Good afternoon. My name is Chantelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the RH Second Quarter 2019 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. [Operator Instructions] Thank you.

Allison Malkin of ICR, you may begin your conference..

Thank you. Good afternoon, everyone. Thank you for joining us for RH's second quarter fiscal 2019 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Jack Preston, Chief Financial 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 opinion only as 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 this 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 the 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 the operator to begin our Q&A session. Chantelle, we’re ready for questions..

[Operator Instructions] Your first question comes from Tami Zakaria with JPMorgan. Your line is open..

Hi, thanks for taking my questions.

So, could you comment on the 3Q revenue guide? And why revenue growth would step down to 5% to 6%? After over 8% in first-half, was there any revenue pull forward into 2Q that's part of the expected sequential deceleration?.

Hi Tami, it's Jack. So, you may recall that we have the sort of self-inflicted drags in a sense the decisions we made to exit certain revenue items. And so that – those are 2%, 4% to the quarter. And that – so there's the impact of the drag being different.

I think one of the other things you're saying is, we saw an outlet – you see all the outlet sales in our press release. And so there, we talked about the closure of the 500,000 square foot distribution center last quarter. And so, we've cycled most of that inventory out.

And so, you're not going to see that, that benefit, and that benefit was worth about 2 points in Q3, and it was also a big drag on gross margins..

Got it. So, my follow-up question is, earlier this year, you’ve guided to $15 million to $20 million additional savings from the home delivery initiative.

So, does that still hold, or are you seeing incremental savings that could come from this initiative?.

Sure, Tami. I think at this time what we guided was $15 million to $20 million, with third of the benefit in this year and two thirds next year. At this time, we're holding to that. I mean, we're optimistic in looking forward to even better benefits there. But for the moment, we are holding to that and that is the timing..

Got it. Thank you so much..

Your next question comes from Steve Forbes with Guggenheim Securities. Your line is open..

Good afternoon. Maybe another question on the 3Q guide, but this one really on sort of the gross margin outlook. The third quarter sort of, I guess, looks a little weaker than we were modeling and the fourth quarter looks a little stronger.

So, I don't know if there's sort of any shift in both margin and expenses because you sort of have seen the dynamic as you move down the P&L.

Can you just talk about, if there's anything to call out, sort of idiosyncratic that’s sort of impacting the model?.

The only thing is advertising is swinging around, yes..

Yes. Nothing idiosyncratic, Steve. It's – I think we don't – we didn't provide you quarterly flow, and I think a lot of times what happens is, the – unfortunately, the one asking me doesn't always get it right if we don't give you sort of the guideposts to where to go.

And so, when I look at it on the half, we're guiding 40.5, 40.8, and that’s up 140 basis points versus last year versus what we did in the first half, up 100 basis points. So, I think that's one way to look at it..

Right. So, nothing idiosyncratic call out. And then maybe for you, Gary, right, I don't – I didn’t fully get to digest the whole release yet.

But if you think about the comments around international opportunity last quarter, I think during the preannouncement, I don't know if you can help us right, as we start conceptualizing the international expansion opportunity? Can you update us on the timeline and maybe discuss sort of the the infrastructure needs of the business for successful transition into one or more international markets over the next few years there?.

Yes. Let's go back to your first question, and because I think that there is confusion and has been confusion about sometimes how to landscape the business year-over-year if you're not paying attention to it. So, the biggest thing year-over-year is, we used to book advertising and advertise it to our catalogs and the curve of our catalogs.

And now, we book advertising based on when we mail the books. And so, if you're trying to model the business, you could be kind of surprised to see.

We have – how much of our advertising expense for the second half is in the third quarter, it’s like 80%?.

That's right..

Yes. 80% of our advertising costs are hitting in the third quarter because of the timing of our books, and only 20% is hitting in the fourth quarter.

So, you've got that kind of landscaping that can sometimes make the numbers look a little funny, but I think if you just look at the second half, I believe we took the second half above everybody's numbers pretty meaningfully.

So, what – how it exactly landscapes is going to sometimes be affected by different changes like county policies and so on and so forth. As it relates to international, I can tell you, I don't know if I've ever been more excited about anything, any idea or any opportunity.

We just actually -- just got back Sunday night from another trip overseas to look at opportunities and locations. And I think a couple of things becomes clear as you get closer to the opportunity and kind of look at it at a micro and a macro level.

There really is a complete void in the market for a concept like ours and for a higher end kind of dominantly positioned and assorted home business. And in the U.S., retail is a lot more uniquely developed in – especially in all of Europe. So, we just see the opportunity as so significant.

The fragmentation in our marketplace in Europe is exponentially greater than the fragmentation in North America. And we – it hit us several months ago. We went to the Salone Show in Milan. It shows that it would generally be commercial attendees and B2B attendees are attended really by the open public and almost act like a pop-up store.

And it – I kind of stood back and looked at it and I said, “Wow, this is interesting. There's 500,000 people here shopping a commercial show.” It would be – to give you a comparison, it would be like, RH didn't have any stores opened daily in America, and we popped up with a big store in New York City once a year and 500,000 people came.

And there's no way you're going to get the whole market, but it was really a kind of not just a business to business kind of environment, it was a consumer kind of interfacing with the business not in a typical kind of retail environment.

And so, it was – again, it just opened our eyes and again we just got from it – got back from another trip and we were through Europe in dealing with the actual potential locations, and we've got multiple. We always have too many really good options and the hard part is going to be about, which ones to say no to and which ones to say yes to.

And the other thing I'd say is yet two more things is that – we have to – in North America, I think what people don't realize is, we have to drag kind of our – I hate to say ugly past for – forward with us. But in many ways, it was ugly.

If you picked up a – anybody picked up an 86-page catalog with a box of – box of laundry detergent that I carry around in my bag to kind of show people like where we came from. We don't have to drag the past forward.

We have so many people in America who say, “Where do you work? What do you do? And say, oh, Restoration Hardware and they go.” I bought this interesting knickknack there, and they haven't shopped from us for 10 years or 20 years and whatnot. And so, we don't have to create a force reconsideration of our brand.

We get to make a completely new impression. And if you thought about going into a market, I mean, still today, most people just where we live in the San Francisco Bay Area, there is no new expression of our brand. In most major markets, there is not a new impression of Restoration Hardware.

We have an old legacy store from 25 years ago, right? That's the impression of the brand.

And so, here I mean, I meet people here in the Bay Area and some will say, “Hey, what do you do? Oh, I work for RH.” “Oh, gosh! I’ve been to your flagship store in Corte Madera, or I've seen your flagship store in San Francisco.” Our store in San Francisco is 4,500 square feet. Our store in Corte Madera is like 6,500 square feet.

And I have to go – no, no, it's not really our flagship store. And some of those people ask me, oh, so do you work at the flagship store? And I go no, no I don't work there. But I go there now and then, but really no one -- still in America, maybe two things.

One, it helped me see like in America, there's so many markets where people just don't really understand what we're doing, because they can't see our assortment, right? And this is a visual business, right? It's not an intellectual business. Retail is first and foremost a visual business.

If people don't like what they see, they don't even begin to start to intellectualize and think about whether they should buy it or whether they’d like it or not, right? People don't walk up to things that are kind of visually not appealing to them and take another step.

