Cammeron McLaughlin - SVP, IR & Strategy Gary Friedman - Chairman & CEO Ryno Blignaut - President, Chief Financial & Administrative Officer.

Michael Lasser - UBS Investment Bank Geoffrey Small - Citigroup John Heinbockel - Guggenheim Securities Tami Zakaria - JPMorgan Chase & Co. Seth Basham - Wedbush Securities Michael Baker - Deutsche Bank Curtis Nagle - Bank of America Merrill Lynch.

Good afternoon. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the RH Third Quarter Fiscal 2018 Q&A conference call. [Operator Instructions]. I would now like to turn the call over to Cammeron McLaughlin, Investor Relations. Please go ahead..

Thank you. Good afternoon, everyone. Thank you for joining us for RH's Third Quarter Fiscal 2018 Q&A Conference Call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Ryno Blignaut, President, Chief Financial Officer -- 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 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 the call over to Gary for some -- to start off with Q&A..

We'll start....

Yes, right to Q&A..

[Operator Instructions]. Your first question comes from the line of Michael Lasser from UBS..

Gary, in your letter, you talked about some macroeconomic factors like the wealth affecting the stock market and the housing market, and in light of some volatility in those factors, can you give us more detail in how your sales trended over the course of the quarter, maybe by month, and from a geographic perspective?.

Yes, we generally don't give that level of detail, but I would just say our business strengthened throughout the quarter.

It's funny, I had some people ask me the other day about how I was feeling about the housing market, and they said, "So you feel it slowing down?" I said, "No, it's not how I feel, it's just a fact." And the data that's out there, I don't think I put any information into the shareholder letter that isn't widely known.

I think it's just stating the facts and trying to create the right way to think about how we're going to operate in this market no matter if it continues like this, if it strengthens or if it weakens further.

So and I think -- and many of those things will have to do with how the tariffs get resolved here, what happens to the price of oil, all kinds of things.

But the facts are the facts, and I think despite the fact that we're in a slowing market, despite the fact that we've got tariff headwinds and other things, that we like the path we're on and how our model continues to evolve and unveil itself, if you will..

And for my follow up, one related and one unrelated. Related to that, when you say it strengthened over the course of the quarter, do you mean your comp strengthened over the course of the quarter? And my unrelated....

Our comp and overall business, yes..

Okay.

And then my true follow-up is you raised your operating margin guidance for 2019, and there's a lot of factors that could impact 2019, like you said, tariffs and some of these macro issues, where are you seeing the visibility to provide that level of insight right now? And can you give us a breakdown between the gross margin outlook for next year and the SG&A? So, will a lot of the SG&A margin expansion come from some of the cost rationalization efforts that you outlined in the letter?.

Yes, well, yes, sure, Michael. Well, clearly, we gave you about 100 basis points of SG&A, right, in the cost initiatives and saving. So, I guess it's not quite 100 basis points because the occupancy on the closed facility will be in....

Gross margin..

Will be in gross margin. So -- but yes, I think as far as the tariff outlook, we're --- well, I finished the letter last night. I wrote the letter days before, weeks before and days before the update from the G20 Summit. So, we've got incorporated into our guidance the expectation that the tariffs will continue.

If they don't, that's good news for us and good news for the consumer..

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

I also want to ask about the top line. It was nice to see the acceleration in sales growth that you called for in September, Gary.

I'm just curious which factors you can point to whether it be the fall source book mailings, the boost from new galleries or perhaps external tailwinds that you point to as being responsible for the improving top line growth you posted in the third quarter..

Well, I think it's just the building of the momentum of the business, the books getting home, the ramp of the books, and the fact that we're kind of evolving from a business that was kind of more focused on products versus projects, and we have a significant amount of our business now that's happening with RH Interior Design and external designers.

In fact, I think we're, what, about 68% of our business goes through either our interior design or external interior design, right.

So, you’ve really got an interior design-driven business, which is a project-driven business, which means a smaller and smaller percent of our business is going to be quickly reactive to a new product or to a source book mailing.

And so I think some of it is just understanding how to forecast in light of the fact that we have an evolving model and being smarter about it and getting more data behind us.

