Good afternoon. My name is Ken, and I'll be your conference operator. At this time, I would like to welcome everyone to RH Third Quarter Fiscal 2017 Q&A Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

I would now like to introduce Cammeron McLaughlin, RH Investor Relations..

Thank you. Good afternoon everyone, thank you for joining us for RH's third quarter fiscal 2017 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Karen Boone, President, Chief Financial 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'll 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'll turn it over to the operator to take our first question..

And our first question comes from Steven Forbes from Guggenheim Securities..

Good afternoon. Maybe to start with a high-level question like giving the current outlook for corporate tax rates. So, Gary if you can just discuss your willingness for general thought process around the idea of investing margin into the business right in a lower tax environment to drive share over the long-term.

Would you accelerate the roll-out of home delivery or hospitality initiatives or are you really committed right to that kind of margin outlook that you provided at the Analyst Day and would not right proactively invest margin to the business in the environment that we may see..

Sure. Well, thanks that's a good question. The way we think about the operating margin guidance for next year is that its inclusive of investing pretty aggressively into the continued enhancement and redesign of our supply chain including home delivery. So, would we consider investing faster depending on the tax.

I think depending on where it all lands and what gets past I think will evaluate it more specifically then I think it'll obviously open up some optionality for us to consider things.

But if I think about next year and I think about the guidance that we've given we're very committed to that guidance and that guidance is inclusive of some pretty significant investments. And continuing to redesign and enhance our supply chain including home delivery..

And then a quick follow-up here. Can you just remind us how many next gens are in the plan for 18? And then maybe also a high-level question or as you think about the evolution of brand awareness in how differentiated the RH brand is from the cohort here.

Are you guys starting to have discussions right about a scenario where you can have even a larger footprint right in that 60 to 70 store current goal right and maybe penetrate cities that may not necessarily house a legacy store today as brand awareness continues to evolve or it is still too early as you think about that?.

Sure. Let me take the first one on current goal..

Next year we have three in the plan for sure and then there is a smaller billboard gallery as well in the Napa Valley. It's the three of the larger and one smaller in Napa Valley..

Sure. And then as we think about the evolution of kind of brand awareness and having a larger footprint than 60 to 70. I think when you're if I think back on my career and whenever you're successful with the brand and a business and you continue to improve it and evolve it you generally over time see a bigger market than a smaller market.

And I think that's happened to us over the years at RH and I think it will continue to happen to us.

I was in a conversation with one of our investors the other day who was commenting on some friends of theirs that had been into our Palm Beach gallery and went there for I think lunch or dinner and then came out wanting to redo their bedroom and other parts of their home.

The comment was that these new retail experiences that were beginning to unveil in the marketplace, it had the opportunity to create a real tipping point in the perception of RH as a brand and I think for those of you that were at our Investor Day in Palm Beach, and you had a chance to look it just 50 yards away from where we built the current new expression of our brand was the legacy expression of our brand hidden in kind of the center, no real dominance a very impressive shopping experience.

And that's a new physical expression the brand is such a leap frog. It's almost hard to believe that the company that runs the current legacy stores is the same company that's creating these dramatically different and enhance shopping experiences.

So, I think we're going to find that tipping point and the people that maybe don't think about shop in RH today and maybe don't perceive us yet as a luxury brand or don't quite perceive the breadth and depth of our assortment and the design services that we're investing into and the capabilities we have and the experience we can offer.

I think when that really gets known, I think our market is going to get bigger not smaller. And there's going to be a meaningful tipping point as we really continue the positioning of the brand in these new next generation galleries.

So, and if I look back at the history of my career whether it was early days at the Gap or Williams-Sonoma and I've never get -- when I first joined Williams-Sonoma I think we had 48 number of stores and the discussion there was I think we can have 60 and 70 and that was as big as anybody thought it could be and I think what Sonoma have today 250 stores.

I don't think, I remember first conversation with Chuck Williams and Howard Lester. The most we can have is 60 or 70. And so, that just happens to be the exact number we're saying about RH. Now, do I think RH is going to have 250 I don't think so, not the size and scale that we're building.

But do I think that there's market that are not on our target list today, that are not included in the 60 to 70 that as our brand becomes more successful and brand awareness is higher and the understanding or the assortment and the services that we offer.

I think of course I think the market will get bigger than maybe what we see today and I think that's the natural evolution of a growing brand or business. I think if we're sitting here with still knife [ph] at the same stage that we're at today and said how big could 90 be. I don't think Phil or anybody in the team would have seen it.

I know nobody saw it at the Gap and nobody saw it at Williams-Sonoma or Pottery Barn. And if you ask me 10 years ago, what we are trying to do, we are trying to build a $1 billion brand that could make 8% to 10% operating margins. And clearly, we've blown by that.

