for both RH Interiors and RH Modern this year.

As you know, we've over the years went from, I think, 10 to 12 books a year, we went down to 2 books a year, and then we went to 1 book a year.

And then again, you've got a longtail data on the business we're in.

And you really got to look at your contacts.

It's not like typical catalog businesses that look at their contacts every 6 to 12 months.

Our contacts sometimes, you've got to look over 3 to 5 years because again, people don't necessarily change their home that often.

And as we've looked at our data and looked back at the data from when we went from 2 contacts to 1 contact, there is enough data now that says that there is people that were affected by that contact, and we believe there's an opportunity to test the second contact.

So you're going to see us have 2 contacts of RH Interiors and RH Modern, and we'll test that again this year.

We think that will also be a benefit to revenues in the second half by having especially having that second contact to Modern in the second half.

Your next question comes from the line of Geoff Small with Citi.

I first want to ask about the longer-term 8% to 12% revenue growth target, particularly the level of comparable brand revenue growth you're anticipating as well as the proportion of growth that will come from gallery openings and other new initiatives.

Yes, the way to think about it is probably we've got somewhere between 1/2 to 2/3 will be new store kind of driven, and 1/3 to 1/2 will be comparable growth driven.

And then it will change depending on what years we are introducing kind of new businesses, brand extensions and et cetera.

Okay.

That's helpful.

And on the longer-term operating margin target for low to mid teens level, can you potentially break that down between the gross margin improvement you're expecting and the SG&A leverage, please?

Yes.

Well, we kind of laid out the key levers, I think, in the letter.

I don't know if Karen could comment.

I'd say it's not unlike what we've -- our prior bridge, but just seeing very specific things that were -- are a drag right now that we'll kind of grow out of as we start to not having as big of a hospitality drag.

Some of the things that we will continue even just this year, continuing to cycle out of inventory optimization.

But now we're seeing, I'd say, even more benefit in gross margin.

We've always seen benefit from gross margin occupancy related to the stores as we have this more efficient model.

But now we even see more opportunity with the DC architecture and some of the works that we've been doing.

And then as we put more of these real estate boxes and have those opened and have the higher volumes, we will see leverage in SG&A.

So at this point, I'd say it's about 2/3, 1/3 gross margin versus SG&A.

And we'll continue to tweak that.

Some of the savings we're seeing in the DC architecture is actually coming from some labor that actually hits SG&A.

So as we continue this work, we'll have even more refined thinking on how that will split.

Your next question comes from the line of Adam Sindler with Deutsche Bank.

So I guess, my first question, either for Karen or Gary, was on SG&A.

And maybe you just answered it with the second book drop.

But I think when we heard back in November about some potential outlook for 2018, we're talking about 50 to 100 basis points of SG&A leverage.

Now looks like we're talking maybe about 30, 20 basis points of deleverage.

So wondering if you can help us bridge the gap between those 2.

Sure.

We just have some continued ongoing investments with both hospitality, with some store openings.

There's actually more this year than last year.

And then just thinking about some of the other investments we want to make in the business as we're thinking about people and process and just some of this architecture we're doing.

So it's still modest.

It's not as big as we thought then, but it's still roughly flat.

It's not a huge deleverage from prior year.

Yes, we did have a onetime step-up in bonus plan too because we're planning to have a really good performance this year.

Yes.

Incentive comp is up modestly, not as big as the jump from last year to this year.

But in '18, it will go a little modest step up as well.

Perfect.

And then just thinking about some of the new businesses and brand extensions obviously in the out years, is there a way -- and I know in the past, when we're thinking about Modern, you gave us sort of a few things you guys were thinking about working on.

I know in the past you've talked about the hardware side of the business.

I know in the past you talked about RH Color, things like that.

Any way to help sort of conceptualize what maybe some of these things could look like or some opportunities you like to address?

Not at this point, no.

We don't need to lay out our product road map for the rest of the world, so yes.

Your next question comes from the line of Peter Benedict with Baird.