I mean, I think everybody could probably appreciate that just the significant changes we've implemented over the last 24 months, right, moving from a promotional to a membership model, really positioning and ramping up RH Interior Design, changing our real estate development model, redesigning the entire operating platform, taking out -- if you really -- if you were looking at the numbers we looked at, right, I mean, two years ago, we had a long-term plan that said 2019, we'd have about $400 million more inventory than we're going to have in 2019, right.

So in essence, we've taken $400 million out of the inventory based on where we thought we'd be. And we're just creating an entirely new operating platform in the company. And when you change as much as we're changing and you pull back on growth levers like we did, it's just very hard to be so precise with the forecast year-over-year.

I think the good news is, and I think I mentioned it in my last letter, is that we expect to gain more experience and more insights every quarter that goes by and get better and better in forecasting our business. So I think that's what's happening.

You just got so many moving parts, so many things different year-over-year, and when we probably had too steep of the ramp against the mailings of the source books and now you see the business beginning to ramp and no different than New York, I think.

We look -- went back and looked at our original forecast and we have New York coming out of the gate too aggressive based on the fact that the streets were all torn up, right. And so now the streets are getting a little better, you can finally park in front of our store, people can begin to walk across the street.

And our business in New York is ramping, right, week-after-week. So I think it's those things. I don't think anything's really changed from a macro point of view.

If you look at the housing data, at the luxury end, you've got a market that looks similar and difficult to earlier in the 2016 period, and what it feels good about is that while it looks like that, '15, '16 period, our business looks a lot better and I think it looks a lot better for many reasons.

We have an entirely new model, and we spent our time so much differently than we used to. We probably recaptured, in the leadership team, 50% of our time. 50% of our time used to be spent managing week-to-week promotions and all kinds of nonsense then, none of us were spending enough time really thinking deeply about our business.

And seeing bigger moves than, oh, let's have an extra promotion this month, right, which all of that is nothing but a downward spiral for our branded business. When that's the game you're playing, there's no long-term view. There's a quarter-to-quarter view and you kind of hope for the best.

And we got dragged into that noise post 2008, 2009, several years ago. And honestly, we wanted to move to a membership model before we went public, and our previous sponsors and private equity partners thought it was a good time to go public, and they even granted us the opportunity to shop the business and keep it private for a couple more years.

And we had four offers for the company. Unfortunately, none of them, our sponsors thought, were better than what they would get in the public markets when we went public, but we wanted to create a membership model seven years ago, like, while we were private and we just unfortunately hit the public market.

And then making a move like that, which we knew would change everything. We knew it would allow us to build a completely new operating platform that's more like a luxury brand, right, as opposed to a traditional retailers running on promotional models and has so much inefficiency.

So, you just see us kind of evolving now and getting smarter and better by quarter, and we'll continue to do so. I mean, we're still in the thick of this, right. We've got so much opportunity ahead of us which you see now reflected in our long-term targets. I mean, I've been doing this a long time, right. I'm not a rookie in the retail business.

I never pulled forward long-term targets quarter-after-quarter, but that's just how good it is and how good it can be when you actually spend your time thinking deeply about your business and leading a business versus managing the business, right.

Truly, having the leadership team involved in the business and leading the teams to better outcomes versus running from meeting to meeting and kind of managing what's happening right, and shifting the culture from news casting to news making, right. Most businesses, the culture is a newscaster business.

Everybody's basically reporting the news and nobody's making the news. And I think we’ve flipped that on its head, and we have a culture now that is a newsmaker culture.

We have leaders that are no longer managers, and all of us are thinking deeply about this business, getting involved at the lowest level of detail, motoring up and spending time thinking strategically and connecting dots and then leading the organization to a better outcome.

And it's just a massive cultural change and you have to get over bad habits, right, because you get into habits of going from meeting-to-meeting and getting updates and seeing how things are going, and somebody goes to a meeting and gets an update, and then they go to the next meeting, they give that update.

And you basically have a culture of updating layers within the company and then it finally gets to the senior team and you get a bunch of updates. And I think that's the prevalent culture in American business, and we're just trying to take a different path..