So, I think that's just a natural evolutionary process that evolving and growing businesses go through. You just, the market grows. You kind of create a market if you're really building the brand correctly..

Thank you..

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

Hi, thank you. We had a question regarding the merchandise margins.

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

Thanks..

Hi Oliver. I'll take the first one this is Karen and then we'll turn it to Gary. On the merchandise margins the 460 that we are up from last year. We are still lapping some of the key rationalization and other items from 2016, so I wouldn't necessarily take that plus 460 and carry it into future quarters or even next year.

But that 36.9% that 37% or so margin, you can see based on the guidance we have in Q4 that we do feel quite comfortable with that and then as we head into 18, we've given you guys some indication of that 170-220 basis point improvement there.

So, we do feel very comfortable that we're getting back to those prior highs that we've had in that 37% range, longer-term we see even further opportunity and upside beyond that..

Thank you..

Yes. Let me take the question about the evolution of the breadth and depth. The assortment, how do we balance the breath versus the depth and what's best for innovation I think was your question. I think about, once I'd say think about 2017 as kind of a reset year in many ways, right.

If we articulated the 2017 with year of execution, architecture and cash that we're going to be focused on executing our new membership model, architecting the new operating platform and optimizing cash flow by increasing revenues and earnings and decrease in inventory and capital spending and that we are going to have no new businesses introduced outside of hospitality introduced in 2017, right.

So that's not a long-term view, I would say. Someone asked me the other day, Gary how do you think about 2018, and I said look 2018 to me looks a lot like 2017, I think it continues to be the year of execution, architecture and cash. I think we see a lot of opportunity in fine-tuning and executing our core business.

We're in the early stages of architecting what I believe will be one of the most innovative and optimized operating platform in our space of retail. And the focus on optimizing cash flow is important because of the current structure of our balance sheet and the risk we took on in buying basically half of the company back.

So, 2018 will look a lot like 2017, but slightly different because we'll be farther down the path and our focus will now kind of shift back to our natural tendency of building growth. I think it is one of the core strength of this business and with its team and one of the things that we've demonstrated that we can do well.

So, as you think about the reset it was important for us to reset the supply chain and redesign the supply chain, because it was in its previous design it was going to be a highly inefficient kind of capital usage and we thought we could build a much more capital light model and capital efficient model by rearchitecting the supply chain.

We avoided building a fifth furniture DC in Savannah Georgia. We stopped. We stopped moving forward with that project and then we've now rearchitected the supply chain and are moving to a two DC network and some people have asked well can you still grow the assortment with that two DC network and we can.

We've got a lot of room to grow on the new platform. We're doing some things that are very innovative that quite frankly are new revolutionary ideas on how to think about DC's and inventory turns and just using a supply chain in a very new and innovative way and I won't talk too much about and give away too much to our competitors.

But you'll see, we've got a whole assortment architecture that has many new business opportunities within RH that we're going to be focused on and previously we had -- we also have other business opportunities outside of the core RH brand that we believe we can grow and be dominant in the home space.

I think our tendency today is to kind of stay focused in the RH Brand.

We think that there is so much opportunity here and hence really the announcements around the opposite president with Sandra who initially joined us as President for New Business Development and I think is communicated to me that she's excited about what we're building here in our agency so much opportunity in RH, she's like her comment to me is like how can I help.

Like they're so much opportunity to grow this business and I think augmenting our merchandise and creative leadership and having both Eri Chaya and Sandra at the helm gives us a huge capability and great leverage in that area. And I think you'll see us start to bring on new growth vehicles within the core RH business.

There are multiple ways that we believe we can expand the assortment and open up the aperture of the brand and reach new customers and open up new market. So, you'll see I start to accelerate that in 2018 and we'll be accelerating that on a new significantly more efficient and optimized operating platform.

So, we think it was really good for us to kind of take that breather for a year and as we get into 18 you'll start to hear us talk about what's next and how we plan to continue to accelerate growth going forward..

Okay, Gary. And just a final question. On the platform and thinking about the platform that you're building.

What are your thoughts on the opportunities for up through the lens of customer engagement and what you want to accomplish there and through the lens of M&A versus organic development? As you look, as you've done the successful Waterworks deal and how you think about the extendibility and the aperture and the capabilities in the brand?.

I think today, I think Waterworks was a once in a lifetime opportunity right. I mean Waterworks was by far the best brand in the bath and kitchen space and at the high end of the market.

And in many ways, helps render the RH brand more valuable through its position in the market and through its relationships with architects, interior designers and their engagement in the building process of the home. So, to me that was a very rare once in a lifetime opportunity and we thought it was important to capitalize.

And quite honestly, if you sat here with me 15 years ago and looked at the merchandising architecture and strategic architecture for the company Waterworks was on there. So, I waited a long time for the opportunity to work with the talented team there. And we're just really excited about the kind of opportunity that presents long-term.