There were some filings yesterday that provided some additional disclosure around the revenue mix.

Sort of like 20% of your sales in the first half of last year were contract and shipping.

I'm just curious how that 20% breaks down between the 2. Is 1 materially larger than the other?

And how does that look on an annual basis?

I'm not sure if there's any kind of seasonality that may have affected the first half numbers.

So Peter, I'm not sure what you're referring to when you said filings yesterday.

Well, there were some letters that were filed that were going back and forth from you guys and, I guess, the SEC.

But we can take it off-line.

But it just gave some further breakdown in terms of your revenue mix over the first half of the year.

It's not a big deal.

We can follow up off-line.

I guess, my second question would just be, help us -- help frame the home delivery reconceptualization that's going on right now.

Where are you with that?

When do you think it will be completed?

And just remind us what the key benefits are going to be of that.

Yes.

We're at the very early stages.

We're working on designing it.

We're learning a lot.

We're testing.

We're testing the market.

And as we get ready to do more, we will share that with you.

I think we've articulated the key benefits many times when there's an opportunity to enter our customer's home, so what should that experience look like and what are the opportunities when you enter your customer's home, which is the place you're working on or there's tremendous opportunity, and it's a sacred place for the customer.

So what should that experience look like, and we think we can massively improve that experience and capitalize on opportunities when we enter the customer's home.

We think that there's tremendous opportunities to reduce returns, to reduce damages, to reduce transportation and handling cost.

All of these are going to be huge impacts.

So again, I think if you look at the rest of the industry, everybody is basically doing it the same way.

And one of the benefits we have and why we can do it another way is because we have a much higher ticket than everyone else, right?

So we have the opportunity to invest where other people might not be able to, right?

So if you do think about the simple math and why we will probably be able to build something nobody else has, we're the only ones selling high-end furniture at scale in the United States today, period.

We're the only ones selling what we sell at scale in the country today at our price points and average ticket and average orders.

So that allows us to have an opportunity to build a platform that nobody else can.

That's helpful, Gary.

Last one, just on the tax change, I'm just curious if it influenced your '18 plan at all.

Or are you guys just pretty much letting it flow to the bottom line?

Sure.

I think our investments and what we're going to focus on hasn't really changed.

So for the most part, flowing to the bottom line.

And we continue to feel really strongly about what we are investing in and don't really think that needs to change.

Your next question comes from the line of Peter Keith with Piper Jaffray.

Interesting point on West Palm running substantially ahead of Chicago.

I'm wondering if the early read is the more successful hospitality you have within a store, does that then lead to more successful furniture sales in that same store as well?

Yes.

The store is outperforming our expectations.

And that will be from both hospitality and on the furniture side as well.

Correct.

We have an expectation of the translation of hospitality revenues to retail revenues, the incremental lift that we get, and we are getting the additional incremental lift based on high performance of hospitality.

Okay, very good.

And then the second question is just on the overall macro backdrop, I would say, affectionately, I think you guys kind of marched to the beat of your own drum.

But the broader furniture industry seems like it's had a little bit of a slowdown here in the first quarter, maybe it's from weather, stock market volatility, what have you.

Curious on what you've seen as of late, if it's been pretty consistent or if you've seen a little bit of a slowdown that leads to that Q1 guidance.

Yes.

This is not really anything outside of what we communicated in our release.

We did have stores closed with weather in the East Coast, but everyone had that.

Yes.

Like, the northeasters have hit us and closed stores.

And clearly, other disruptions.

March of our lives was disruptive to the weekends business and as you might expect in some markets.

And luckily we're -- it is unusual times, right?

So we're being cautious and optimistic at the same time.

We understand we're in the late cycle of an economic expansion, and we're in a period of rising interest rates and the expectations for rising interest rates.

And so I think that's creating volatility in the markets.

And again, I think we've got a conservatively positioned plan that we believe we can execute and perform against.

So -- and we feel relatively similar to how we felt last year.

I mean, the market wasn't quite as volatile.