That's helpful. I want to stay at the top line for my follow-up question. You're guiding for 8% to 12% revenue growth next year, and I was hoping you could help us understand how that breaks down between comparable brand revenue growth and the noncomp items like the new gallery contribution and outlet revenue..

Yes, I don't think -- we don't have a very aggressive comp assumption in that number. I mean we've got accelerating the real estate transformation and we've got brand expansion that will give us some boost in the comp number and then just open up some overall market shares.

So, it's slightly better comps and then you've got really the growth in real estate, and you've also got growth in our other businesses, right. You've got growth in hospitality. You've got growth in our contract and trade business and so on and so forth.

And so, we think based on where we are, where our run rate is, the fact that we are now going to shift from a what I call a nongrowth mode into a growth mode that we've got a really realistic plan..

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

It's actually John Heinbockel on for Steve. So Gary, first question on the organizational redesign, maybe touch on what were the key changes that you made to the organizational structure. And then as part of that, maybe some tangible examples of how that will speed up the decision-making process and benefit the organization..

Sure. It all started with the move to membership, right. It all started with the simplification of the business, which allowed us to then begin to redesign and architect the operating platform. And first, we dealt with a lot of the low-hanging fruit. But once you start to redesign the platform, you really have to redesign the organization.

And we didn't go into this as a necessary thing to do, and we didn't go into it as a cost-savings approach. And that's why honestly, we spent nine months beginning of -- starting in March, and we had seven off-site meetings that were two plus days.

And we started really, really clearly, honestly, with getting very, very clear and very aligned around what were the key value-driving strategies in the business.

Like as we looked at the business and looked at our plans, our short-term and long-term plans, what were the key value-driving strategies and why were those the right ones? And what's the hierarchy of those? What comes first, what comes second, what comes third.

If we can only do one thing or die trying, what would we do and getting really clear about how we were going to create value, right. And how does it pass through our filters of emotional value, strategic value and financial value.

And so we spent a good amount of time as a leadership team, cross functional team getting super clear and very much aligned. So there is just no doubt what was important and the prioritization of what's important.

And then once you're clear on that, the next piece is getting -- reconnecting with our values, what do we really value here? And our first values are people value, and there's 11 tenets in our people value, and understanding is the organization populated with those people, right, and only making sure we only have 11 out of 11s.

And then once you know what you're doing and you understand what you value, right, from a -- your biggest asset in any company is your human capital. And then how do you design an organization that's going to optimize that, right? Because most organizations get designed over time.

Companies start, they start growing, things get added, you bring in new people, you bring in outside people, who bring outside views, sometimes good, sometimes not, right, depends on how distinctive your model is. And over time, you also develop silos, so people start working more independently.

And when you build silos in organizations you always have inefficiency and you can tend to get lots of people working really hard in all the wrong things because they only have the view of their silo.

And so once you're clear on how you're going to create value then you have to cross functionally say, how are you going to allocate human and financial capital to optimize that value? And how are you going to design an organization that will do that? You have to then start with the whiteboard, right, and you can't be a victim of your own history.

You can't try to protect history or you'll never see the future. So we then -- I think the first three out of the seven sessions were really just getting clear and getting aligned, and the next four sessions were about design. And I don't think I drove one decision, honestly, I just tried to frame the right questions.

And the organization, the leader is just -- we're able to see so clearly what kind of organization would you design based on what we're trying to do? Not based on what we have done, based on what we're going to do next. And so it's an entirely new organization in many ways and we've eliminated a lot of steps.

We've eliminated a lot of duplicative work across the organization, across the silos and we're just -- it's like a kind of a squeaky clean organization now, right, that doesn't have a lot of rust and leftover kind of methodology that no longer add value. So that's what we have.

Specifically, what were the big changes? The changes are massive everywhere. I don't know if I can say one place differently or the other, I mean, just massive change. And I just give so much credit to the presidents and the key leaders in the company who did the work.

They spent the time to think deeply about where are we going and what are we building, what really creates value, not what's nice to do, what creates value. And so I've never done work like this in my career. I've never done anything close to this, right.