So, today, we're visually trapped in so many markets in America 20, 25 years ago. And that's what people see, unless they happen to get one of our source books, or they happen to somehow be to go online, but even if you go online, it's only a one-dimensional experience.

You have to click the website too many times to kind of see it and get it and understand the depth and breadth of the assortment through the level of services and experiences that we can offer. So, that's a big piece, I'd say, in Europe. In the rest of the world, we get to make an incredible first impression.

And when you see what we're going to do when we finally choose, which of these locations we want and what we're going to do, I think, it's jaw-dropping.

I mean, we seriously -- we are sitting around thinking as a team like we opened in New York and I am sitting next to Eri, she's looking at me smiling right now and – because we were sitting there Eri, I, DP and Dave and Jack and all of us were there and like – and we're like, “Oh man!, how do we top this?” We – a year ago when we opened New York City, like, wow, we did a good job here, and you know, but now what do we do now? Now what, it's like when -- the movie I still watch with my kids, Finding Nemo, right? If you've ever seen Finding Nemo with your kids, anybody has kids, I’ve watched it 100 times.

But the fish tries to get out of the fish tank and he figures out how to get into a plastic bag and get out on the dock and then jump into the ocean, but they're still in the plastic bag and they look at each other and they go now what.

And we had one of those now what moments, and we just got back from Europe and saw some things that are going to make New York look like yesterday's news seriously, I mean incredible. So, this opportunity to make a first impression and to disrupt the market, we're trying to disrupt the market today in America. We've been disrupting the market.

In some ways, disrupting the market and creating the new market. We've been trying to make – create a new market with old physical presences like that's kind of crazy as you think about it. We had these old physical presence. We've been able to create a new market. We're here at Corte Madera.

When I joined the company 18 years ago, the Corte Madera store did $2.5 million and now it does $20 million, right? And so, when I joined the company, New York did $3.9 million, now it's tracking to do what $114 million, $112 million something like that, and that’s kind of a really hard thing to do, to kind of show up looking one way and then try to get people to reconsider you, right, when they've already judged you.

And in the rest of the world, they – we’re not kind of dragging that past forward with us. We don't have to kind of have them reconsider us. I mean, we get to make an entirely new first impression.

But then the other headlines that I think people can miss most, there has been a lot, if you look at history of retailers going internationally, for a long time, a lot of retailers didn't have a lot of success internationally.

Even today, most people get massively deleveraged when they go out and they roll internationally and look at the cost and the returns and sometimes get turned down. It's generally because it's not that the rest of the world is underdeveloped in retail. They're just underdeveloped in retail in certain categories.

If you're someone like Home Depot and you go international, there's like someone's done at Home Depot like concept. If you're a discount or someone's they've got discount stores internationally, they've got all kinds of businesses. They don't have a business like ours internationally. There's nothing like us internationally.

But the other point that ties into that is, the potential for a business when you're selling commodities versus selling proprietary product is massively different. So, there's not too many American retailers, where 75% of their business is outside the United States, when they're fully penetrated in the United States.

LDMH carrying [indiscernible], all the luxury brands, right, where we're kind of evolving and positioning our brand to be like, 75% of their business is outside the United States, right? So, if you think about the right roadmap to look like – to look at, and how-to kind of correctly dimensionalize the opportunity, you really have to look at not the mass market, you'll totally miss it, right? It's like looking at home sales and looking at total home sales that are affected by all kinds of units of homes that are $200,000 to $400,000 or $500,000 or $600,000, that's not our customer.

It's like someone was trying to sell me digital advertising not too long ago, and saying, like, why aren't you buying the word sofa? Why aren't you buying the word couch bath hardware? And so, it has 96% of the world can afford my sofa, my couch or my bad – bath hardware, be, it'd be like putting my store in the middle of a city that was massively populated with people that can't afford my goods, you wouldn't do that, right? And so, when you look at that kind of the pattern of the luxury businesses, there's a lot of wealthy people and a lot of people – wealthy people spend multiple times exponentially more in the home.

And so, we think long-term, I mean, now that we've spent time thinking deeply about this, right, getting into it at a detailed level being, boots on the ground, walking streets, walking stores, looking at it really from a customer's point of view, in the cities, in the countries and talking to customers and talking to people that shop.

Yes, I think the opportunity internationally is probably could be three to four x, what we do in North America. So, that's how we think about it. I'm sorry, this is a really long answer, but you happen to catch me just coming back from a trip. We landed Sunday night and we've been doing recaps on this and that we just think the opportunity is huge.

And the other thing is, it's from a growth opportunity, today, if we go to kind of transform a store from a legacy gallery to a new design gallery, we've got an opportunity to double the business at the retail level in a market and then get a lift in the direct side of the business.

So, if you take a $15 million gallery, it can go to $30 million, and then you take the other $15 million in the market and lifted 10% to 20%, you can get another $2 million to $3 million, right, so that's how you think about it.

So, you take like a market that was doing 15% at retail, 15% at direct, and the retail doubles to 30%, and the direct lifts by 10% to 20%. So, lifts by $1.5 million to $3 million. So, say you get the upside on both ends. You're picking up $15 million and $3 million, you're picking up $18 million.

But the real piece of that, you really go at retail, you go from $15 million to $30 million, right, and direct goes from $15 million to $18 million. So, you really have a $50 million pickup, right, not an $18 million pickup.

And then if you kind of just think about going into the United Kingdom, for example, and if you just look at the data and you look at the numbers, there's 68 million people in the United Kingdom with a democratic profile, I'd say, with a demographic profile and wealth profile that kind of looks like California.

That's not too different here and there, right? And London looks a lot like New York. So, you could – or Southern California with a secondary piece. And it’s kind of a little bit more fragmented than – it's not really next San Francisco. But 68 million people, it's pretty kind of similar demographic profile. California has 40 million people.

We do $450 million in California and we only have one new store, that's not even the full big store, right? So, when California – when we transform the real estate in California, it's going to be like a, I don't know $700 million to $800 million market, when is that full maturity, each of the galleries open three years and we expand the assortment.

So, you say like, California is like $700 million with 40 million people, will 68 million people is what is that 60% something like that more than that. So, you kind of take like, potentially the market 700 million, 600 million, 700 million times, 60%, it’s like a $1.1 billion opportunity. Like, we don't have opportunities like that in North America.

We're going to go into the UK and have a $1.1 billion opportunity with that demographic, and then go in fresh, not drag the [Aquatrol] or occidental laundry detergent into the market with us and open galleries, it could be our best and finest work ever. Like, you can go into a market and do $250 million overnight.

So, we don't have that kind of growth potential in North America with a lot. We doubled the company and get to $5 billion North America we think today. But now we're looking at the landscape and saying, there's another $15 billion to go get. And it's – and you're not kind of getting the lift on the piece you've already got.

You're going after an entirely new market. So, it's a huge opportunity. A huge opportunity and we get to go in with all our best thinking, not dragging, old thinking from legacy stores, not dragging old supply chain infrastructures, not dragging any old technology, not dragging any bad habits, we get to go in with all our best work.

So, we're super excited about it. Sorry for the long answer..

Thank you, Gary..

Okay. There's no time for other questions. Sorry..

Thank you, Gary..

Your next question comes from Michael Lasser with UBS. Your line is open..

Good evening. Thanks a lot for taking my question. There's two questions on what's implying the fourth quarter. So, we assume that half of the growth in the second quarter came from the increases in the outlets and increases in the RH New York store.

