RH (RH) 2018 Q1 法說會逐字稿

Good afternoon.

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

At this time, I'd like to welcome everyone to the RH First Quarter Fiscal 2018 Q&A Conference Call.

(Operator Instructions) Thank you.

I would now like to turn the call over to our host, Cammeron McLaughlin, RH Investor Relations.

Sir (sic) [Ma'am] , you may begin your conference.

Thank you.

Good afternoon, everyone.

Thank you for joining us for RH's First Quarter Fiscal 2018 Q&A Conference Call.

Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Karen Boone, President, Chief Financial and 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 also 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 the call over to the operator to take our first question.

(Operator Instructions) Your first question comes from the line of Michael Lasser with UBS.

So you're looking for a big acceleration in your top line growth over the next couple of quarters.

You'll benefit from having some of your new design galleries opened.

Can you give us a sense for what the underlying comparable brand comp is implied within the next few quarters of the top line guidance that you've outlined?

Sure.

This is Karen.

For the comp, we're in Q2 through Q4.

We expect a range of about 8% to 9% in Q2, about 5% to 7% in Q3 and about 4% to 7% in Q4, and that should line up pretty closely with the guidance table that we've included in the release.

The reason it dissipates in the back half and gets smaller is because we expect the new stores to provide a greater contribution to total revenue.

So that, therefore, is kind of the plug to get to the comp to total.

And do you expect your membership growth during that same time to mimic what your brand comp growth should be?

Yes.

Correct.

Generally, we expect membership to just translate to total growth, not outlet necessarily.

But new store growth, even though it's not comp, would have a membership correlation as would comp brand.

So in general, when sales are growing, membership's growing.

As we've kind of previously said, this was really not intended to be special, just a loyalty program for a loyalty program.

It was a new way and a different way to have a better promotional program.

And then my follow-up question is on gross margin.

You're guiding to, call it, 39.5% gross margin this year.

That would be 200 basis points higher than the highest gross margin that you've achieved in the last 10 years or so.

Is that -- is the delta, the 200 basis points all related to the difference in the economic structure of your membership program versus the more promotion -- promotional-oriented model that you had in the past?

And the reason why the question is important because markets sort of want to understand what the upside and the shape the gross margin is going to look like as you roll in incremental top line dollar in the next couple of years.

Yes, it's really a combination of everything we've outlined in the letter.

So I think we're pretty complete and articulate in what's driving it and what the bridge is to the low to mid-teens operating margins and beyond.

So it's everything from the power of the membership model, unique and proprietary product offering that allows us to get better margins than people that are selling other people's goods, our efforts to revolutionize physical retailing and the work we've done, thus far, to rearchitect and redesign our operating platform, which we're in the very early innings of, right.

There's a lot more good news to come there.

So...

Okay.

I guess, I was talking specifically about...

There's nothing -- there's no news outside of what I wrote in the shareholder letter.

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

First, just a quick one, just a clarification.

So on the converts, I mean, it looks like basically, all we've got here is now you're going to pay them off in '19 and '20 and there's really nothing else to consider with those between now and then.

Is that fair?

Sure.

We have included a share count table in the one of the tables in the press release that shows kind of the illustrative examples of -- at different rising share prices, the dilution that will come between now and then in our EPS, but that's more of an accounting item.

For GAAP purposes, we would have dilution all the way beginning at the lower strike prices of $116 and $118.

But because we have these economic bond hedges in place to actually deliver and offset that dilution, we won't actually have true dilution until above the upper strike.

So there is some accounting that will go on with our diluted shares calculation above the lower strike, but we truly will not have dilution until we pass the upper strike.

Yes, the $172 and...

$172 and $189 million.

Yes.

Okay.

Now that's helpful.

And then you talked about leverage and where that's going, I guess sub-2 by the end of this year.

Where do you guys envision being comfortable running the business?

I don't know how far out you want to go, 2021?

Or just in the next few years, what's a good level of leverage you think that the business should operate under?

Yes.

As we mentioned, we could be in a position to be at 2x by the end of this year.

Beyond that, we haven't really set a target.

We think 0 to 2 is probably a good range, but we haven't -- it really depends on what the uses of cash are that we would have for any outstanding borrowings.

Yes.

I think as we said in the letter, we will continue to be opportunistic with the capital markets if there's the ability to have offensive cash on the balance sheet.

We may think about that and pursue those options and so -- but that wouldn't necessarily be leverage.

If you will, it will be cash sitting on the balance sheet, no different than when we first did the 2 convertible notes.

We've kind of carried that cash for a while until we acquired Waterworks, and then significantly made a repurchase of our stock.

Understood.

And just one quick -- last one, just around Hospitality.