The only time, historically, we've taken passes at this, but it's just habit but only the only time to do this when you need to come, oh, it's about cutting some heads, eliminating some jobs, reducing costs, oh, I'm reducing five people and you need to reduce at least five.

And it becomes a stupid kind of democratic approach that doesn't necessarily make the organization better, right. So this is just really the result of focus and deep and critical thinking and work that I've never experienced or seen done before.

Whether it's a consulting company coming in and interviewing your people and then giving you a binder and telling you what to do with your company and getting on to their next job, right. So we designed this. This is -- the organization we'll lead.

And by the way, we built such a new set of muscles where we're just completely comfortable to improvise and adapt, right. And we know we're not going to be exactly right and we're going to have to improvise and adapt but we're directionally right. And when you're directionally right, over time, that gap gets really big over time.

When you're directionally wrong, over time, that gap gets really big over time, right. And I would say there is a lot of things inside our organization that were directionally wrong. And over time, they become a burden and a weight and a level of dysfunction that creates excess cost and poor customer experience and so on and so forth.

And so now I think we're more than the direct, I think we're massively right because we spent the time. If we would have probably spent three months doing this, we would have been directionally right. We spent nine months doing this. So I mean this is -- we're massively right.

We're going to make some tweaks over time, but this is a result of some really, really deep and critical thinking and not focusing on who's right but what's right, and getting out of your own way and being able to see the organization and then really committing to leading, not managing.

And I think we're going to -- in this new structure, in this new organization, we're already seeing more opportunity. We're like, oh, my, what we can see now is like cleaning the windshield, right, and getting a new pair of glasses like the things aren't foggy anymore.

There's not a bunch of middleman and layers that are kind of just reporting news and distorting news, right. And honestly, it was like, I think, Eri Chaya kind of quoted the term inside the company, the facts remove the fear, right. Most people don't make big change because they're fearful. And why are they fearful? They don't know the facts, right.

So as a manager, you have to actually get to change yourself and you have to get deep into the organization and get to the details and get to the facts so you know them. And then that removes the fear and then you have the confidence to truly lead the organization towards a better outcome.

And it does sounds like -- maybe just to specifically answer your question, how much did you save here or there? Just these things are massively different here. I don't know how to put it any clearer. I've never -- we guided, one year ago, we guided 9% to 10% operating margins. We're going to come out around 12%, right.

We just guided 13% to 14%, I mean, like we probably have room in that number, right. We gave you long-term targets at mid- to high teens now. It's because we believe we can and we believe we're going to see 20 operating margins here soon and because we're building an entirely different platform.

We don't have a kind of a Pottery Barn, Williams-Sonoma platform anymore for a luxury business, like, we are building a luxury platform. We're doing things completely differently, right. And we used to do things like where many of us came from, and that's what we do as humans. So it's just things are very different.

I don't know how to say it anymore, right..

Your next question comes from the line of Tami Zakaria from JPMorgan..

I actually have a more bigger picture question and then a quick follow-up. So my first question is in the press release, you've mentioned about being able to continue to gain market share even in a moderating housing environment.

So can you elaborate a bit on that? What strategies do you think will help you do that in a floor environment, who you're taking share from, where you see your market share going and anything along those lines?.

Well, you see us doing it right now, right. So you look at our growth rates versus other people that are selling product at our level, our growth rates are stronger. And we're not even trying, right.

We've been focused on like really building the operating platform, redesigning the supply chain and many other things, right, and conceptualizing new real estate and development model and so on and so forth. And so really we -- I mean it's all in the letter, right. It's a return to our product and brand expansion strategies that we've laid out.

It's fixed now. Accelerating the real estate now that we've got such a clear more disciplined and capital-efficient strategy, we think we can begin to accelerate the real estate. And it's not more complicated than that. Like I can try to make up a bunch of fancy things for you. Again, we're going to execute really well, right.

We're going to execute our merchandising strategy really well. We're going to start to expand the offer and expand the brand ideas. When we launched Beach House and Color, we think those will open up the market and we're going to continue to invest in Interior Design, we're going to continue to invest in Hospitality.