So, is the difference between the 10% sales growth recognizing that there are some nuances with what you are lapping from the year-ago period, but is the difference between the 10% sales growth that you experienced in the second quarter and the 5% to 6% that you're implying for the fourth quarter, basically, that you won't get as significant a contribution from those two sources the growth in New York and the growth outlets in the fourth quarter?.

You are very good with math. Yes. What – I mean really, you've got the outlet. We've been burning through the inventory. But we closed the 500,000 square foot distribution center that was sitting on reverse logistics, is part of we talked about, I think, for the last 18 months, 24 months.

We are kind of redesigning the whole reverse logistics outlet business and part of that was don't hold outlet inventory and close facility. The last thing I want to do is like store – second quality goods, a lot of retailers do and a lot of retailers are sitting out there with liabilities, not moving through inventory or markdowns.

And so, we wanted to be make it almost impossible in our company to sit on bad quality goods, because they're like tomatoes at the grocery store. I mean, they just don't get better with time. They just really don't. They don't turn into antiques in our lifetime. So, we closed our facility. We burned down those goods.

That gave us – those words that goes about a point, little more than a point. That – those goods are burning down. Outlet inventories are – we have today versus 18 months ago 75% with outlet inventory, something like that. And so that channel is now really cleaned.

We've – we swallowed that margin, yes, I mean, a lot of people are like, wow, is there more margin to expand here? Well, I mean, the outlets were massive dragging in the first-half of the year. So, we've got lots of margin opportunity and expansion.

From that point of view, for those people that care about earnings growth, I mean, might only be me and a few others. But the earnings growth opportunity based on lapping the burn down at the outlet inventory and we got rid of that distribution center that was holding a bunch of stuff that we didn't need. So, ….

Yes..

…so that's the piece of it. And then New York, right, opened really big and recycling New York. And then the timing of the new stores this year versus the timing of the new stores last year, kind of gives us a little kind of temporal trough, if you will, like we – until the stores were opening this year come on.

And then what we got is, we had a different dynamic. We not only have the stores coming on a little later that we're going to open in the second-half this year, but we have stores that we thought we were going to open in 2019 that are going to now open in the first and second quarter of 2020.

And they're going to open on top of no openings, right? So, in the first-half of this year, we had no openings, right? Correct. How many openings do we think we have in the first-half next year? Where we have like….

Three..

…three openings, right? So, you've got these, kind of, three that are opening later, then you've got three that are opening on top. And so, you're going to get just like you see a little trough, you're going to see a spike in the first-half next year, and you'll see our revenues kind of kick back up and grow.

And then, we start to kind of kick back up.

And then really when we start to kick up is when you get in Q3 and Q4 of next year, you can have – we have some some periods where we have up to seven, eight new stores on top of two comparatively year-over-year, right? So, if you look at it right now, as we go into kind of Q3 in early Q4, we have a little bit of trough and timing, and then it kicks right back up.

So, maybe that helps to hedge fund..

Helps a lot. Two more quick questions on that. One on that line of thinking is, because you won't get such a contribution, or as meaningful as a contribution from – to the growth from the outlets. That's why gross margins are expected to sharply inflict in the fourth quarter.

I mean, the other question is just now that you've had time with RH Atlanta, RH Denver, RH Tampa, and those types of galleries have been in the market for quite sometime. Can you give us a sense for the shape of the growth profile many years later? And how the returns for those – that class of initial openings are trending? Thank you..

Yes. The returns are fantastic. And generally, our bigger stores are growing faster than our smaller stores. And – but some of them, right, market-to-market you have different dynamics based on how housing markets kind of more localized, regionalized economies are doing.

But yes, there's also a whole another layer of opportunity with all of those kind of first- and second-generation galleries if they don't have hospitality. So, we're looking at adding restaurant to the rooftop in Denver, Billy Taubman and Bobby Taubman might be on the phone. Yes, guys, I'm going to ask you for tenant allowance to build the restaurant.

So – and you want these restaurants. But Denver and Tampa, both can have rooftop restaurants. We’re one we're massively happy.

All those galleries that you've mentioned and all of our design galleries throw up massive cash, right? And the cash return profiles and the earnings return profiles on all of our big galleries, we're extremely happy with, right? We don't have one that we thought, Oh, look, that was a mistake.

But we now think we can add hospitality, which not only adds that revenue, it – hospitality lifts the overall revenue of a gallery. So, we’ve got an opportunity to go back to a lot of the first-generation galleries. And I think, almost all of them, except for the smaller ones, Houston can't fit it, or maybe Greenwich, Connecticut, a few others.

But all the ones you mentioned, we actually have – already have conceptual designs for the restaurants in Atlanta, Tampa, and Denver. And so, we've got to know a whole another layer of growth that we can go back and get in those markets. But yes, but, look, those are the best positioned retail businesses.

There's no one, I mean, going to Denver, going to Tampa, going to Atlanta, and see if anybody's opened that looks like a competitor to RH. It's going to be a long time before you see anybody take – make place that kind of bet.

So, I think those galleries will continue to take market share over time as customers find them, as people kind of cycle around into their buying cycle and it's their time to either bought a new home, remodeled a home or refurnishing their home, which is a cycle of anywhere from five to 20 years.

When it's their time to go shop and you can have more top of mind in the market because of these physical presence – presences, we're just going to continue to be relatively disruptive and take market share. And I don't see anybody coming that's going to make the kind of bet, place the kind of bet.

They don't have the assortment, don't have the merchandising finesse we do, don't have the creative conceptualization to design or develop buildings and experiences like that. I haven't seen it. I mean, the Wayfair stores sure doesn't look like that and that opened in Massachusetts, so..

And, Michael, as it relates to your gross margin question, certainly outlet has an impact. And then you may recall, we plan to exit the holiday business. So, that business overall has a lower margin in Q4. So, we will get the benefit of not having those low-margin sales. That's another pickup for Q4..

Yes. I think the other thing of this is – ton of the questions is all kind of based on our guidance, right? And I would just remind everyone to think about what was our original guidance in Q1 and what happened? What was our original guidance in Q2, and what happened? There's – there might be a pattern..

Thank you very much. That's helpful..

Your next question comes from Oliver Chen with Cowen. Your line is open..

Hi. Thank you. Inventory management, you've made nice progress there.

What are your thoughts on a multi-year basis, as you look to some of the newer concepts and you manage breadth versus depth versus surprise and delight in terms of inventory management and working capital on a multi-year basis? And then as you think about, it looks like you've also made really nice progress with your home delivery and fulfillment.

Would love your thoughts on what inning you are there? And what's next in terms of just increasing the customer satisfaction and the vertical integration there? Thank you..

Yes. That first of all, is a very good, what we call a multi dimensional fully integrated question, a lot of depth and breadth, but a lot of focus. So, a good one, this one could take a while.

But it's exactly what we think about right, like, have you build any business, any brand? How do you dimensionalize it without diluting it? How do you elevate it versus just expand it, right? Because generally, when you expand something a lot of times, it kind of gets worse versus just thinking about elevating.

When people usually are trying to be additive, they're generally dilutive. When people try to do more, they mostly do less and that's very true with businesses. So, you have to these super disciplined and go through really just the absolute right filters.

I mean, one of the overall arching filters we use here is that, we say everything that we do has to render everything else that we do more rather than less valuable. Most of the time, when people do new things, it actually creates distractions and it renders other things less valuable.