I think the market is a little bit more volatile now for many reasons.

But we're not good speculators on the economy.

Look, I thought there's going to be a recession 3 years ago, that's why we did the 2 convertible bonds so we can play offense in a defensive market, and nothing happened.

So we're just more focused on what we can control and what we're working on here.

And we're in a position where we have contingency plans based on any kind of market we operate in.

Your next question comes from the line of Oliver Chen with Cowen and Co.

Gary, as you do build these really unique capabilities and this vertical inspiration and curation skills, what are your thoughts on M&A as a method of value creation?

And our second question was just about the reality of the membership program over time and the intersection of membership and personalization and big data.

What do you want to build in terms of community and engagement 5 years out in terms of the future of your membership program?

Our biggest priority is to -- is have them be excited about the goods we sell, right?

Because I think a lot people in our industry miss that point.

It's about the goods, and it's about your presentation of the goods and the value equation of the goods.

And you can do all the social media stuff and all the loyalty programs and all the customer engagement you want.

And if you don't have the right goods, and they're not presented in the right way with the right value equation, you're going to go home.

And so that's where we focus.

As we mentioned, membership was first and foremost.

The strategy was to smooth out a chaotic business, and it's done that.

And so our priorities are to have the best product in the world presented in the most inspiring ways in the world at a disruptive and the best value equation in the world, and that's how we've gotten to where we are today.

And we think that's -- there's nothing to that, that has changed.

Nothing to that, that has changed.

And a lot of people doing a lot of things on social media, investing a lot of money and a lot of fancy talk about all kinds of -- all the trends, anything you want to talk about, augmented reality, this, that, so on and so forth, put on a glass, that pair of glasses and walk through a virtual store, looking at crappy goods, they're still crappy goods.

And this is a business about the right product presented the right way at the right value equation and being the best in the world at that.

And then also in our business, what's so important is being the best in the world at delivering those goods and executing on the back because it's a part of the business that I think is very different than apparel or other things.

From supply chain, it can be something that is a huge positive or a huge negative in a business like ours.

So that's how we think about it.

I mean, I don't think you're going to see a lot of bells and whistles in membership coming out from us.

We're extremely happy with what's happening today.

Doesn't mean we won't keep evolving and thinking, but we're not kind of following all the trends everybody else is.

And big data is interesting.

I always tell people, like I know you know what big data means, right?

Everybody is like big data, what does that mean?

I was like all I care about is the right data, the right data to make the right decisions, like what is the decision data we need.

Like most organizations, most people are overwhelmed with data.

I just read a study the other day that we are absorbing 7x the information than we were 20 years ago as human beings, right?

The pace of change based on that.

Generational change used to be measured in 30-year increments.

The same change that happened 30 years has happened in 5 years.

And I think in a world of massive data, it's even more important to be able to edit, right?

To be able to edit and focus.

And so the great skills we have with product and presentation, I think those skills are going to be very valuable when you think about data, when you think about assorting, editing and focusing and presenting data to make great decisions.

And Gary, about M&A, you've been creative, and you've pursued some great assets in the past, and you're building capabilities, which will be difficult for others to replicate.

And there's also a lot of innovation happening at all kinds of brands and capabilities.

Are you -- do you think that's part of your journey as you think about different ways to drive value?

It's not our focus.

It's not what's at the top of our list.

At the top of our list is all kinds of internally generated ideas and opportunities.

I think I've mentioned before Waterworks was on my list of I'd like to own businesses for 15 years because they have the best assortment and have the best brand in their space.

And 15 years later, that business is now part of RH.

But we don't have some M&A list.

We're not an M&A-focused business.

We don't have an M&A team inside the company.

I'm not going to say never, but that's -- if you look at our past, I think I'm 16 years here now.

We've done one thing, right, so I wouldn't expect that cadence to kind of change materially.

And again, I never say never because it could be 3 years from now we're sitting on such a prolific operating platform that gives us so much leverage and so much capability that, could you put other brands on top of this, and could you do something like a LVMH kind of platform for the home?