We're making transformational and revolutionary changes with the physical expression of the brand, which we think is a game changer. And we've got opportunities to merchandise our website, improve the experience on the website and just all over the place. Some things more revolutionary but really execute really well, stay focused.

And I think the other thing I probably left out with some of the other commentary, it's just that I look back and like I grew up at the GAP.

And at the GAP, we had multiple brands, the GAP and Banana and Old Navy and Sonoma, with multiple brands, ran multiple brands in Sonoma, oversaw the William Sonoma business, the Pottery Barn business, Pottery Barn Kids business, Chambers, Hold Everything. I conceptualized and basically launched West Elm, was launched four months after I left.

So for the first time in my life, I think I'm learning and appreciating focus, right. And just how powerful focus can be and no different than if you're listening to Jony Ives describe Steve Jobs talking about focus.

The need to say no to a thousand things and not just the easy things that you go -- that's like not the easiest thing, but to say no to the things that you actually know you can do, that you believe deeply, but you're going to say no to those things because you know that there's so much value like focusing on the things that are more important.

And I think that's another new muscle for us. We could easily -- we were going to launch a new branded business here and we have a whole team working for almost three years, right, on a business called Compound Bungalow. We have multiple names for it.

And I think about that now and I think oh, my God, more meetings to go to, more people to lead, more -- like it becomes a watering down. I think back to my years at the GAP, there were never -- you never had them all right. There's always issues. And I look at, studied a lot of people in the business.

You look at Limited Brands or L Brands or whatever you call them now, right, like what happens when you get a lot of brands? Like the GAP or Limited or other people, who I kind of fashioned my career off of, right. Those are my heroes and still are.

Mickey Drexler and Les Wexner, I think, are two of the greatest retail leaders and merchants that ever lived. But I think about it, I think like how good could they have been if they focused on fewer things, right? Like when you build an Apple or build a brand that's like so good or you even look, study LVMH.

You look at LVMH, it's got a lot of businesses but I think, what, 60% of the profit comes from Louis Vuitton, right, or something like that.

And so we sit here and we say, today, the opportunities that we're seeing by just focusing on RH and getting really, really deep into RH and thinking about how to amplify this brand, how to render it more valuable, what are the strategies, how important Interior Design is becoming to our business, how important Hospitality is becoming to our business, we're just so excited.

We've never been more excited and optimistic about the future. How important international can be to this business, there's no competition over there. I mean, when we open internationally, it's going to be a slingshot. And again, what's great with international, right, we're not carrying any baggage with us.

We don't have a bunch of legacy stores that were designed for a completely different company and trying to operate out of physical spaces that weren't designed for the business that you're running today. And so we just see so much opportunity in front of us in so many levels.

So I wouldn't get lost in the details, right, like, exactly how are you going to get that 0.5 point or that point in your bridge? We've got plenty of bridges here, and we wouldn't guide to at 8% to 12% if we didn't think we can do 8% to 12%.

We -- you look at all the data we look at you can -- if you maybe -- not everybody, by the way, looks at the luxury housing market, right. The home sold at over $1.5 million or....

$2 million..

Yes, over $2 million..

Redfin.

Redfin puts out that data. You can see the lines. I mean, we've been a big headwind, right. And so we sit here and go, okay, we're in a big headwind, we haven't really flexed our growth muscles, and we're going to be running 8% to 10% right now.

So when we do the math and we say what happens when we pull this lever, we say -- we know we can grow faster than that. If the market continues to slow, might that hold us in the 8% or 10% range, maybe it does.

If we get a real recession, does it pull you down 10 points maybe? If you go into a recession similar to '08 or '09, does it pull you down 20 points, maybe. We've got all that math.

We know what all our downsides look like and when you've got the model that's going to be approaching 15% operating margin and you get a 10% headwind, it still looks really good. When you get a 20% headwind, it still looks really good.

When you have a real estate and development model, where you made it so capital efficient, your return still look really good. Your ROIC still looks really good in our downside scenario. So we love the fact that -- we're indifferent, by the way. Good economy, bad economy, we're going to win in each one.

And the economy doesn't stay good forever and the economy doesn't stay bad very long, right, if you look at the U.S., right. And so you usually get much longer bull runs than you do bear markets. And so we're indifferent in a bear market. I mean, we kind of laid it out for you, right.