And it's really hard, it's really hard, honestly, to kind of use those kind of filters and just like, you asked a beautiful question is, kind of, it was multi-dimensional, yet fully integrated, right? It wasn't – it's like when brands start branching out and adding other brands a lot of times unless you're – you've built such a kind of clear and concise platform and methodology like; Bernardo knows built with LDMH.

I mean, it’s me, that's like one of the hardest ones, but he's made it look simple, because he's got so many brands, different countries, different cultures, different people woven together in such an integrated way with such great harmony around luxury, right, businesses and from alcohol, to watches, to apparel, to Belmont and hotels and trains and so on and so forth.

But just beautifully thought about and beautifully integrated yet still kind of isolated in brand dimensional – yes, brand dimension and so on and so forth. And – but most of the time, you have businesses that the downfall has become and trying to get bigger and the pressure on growth usually leads people to isolation and fragmentation.

And what happens is that isolation or fragmentation, you start doing completely different businesses and completely different brands. But the problem is, you can't split the people up. We're all made of lots of atoms in cells, but you can't – you can split an atom technically and scientifically. You can't do that with a human.

They won't respond very well if you try to break down their cells. So, you only have so much talent in an organization. You only have so many truly gifted people. The key is how do you elevate and amplify those people and not distract and dilute their efforts and their talent.

And so, you have to be really, really disciplined about building your thoughts and ideas in a completely integrated way versus an isolated way, right? When people work in isolation, you get a lot of people working really hard in all the wrong things, not because they're – they think they're working on the wrong things, it's just that they're in isolation and they don't have all the information and the flow and you just have a lot of discord versus harmony.

So, one of the breakthroughs I think we had and one of the best ideas we made, and is when, we were working for, I don't know, five years on a completely separate brand.

I was kind of following an old path from what I did before and worked on West Elm for three years, and it launched right, when I left William-Sonoma, and it’s a great business, great brand, and I think William-Sonoma has got a really great model, right, and built a great platform with a lot of leverage.

The problem is, every business is really pretty different. And I think no differently than the gap that now wants to break apart, right? No differently than limited brands, right, which was built kind of in a, like the gap with kind of multi-brands, multi-dimension and kind of ramped up, but then they got all kind of diluted.

And I think there’s isolation and not integration. And you have discord and you don't have harmony. And so, you can't have true focus in situations, like business like that. Same thing here. We had a whole team for five years. I don’t know, we’ve spent $25 million or $30 million building a brand that, honestly, I wish I could go sell it.

We can – we could – anybody wants to come here used to, it's not still set up in a room. But we had it all set up. We had samples. We had everything, we thought we could kind of go underneath it RH and build a whole kind of another brand, another business, hit another market.

And then we talked about time allocation, right, and we talked about human capital, and how we're going to allocate our time. And when you really go through human capital allocation, what you realize and what we always say, I would say, “You know, look, we can always raise more money.

I don't know how to raise more time, right?” Like, we can make a mistake financially and we can kind of clean up that mass, raise some more money, you can always – there's always ways to get capital.

And so, we always say human capital is exponentially more valuable than financial capital, because you can't get the time back, right? And anybody says, it can save you time. It's like, I can't – I don't know how you save time either, spend time or waste time. And so, how you allocate your human capital.

The company is so important, as we are going through a process and a debate on what was next, where we're going to focus our time, Eri sitting next to me, said to me, “You know, Gary, you know, right, like she said, it's like, if I could do her voice the way she would, she'll kick me here, if I says.” But like, how hard is it? How hard it has been to get RH to where it is? And how do we build the next brand? There's – it’s an isolated thing, we can't build an integration.

What we can do in integration is, we can kind of multi dimensionalize RH and weave it together in a very integrated way and create a lot of harmony. And where everything that we do in RH will render the rest of RH more valuable.

But everything that we would try to do outside of RH, if we're allocating human capital towards that, it’s actually going to render RH less valuable, because you only have so many great resources anywhere in an organization, right, and so much talent, so much expertise and so – people that have the scar tissue from getting knocked down 10 times and giving up 11.

And so, the ability to truly allocate human capital correctly is, we think is the winning formula, and we think doing that in a focused way. And we make – we're debating here whether we do a whole Investor Day this fall sometime in October. So, maybe news that comes on that.

And if there's not, it's only because we're kind of too busy working, not because anything is wrong, but we – we’ve got a, I think a really compelling like your question, very clear, very multi-dimensional yet beautifully integrated vision of where this business can go. And we believe it can be one of the great ecosystems of all time.

And if you think about the ecosystem – the great ecosystems, I think Apple built one of the great ecosystems of all time. Once consumers bought into that brand in that ecosystem, they had you on so many levels.

They beautifully integrated, and if people almost forget that we used to carry around a camera, we used to carry around a video thing, not too long ago, video of my little twin girls with a little video camera, we used to carry around a phone.

We used to carry around something that, what they called Walkman, music thing, you had all these kind of separate things. And Apple, really beautifully integrated all these disparate things into kind of an ecosystem, our businesses and products, that really changed the way people shopped and created an entirely new market.

And everything they did, rendered everything else that they did more valuable. And Disney has created one of the great ecosystems of history, right? I mean, everything that they do renderers others everything else that they do.

The characters they develop and the stories they tell and the movies they make, and how – what – how that integrates and happens in the theme parks, and how it gets communicated and how it gets licensed into the toy business and divisions and it's all beautifully integrated, and that's why I think they've stood the test of time and have performed so well.

Well, we happen to kind of exist in a kind of category of the – of home goods, that relates to the biggest part of the economy, which is the housing market, right? And so, if you stand back and think about kind of the bigger picture and what you might be able to build with the RH brand with the head start that we have, and what an ecosystem that extends all the way through the actual largest part of the economy, right? And think about, like getting small percentages of the biggest market in the world, like we – at some point, I can't – I’ll get too excited and I'll talk about the whole thing and then – anyway.

It's –I think we can build one of the great ecosystems of history.

And one of the most focused integrated businesses that anybody' has ever seen, no different than our galleries in physical locations, render our products more valuable, our interior design business, right, embedding that into our galleries, renderers our product and our galleries more valuable.

Our hospitality business beautifully integrated into our galleries and into our experiences, renderers our gallery, renders our products, renderers our experience, even renderers interior design more valuable, because they can sit down and have a lunch catered into a room and create a beautiful meeting setting and feed a customer, so they don't get hungry.

And so, it's just thinking about weaving businesses together in a really kind of really thoughtful way that they – were they all amplify each other and they all render each other more valuable. So, we think pretty deeply about those things. And I think, we're most excited about it.

I think we believe we can build one of the most admired brands in the world.

And from a financial point of view, we believe when we unveil this thinking, it will be pointed, and what would be able to have the opportunity to create an entirely new market like a Disney, like an Apple, right, and be one of those brands that that really stands the test of time for generations..

Gary, that's really helpful. Just a follow-up. And our final question was, as you do think about global in your earlier comments, what are your thoughts about the flywheel and network effect, as well as sequencing the growth and thinking about supply chain? Awareness build can also be very difficult for U.S.

brands, historically, and how might you approach know a lot of the DNA of your merchandise is Belgian Linen and that aesthetic? I'm just curious about how that will translate globally as you think about the product matrix?.