Can you help us kind of understand maybe the size of that business, if not today, where you maybe see that as a percentage of the business as we move out a few years based on what you have planned?

Yes.

So I mean, we couldn't be more excited about the integration of Hospitality into our business model.

Not only does it drive significant incremental traffic to our galleries and brings in the right customer and is -- we can see mathematically adding the significant bump to our revenues in the galleries that have hospitality.

But as we are evolving and learning and designing the business model for Hospitality, we think Hospitality will be incrementally profitable to the model, which -- besides the integrative benefit, which we really never had a plan for, quite honestly.

But I think the experience that we're designing, the incredible food and hospitality experience that Brendan and his team are bringing to life inside these pretty magnificent spaces we're creating, it's -- I think what surprises is just how popular they're becoming.

And so as we think about it, I mean, I think there could be 1/3, maybe more, of our galleries, 1/3 to 1/2, long term.

It all depends.

And what we like about this, one of the great things about it, I mean, it is a different business integrated into a retail business, right.

So I don't -- this is all hard work to kind of thread these needles and get it to all work seamlessly.

I think we found a model that's really unique, and there's lots of things to like about it, right.

It doesn't really impact our overhead or cost structure.

You don't have inventory.

You have fast turns in a -- in the F&B business.

We don't have to build another DC for those sales.

We don't have to carry the inventory, the increases turns.

It's got faster return on cash and so on and so forth.

So lots of things to really like here, but we're still really early and we're still learning so much.

I would just say it's just significantly beyond our expectations, how this turned out.

We -- our original vision was to have a really nice amenity inside our galleries because our customers spend so much time working with us, designing their homes and the ability to have them -- have a place to have lunch or early dinner and to keep them in the gallery.

We hoped it would drive some traffic or revenues, but it takes -- Chicago, for example, there's a building in a residential neighborhood.

There's just a little sign on the building that has RH.

There's no identification that there's a restaurant in there, you'd have no idea walking by.

And initially, our questions internally, like who's going to really want to go to a furniture store for -- to have dinner?

So just so far, everything beyond our expectations and we're just in real learning mode and making a lot of adjustments and fine-tuning the model.

And now we're in a position to believe that this is going to be meaningfully more incremental than we thought and will be a real business.

I think we're going to build a several-hundred-million-dollar hospitality platform here.

Your next question comes from the line of Steve Forbes with Guggenheim Securities.

I wanted to focus on the customer insights that you are gaining from your RH Members Program, especially as it relates to demographic appeal of the brand or the RH brand.

Are there any learnings that make you rethink that $4 billion to $5 billion long-term opportunity as you think about how broad the brand can travel as it relates to just demographic, whether age or income spreads and so forth?

Any insights will be valuable.

Nothing particularly different than what we anticipated.

So I would say if you look at where we -- how we thought membership would translate and how it would impact the business, we -- we're just really happy that we're really directionally right with this.

Again, it's relatively early, right, first couple of years with all of this.

But the real key to membership, we can all talk about customer data and customer insights and all of this other stuff, and I'd listen to so many retailers' conference calls and they're all talking about all this big data and all these customer data and insights.

Well, we've all had the data on the customers, right.

I mean, you have retailers out there that have credit cards for years.

They know everything.

They've got all this data yet they can't grow their business over the next -- the last 10 years, right.

So I think people sometimes put too much of a premium on these things.

For us, the -- remember, the objective here was to smooth out our business, right, to not run a chaotic promotional business that we believe had just massive -- it was massively distractive to leadership to try to run a business like that.

You're not making high-quality decisions.

It's enormously cost-inefficient to manage inventory or manage the business.

So this was to really simplify and streamline our business.

That was our major goal.

We run a big direct business, right.

We have data on our customers.

I mean, I didn't expect all of a sudden -- find out we have -- we're going to have all-new customers on membership.

I mean, honestly, that would have alarmed me.

I mean, the idea we have -- we know a lot about our customers.

Do we know that much more?

I think what's happening is, look, our average transactions are going way up.

We're getting great leverage.

We're spending more quality time with our customers.

They're not all rushing in at the end of an event and you've got a store of 300 people and a staff and a team trying to serve everybody on the closing weekend of an event.

Now our business is smoothed out.

We're giving significantly better service.

We can staff the business better.

We have better relationship.

Average orders are going up.

Our interior design business, which is an important element that's linked to this, is really growing and becoming more and more important.

Every month that goes by, we have more and more hundred-thousand-dollar interior design jobs.

I mean, we just did a, what, $900,000 job in Italy [DP].

We finished an install in Italy.

We're working on a $1.3 million installation in Shanghai.

We're becoming a serious interior design firm, right.

And the membership is linked to that.