We think about our business kind of like Berkshire Hathaway, with one company, right, with a lot of little small businesses in between there that we're allocating capital to, but we're good at buying and selling our company at opportunistic times.

If the market undervalues a company, as Warren Buffett said, if the skies darkened and there's an opportunity it's going to rain gold, you want to run outside with washtubs and not teaspoons, right. So during our transformation, we believe the market massively undervalued us and we went out and bought half the company back.

And if there's a recession and we get undervalued, we'll do something similar. I mean, we believe deeply in this company, the value we can create, if we create more for ourselves, all good. So we're playing a different game, right. And this is not a quarter-to-quarter game for us.

It's a really a long-term game, and everybody here is very vested into this company. I mean, it's not just our job, it's our life. It's an authentic reflection of who we are and what we believe in, and it's a very unique business brand and culture.

And so -- and I think it's going to -- the outcome is going to be a very different operating model than anybody has ever seen or created in our space..

That's really helpful.

I just have a quick follow-up, which is do you have any plans to include Waterworks in your membership offering?.

Not right now. Right now, we're just learning the business and working on integration strategies and amplification strategy and so on and so forth. Waterworks operates at a discount, right, because the vast majority of the business happens to the trade, business-to-business, interior designer discounts, builder discounts and so forth.

So it's really hard to put a membership model on top of that business. As we integrate it, we'll have to kind of figure out how to blur the lines there, right, because one of the key opportunities to Waterworks is obviously having more points of distribution and accessibility. There's only 13 or 14 showrooms, right, yes. Yes, 14 U.S. showrooms, right.

It's a -- I kind of joke around here and say it's close to an invisible brand like the best invisible brand in the world..

Your next question comes from the line of Seth Basham from Wedbush Securities..

My questions are actually you mentioned in your letter, you mentioned your goal of building a leading interior design firm in North America and a significant revenue opportunity associated with that.

Can you provide some color on how you plan to do that and how you think about the profit contributions from that opportunity going forward? Then I have a follow-up..

Sure, sure. Well, it's a people-intensive business. We have built the capability from a human capital perspective and so we've been making investments -- we'll continue to make investments in interior design at all levels, right, leadership, tools, marketing and presentation.

New York was the first gallery, where we really approached it from a perspective of kind of putting an interior design firm inside a gallery. So there's real offices, right. There's, I mean, it's a business within a business. There's real presentation and media rooms. We run it like a real interior design business, Seth.

That's very different than having a 6,000 square-foot store, where you can't do that, right. We still have regular galleries of 50 almost, right. Yes. So we can -- still have a vast majority of our business operating out of whole legacy stores. And now we're learning a lot from New York.

We're learning a lot from some of the other tests we're making, and we think it's -- the great thing about interior design is there's massive leverage, right. So you talk about making human capital investments. We don't have to build distribution centers. We don't have to buy more product.

We don't have to create a whole lot of complicated systems to run the business. We don't need a new finance department. We don't need a new supply chain. It really leverages everything, right. So it's really among the highest return on investment opportunities we have in the company. So you'll see us continue to focus on that for a long, long time.

And what else is very different than -- and the competitive advantage we have, if you haven't seen New York, you should go see New York. But when you present goods the way we do, the whole gallery becomes like the design office, right.

And so if you think about the interior design trade, like, most interior designers don't have a physical presence at their work. We have the most compelling and extraordinary physical presence of our work in many of these new big galleries.

And so the credibility that gives us, the ability to walk into a gallery like ours and see great work, see great interior design and inside great architecture is a proof point, right, versus an interior designer that you met through a friend that doesn't have any -- can show you a few pictures, right, but you can't see or touch the work.

And by the way, they don't sell any products and you can't aggregate orders and you can't do all the things that we can do. So it's a massive opportunity. Again, when you think about it long term and big picture, and no one's really doing it at our level and the way we're doing it.

And yes, I know other furniture stores and retailers have design services, but walk into their stores, tell me if that inspires you, do you want your house to look like that, right, when there's a bunch of Christmas [indiscernible] all over the tables and it's all junked up, and it looks like a store, right, with shelves and products all over the shelves.