You could.

We talked about things like that.

But let us get there first, and maybe there's opportunities that will open up.

But right now, we're heads down and focused on getting the work done.

Okay.

And lastly, you gave us a lot of details on supply chain, Gary.

Which are the harder -- what's the nature of the harder questions that you're facing as you build this yourself?

I'm just curious about which ones are the more challenging questions about the network and digitization and kind of the omnichannel approach or the easier ones?

If you can contextualize what kind of decisions you're facing to make sure that you try to make the best decision possible.

Look, I think, it's all hard work.

So none of this is easy.

Most people don't really try to do it themselves.

They're hiring consultants to come in and spend a couple of million bucks and have someone give you a binder and tell you what to do.

And it usually looks like everybody else.

So we're -- the hardest thing is allocating the time and the human capital to get into the details and understand your business at a level that nobody else does, right?

And that's where the opportunity is.

It's being able to motor up really high and see the bigger picture, see the opportunities at a high strategic level and be able to get into the smallest details to really understand the truth, if you will.

If you ever listened to Elon Musk talk, he talks about first principles thinking, and that is basically doubting everything and boiling everything down to the essential truth and then building up from there.

And we've used that framework of thinking inside our company.

Whether it's the physics, first principles thinking or the Cartesian doubt theory where you just doubt everything until you get to the truth.

Because most of things that happen inside companies or even inside life are some version of somebody's perspective, or it's some outcome of other people's thinking.

And we can all be victims of our own history, and our history can serve us well.

But in a world that is speeding up and evolving faster and faster, your history can be a prison, right?

Because there's new data, new information, new methodologies and technologies being introduced all the time, you have to be completely willing to be open and to pivot, right?

And so -- but it's really hard to do that if you don't even know what people are talking about.

As I think about all the supply chain strategy sessions I was in over the last 30 years of my career, most of the stuff everybody is talking about, you couldn't really understand, you're in a meeting for 1 hour or 2. And people are presenting a deck.

And you are like I guess, that must be right.

We -- if it moves right now, we're going to know about it, and we're going to measure, and we're going to understand it.

And it's not rocket science.

We are like moving things around, right?

So I think we can figure that out.

Your next question comes from the line of Cristina Fernandez with Telsey Advisory Group.

I wanted to ask about the fourth quarter comp, the 2% versus the negative 18% the year before.

It was a little bit lower than we expected.

Can you quantify how much is the SKU rationalization pressure the fourth quarter?

And any other factors that could have held back that comp from being higher?

Sure.

So I think one of the things that people are getting confused on, so I'll just give a breakdown of how that 13% growth breaks down is we -- the 53rd week, that extra week, we did consider noncomp.

So just looking at most people were in line with where we were on revenue, but just had the comp sort of out of whack.

So I think people didn't include the 53rd week as noncomp.

So outlet contributed 2 points, which is a noncomp item.

The 53rd week was worth 6 points, and the new stores was about 3 points.

So that's just basically the 2% comp.

So hopefully that clarify things because we've been getting a couple of questions on that item.

And really, I think for us, SKU rat, we've been saying has been something that was contributing this year but also was even more so last year.

So if anything, it was a margin drag, but hard to be up against, and that's something that this year, most of those efforts are done in the inventory optimization.

You saw the down 30 in inventory.

We feel really good about the progress there.

But it is something that even in Q1, that we're up against versus last year.

So that will start to dissipate as the year goes on.

Yes.

I think, we're living in really interesting times, right?

I can't tell you how many retailers who have kind of had a dead cat bounce, right?

Like, they've run negative comps for so many quarters, and all of a sudden, they run up 1 or 2, with operating earnings down and earnings down and their stock goes up 10% because everybody is so excited about comps that drive less earnings.

We're not interested in that, right?

We're just not.

And so we're really focused on building a great model, and we're not going to send out a whole bunch of friends and family last minute e-mails and take a bunch of -- create a bunch of crazy promotions to try to squeeze out another point or 2 and not make money on it, by the way, have our operating margins go down.