But the real objective here for us was to move from a promotional model, right, to this membership model to smooth out and streamline the business.

And we thought there was massive cost efficiencies, right.

And it allowed us to reverse engineer the supply chain, take -- from our numbers, if you really look at the numbers at the end of this year, we would have planned to have $400 million more inventory than we're going to have if you looked at our previous long-range plan.

So net-net, you guys are seeing that we're probably going to take somewhere around $300 million out that, right, but we would have inventory growth.

If you were to run the business on the same terms, on the same turn, it's about a $400 million difference in inventory.

You couldn't run the inventory the way we're running it if you were running a crazy promotional model like we were.

You just would always be buying wrong, right.

And yes -- so that's -- there are so many things here that membership is unlocking all kinds of opportunity in the business.

And I'd tell you the least important part is, do we know more about our customers?

We know a lot about our customers.

And then as a follow-up there, Gary.

You mentioned some international sales there.

Can you update us on your thoughts around the international opportunity in general as it relates to having a footprint there, whether it be in London or other countries?

Is that...

Yes, yes, no, well, a good question.

We're really excited.

I mean, our -- we're shipping goods all over the world, and we have customers that are really passionate about this brand.

And so we keep getting more and more excited about the international opportunity.

We just want to be really smart about it.

It's complicated in a business like ours, where I tell people a lot, when you are in the apparel business, it's men's and women's, tops and bottoms and accessories, right.

Everything comes folded the same size.

It all comes in a same-sized box, and nothing breaks in transit.

Our business is exactly the opposite of that.

So when you decide to, all of a sudden, take your business to another country, you really got to think through all those aspects, the supply chain and so on and so forth.

And we've been working on that.

We've done a lot of work on the real estate side.

We think we were zeroed in on a location in London and possibly one in Paris.

But our deals are not the simplest and easiest to do.

These are pretty iconic locations that we think are perfect for the brand.

And if we can get them done, we're in -- we're kind of parallel pathing, working through what the operational mechanics and how does that all translate.

So as we know more and get closer to it, we'll be there.

But clearly, there's a huge market opportunity here.

I mean, it may be that the international opportunity may be as big or bigger than the U.S. opportunity because the competition is -- I mean, there's really no competition internationally when we look at what we're doing.

And we have all kinds of people that want to license it, right, want to franchise it, license it, and we just said no to everybody.

We really believe we want to control our brands.

So for now, that's the path we're taking.

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

My first question related to gross margin.

The gross margin was substantially better than you had guided to at fiscal year-end, as was your guidance for the year.

Can you give us a sense on this line item?

In particular, what's really breaking your way up and beyond what you had initially expected?

Because lots of the changes that you're speaking about have been in place for a number of months.

So is it the mix of business?

Is it what the cleanliness of the inventory does to your ability to sell at full price?

So give us a sense, if you could, about the nature of the upside surprise here?

Sure, Matt.

So gross margin was really hitting on all cylinders in Q1.

So we have been talking about the SKU rationalization and inventory optimization efforts, and cycling through those was, by far, the biggest item.

But to your point, we did have very clean inventories.

We -- now that we have the membership.

We're not going -- we don't have a lot of variability in selling price.

We have to do a lot of full price selling.

But then the other things that also fall into gross margin for us are things like having a full quarter of the benefit of the DCs and the reverse logistics of not taking the outlet goods all the way back to the DC that's in transportation.

So there's just a lot of benefit of the way we're handling the goods and having fewer DCs.

And the way we're really just -- the way we've kind of architected the platform, as Gary mentioned, just has a lot of efficiencies as it relates to the movement of goods, the storage of goods, the handling of goods.

So it's kind of -- product was, by far, the biggest item.

But within transportation and occupancy, there's also savings there.

Yes.

And it's a little hard.

As Karen said, we're still in the very early stages, right, of kind of realizing the opportunities that we anticipated.

And so trying to forecast that and trying not to get ahead of ourselves until we're ready -- I mean, at one point, it's earlier in the quarter.

We've got one of the (inaudible) came in and he said, "Gary, money is falling out of the trees." And -- yes.

And it was just true.

I mean, I think the simplification of the back end of this business and the business being architected in a truly unique way that's custom to our business, right, not like anybody else's architected operating platform.

I mean, we're really thinking deeply.

We're bringing first principle thinking to everything.

We're not looking to best practices.

It's all next practices.

And I think the time and effort that this leadership team is putting in, you're just seeing opportunities all the way through.

So I wish we could be more specific with all this, but we took the learnings in Q1 and we tried to reproject the year.

And we tried to be conservative projecting the year, right.

We don't want to get ahead of ourselves.

So we're learning.

You're learning, all good so far.

Super helpful.