And it doesn't -- like I wouldn't trust them to be an interior design resource for my house. So I think what we're building, physically building is this kind of proof and calling card to the business, and it's really powerful, so..

One follow-up related to that and then a second follow-up separately. Do you plan on charging for these services in the near future? And then the separate follow-up is around the tariff outlook. You mentioned your guide for 2019 includes tariffs.

Is that at a 10% rate or a 25% rate?.

We do see charging, yes. And generally, things you get for free, you don't value very much, right. And so we know in some situations where the consumers don't necessarily, I don't want to say, value -- they don't act like they value. They don't act like they value -- you value things you pay for. Things you get for free, you sometimes take advantage of.

So we think strategically as we build capability we become better that it becomes a true business. And we run it like a business and we charge for it, and we charge for installation and a lot of things that we're doing today. So we see a lot of opportunity there to drive revenues and margin. And then on the tariffs, yes.

We're architecting the business like the tariffs are going to 25%, right. So if they don't, there's opportunity. And I think it's good news if they don't. Obviously, I think -- but in our business, the math isn't so bad even if they do. If you just look at the rough math and say, again, just started, let's say, let's split the increase, right.

If there's a 25% increase and if your vendor partner takes 1/2 of that, we take 1/2 of that, that's roughly a 12% increase on of the product cost. We have proprietary products. The whole industry, it's going to have to take up the prices, right, so. And even if you take up the prices by 12%, you're still way under U.S.-based company prices.

So there's anybody -- and by the way, the other thing, I think, people are making a mistake is like trying to rush out of China, to rush to other countries. Like good luck but China is the biggest, most sophisticated manufacturing company in the -- country in the world. There's no one close.

Other countries are doing things better but you can't shift all this business to Vietnam. You can't shift all this business to these little small countries without massive dislocation risk with your business, right.

So we think we're being really smart in where we're looking at resourcing, but I'd rather make sure I got high-quality goods delivered on time than try to save a few bucks and have a dislocation to my supply chain. So I think the people are saying we're rushing out of China, like, yes, I think they don't have that much experience.

I've been sourcing goods from other countries for almost 40 years, like I know how bad it can be. And so we love our manufacturing base and our partners in China and we all hope for the best. But if directionally if we raise our prices by $12 and you sell 6% less units, you're going to do pretty well.

Even if you sell 12% less units, you're going to have the same revenues. And you might move less units and sell less units but you're going to make a lot more money because you don't have all the operational cost with it, right. So I go, okay, prices go up 12%, we lose 12% less units, we're going to make more money and do the same revenue.

So I'm less panicked about it than other people I talk to. And I think probably because we really understand the math and we have the leverage and we're a luxury position brand that has really good pricing power..

Your next question comes the line of Mike Baker from Deutsche Bank..

Real quick, I just want to follow up on that last point about not moving out of China. I do believe earlier in the year, you did say your percent of goods from China will drop from about 40% to -- in 2017 to something around 25% to 30% in 2019.

Is that still the plan, it's still thought of as one of the ways to offset the tariffs?.

That was happening as a lot of it -- as the result of also rearchitecting our business, right. We basically exited the holiday business. We exited a lot of categories that were nonessential assortments coming out of China, and then we just had some natural evolution to the business and where opportunities present themselves.

But so our manufacturing is always going to evolve a bit, so, and it just will. The world's going to keep moving so, but all I'm saying is don't rush to move out of China. Like those numbers were happening before anybody said the word tariff. They're really a result of structural changes in the assortment architecture..

Okay, that makes perfect sense, just wanted to clarify that. A couple other quick ones. So in your press release, you talked about the stock market at all-time high. You seem to position that as a positive for your business, which makes sense.

But at least in the past, when there's been big market gyrations or declines as we saw prior to the last couple of days, historically, this has tended to impact your business as I recall, because your customers are generally invested in the stock market.

It sounds like you didn't really see that this time because your business got better even in October and November when the stock market wasn't great.

So why has that changed, I guess?.

Yes, I think it would have been even better if there wasn't volatility..