That being said, today I would say our bias is for internal organic growth. We have again, if you saw our merchandising architecture and the number of opportunities that are before us we they are almost kind of endless, right.

It's like someone asked me like when do you think he might buy another business or another brand and not that I want to ever close the door to optionality. We treasure optionality and we treasure trying to see all the possibilities that we can make the best choices.

But someone asked me the other day, when do you think you might buy another brand or do another thing I said probably not in this lifetime. You know that if I look at the opportunities that we have in front of us they're so meaningful and robust.

And when you really start to think about RH internationally, we like to say we're building a brand with no peer in North America I think that amplified.

If you look at it internationally, we just spend a lot of time in London and Europe and studying the market and looking at opportunities locations and we look at the amount of business our customer ship over to those countries. We just think that there is a huge opportunity to the brand.

We have a lot of people approaching us, knocking on our door about expanding the brand in the Middle East, expanding the brand in China, expanding the brand in South America, expanding the brand in Mexico. And the thing, we've said no so many times. It's funny, if you say no enough, at some point the deal looks so good, it looks tempting.

But as we study other brands that have grown internationally, it almost seems that all the great ones tend to try to reacquire their brand overtime and get control back. We're not in a big rush, we think we're just so focused on growing in a quality way and building quality into the brand and having more control than less control.

We think control is an important word. Control of our brand is really important as we look out into the new and developing retail markets where people with less control of their brand and their distribution network are going to get, they have price competitiveness and actually brand erosion.

It's hard enough to execute a brand yourself, when you start giving it to somebody else then you got to be really careful about how much money they'll pay you to get control of your brand. We'll how we've been, I've been here 16 years. Now, I've been building this brand for 16 years as most of this team many of them been here with me more than 10.

And yes, of course they will pay a lot of money for this brand, with 16 years to do tried doing it themselves. And I don't think anybody is going to be able to copy us anytime soon, so just our general sense when we think about M&A versus organic development and growth is that I just think that we're going to be doing this a long time internally.

And I don't want to say never and if another Waterworks opportunity comes up, we look at it. We look at everything. But today if I had to place a bet on what will RH look like in five, it will look like an even more exciting and a dominant brand in the luxury home furnishings marketplace and probably doesn't need to be augmented by outside M&A..

Thank you. Thanks Gary. Thanks Karen..

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

Good afternoon. Just some of the longer-term guidance that you shared at the Analyst Day and comparing that with your 2018 revenue growth outlook. You've just touched on some of it. But I'd be curious going from the 8 to 9, kind of comparable weak growth next year to the 8 to 12 longer-term over I think it was like a 10-year period on average.

What would you say would be the main things, would it be additional store growth domestically would it be international, would it be brand or product extensions? What do you think are some of the biggest areas that would help you think about that little bit higher longer-term range relative to 2018?.

Sure. Well, its two things that have really been growing the business over the past several years. It's -- our two key value driving strategies are they continued expansion of our product offer and the transformation of our real estate.

And like I said, the brand architecture the kind of the growth platform that we see today to continue to expand the RH brand through product and through services. We think it looks really robust and again probably take us at least through the rest of my career probably longer to kind of do that.

So, we see real growth coming from that part of the business. And we see real growth obviously coming from the transformation of our real estate and on top of that I think you think about what international could offer to the business.

I mean we were just, Dave and I and the team were over there London and we were looking at a gallery in London, it wasn't really about a gallery location in London, it was really about the launch of RH international, right.

Because one gallery in London with our direct platform and capabilities really reaches for the most part a lot of key wealth in Europe because everybody interacts with London, right.

And so, whether it be business from Moscow, business from the Middle East, business from Paris and other parts of Europe and London itself right which is a very robust retail environment. So, that becomes an important third leg but I think back to the point we talked about earlier is the brand awareness and the tipping point of the brand.

I'm kind of amazed at the early numbers out of West Palm. It's, I've always been a little nervous about that market.

If I look back when we were initially doing that deal, the store was -- the gallery had the, the legacy gallery was modest, I'd say middle of the road gallery and for the last couple of years while we've been putting this transaction together building the gallery its comped up nicely.

But you really look at and say like okay, how big is Palm Beach, right. Like how big can we, how far can we draw from. How do we think about our business here? And what's interesting about that is that the early response is good and so strong it's made us think about again that tipping point, right.

When people see you differently and see the brand differently and really see the brand for what it is and the services that we offer today particularly in interior design and the ability to do something.

We just had a, I know we talked at our investor day, but what was $560,000 in Tampa, right that we had and our gallery leader and our team were and discussed that. But we just had another $500,000 interior design job close in Texas and Willowbrook for a home in Williamsburg. And so, we're just starting to see these bigger transactions.