And then by way of quick follow-up, I know margin was really the big source of the upside surprise, but you spoke about sales overseas.

There's a point of couple of -- 3 years ago where the oil market and that tourist market, et cetera, did start to weigh on the business a bit.

If we look at macro factors, we listen to other companies, the oil markets are in better shape.

Tourism into the U.S. seems to be in better shape.

Are you feeling that all?

Is that a factor in the strengthening of your comparable brand sales momentum that you can discern?

Yes, Matt.

The markets that we've mentioned before that are most impacted by oil, you would anticipate in Texas.

And as you kind of go to Canada and look into Florida and then some of the ones, tourists not as much for us, right.

But the oil markets, we're seeing better performance out of the markets that would have been negatively impacted and the oil would drop all the way down into the 20, 30.

So I mean, oil will move those markets.

It's just no getting around that.

So logic prevails here.

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

Gary, in your letter, you highlighted a number of things that DeMonty and his team are working on, like the supply chain and customer service, the in-home delivery, the call centers.

I was hoping you could take a little bit about the time frame with which you hope to make maybe the most meaningful progress on this.

And maybe talk about what might just be more customer-facing versus the areas of what he's working on that are really contributing more meaningfully from a financial standpoint.

Yes.

I think we'll be prepared to kind of be more specific and give you a lot more color probably later in the year maybe with our next quarter.

I mean, DeMonty is just completely getting close to this with his team, making real changes, putting fresh minds and -- in the business and also just putting people in the supply chain that actually come from a customer perspective, in a gallery and stores perspective that think about the business completely differently than a typical supply chain person might.

And we're just seeing opportunities that other people can see and unlocking a lot of value.

So -- but we're so early on here, the moves we've made to consolidate the DCs from 4 to 2. I mean, there's still more work and more opportunity there in the DC network design.

In the outlet piece, where we simplified the reverse logistics, that's the early work.

There's a lot more work there.

I mean, we're seeing benefits in outlet margins and other things, but we think there's continued margin opportunity in outlets from minimal handling.

We think we're going to turn the goods a lot faster by not transporting them as far.

So we still don't have outlet stores in every market by our galleries, right.

So there's still places where we have to take it somewhere, cross-state, still moving it too far.

So we're in the early innings of rearchitecting the outlet platform.

We're in the very beginning innings of rearchitecting the home delivery platform and network.

Soon, we'll have, in the Bay Area, the new model up.

And we're -- and we'll have more to report there when we have real data.

But one of the things that's really interesting, when I got here 17 years ago, there -- in the Bay Area, we actually did our own home delivery.

We in-sourced and did it ourselves, and it had the best metrics in the company.

And it was that way for, I don't know, 3 or 4 years.

And then we decided to outsource it, and then the metrics looked a lot worse.

So it's interesting that the guy that used to run it is still with us.

And now that we're listening to him, telling us, "Look, guys, here's how we used to run it.

Here's the metrics from 15 years ago." It's just that nobody believed it could be done.

So it's just bringing first principle thinking into the business, looking at things with fresh eyes, building up from what is truth, not speculating.

And if you came into our office, as you've seen on one wall, kind of current state and then you'd see, right across on the other wall, a design of future state.

And I think the logic of looking at the fact that -- today, I would say we have a home delivery network design that almost looks like a DC network design.

For example, in the San Francisco Bay Area, we pick the orders at our DC in Patterson.

We drive the orders 20 minutes to our HDL in Tracy, and then we unload the goods after 20 minutes, take them out of their protective packaging, blanket-wrap them, which kind of protects the goods, and then we send drivers into traffic for 2.5 hours to get to their first delivery in Marin or San Francisco or Palo Alto or Woodside, right.

And if you've ever driven a truck or been in a truck in stop-and-go traffic, you can only imagine the furniture banging around against each other, right, with the blanket.

And so just a simple solution like, hey, why don't we put the home delivery and delight centers near the customers?

And why don't we send the goods at night, not during the traffic?

And why don't we leave them in the protective packaging?

And then why don't we unpack it 5 minutes from the first delivery and so it's not getting banged around for 2.5 hours?

And by the way, what does the math look like when your drivers aren't sitting in traffic for 2.5 hours before they make their first delivery and then have to drive back with the returns in 2.5 hours?

What if you just drop the return off in an outlet that's somewhere in the market where all the customers are, instead of taking it into the middle of nowhere, where there are no customers.

Maybe the turns will be better.

Maybe the margins will be higher.

Maybe the teams will deliver twice as many orders in the same day.

Like it's just bringing fresh eyes, fresh minds, first principle thinking, build -- find out what the truth is, build it up from the truth and don't hire a consultant that's going to come in and tell you how everybody else is doing it because they may be doing it wrong.