Yes. Yes, I think when we – you kind of have to look at it country-by-country. I think the world is getting smaller, not bigger, right. And that's what the internet is doing. That's what social media and networks and connections are doing.

And my girls now turned 17, but they've had friends in multiple countries through technology for years now that they've never met. But they – if I look at their ability to curate and see things and react to trends and know about brands, it's – yes, it's completely different.

So, I don't think, the ideas of the future don't exist in the past the clues do, right? There's dots in the past. You can kind of reference in the future, but you really have to kind of think about where it's going and not necessarily where it's been.

And as we look forward and think about where the world is going and how brands can evolve in the world of tomorrow, we think that brands are going to be more valuable, not less valuable, that the world is so cluttered with choices, with information, with really bad visuals, right? I mean, for the most part, the Internet is a really good platform, like we, look, I joked around because of consulting company called this feeble, right.

So, like my mom used to always tell me, if you don't stand up for yourself, honey, no one else will. So, yes, we – a lot of people take potshots at us, because we say it's not about the Internet, it's about the fact that the decay of retail is because people haven't really done anything to evolve retail environments, retail stores.

It's not that we don't believe in the Internet. We've got over $1 billion businesses online.

But really, the – what we're doing physically in the world, I really believe people are going to look back in 20 years and 30 years and think that this is going to be one of the relevant stories of how to build a brand, There's a lot of kind of followership in kind of humanity, right? Someone heads in a direction and have some successor, then everybody starts building a thesis around it, and then you have consulting companies talking about that success.

And then you've got everybody kind of following the same direction, whether it's reengineering or used to be multi-channel retailing, then it was omni-channel retailing, then it was this and that and then everything else. Now, it's customer centricity and put the customer in the middle, or build everything around the customer.

Well, that’s interesting like, the customer doesn't know what they want unless you're selling dog food, or and stuff like that. But if you're trying to lead customers and create brands, you better not be using focus groups, because that's a good way to go backwards. And usually, all the dining brands are the ones who use the focus groups.

And the living brand, we always say, we say, great brands, don't chase customers. Customers chase great brands, right? And I think we're building a great brand.

And when we look forward and we think about international, and we think about what we're doing, and we think about what we're doing with the product assortment, and how we're going to beautifully integrate that and how our brand is going to be more focused, more powerful, more clear, even though it's got more dimension to it, and it's rich – it'll be richer, but it won't have discord, it will have exponentially more harmony, right? Like you think about RH New York, we basically tripled the size of our New York gallery.

Think about what retailers in the world could take their store size and triple it, and actually have it be more focused, more clear, more beautiful, more harmony, less discord, that's really hard to do, then throw a restaurant into it, then throw a [brief the bar] and a wine terrace into it, then throw it embed an interior design business into it, right.

You're adding complexity, but yet at the same time, you're creating clarity. That's super hard. So, when I look forward and I think about over the next couple of years, is we're going to take the first few baby steps into kind of Europe first and wherever second and we'll figure out how to kind of sequence this. We've got lot of ideas.

We're still debating. I think we're going to enter these markets with such intention, such clarity, such purpose, with such a clear and compelling brand that I think we're going to break through the clutter and create a new market.

I think there's people – we're going to get people to shop for the home, to redesign their homes that aren't even thinking about it. I mean, that's how we built the business. There's people that walk into our galleries every single day that were maybe thinking about their home, or maybe they decided to kind of walk in.

But they see such a beautiful inspirational space and they see product displayed, maybe the way they never would think about it in a home and they become inspired.

And then they just might decide, “Hey, you know, look, let's forget about the Caribbean or Hawaiian vacation this year, let's save that money and redo our living room or completely redesign our backyard.” And that's where you start to create a new market. So, I think, it's – awareness is really difficult for U.S.

brands to build when you're selling commodities, right? If you're going in and you're now that the fifth pet store in Europe, or you're going to come in sell TVs, or you're going to come in and sell tools or lumber or, you're a discounter, got it. There's – there they got good people at all those businesses internationally.

They don't have anybody like us out there. There's more people that are closer to our business here in the U.S. We think we're massively differentiated here. But there's other people that sell furniture, home furnishings in a lifestyle kind of approach, that aren't half bad. Over there, it's super mom-and-pop.

I mean, there's – and I just think that, it's gong to be very different for us versus you can't compare the way we're going to do it versus other businesses. Again, it's like the housing market, right? Like, it'd be like counting the units of homes that are 500,000 below or counting the homes that are 5 million and above.

There's a lot less units, but there's a lot more dollars, right? And so, the answers and kind of the subtleties, but I think we're going to enter a market, enter these markets with more differentiation and uniqueness as a new brand, entering a retailer – entering a new country from a retail consumer point of view, and then the history of the world.

I think there's going to be that much differentiation of how RH introduces our goods in our category to kind of differentiation that no one's ever seen, like how different is RH New York than every other home business in New York City? How different is it? It's not close? We’ll then now take the next closest people, the next closest 10 people and take them out of New York, then how different it is it, exponentially different.

Those next closest 10 people don't exist internationally. Does that make sense? I mean, that makes sense to us, so..

Yes, very helpful..

Yes..

It sounds like complexity and also balance. Thank you. Best regards..

Yes..

Your next question comes from Zach Fadem with Wells Fargo. Your line is open..

Hi, good afternoon. Gary, it looks like you're now on track for about 240 basis points of operating margin improvement this year.

Curious if we could bridge the gap here, as you approach that mid-teens or higher target over time? How much is sales leverage? What's going on and what going forward? Would you attribute to operating initiatives, things like home delivery and reverse logistics? And as you reconcile those, maybe you could talk through the levers that you view is more near-term one to two-year opportunities compared to those opportunities may be further out?.

I – yes, I don't know if we can kind of prepare great [indiscernible], but I think you can pick up the last press release we did. And look at the last letter I wrote, I think I listed five kind of key points that were somewhere between 400 and 600 basis points more operating margin.

I mean, I think as we look at it today, we click this thing up from low to mid-teens to mid to high-teens operating margins. And we've got a really clear line of sight today. I think, it's 20 to 20-plus operating margins. Look, very doable to us as we look out over the long-term.

Again, think about, start with we're from a design gallery roll out, we're one-third penetrated. So, we take two-thirds of the market, put these new disruptive design galleries and the rest of the market lift the sales to $5 billion. Think about the next generation of design galleries are going to take a fraction of the capital.

They're going to have a fraction of the depreciation. They're going to have better rent structures. So, the whole occupancy pieces of business has a lot of opportunity for leverage. We don't need to build new inventory teams or merchandising teams, or overhead teams to support bigger stores, right? We need to make investments at the gallery level.

We need to make investments in hospitality at the local level and so on and so forth to run those businesses. But think about adding – if you could just like today, right, we don't really need, I don't think one more person at the headquarters level.

Like, if we just had all big galleries out in the market today, we wouldn't have to add a person corporately.

So take our company from $2.7 billion or – and take it to $5 billion and think about what advertising looks like, what SG&A looks like, what occupancy looks like, if those new galleries have a completely different structure from rent, from depreciation perspective, from return on invested capital perspective, we didn't like put out that we can be in excess of 50% ROIC, as like that's a dream, like, we have a five-year plan that shows it, and it's just – and it's a pretty conservative five-year plan, right? This is going to be like a cash machine, like what we're building and the structure in the model that we built.