And I think people are just seeing us differently. And so, how do you think about the value of brand awareness, how do you think about the value of that tipping point is that worth 2, 3, 4 points a year as you really start to position this brand. We're just at the early stage of building these design galleries.

And so those are the pieces, it's really the continued expansion of our product offer that transformation of our real estate, the increased brand awareness and growth of the brand. We can always step on the advertising lever if we want, pull the advertising lever farther if we want. Right now, we're holding back a little bit.

We're testing a few things, but we're really trying to optimize the model but as we look forward can we expand the circulation of our books? Can we invest more in print and digital advertising? Those are other ways to invest in driving brand awareness. So, we're early on there. And then international is I think going to be a real business.

I think it's going to be much bigger than we ever thought..

Great. Garry, appreciate it. Best of luck..

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

Thanks so much. Appreciate the time tonight as well as the time a few weeks back. Delivery, I spoke a lot about delivery at the Analyst Meeting in West Palm. And our sense if that delivery is misunderstood by many consumers as a commodity. I know that you're stepping up the execution of your delivery effort and insourcing more of that.

I know you also have talked about not really believing in marketing per se.

But how can you integrate what you're willing to offer the consumer in terms of getting the product to them [indiscernible] interaction into the membership message in terms of their expectation on what they can get from their association with RH?.

Yes, I think again as we execute better. I think there is going to be tremendous word of mouth and we clearly will continue to talk about what we do and the work we do.

And again, it's not that we don't believe in marketing, I say look we don't have a marketing department, we have a truth group [ph], right because our brand is much more about our truth and our truth is the products we create and bring in the market.

The way we present those products in the market, the galleries we create, the sources we create, we the web experience we create, the service we deliver, the interior design offering and service that we're building. And when you do great work, the world talks about it.

We just have a bias to do great work and we think it's more important to invest in our work than invest in talking about ourselves, right. And so, just thinking about how we might go through capital allocation here, right.

And somebody goes like, I'd like $10 million more to put into digital marketing to run more ads or more this or connect to all and our $10 million more for print ads or $10 million more for more catalogs. And look the catalog is marketing but it's really our work, we're putting our work out there.

But we don't spend money on social media talking about ourselves. As you read in the letter that Instagram, I think day before yesterday just came out with their most posted café's and bakeries in the country and our 3 Arts Café is the seventh most Instagram cafe in the country. Like a cafe in the middle of a furniture store, think about that.

Like how if you awake in the morning, let's go eat in the middle of a furniture store and it that inspiring that we're going to Instagram it. By the way, I don't know how many. By the end of last year, we had 32 marriage proposals in the café at the 3 Arts Club in Chicago. 32 marriage proposals in the middle of a furniture store.

You can't make that up, right. And so, it's just our bias to kind of do great work and I think as we continue to do great work we will put the work out there. We will talk about the work we do in a direct and humble way, but we just don't think, we don't want to go try to chase a bunch of low quality revenues, right.

Like we want to build a high-quality business over time and so it's going to continue to get out there. When we perfect home delivery, will we talk about it? Yes, we will. Of course, we will. Will you read about it on our website, will it be in our source book, will you hear about it from other people? Of course, no different than our galleries.

We talk about the new galleries that we open. We have pretty interesting opening events when we open them. I mean, so we celebrate our work. But our capital is more focused on doing great work..

Thank you. A very quick follow-up for Karen if I could. I know that you are largely through the clearance activity and the merchant margins coming up would show that.

Can you talk about the role of the outlet has played in the quarter from a revenue perspective and how many of them are still standing?.

Yes. So, we have about 30, we have 31 stores right now. I think we'll open one more by the end of the year and outlet growth was actually, if you look at that 460 basis point number outlet was actually a drag within there because revenues were up about $5 million.

So that's about a point of revenue growth and the margins were lower than they kind of have been in the past and could be. So, we do think that that's another area where we'll have better margins in the future, when we are still working through some of the outlet inventory.

As far as the number of stores long-term, we actually although at one point we were thinking we would open these temporary stores and close them down because of changes in the logistics model, we're not going to be having outlet inventory sitting in the DC's any longer.

So, our bias is to turn that more quickly and as we've been talking about we're going straight from wanting to return in exchange and it gets dinged or whatever, it's going to go straight to the outlet. So, we need more boxes, more outlet doors to turn through that inventory.

So, some of those locations we won't keep, they were temporary so we might close them down and then open ones up that are closer to our home delivery centers..

Thank you so much..

And our next question comes from Michael Lasser from UBS..

Good evening. This is Atul Maheshwari filling in for Michael Lasser. Thanks a lot for taking our question. So, my first question relates to your third quarter comp drivers.

So how much of it was really driven by modern and what really was the contribution to your source book and were there any other significant drivers?.