So you're just seeing the very early stage of this.

I mean, I think it is going to be so transformational.

I think the model we're going to build here is -- we wouldn't tell you mid-teens operating margins unless we really believed it.

I mean, we believe this and it might be more than that.

So I think we're going to build a model that is unlike anybody has seen, no different than -- look, no different than the front end.

Like why do we build these spectacular galleries that do -- when I inherited the business, the average store volume here was $2.9 million a store.

We have stores doing $60-plus million, right.

The same little boxes that were doing $2.9 million a store are now doing $15 million a store in the same square footage, right.

It's just looking at things differently.

But that same creativity, that same approach, that same cross-functional collaboration that helps us architect an integrated solution that is unlike anything anybody's ever seen, is the same energy, creativity, cross-functional collaboration that is going into building the operating platform.

And we're having a blast.

We're finding things that -- we're like, "Oh my god," we feel stupid for doing it the other way for so long.

But you couldn't be more exhilarated to find -- like every problem, there's an opportunity, right.

So the opportunities are enormous here.

And I just think that we're just taking our own path and bringing fresh eyes and thinking and not having consultants come in and tell us the way that everybody else does it.

That's not going to get you ahead of anybody, right.

So we're going to conceptualize a leapfrog operating platform and you're just seeing the beginnings of, I think, what's going to unfold here over the next 5 years.

That's great, very helpful, Gary.

If I could squeeze in a quick follow-up for -- maybe for Karen on the Source Books.

I know the interiors book is getting out meaningfully earlier this year than it did last year.

Clearly, that should benefit, I would think, sales at least for 3Q from a timing perspective.

How should we think about the other maybe P&L impacts from getting that source book out earlier?

Sure.

So what's different is actually, it's not just getting it in early.

We're having 2 drops.

So last year, we had Modern drop in the spring and Interiors drop in the fall.

And now we have 2 drops of Interiors, 1 in the spring, 1 in the fall; and 2 drops of Modern, one in the spring, one in fall.

So it is -- there's an incremental advertising investment, but in total, we're doing different things with circ and page counts and such that on the year, the ad cost shouldn't be that different.

And then with respect to the new accounting rules, we have tried to make it clear how that's going to shift significantly between quarters and put a table in the press release to try and show some of the variability between quarters.

For example, in Q3, when the fall books go out, you'll see all of the expense in Q3, then Q4 will be massively improved because there isn't really any expense in Q4.

So there is some variability by quarters, but in total, on the year, ad cost should be relatively consistent with last year.

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

Gary, you just touched upon gallery productivity.

And I believe in your next-generation galleries have now been open for more than a year or anything from something like 18 months to about 3.5 years.

I'm just curious whether you can offer any color on the comparable sales growth you're seeing from those galleries relative to the company as a whole and also whether it be market-wide lift in direct revenue from those new galleries.

Has that met or exceed your expectation?

Yes.

So we continue to be extremely happy with our new galleries and we continue to fine-tune them.

As far as the impact of the direct lift, we -- the model is relatively similar and we've articulated before.

We expect a modest direct lift in the markets when we open the big galleries.

The major lift is in the galleries themselves, right.

And that will actually change the whole complexion of our sales over the next several years.

So if you just think about a market where our sales at retail will lift by 2 to 3x over a few year period at retail and our direct business might lift by 10% to 30% over that period of time, you're going to wind up with the business here.

People -- it's funny, again, you study what other retailers are doing and what people are excited about, and people get excited about their direct business growing than -- faster than their retail business.

I don't know why because the direct business makes less money in every retail company in the world.

I'm positive of that but -- and that's why you see declining operating margins.

But I'll tell you this.

Our business will go -- we were almost 50% retail, 50% direct.

That was because we had significantly undersized retail stores, right.

So when you really size the retail stores correctly, this model is going to look like 65-35, 75-25, right.

And quite honestly, we're kind of ambivalent where the sales fall.

I can't influence whether someone is going to place the order from home or they're going to place it in the gallery with an associate.

We just want to kind of build the net, if you will, that we catch the customer, right, where the customer wants to interact -- or not even where the customer wants to interact because how could they want to shop your gallery if there's not one there, right?

So really, it's about where and how do you position the business to grow in the most productive way, how do you allocate capital in the most productive way.

So we look at a market and we try to size the gallery, size the circulation, think about the investment in advertising, think about all of the things we're going to do and the investment in a market and then how do we really optimize that market from a return on invested capital.

So -- but look, we think we have the most exciting retail stores in the world today, and they're only going to become more productive over time, not less productive over time.

We will only get smarter in how we merchandise them, how we market them.

I think the fact that they're so unique and different that we're getting the share of traffic that others are not getting, we're becoming more important to developers and landlords.