And then you look at the supply chain, we've made some big moves, right? We've simplified this thing and been able to focus and it comparatively, it's – we had – if we had inventory turns today that we had just three or four years ago, right, three years ago, we would have $500 million more inventory in our system today.

So, we basically have taken out $500 million of inventory in three years, three-and-a-half years, something like that. Like that was just like looking under the hood. I don't want to make it sound that simple. But we've attracted new talent into the company. We've got – you'll hear more about some of the things that we're doing as we're coming.

But we think there's lots of opportunity, lots of ways to amplify things with technology and systems. And what – I always say, we say inside our company that systems don't simplify, systems amplify, right? People simplify. You can take a system and put it on a bad platform, you're just going to make that bad platform go faster.

You're going to make the outcome, like you're going to amplify bad, right? And systems can make a flywheel go faster. They're not the flywheel in a lot of cases. You have to first design the business process and the methodology and architect it, right, and then you can amplify it.

And so, we're architected things, and then we're going to be in the process of amplifying what we've architected. And we think there's exponential opportunities to all of that through simplification and clarity and removing complexity, right, and creating harmony. So, home delivery, we’ve just gotten started, like, just gotten started.

And we've got an incredible new leader, and can I talk about ETFs, or…..

You can..

I can, or your deal set, everything's good. Okay. So, I can talk about them. It might take the whole conference call with like four questions today. But Fernando Garcia has joined us as the President of Furniture Operations and Home Delivery.

And Fernando is a young man compared to me, but that – came to America with a dream with $5 in his pocket and was your first job – your first job was in a Kmart, right, cleaning, and decided, got an opportunity to deliver furniture. And through that opportunity to deliver furniture, figured out how to save enough money, bought a truck.

And off the back of one truck built a company that spanned 26 states and controlled 550 trucks and drivers, and built one of the best logistics companies in America and just – we got a chance to meet Fernando who's one of our providers.

And we both found that we were very much aligned in our vision and our values and what we wanted to do and the dent we wanted to make in the universe.

And, Fernando said, “Look, I think I can help you guys and be a part of it.” And Fernando has just completed selling his company and joining our company full-time and he has been been working with us part, which – his part time looks like everybody else's full-time. So, I don't can't imagine what his full-time looks like.

But the opportunities he sees, because he's actually built it from the ground up. And he knows the model and he knows, how to take the complexity of a business like that and simplify it and his intellect drive and desire and what he can do to help us take the learnings.

And what you see when you're really at the point of contact with a customer in the home and see those issues and actually architect and engineer that all the way back to our factories, right, whether it's the design of the products, whether it's the packaging of the products, whether way it's being handled in a distribution center, or whether it should even go through a distribution center.

What – how the truck is designed. How the cab is designed. How you handle things in reverse logistics. How you look at the entire transportation network. What are all those opportunities? I mean, that he came when we first met.

He told me, “You know, like, I've been trying to meet with you for three years, but I couldn't get a meeting with you, because I think I know what you need.” And I said, “Well, really what you know, and I didn't even know.” We were doing a meeting here and I was asking some questions on metrics. And nobody in the room knew the numbers.

And I had the numbers at the tip of their tongue, and I said, “Well, somebody in the company's got to know those numbers. Look, can we get those numbers right now? Can we call somebody?” And they said, “Well, Fernando will know the numbers.” And I said, “Oh, I didn’t think Fernando worked for us.” So, they called Fernando.

Fernando gets on a conference call, and I'm – this guy is like bang, bang, bang on every metric, every detail, every input and output. And I'm, like, I write on a piece of paper, we're in the room, that’s probably 20% of the room, I go. We should promote him. And then he – they said, “You know, he worked, they write a note back. He works for FTO.

He's one of our providers.” And I go, oh, okay. And then I write on another piece of paper, I said, we should hire him. And I hold that up in the room, and then they go, he owns the company, and he's like, they're whispering, he owns the company. I'm like, “Oh, shit, and I'm thinking, maybe we should buy his company”. But we didn't have to do that.

Fernando had opportunities to sell his company and did quite well as American dream. They'll write a book soon. You'll be reading about this guy. And – but he – when I sat down, he actually flew out the next week and offered to come out and just help us think through the problems we're trying to solve.

And we get to spend a few days together and you had a one-on-one with him. And I said, “Well, what really motivates you?” And he said, “Well, just being here and talking to you guys, isn't it because I've been trying to get a meeting with you for three years and I’ve been able to get in the door, because I've got some ideas.

I think I know what you need. I'll get a little presentation here if you'd like to see.” And I go, okay, and he pulls out a whole, beautifully laid out PowerPoint on a complete strategy that we got to pursue, that was sounded to us exactly like what we ought to be pursuing.

And he said, “Look, I think I've got an opportunity to sell my company and join your company.

And I think we can make a huge difference together.” And so, here he is and I can tell, I mean, in his first signing of 30 days, it's like when we said, well, we said $15 million to $20 million, or $15 million to $30 million?.

$15 million to $20 million..

Yes, $15 million to $20 million, which means, it's always more than we tell you, right? So – but I know in the first couple of months, he's finding just huge opportunities to simplify and massive savings. And he didn't come here and think he was going to find it all in the first two to three months, I guarantee you that.

So, we think there's huge opportunities and we're just getting warmed up here on so many levels. And again, I mean, take whatever we're doing here and whatever you think we might do here over the next five or seven years, and then kind of for exit, and that's what the global opportunity looks like.

We – I mean, that the global opportunity of this dimension of RH when we unveiled the entire ecosystem, you can, like 10x that. And so, it’s – we're just more excited than we've ever been about the future. And I know, everybody wants to kind of get into the weeds and the next quarter and the guidance and so on and so forth.

And we – look, we all know business, that there's some form of pattern recognition that's important and relevant and short-term information, that's key. And – but there's pattern recognition here that you should look at. And there's massive opportunities ahead of us in the future. And – but there's exponential value creation that's going to come.

We point out, I tell people, 10 years ago, LDMH stock was at $39 a share, right? 10 years later, it hit $390. I think people are going to look at, 10 years ago, RH was whatever its trading at today, $150 a share, $160 a share. 10 years from now, the stock could be $1,600 a share. And we have lines of sighs and stuff like that.

So, we're not going to get too caught up on the next quarter or this guide or like, did we go out there and guide really aggressive? I don’t know. Did we guide aggressive in Q2? What happened in Q2? Did we guide aggressive in Q1? What happened in Q1? Think all of a sudden, we're going to guide too aggressive in Q3 and Q4? No..

Thanks for that, Gary. Welcome – and welcome aboard, Fernando. I appreciate the time guys..

Yes. You can say hi to everybody. Fernando..

Hi, guys. Thank you..

Just in case you thought I was making you out. But I know you're here..

Your next question comes from Brad Thomas with KeyBanc Capital. Your line is open..

Hi, thanks for taking the question. Just to dovetail off of some of that opportunity on the delivery and reverse logistics side.

Could you talk about a little bit more about the outlet strategy? And how many of you think you'll have at the end of the year? And what that may look like over two or three years? And how that'll fit into the business model?.

Yes. Not a – we – I think we now have the inventories at a level where there – what kind of clean and moving. And that, in our mind, the outlet ought to be like a really super simple flywheel, right? The stuff that gets returned or nicked, or damaged or did just spin.