Yes. We don't actually give a lot of detail on the specifics within comp, we just give that 6% comp growth and then the things that are not in comp is the new real estate and then outlet is a point which is non-comp. But we parse out the details of the six..

Okay. That's fair..

We continue to be very happy with modern. So, we're still happy, very happy with that business. Still think it's incremental. It still has a lot of runway to grow and it's doing great..

Okay. And I have a follow-up question on your guidance for the fourth quarter. So, we've seen that holiday spending has been pretty volatile in the past few years.

So, could you provide us sense of how trends have been recently and whether you're tracking in line or above your expectations at this point in the quarter?.

So, the question is..

Around holiday. So, I think….

Well, holiday is you know over the last several years we deemphasized our holiday assortment, right. As we've emphasized our positioning as a true interior design platform the holiday assortment that was kind of the legacy assortment whether stocking stuffers or gifts and knickknacks and holiday decor.

We believe it detracted from our ultimate goal to position the businesses is really the leading luxury interior design platform in the country. So, holiday has been a smaller part of our business. We added a little bit more than last year a layer of décor and some gifts quite frankly.

We are always [ph] to go through the assortment because some of its relevant and some of it just seems like it just doesn't fit anymore. But we do have a lot of location that are still in malls, we still have holiday traffic to come to the malls and you still have a customer that are shopping for gifts.

It fits a lot less in our pre-standing larger gallery location. So, we're less impacted by the volatility in the holiday quarter than others. We're not a typical business like most retailers anymore.

Our business is not as dependent on that fourth quarter and you'll see that start to unfold next year as you start to see our operating performance and how it begins to smooth out. Not too unlike the graph that we showed you with our sales pre-membership and post-membership.

But our sales and earnings and our business will have some seasonal movement to it, but we're not banking everything on Q4 like we have in the past and our new model. So, we feel confident about the numbers we put out there. I think it's said in my notes that we're running the business with the bias for profits versus revenues.

We're not going to chase low quality sales and low-quality revenues. We're going to try to optimize the business. We're focused on kind of maximizing gross margin dollar growth. If you think about our revenues even this past quarter being up 8% with merchandise margins being up several hundred basis points.

The way we think about the business and if you just directly think about the math one point of margin is really worth two points of sales when you think about margin dollars.

And so, when you think about our business being up 8% with several hundred basis points of merchandise margin growth our growth margin dollar growth is significantly higher than that.

And so, we're not going to let ourselves be victims of a lens that other people might be looking at our business or looking at our stock in short term momentum players who were in and out. When we're sitting with the stock here with almost 50% of the active float short still, right. They are very high, high forties. It changes week to week.

We're positioning the company to win over the long-term and that's how we think about the business. So, very comfortable with our guidance for Q4.

We feel very comfortable with the guidance we put out there for 2018, which by the way 9% to 10% operating margins would put us at the top of the heap if you look at the people who have had the historical high operating margins in our sector. Most of them their operating margins are eroding.

We've set our company up for the long-term and you are going to see operating margins expanding over the next several years..

Okay. Thank you..

Our next question comes from Geoff Small from the Citi..

Hello, Gary and Karen. Thank you for taking my questions.

I first want to circle back to you 9% to 10% operating margin target for 2018 and specifically I was wondering if you can provide some color on the internal external variables that would allow you to achieve the high-end of that range of conclude 2018 with the lower-end?.

Sure. So, we've in the guidance that we gave both gross margins and SG&A that kind of assumes that [ph] certainly is something negative happens with the economy we would be closer to the low end of the range or not really speaking the things that we can't control.

We have not factored in obviously some of the benefits that could come from tax rate changes and such. But really, some of that depends on level of investment and things like home delivery and hospitality, timing of new stores because when there's new stores open we get nice volume lift and occupancy savings or sort of old model.

So, I think we're focused on all the things we can control if things go sideways or out of our control whether macro or otherwise, we'll certainly pivot and make changes as necessary..

Thank you. That's helpful. And I was also curious what level of revenue your two-distribution center model can support, and if and when you reach that level.

Are you planning to open up additional DC's or simply add square footage to your existing locations?.

Yes, that's really depended on how we grow the business, right. One of the thing that's a big positive to some of our recent growth and one of the biggest growing parts of our business is our special-order business and our special-order business is a business we don't hold inventory, right. We really just can't stock the inventory.

So, as we continued again to business this as an interior design platform as you think about interior designers using our platform. As you think about people wanting to have their homes reflect their own unique point of view in style.

Our sense is our special order business will continue to grow and we think that there is - despite we just built it, it's just significantly more efficient for ahead of position in turn inventory and how we think about it.

So, we think we've got the ability to grow for several years on the existing platform and if we needed to expand it, most likely we're just going to expand the platform itself and just add some square footage in a simple way.