I mean, just interesting fact now that we now have a real, proven concept, we have enough of these open, that developers now believe this will work, right, we've now layered on top of that a hospitality experience that is really terrific compared to anything else in a retail development.

And that has developers excited, right, because it drives traffic not just to our gallery.

It drives traffic to any development.

So I just think we're -- again, we're on the right track.

We're on our own track, and we couldn't be more excited about what's happening with our galleries.

It's really helpful color.

And on the SG&A side, it looks that spending came in above your expectations in the first quarter after adjusting for the accounting change.

And I think you took up the plan for the year again after the adjustments.

Presumably, the spend behind the new source book mailings was one component of that increase, but I'm wondering what else is driving SG&A higher than initially expected.

Sure.

So we do have a couple just investments this year that we are continuing to invest in hospitality, as Gary mentioned.

We have 3 experiences this year.

So that's incremental start-up cost there plus just more openings than we have last year.

So we have more preopening cost.

But then separate from that, we have 2 kind of compensation things.

One is incentive comp is higher than it was last year.

Obviously, we didn't have the same strength of our business that we have this year.

So we have higher incentive comp in our base.

And then there's these other small incremental investments, modest in other areas, things like our call centers and some of the changes that Gary mentioned in the release of opening a call center on our campus, for example.

So there's other modest SG&A investments in there.

Yes.

That wasn't in our plan, and we decided we needed to get the customer closer to us, right, whichever way we can get closer to the customer, get out to the customer, bring the customer's voice into the hallways of our corporate campus here.

And so we're making investments to just strengthen our ability to serve the customer and -- but I think, look, I mean, are we spending a little bit more money?

Yes, we might be.

Are we making massively more money?

Like, yes.

This is about -- a business is about investing.

It's really not about spending, right.

So if we're investing more, are we making more?

That's what we always ask at the table.

What are we investing in?

What do we expect to get from it?

So -- and I think our numbers tell a pretty clear story that any incremental investments in SG&A that we're making are a result of significantly better returns.

Your next question comes from the line of Adrienne Yih with Wolfe Research.

Gary, I was wondering if you can give us an update on the RH delivery network, what you're doing there.

And then also, can you talk about the quality of transaction, either increase in order size, return rates lowered, that lead time just from having cleaned up that inventory?

And then for Karen, with regard to the warehouses that -- with the SKU rationalization, how many of those warehouses are now, I guess, decommissioned, so to speak?

You talked about one of them being anniversaried.

And what -- as we go forward, what can we see from the remaining warehouses?

Yes.

So I think the first question is an update on the RH delivery network, right, and I think I just talked about that, right.

The simplification of that and the ability to kind of move home delivery and delight centers close to the customer.

So goods travel farther in the original package, that gets to -- it gets to almost anywhere in the world undamaged.

Just when you take that packaging off products, what are you doing with it, right?

So that...

Maybe timing.

There's not much color.

Huh?

Timing on -- timing of implementation or when we might see as far as on...

Yes, it's going to take several years, right, several years to get through the whole country, right.

And so this is a long-term project.

But the returns and benefits are -- we believe, are going to continue to be really good.

So as we learn, we'll adjust.

But we think there's tremendous benefits to make in lowering returns, lowering damage, lowering exchanges, getting orders to stick, being able to deal with a customer issue immediately as opposed to you make a delivery, a customer has an issue and it goes into a process and a system them and it gets back to the customer and it could take days or weeks.

I mean, we can have a medic in a customer's house in 30 minutes in our new model.

So -- but it's going to take a long time to kind of get this everywhere nationally.

Some things, we'll be able to go faster about, just doing simple things like adding more routes, moving to 7-day deliveries, delivering when the customer wants the goods, just not when it's most convenient to -- from the trucking company to deliver and any -- all kinds of things like that.

So -- but we'll -- I think we'll be more specific with our plans here probably in the fall.

I think sometime in September, when we report second quarter, we'll take you through a more broader view of what we've learned and what we're doing.

I think -- but we're just at the early stage there.

I think I was referring more to the -- where the -- you wanted to have your own employees, the RH employees if that's part of the same -- yes.

Sure, yes, no, I mean -- yes, we have a bias for more control than less control, but at the same time, we have a lot of partners on -- that are kind of raising their game and expressing -- very passionate about wanting to be our partner and wanting to integrate with us and work in a deeply collaborative way to do -- provide a service that's not being offered in the industry.

So if there's people that can partner with us in the right way and can actually differentiate themselves, great.

People that are -- that can't differentiate themselves, I mean, we're -- look, we're operating in a business that really doesn't have a peer.

We really don't.