So yes, I mean, it's just really hard to compare us to everybody else right now.

We talk about it here.

And I'm like -- I'm serious, I sit there and go, you're kidding, like earnings are down, operating margins are declining.

But because somebody got a 2 comp or a 3 comp, like Wall Street thinks it's really good.

That's not the lens we use.

And I do think the prior year was not even a real comparison because we went from pre-membership to membership.

So this year, it's not really -- the growth rate from last year is not really relevant anymore because it's 2 completely different models.

But just looking at last year Q4 to this Q4, that's more relevant, and that's where that 13 is from with the 2 comp.

Hopefully that helps clarify.

Yes, that's helpful.

And then my second, I wanted to ask sort of a macro question.

When you think about some of the changes from tax reform and the impact they could have on your business, particularly you do have exposure to high tax, high property states, like New York and California, how are you thinking about your customers in those markets and whether you could see a negative impact from the changes there?

I think it's too early for us to tell you exactly how it's going to impact those customers.

I think it's -- what you're saying is well known.

I mean, like we know we're thinking about it, but again, we're not economic predictors, and we don't exactly know how it's going to shake out.

You've got the stock market still at relatively all-time highs.

You've got people paying lower taxes on some levels, paying higher taxes on other levels.

We're not smart enough to figure it out, and so that was the end of my comment, yes, by the way.

Your final question comes from the line of Janet Kloppenburg with JJK Research.

Just a couple of questions.

Gary, when you talked about the holiday quarter, you already said it's kind of...

We can't hear you, Janet.

Janet, speak up a little bit.

Yes, we can't hear you.

Can you just talk about the holiday quarter a little bit, Gary, not so much about the comp or anything, but about what Restoration Hardware's opportunity is in the fourth quarter.

It's always a bit of a conundrum for the brand and just love to hear your thoughts there.

Secondly...

Yes.

We can't -- go ahead, yes.

I'm better with one question at a time, by the way.

Okay, that's fine.

Go ahead.

All right.

As you know, we keep kind of pulling back and editing holiday out of the assortment because we're no longer a typical mall-based store that piles up products on their dining tables and coffee tables at any time of the year.

And we think especially it's detrimental at holidays.

So we're giving back a lot of businesses and exiting, and we'll be exiting more this year as we kind of finally completely transformed the brand into interior design platform.

So holiday will become less and less important to us.

In fact, the month of December is generally the smallest month in the furniture business.

Okay, great.

And then when you think about SG&A, Gary and Karen, with the tax opportunity and all of the ideas at hand, I was actually impressed that you only look for a small amount of deleverage in '18 because of the gross margin opportunity and also the tax opportunity.

So I wondered how you thought about the timing of investments?

And if you're skewing them all or a greater percentage to '19 and perhaps then we won't have as much operating margin improvement in '19 because you're making the greater investment.

I know what the goal is for '21, and I get that, and I see how it's achievable, but I was just wondering about the cadence of operating margin and your thoughts there with respect to investments.

Yes.

Again, we're -- I think if you think of -- take the guidance that we're giving today of 9.2% to 10.2% and then projecting that out to 2021 and say we're going to be in the low to mid teens, I mean, that's a pretty huge opportunity.

Oh, no, I mean -- that's not it.

It's just I wondered about the cadence between '18 and '19, that's all, so yes.

Oh, it's going to depend on the pace of work and the opportunities we uncover.

So we'll let you know more as we know more.

Okay.

Let me ask you another question.

Karen, are there more opportunities to lower infrastructure in fiscal '18?

Like could there be another DC closing or something of that nature that would provide some natural opportunity on the SG&A line while investments are being made?

We're not prepared to comment on anything we're not commenting on in our broader release.

So if we had plans on anything like that, we'll be talking about it.

So I wouldn't anticipate anything like that today.

Okay.

And then can I ask one more question, Gary?

The first quarter guidance, largely anticipated because we knew you had a heck of a lot of clearance last year.