So, it's not anything that I see in anytime in the future that we're going to have big significant capital expenditures as it relates to the distribution center network. We'll be making investment in home delivery.

Obviously, as we go forward and we simplify that model and we -- I think we're going to -- as we articulated, I think at our Investor Day, we're going to really -- the existing home delivery models that exist are really built for the middle market and there is really no luxury home delivery networks built out there, people that play at that level control themselves and we think we will either take more control or we will partner with providers to build a whole new level of quality and service that's deserving of our brand from a home delivery point of view, and so we expect to invest in that part of the business and that's built into our operating model for 2018 and beyond..

Our next question comes from Peter Benedict from Baird..

Back on the fourth quarter, I mean the CBR compares really greater and the guide seems to imply something similar to what you probably did here in the third quarter, so I appreciate the bias for profits over revenues.

But I'm just curious, is there anything -- any discrete puts and takes that we need to be thinking about here in the fourth quarter that would prevent I guess an acceleration in CBRs as we think about the fourth quarter relative to the third quarter?.

Brand talk -- the acronym was similar [ph]..

Didn't know with CDR, but -- CBR.

I don't -- Karen, anything we want to add to that?.

Yes, I mean -- no, I mean -- I guess the one thing that I would just say is that the holiday business for us just isn't -- you would think that it might accelerate if we had a big holiday business when you go from Q3 to Q4 but that's just not the case for us as Gary mentioned.

So I can't think of any reason why it would accelerate, I think it's going to be similar but I don't know that you would expect a big ramp up for any reason..

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

They are the biggest two things that we have achieved is just the plans and one it's done and the other ones forthcoming is the closing of those two distribution centers.

So when you think about the occupancy savings and the fixed costs that's going to come out of the business from that and frankly, there is still one other facility that we've kind of spoken about that probably could be another candidate to close down further in '18.

So I do think we have a lot of progress that's been made just on the DC networks footprint.

And then, really what we've done with reverse logistics and the savings that have already come and we're 90% through that and frankly, that last 10% is just markets that are -- there is just not really in outlook extent or it goes back to the DC that's right there.

So not having all those transportation and labor charges and touching the goods has been a huge achievement. So those are the big things that we've already done, what's on the come and that we've keep talking about is how we're going to think about home delivery and what that experience is going to be like; so I think that's the biggest thing left..

Yes.

I'd say it's the home delivery and phase 2 of the reverse logistics and outlook business is, if we thought about our reverse logistics and outlook business and how it's architected today; our outlets are not necessarily architected or in all the right places to optimize that network, so we think there is continued opportunity in savings as we architect the outlook footprint to align with the business and the returns in the most optimal way to turn the product at the highest possible margin and handle it the least amount of times.

And then the home delivery architecture, the home delivery business and design of that will, in some ways emulate and look like the outlet architecture and that's -- we think there is just huge upside there.

So I think the home delivery piece; how fast can we go, where we will be a year from now, I think we'll know more after the first or second quarter of next year when we start to get the real data on the test market here in the Bay area and we start to get more clear in the learnings than the opportunity that we see and it may tell us to go faster, it may tell us we need to learn more and test more but the early indications and the numbers we shared with you at the Investor Day and just we have some of -- few of the metrics that we're measuring just indicated it's a huge opportunity.

So we're still pretty early on here, I mean even if you think about our DC network, and you think about how to optimize the parts of the business, how do you really optimize a 2 DC network; if you have goods, what percent of the goods are coming from -- coming into the west coast, what percent of the goods are coming to the east coast, how are you moving those goods back and forth, how are you think about transportation and the design of transportation, long-term do we have a bias to control more transportation right, if we're going to control our own trucks on home delivery in some markets and partner with others, do we control our trucks or partner with others on key transportation lanes in our business and take more cost out of our business.

And we have a unique opportunity, as you think about our supply chain versus others, right; whether it's versus the former businesses I-Brands [ph] across the Bay, whether you think about us versus the way fares or just other regional players, I mean, we -- our average ticket of our project -- product is significantly higher than everybody else, right.

So we can architect a supply chain and we have the scale, right; so if you think about the average ticket, you think about the average order, you think about the scale of our business exceeding $2 billion, going to $3 billion or soon, we just have opportunities that other people don't have because they are playing a different game and they have to play with the different cost model.

If you're delivering a $800 to $1,200 sofa and you're talking about how much quality can you built into delivering that sofa? Nothing compared to if you're selling a $4,000 sofa, right.

If you just think about that math and that's why we like our model and that's why we believe with our -- with the market we're focused on and the scale we have, the math says you can do it entirely differently than almost everybody else that's out there.

So we like what we see going forward, we like what the math indicates the opportunities will look like, and we like the ability that we have doing best into quality that other people are not going to be able to invest in the quality, you just can't invest that much when you're selling an $800 to $1,200 sofa..