We – I don’t know, it was three, four years ago, and we have actually the flip chart that we were mapping this thing out that three, four years ago, isn't exactly the same place I'm looking over. And we actually made a joke last night, as we were kind of going through some details and planning. And we said, “Hi, look, like there's the flip chart.

And there was a famous meeting, where we realized that the slowly turning inventory in the company was the outlet, which is like, hard to believe, right? That should be the fastest turning part of the company, because that inventory really rots quickly. And it's out of a box, and if it gets handled multiple times.” So, we've simplified it.

We've got it to – an okay place.

Exactly, the dynamics of the future of the outlet, the outlet is – will be responsive to the changes and improvements we make to the entire business versus the business being responsive to the outlet, meaning that, the outlet is, that whole strategy is going to be – is – should be triggered off a create rate, right, that's driven by returns or damages or what's happening.

And all of that is triggered off your quality, your packaging, your delivery experience, your customer experience. And so, there's all these things that all kind of weave together that are all absolutely actually completely integrated from product ideation to presentation from concept all the way to customer.

And you've got to kind of see that whole piece and understand all the pieces and integrate them beautifully together and not play whack-a-mole. What happens when organizations work in isolated ways, somebody makes an improvement over here and look how much money I saved over here.

And then they created 1.5 times the cost somewhere else and the whole company goes backwards. And it takes a certain kind of people and a certain kind of culture to really work in a deeply collaborative way to build a really integrated methodology, where everything that you do renders everything else that you do more valuable.

And just as we think about the brand, we think about the operating platform and every piece of our business, right, capital structure, everything. It's – we take the same kind of approach and view and deep thinking about it.

So, we think that there is lots of opportunity exactly how many outlet stores and exactly where they should be, like we have a lot more to learn before we can really know.

There's a lot more kind of – we say inside our company that you have to listen, learn, and then lead in that order, right? So, all of us have to continue to do a lot more listening, get close to the details, get close to the problems, get close to the opportunities and learn and really learn and understand and then be able to lead the organization forward.

We say inside our company that the smartest people in the company are those people closest to the customer. And those of us that get farther and farther away from the customer usually get dumber and dumber, so which makes me the dumbest guy in the company, by the way. And the only way I can do my job is to spend time listening and learn.

And then if I do those two things, well, I can actually lead, right? And we have a leadership culture here, not a management culture. You don't need to really listen and lead to try to manage people, because you're just kind of arranging and organizing the status quo.

But if you want to lead people do a better outcome, you really got to understand what the reality is today and get the kind of key insights. The organizations will tell you what we do smart and what we do dumb. Leaders have to listen, so they can learn and then therefore lead. And we've got a lot of listening to do and a lot of learning to do.

So, we can lead. And by the way, you find out when you really build a culture like that you never stop, you're never done. You're just never done. The opportunities get bigger and bigger and bigger, and the dots connect faster and faster and faster.

And just when you thought like, you've done something like RH New York, and you say, “How the hell would we.” This took us 20 years of our life to get to this point, how the hell will we ever do anything better than this.

And like within a year, you see something that could be exponentially better and more exciting and more valuable from a – from an emotional value point of view, from a strategic value point of view and from a financial value point of view..

That's great.

And if I could get a follow-up on the source book launchings that you have here in the back-half of the year, could you talk a little bit about the new modern book and how you're continuing to grow that important line for the business?.

Yes. We think early stages, I mean, that was a – it's been our big focus. We went to the Salon Show in Milan, really for the first time and spent a lot of time there. And we're able to kind of see the market in a whole new way and think about modern in a whole new way. We – modern was – we just got back from the [indiscernible] Show last week.

We were in Paris for the [indiscernible], when we were in the flea markets. And the big headline and takeaway for the team is how much bigger modern can be and how that – it’s continuing to evolve.

And I joke around a lot of times people ask me, so, where did trends come from? And in our business like I usually tell them the dead, right? And what happens is generations pass away. Their belongings go into estate sales, the estate sales, feed, the flea markets and the antique markets.

The flea markets, the antique markets become inspiration for the reproduction markets. The reproduction markets are inspirations for the next level, broader markets, higher-end markets and then it gets into the broader and mass markets.

And that's kind of the evolution of home trends, right? So, the reason you've seen all this mid-century modern and all these products kind of develop, you've had a couple of things like you've had amplifiers here.

But you've had all the people that were at home buying ages that were anywhere from 30 to 60 years old in the 50s and 60s are kind of either aged out or died, right? And so, their belongings went into the estate sales.

They then went into the antique markets and flea markets and depending on how valuable they were, and then they get picked up by the interior design market, and then they feed the reproduction market, and so on and so forth, right? The antiques of today, a lot of the one’s kind of feed the products of tomorrow.

And maybe I just gave an education to all my competitors, but that's kind of how it goes, where you take years to figure that out. So, if you're – it's like, you got to go to a lot of flea markets and go to a lot of stores to figure out like, oh, that's how it happens. That's why I'm here.

But – and so the amplifiers to that and I think I talked a lot about this when we launched modern is that, you've got then these other kind of things that have happened at the same time. You've had to move to modern architecture.

Most of the major architectural work that's been done around the world has been contemporary and modern, right, from the Bilbao in Spain from what 20 years ago, right, and to Hudson Yards to go to every major, okay, every continent on earth, and look at the kind of the greatest new architectural work, like look at the apple campus, right? We got back.

We spent a day at Foster + Partners in London, a Norman Foster famous firms like incredible. They did Apple campus and they do – they're doing some of the greatest work in the world. It's all contemporary and modern, right? And, then you look at the influences of the devices we carry.

I’d say that, Apple is kind of the champion of the move to kind of taking technology and making it so beautifully designed, right, that they created a movement. In their own, they've put a dent in the universe from a modern design point of view, and then the stores that they created and the spaces they've created.

So, we think that, we're in a long upward trend for modern. Now, that decades make some people go, oh, my God, classic is going to go away. Now, that's not going to happen, because really, architecture kind of drives aesthetics and home buying too.

So, when we launched RH Modern, we had this epiphany, right? Dave, we remember that, like we’re looking at Modern and it's like we launched Modern and Modern was off to a great start. And Dave and I were down looking at real estate and we're in Santa Barbara, right? And we go to our gallery, this – end of the day, early evening, and the whole team.

They must have heard that, we are going to be in town, because like all the designers, everybody like we had so many people there. We realized first if I like God, like who's doing the scheduling here. We have like a dozen people in the store. And there's only customers at 7:00 P.M.

And Dave and I walked in and realized that they knew we were in town and everybody showed up until we winded up the stores, getting ready to close. We had a meeting with them for about two hours, three hours, walked the gallery we just launched Modern.

And we said so, how is the launch of Modern doing? And they kind of looked at us and then they looked at each other and no one kind of said anything. So, I said, so have either of you been to Santa Barbara? And really, yes, we've been here quite a few times. And we're looking for gallery space and do big new beautiful gallery here.

And they said, yes, there's not a lot of modern architecture in Santa Barbara. It's all kind of classic and Spanish colonial and so on and so forth. And so, people are coming in saying like this, yes, this looks really great. But I don't know how it fit in my home.

So, you have to respect the fact that architecture does drive design vernacular, right? And you're not going to see really kind of hard straightedge modern goods inside probably a beautiful Montecito home in Santa Barbara.