But could you just comment about the underlying strength of business and the full price business?

How are you feeling about that?

Yes, we feel really good about the full price business.

We're as excited as we've ever been about the potential of the brand on every level.

So we're just cycling through a lot of transformative efforts.

And so it's -- the landscaping of the P&L and the business is going to look a little funny for the next 4 more quarters at least, through this year.

And then I think the model is going to be much more understandable.

I do think if you stand back and just -- at least the way we think about it here is, look, Q4 from just an operating margin point of view, right, gets us back to historical kind of high levels.

And Q4 still has drags in it, right, in the P&L.

So Q4 is nowhere near where it could be.

But if you look at Q4 and then you -- I mean, we're halfway through the quarter, right?

So we're not going to be a lot off on Q1.

I mean, knock on wood, I would hope nobody does anything crazy from an economic environment point of view.

But if the world is similar to how the world looks today, your -- everybody is going to believe Q1, right?

And so if you believe Q1 and you believe Q4, and you've just booked end the year, then you believe the full year guidance, right?

And then you go, okay, that's where they are today, and here's the other opportunities, right?

That's how I think about it.

The biggest thing is -- I mean, we've had a -- we'd have to have the most volatile stock over the last 10 to 12 months in our industry.

I mean, every time we do a release, our stock is, I mean, our stock move 40%, 42%, 44% one day, went up 27% at our investor meeting.

I don't know how much it is in after hours now.

I mean, that's a reflection of a lot of people not believing what you told them, right?

And so -- and I tell the team here, guys, no one is going to believe what we're telling them.

When we told you 9% to 10%, it's like I got to believe 90% of the people didn't believe 9% to 10%.

And, of course, they didn't believe 9% to 10%, our stock went from a high of $109 and went all the way down to $75, right?

So they just told you how -- what everybody believe.

And so the key is how people can connect the dots and see what we see, right?

And we obviously have an internal view of this and can see more than any of you can see today.

But we'll try to do our best to help you connect the dots.

And hopefully, some of the dots that everybody is connecting is, wow, look what happened over the last several quarters.

Gosh, there's been a lot more good news than bad news.

And yes, it's a little hard to understand all the moving parts, but the news looks really good and at least as good or better than what they told us.

And we feel every bit as confident about the outlook and guidance that we just gave you for 2018.

I think from our point of view, I tell teams, like don't worry about stock, everybody was saying, like, oh my gosh, like, should we put out a pre-release for Q4?

Like why, because the stock went down?

Like, really?

We didn't do anything different.

Like we're going to build this company and run this business, like we own 100% of it, and we're going to do what's right for the business and right for the long term.

And we're just not going to be reactive to the fact that the stock's volatile or so on and so forth.

And I think if everybody -- but if everybody stands back and goes, hmm, record Q1 operating margins historically for this company was 4.4% in Q1.

That year, they made 9.7% operating margins.

We just guided Q1 operating margins like at the midpoint at almost 8%, right, so that looks a lot higher.

And we just had a Q4 that kind of looks close to the operating margin before.

Well, what do you think, the middle is going to fall out?

It's not.

So I think just now people are going to start to get and believe where we're going.

But honestly, we still have, I think, one of the highest short positions on the stock, so we're going to be subject to short squeezes and doubters and naysayers, but that's what you get when you run a public company.

So I'd just tell you, we'd just never been so confident or excited and driven to build something truly unique in this world.

So anyway...

Just to clarify, I wasn't doubting the guidance.

I'm just wondering what the underlying business tone was.

I just used this as an opportunity to set up to say what I wanted to say, Janet.

Thank you.

There are no further questions at this time.

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

Great.

Well, thank you, everyone, and thank you to all our people and our partners around the world who help bring this brand to life every day.

And thank you for all of your support and all of our shareholders and stakeholders who are betting on us to win.

And for those of you are betting against us, I wouldn't want to be on your side.

Thank you.

This concludes today's conference call.

You may now disconnect.