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

Yes.

As you know, if you followed us for the last 8 or 10 years, it's like -- I mean we are constantly evolving our source book strategy because the market keeps changing as more business shifts to direct, as more business shifts online and plus we -- as we changed the cadence of our -- or just the character of our business from a business that was a more typical retailer with a big holiday assortment that out of big peak in December, if you look at the furniture business and furniture companies, December is not a very big month at all, it's actually -- whenever it goes on vacation, January is a big month, right.

And so the character of our business is changing and is different and therefore -- and the real estates are different and so the source books are going to continue to evolve, we're going to continue to test things whether it's the size of the source books, whether it's the bundling of the source books, whether it's breaking out parts of our business into their own source book, whether we have a lighting book, and rug book or linens book, separate books to build category, dominance, and other things like that.

And then even like when we mailed the books, it says -- I mean those of you who followed us long time, we used to mail 10 to 12 books a year, or once monthly, and then we have the radical change that went to two books a year and everybody thought we were crazy, and then we went from 2 books a year to 1 book a year; do we go back to testing 2 books a year, do we test like -- if you think about our business to short-term, right, like -- the nature of the furniture business being really kind of a big business in January, do we test some books and do we have plans to test books at different times of the year, do we put some books out into the marketplace in January to see how that works as our business continues to change or evolve.

Sure, we're just going to continue to test things all the time, sometimes you're going to notice them, sometimes you're not; as we have key learning's that we're sharing, we'll share those with you. But if we shared every test and every change in this company, everybody would be further confused about what we're doing, right.

We're already so unconventional and define conventional wisdom with almost all of our moves, whether it's big stores or still mailing source books and when everybody is moving to digital, going up market, when people are going down market and you'd think about most of the things we're doing are relatively unusual and it's because we do test a lot of things we are constantly curious and critical of our own work and we're going to constantly test things; so I guess I've just told you don't be surprised if you see some source books floating around in January..

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

A lot of my questions have been answered but let me just see if I can summarize, Gary.

We don't know how the delivery upgrades will unfold next year, you will be testing them and you will give us an idea maybe at the end of the -- well, maybe in the end of the year the fiscal '17 call or first quarter end, is that how I should be thinking about the timing there?.

Well, I think we will be talking about it all next year just like we've been talking about the architecture and evolution in our supply chain redesign and the distribution center redesign and the reverse logistics redesign and I feel now our efforts are shifting to the home delivery part of the business and architecting that, and we'll be testing things and we'll be working through it.

And as we learn, we'll continue to improvise, adapt and overcome, right. So….

Yes.

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

Yes..

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

We think long-term it will be accretive to operating margins, so we think we've got plenty of -- plenty -- contemplated in our plans as it relates to the investment and testing and architecture; and we're going to learn as we go.

Delighting our customers and having furniture's stick and reducing returns and exchanges, and also augmenting the selling experience, right, like -- I mean, think about it, we get to go in our customers' homes, we actually -- they open the door and let us in; that just seems like an enormous opportunity to me.

So maybe we don't just send in the delivery team, maybe we send in other people with them, maybe we create a different experience, maybe there is a selling opportunity in the home.

And while we're reducing returns, reducing exchanges, reducing cancel rates, solving problems in the home, if there is an issue with a piece of furniture and the ability to adjust it or fix it as opposed to -- now if it's handled by third-party, a call goes into the customer service center, I mean it just transfers -- it almost goes into the black hole that gets dealt with over days and sometimes weeks as opposed to minutes.

And so we're just going to get a lot closer to the customer, we're going to architect the backend for the business we're running today, architect home delivery for the business we're running today, not for the business we are running 15 years ago..

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

It's a wait and see. I think more likely than less likely, I mean the teams all here are shaking their head, so if you see -- if you had a little webcam, I mean here you can see everybody shaking their head, yes, yes, of course we are. But we like to make sure we get things right, people say we're one second to be ready, we never say when it's right.

When it's right, we'll watch things, so we've got a few concepts we've been working out for years, and once there is….

Well, I mean it's exciting to think that one or two of them may emerge next year.

And just lastly, Karen I think you said right now you have three stores that you're thinking about opening for next year or maybe have deals in process we've signed on; those structure are fair leasebacks or are those more of a traditional rent structure deals?.

Those are the traditional rent structure deals, the first -- now we have opportunity to do sale leasebacks of one's that are in the pipeline but we've put up all the capital for those.

I mean, [indiscernible] we've put up some but we've put up capital, the one's that we talked about at Investor Day where it's kind of a developed or funded and we don't actually put the capital, the first one of those wouldn't be until leased probably 2019..

But there would be an opportunity to transition these leases overtime to that structure?.

The new deals are going to move more towards that structure..