Say, who else is really at the kind of more luxury end of the market with scale?

No one has that.

So -- but we can't have our goods on the trucks of the other people delivering -- being delivered the same way.

Our customer expects more.

Our galleries are different.

Our experience is different.

Our home delivery experience has to be different.

So -- and we're just being very clear and transparent with our partners.

And a lot of them are stepping up.

So we're optimistic, but it means a real focused commitment and investment into RH, right, for them.

So we'll see who's game.

And then Adrienne, with respect to the DCs, we used to have 4 furniture DCs, and 2 of those closed last year in Q4.

So our L.A. warehouse and then our Dallas warehouse, those both closed in Q4.

And then we still have 2 left in East Coast and West Coast as well as our small parcel, our shelf stock facility in Ohio.

So that's the structure and kind of the plan for now.

We'll continue to evaluate and see if there's opportunity, but that is our -- we don't have any immediate plans with any other of those warehouses.

Okay, great.

And just one last one for Gary.

When would the timing of the gallery in London potentially be?

Too soon to tell.

I mean, we've got to nail down the deal, and so it's not that easy.

But hopefully, it's one of -- it's on the top of Dave's list.

We think it's probably a $300 million or $400 million opportunity if you just look at the U.K. market, right.

We think we can open one gallery and probably create a $200 million to $400 million business very quickly.

Your next question comes from the line of Daniel Hofkin with William Blair.

I apologize if I missed this.

I know you talked about your sales guidance by quarter on the remainder of the year.

And within that, it sounded like the comp expectation was starting with 2Q, some deceleration from that to 4Q.

Just curious what was driving that?

It wasn't immediately obvious why you would expect comps to decelerate.

Sure.

So the real estate -- so when we open new stores, those are non-comp.

So those are bigger contribution to total revenue growth in the back half.

So those are offsetting some of the -- we've given our total top line revenue guidance.

And if the new stores are contributing more comp, it's, therefore, less.

Your next question comes from the line of Chuck Grom with Gordon Haskett.

[Champ Borkan] for Chuck.

I think the outlet sales were down 22% in the quarter.

I mean, given the easier compares and the leaner inventory, I mean, how should we expect this to trend for the balance of the year?

Sure.

So outlets were a 2-point drag in Q1, and we expect a very similar drag in Q2.

But by the time you get to Q3 and Q4, it should be more neutralized and roughly flat in Q3 and maybe down just under 1 point in Q4.

So that's how that should landscape.

And then SKU rationalization -- and this is probably another point for Dan on the prior question, SKU rationalization, which was not in the outlet, it was just our core product that we were discontinuing.

It was selling through the regular channel.

That actually dissipated through the year, too.

So that's another contributing factor to the comp.

So we're having easier compare, if you will, in Q2 than we do in Q4 when there wasn't that much SKU rationalization left.

So in addition to the real estate, lessening impact of SKU rationalization is another factor at play in the sales cadence throughout the year.

Got it.

And then just switching gears a little bit, I appreciate the margin bridge, the long-term guidance.

I mean, I guess, the expectation that some of the new businesses that you've kind of been holding back on over the past few years that they'd be relatively flat to margins going forward once you kind of do -- start to roll those out?

Those are basically the new businesses.

Would those be -- we wouldn't expect those to be a significant impact, positive or negative, to margins at this point.

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

Regarding the inventory, you made some really good progress.

What are your thoughts about the breadth versus you have now and it looks like you can continue to maintain great revenue growth with less -- a few -- with less inventory, which is encouraging.

I'm just wondering where you are in the context of that strategy.

And Gary, as you think more broadly, would you ever intersect hospitality with membership in terms of having a membership model within hospitality and/or think about shared workspaces just because a lot of the consumer model with millennials and the on-demand lifestyle is also shifting in that way as well?

Curious on your thoughts.

We think the -- let's start with the inventory.

I think by the end of this year, the inventory will be relatively close to optimized.

And then I think we'll hit turns, as measured internally the way we measure them, getting up to 3.7.

Maybe we can probably run the turn to 3.5 to 4 depending on how we're buying or how much newness we're betting on.

But I think we can maintain these high turns, right.

It's just a simplification of the DC network design and how we've designed the network.

It's just going to be way more productive and then, obviously, benefited by the consistency of membership, right.

Smoothing out the business, which allows you to buy it better.

When you're wrong, you're not as wrong and so on and so forth.

So as we think more broadly, would we intersect membership and hospitality?

It's funny we get a lot of feedback from people.

And one of the things we're struggling with -- I don't know if struggling with -- I mean, it's a good problem to have.

We're now extrapolating what we're doing and these other restaurants and then saying, well, what does that look like on the rooftop in New York and how we're going to run that volume.