Yes, it's all relative. I mean, we're still -- the DOW is still up all the way from where it was 10 years ago. It's all relative..

Yes, yes. But look, if there wasn't volatility in the market, do I think our business would have been 1 point or 2 or 3 points better? Sure..

Yes, okay..

The market moves like that. It's not like nothing happened. I'm saying despite the market moving, despite the volatility, despite the slowing housing market, our numbers -- we believe we can make the long-term targets.

I mean, I think if we move into a real recession, where the business across all sectors really comes down, then you've got a bit of a reset. But as we see it today and we don't -- I think we're very different than the last go around, the last go around, we had total credit crisis and meltdown, right.

That's not what's happening out there right now as far as we can see or the data points that we look at. You've got a slowing housing market. You might have some oversupply.

I mean a lot of people are forecasting oversupplies in some of the markets, and you can look at that and you can say, okay, that will put pressure on pricing but generally, when pricing goes down, unit sales go up. That's why people lower prices, right. And so unit sales go up. If unit sales go up, that's good for our business.

So we're just trying to put it in a perspective of in light of the things that are happening and have happened to the market today, up until recently, we feel pretty good. We don't see any looming big recession on the horizon. We have no data nor have we seen anybody say or present that a recession's coming.

And I think, look, we've also got a President that is banking his legacy on this economy. So I think you've got leadership that is highly focused on making sure that the economy and the markets do well.

And so while he's not afraid of having some short-term disruption with China tariffs and things like that, if they did done some of the things that they've been trying to get done, I think it's good for the economy. I think the tax cut was good for the economy. I think the tax cut to businesses was really good for the economy. I think U.S.

business, by far, are better capital allocators than the U.S. government, right. So shifting revenue, shifting tax revenues from the government, dollars from the government and giving them to U.S. businesses, where you've got much better capital allocation skills and history is going to be good for the economy.

So forget all the things on how everybody -- I'm not saying I'm a supporter of this President or not. I'm just trying to point out the facts of what's being done and what the agenda looks like, what the motivation is. I feel better about that. I think it was like with the Fed kind of took a different stance on interest rates.

And I think that there's a big, big spotlight on economic prosperity and growth in the U.S. And I think that's a real positive about this administration. I like that from a business outlook. It doesn't mean I think it's great on all levels and all outlook, but from a business point of view, there's a lot of positives..

Yes, that make sense. Understood. One more real quick one. Your previous fourth quarter guidance, I think, embedded a 3% to 7% comps, presumably the increase in total sales that also includes an increase in the comps just because of the catching up of the delays in the ports.

Is that the right way to think about it?.

Yes..

Your final question comes from the line of Curtis Nagle from Bank of America Merrill Lynch..

So I guess, on the first one, I was a little surprised to see the outlet business grow. I think it was up like mid-single digits.

And I guess taking that out of the numbers, what did the full line retail business do, how much did it grow?.

Yes, so I mean, so I think we added $6 million in outlet sales, Curtis, as you pointed out, which was mainly a result of us closing the DC. There was some leftover second quarter inventory on that DC that we had to sell through. So that's the first thing to point out. If you strip that out, the top line grew a little over 7%, versus the 8%.

Was that your follow-up?.

Yes, and then just a follow up on free cash flow. So through 3Q, I think you generated about $30 million. You have another $230 million remaining. I fully get that 4Q is a very big cash quarter.

But just like kind of looking at in proportion to the amount of, at least, EBITDA you guys are predicting for the quarter just looks a little out of proportion, so where is the extra conversion coming from, presumably inventory or other working capital?.

Yes, well, I think we communicated we have two planned asset sales in the year that we have planned in the fourth quarter, right, the RH Yountville and RH Edina, which are two of our first developmental -- development deals..

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

Great. Well, thank you, everyone, for your interest. And I want to say thank you to our team, all of our people and partners across the country and across North America and around the world that are contributing their imagination and passion to our cause and strategy, and thank you to all of our shareholders, who are supporting us.

And thank you all for your time and attention. And we wish everyone a wonderful holiday season, and look forward to talking to you in the spring. Thank you..

This concludes today's conference call, you may now disconnect..