I mean one of those -- you know, there is an opportunity to do and we're going to -- we'll give you guys more details on those as we have them but at this point the three that were open, I mean two of them we've been talking before our Portland and Nashville are early in the year and then New York probably sees [ph], so those three we've been talking about for some time, Portland, Nashville and New York, and at this point we don't have plans to do a sale leaseback on those but of course things could change if we have an opportunity to monetize, we will evaluate that opportunity..

Okay.

And just lastly, Gary, your vision for hospitality within the new galleries; would it -- will you strive to have some sort of hospitality than you in each of the new gallery openings or how do you think about that and what's included in the operating margin guidance?.

Yes. I think there is going to be more than less, it's not necessarily be able to be everywhere and it will in some ways might be determined on -- and the volume of opportunity we think we have in the market, I mean some of these -- the one's you just saw were actually kind of last minute bolt-ons, right.

We were under construction in Toronto, we were under construction in Palm Beach, and they did not have hospitality designed.

And so when we saw the success and the reaction to Chicago and we saw the lines around the block in the weekends and we saw the performance of the overall gallery, the impact that we believe hospitality was having on the traffic and then the incremental sales of the gallery, we quickly pivoted and said where could we add hospitality to.

So in Toronto, we took kind of the front loads [ph] of the store, the store caresses back on the mall facing side, and we built a courtyard café and we kind of figured out how to integrate it and how to do it.

And then, in Palm Beach, the only place we could do it is we said, we put it on the roof and so we delay that opening for several months and had to beef up the steel to be able to put the structure on the roof to handle it.

And what's great about both of those to tell you the truth is we now have -- we have that Chicago location which has an interior courtyard café, we have the Toronto location that now has an exterior street front facing courtyard open café under its skylight, and we now have a roof top café and F&B experience, and so we have test of all three.

And what's really exciting to us, I mean it's almost kind of be wildering a little bit, I mean we -- Chicago benefited I think because we got this great historic building, we've got this incredible central courtyard that we put a steel-in-glass structure over, we had a great passage way with bolt in ceilings, we created a wine bolt and it's just a great neighborhood and we partnered and Brendan Sodikoff joined as President of RH Hospitality as a very well-known restaurateur in Chicago and we knew we would be benefited by that.

And so we quite frankly didn't know exactly what to expect when we went into Toronto and how that would play out, when we went onto the roof in Palm Beach, would anybody come, would anybody know there is a restaurant and wine bolt and breach the bar up there.

And quite frankly, if you look at the numbers; the numbers are really comparable to the initial weeks and months in Chicago which was a phenomenal success.

So I mean, hats off and really bravo to the team that Brendan has built because he is obsessive, compulsive about quality and execution; I mean he is one of the deepest thinkers I have meet in the hospitality space, not just about -- he doesn't really operate as a chef anymore, so he does the direction obviously for all the menu's and as his team says, he is still a great chef; but he is just such a great operator and team builder.

So I mean when I think about the fact that we just kind of opened two restaurants in a very short amount of time in two cities that nobody expected us to have restaurant.

I don't know how well -- I don't think that many people knew Brendan in Toronto or Palm Beach as a restaurateur yet we've got packed cafes and wine box and active breadth to bars, and if you go to Yelp [ph] and the team is holding their hands upto me, it's like 5-stars.

Like if you go to Yelp [ph] and you look at Palm Beach, like we're -- it's all 5-star ratings, it's unbelievable. So we're just really excited about this opportunity and I think you will see it, we're designing them into more than less but Portland, we did not have this space or capacity to get hospitality into Portland.

In Nashville, it is the first built from the ground up version of Chicago; so we designed that to have the central courtyard restaurant, wine box, pantry and it has a lot of the characteristics of Chicago and flows like that.

And then New York will be our second rooftop restaurant, we're building an amazing rooftop park, it's like a 12,000 square foot rooftop park with this beautiful glass box in the middle of it with a beautiful skylight on the roof and it's got views of Freedom Tower and downtown New York and I joke around with the team, I say it's going to be the modern day cavern on the green.

I really do believe it's going to be like this destination in New York because it's so wonderful where you get to -- in New York eat in the middle of a beautiful park and have views of downtown.

And by the way, the great thing about the [indiscernible] district, you don't have a lot of high buildings, so we have all this natural light that hits our building and hits our rooftop, so we think that one is going to be spectacular..

Yes, it looks quite beautiful. I'm anxious to see it. But anyway, happy holidays and best of luck for a great season..

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

Great. Well, thank you everyone for your continued interest in our journey here.

We're extremely excited about the outlook for our business and our future and we could not be more proud and appreciative of really the passion and the persistence and the working effort that our team of people and partners around the world put into kind of bringing our vision or values to life each and every day; and as we continue our quest to be one of the most admired brands in the world.

So thank you, and we look forward to talking to you after the holidays..

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