I mean, we could have a $15 million restaurant on the rooftop, right, of a retail store.

And how does that impact our business?

And how do we think about the inside of the restaurant, the outside, people buying a $4 cup of coffee and have a business meeting for 5 hours on our outdoor furniture outside and on a nice day, right.

So many ideas, people say, "Well, why don't you make it a member thing?" Once you make -- you have to be a member to eat at your restaurant and so on and so forth.

And I think, I mean, you could do that.

At the same time, we really want people to discover the brand, right, and discover RH because people don't go to furniture stores very often.

If we all just step back and say, "How often do you go to a furniture store?" Not very often.

And so you don't -- you miss the opportunity to inspire people, to give them ideas, to help them see their home in a new way.

So I like the kind of the openness of it.

I mean, we can naturally edit it around price point and offering and attract the right people, but I like the incremental traffic -- and look, the SoHo House and other people that are doing what they're doing, like they're great at that.

It's not really who we are.

And so I don't ever want to say never, but I think, obviously, it's been a lot of discussions around how to think about membership and how to integrate with hospitality or the other pieces of business.

And when I think about shared workspaces, I think the same way.

I mean, WeWork is fantastic.

They're doing a great job.

They're the market leader.

Could we do that?

Sure.

SoHo House is doing that.

Other people are trying to do that.

Just like other people are trying to be the SoHo House, no one is anywhere near as good as the SoHo House.

Other people are trying to do WeWork.

No one -- I don't believe anybody is going to be as good as WeWork as WeWork.

So we just want to really be great at RH.

And we think if there's markets where there's an opportunity to be truly distinctive and differentiated, we will test those things.

And we believe that in the hospitality.

It's why we're testing a guesthouse in New York.

I mean, we think that there's an opportunity to bring a product to the market that does not exist.

It's not about people asking, like, "Oh, so you're going to sell your furniture in your guesthouses?" No.

That's not what we're doing.

It's -- we're going to build the hospitality experience that does not exist, right, that's tailored to what we believe is fantastic and great and missing.

And so we'll learn, but we're not rushing out to get into a whole bunch of new businesses that we're not good at and we don't know a lot about.

We really want to want to own this business.

That's very helpful.

And on the strategy of simplify to amplify and thinking about customer-centricity, so what are the -- what are kind of the simple key metrics you're looking at regularly just to judge yourself with this idea of customer-centricity and being on top of satisfaction and the way in which people perceive or receive your brands?

I mean, we're looking at all the metrics that everybody else is looking at, and some that are unique and specific to us that -- I don't know if that's important to talk about, but the good thing about the retail business is you get a report card every day, right.

We know how our sales are every day at what margin every day.

We know our orders and the order -- average order value every day.

We know what they're buying every day.

We know specific products they're buying every day, what finishes they're buying every day, right.

There's plenty of metrics here that are important, that we review and obsess about.

And I think it's not even so much about the metrics.

It's your ability to draw the right insights, right, like -- so a lot of people in the world that are great at reporting the news, not making the news.

And it's really about being able to take data and turn it into insights and, from those insights, conceptualize new and better ways of running your business.

And I think if you look how we're running our business, we're running our business in a very unique way, right.

We're pretty counter to almost everybody in the industry.

People are shrinking the size of their stores and closing stores.

We're building the biggest specialty stores the world's ever seen, right.

People are eliminating catalogs.

We're mailing, inspiring source books, right, that rival some of the most -- the best produced magazines in the world.

If you look at how we merchandise and assort our business, just moving from promotional model, we're -- to membership model, we're -- I mean, just about every aspect we take, we tend to be the others.

We tend to be going the opposite direction and not because, like, we're just, "Hey, we should go the other way," but I would tell you the -- most of the winners in the world, when you really look at -- whether it's countries or businesses or cultures or individuals and so on and so forth, the ones that tend to really win tend to be doing something unique because they have better insights than other people.

And so it's not so much, do we have the right metrics?

Everybody probably have similar metrics in this industry.

Can you -- do you have the right insights?

And from those insights, can you conceptualize a better methodology and a better outcome that you can actually bring to life and execute at scale, which is also hard to do.

So I don't know if I answered your question, but that's how we think about it.

Ladies and gentlemen, I thank you for your questions.

I would now like to turn the call over to Gary Friedman for our closing remarks.

Great.

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

I would like to say congratulations to our people and our partners around the world who worked so hard and bring their passion and energy to bring our vision and values to life each and every day.

We all -- we spent a good 18 months marching through hell in this company, and it's nice to get a taste of heaven on the other side.

So thank you for believing everyone in the call and there's more good news to come.

Thank you.

Ladies and gentlemen, this concludes today's conference call.

You may now disconnect.