You – there's guys, otherwise, you'll have discard – discord and not harmony, right? And so – but as the world is changing, if you look at the architectural movements, you look at the verticalization of cities and the movement back into cities and these high rises and these condos that are being developed, and they're just generally almost all modern, right? So that's going to drive a trend.

But if you look at the data and you look at the data around how many homes are modern and how many classic homes there are, and you can take a classic home and classic condo and you can remodel it and give it a more contemporary point of view, and create a transitional environment. But it's not – doesn't change overnight.

And it's – and, but we'd like where the trend is going. And we also know, that looks like classic in kind of like outdated traditional look is going to be here forever, because you're not going to bulldoze all the architecture in the world. So – but when you think about markets, I say, tell the team, think about a couple of things.

Think about in our business. Think about who's dying and what they're leaving behind, because it's going to probably start a trend. Think about what's been built and what the design vernacular is, and is there a trend that's happening.

And then look around that everything that is existing and every piece of existing architecture is going to have an influence on the potential and possibilities in our business in our marketplace. So, we – we like our position. We like that we were kind of out there with Modern in a big way.

Even though we got out of the gate, people like, oh, man, that launch of Modern got it, cost us $20 million. We had some hiccups when we launched just, that's R&D costs, that's not the modern, massive success. The businesses is significantly bigger than our five-year plan than when we launched it and we’ll continue to be.

So, we like our positioning around Modern. We like our positioning around contemporary. We like our positioning around classic. And we think we can bring our own unique point of view to just about any design vernacular and aesthetic and create beautiful environments and elevate people's lives by creating harmony.

And so, there's just a lot of potential that we see ahead of us..

Very helpful. Thank you, Gary..

Your next question comes from Brian Nagel with Oppenheimer. Your line is open..

Hi, good evening. Thank you for taking my question. So, I’ll keep it short, just because we are running out of time here, but with Gary, you spent a lot of time early in their conversation talking about potential move overseas. So, the question I have is, are there any parameters yet? How we should think about the timing of that initial markets.

And then follow-up on, I guess, another question. You have shown nice progress late in the EBIT margins.

Would a move overseas to some extent, way upon expenses or even capital in the near-term?.

Yes. We're kind of flushing all that out. But how to think about the timing? Well, let me give you some reality. We just got back on Sunday. We saw that we went to the Amazon market and the flea markets, then we had a merchandising trip, and it was an integrated real estate trip.

So, the whole team was kind of a cross functional team that saw multiple locations, multiple opportunities.

And Dave and I are back on a plane, when are we going, Sunday or Monday?.

To be determined..

To be determined. So, we got home, Sunday. We're going to probably leave Sunday. And we've got a whole cross functional team, designers, architects, things like that. And we're going back to see locations and advance of the project.

So, we think that timing wise, our projects are not little projects, right? We're not building a storefront inside a mall and then filling in a – an empty box with some fixtures. We are – we have real development projects, but nonetheless, the projects we're looking at are pretty inspiring spaces that are pretty far along.

They're not ground up builds. Their spaces that we would take over and adapt and then inhabit. So, we think we can move quickly, but at the same time, you want to move really thoughtfully here.

As far as the infrastructure and capital, I don't think there's a whole lot of complexity to it, right? We really run like a direct-to-customer showroom platform business, right? We don't really – what's our cash and carry in a big design gallery now less than 1%?.

1%..

Yes. So, if you think about our business model, less than 1% of the goods is walking out of the store in a bag, like less than 1%. I mean, it pretty soon it might be zero. And so, we don't have the same complexity from a cash and carry point of view.

We really like a direct business with these inspiring showrooms, and that's why I think our model is also so efficient. We don't have to spread inventory all over the place. We really just have floor models on display. And then we can architect the inventory in the most efficient way behind the demand.

And to fill it really well, we have less markdowns, because we run the business that way. We're finally getting rid of the last of holiday. We're talking on this last trip.

We're saying, oh, remember, yes, remember, when we were in all those shitty seasonal businesses, we used to sell like, Halloween crap and we used to sell Easter crap and we used to sell like Valentine's crap.

And like all these businesses that had like a four-week or six-week lifespan, and God forbid, the vendor shifted two weeks late and now 90% of it is getting marked down and your whole margin structure screwed up. And not only that, you're massively polluting all your core businesses, people are like, oh, you should sell all the stuff.

And you have always empty dining tables that you can put all these things on and you can sell extra things. Like, they'll put a bunch of Halloween crap on top of a beautiful dining table and render it less valuable, immediately render that dining table less valuable.

That's why we don't have all that crap piled up in our stores, right? And so, our business and what – the point of what I'm saying is, our business is much simpler than a lot of people's business in a lot of ways and then it's more complex in other ways, right? And – but through the simplification, have it all, I think we're creating a really capital efficient model.

We're doing fewer things really well. We're executing all those things really well. We have less waste, less complexity, less clutter, less waste, right? And so, as we have been thinking through international and how we can do it like, again, it's like stores. We don't have to drag the past into the future.

We don't have to, like disarchitect a supply chain that was built for a completely different business and didn't make sense for the business we're in. We can take our very best thinking of today, advance that thinking into a market and make a minimal capital investment.

Like, I think we used to have, how many DCs that we have, five or six like buildings?.

Four. Well, yes five furniture. Yes..

Yes.

Yes, we have like one-and-a-half kind of today and like it's going to be way simpler, like, it's – what's been really hard and complex is actually taking what we had, whether it was image, brand, real estate, old stores are poorly architected processes and systems and infrastructures, and disarchitect it, redesign it, redo it, like think about, we're changing all this stuff, right? And like you go – like when you guys think like, oh, my god, they're redesigning their whole supply chain, that's going to go really wrong.

This is going to be really expensive. They're going to make less – a lot less money for a time, like we had kind of one transition year when we went from a promotional model to a membership model that changed things. There's timing between when we took membership revenue and how we booked it to our P&L. We explain to everybody.

Our earnings are going to go down. This is what's going to happen. Nobody believed us. Stock went to 25. The people that were smart enough to buy the 25 are pretty happy today. But we're doing all these big moves. We're moving really big rocks, really changing massive things in our company and it's taking less capital.

We've got higher earnings, higher margins, right? Why wouldn't that be the same in international? It will be. What we've got is, we've got some startup costs to kind of train people, build culture. Do you got to build the DC? Yes. Are DCs hard to build? No. Like their tilt up walls, right? And concrete floors and skylights and things.

It's not like building these galleries or developing the galleries. And then you've got, are people delivering furniture in every country in the world? Yes. That's not entirely new. Will we do it better? Of course, we will. And so, to me, Europe and international in a lot of ways just looks like kind of some more stores.

And we don't change anything about our brand. People feel like, oh, well, they don't have the homes in France are not as big and they have smaller apartments. Well, that's why our sofas come in how many sizes, like seven lanes and three depths. Yes, okay, by a petite version of that, by a classic version of that. You got a bigger home.

Buy deluxe version of that, get it in 9 feet, 10 feet, 12 feet, 4 feet. Like how we – we've got the assortment. We can – it's not like we got to build a new assortment here. Not like you go into country, oh, they only like pink sofas, you don't have, yes. We’ll pass on that market. That one, we’ll give Wayfair.

I'm sorry picking up a little bit, you guys saw the new store. Everybody was telling me Wayfair is getting into the retail business. Are you worried? Go take a look at the store. I'm not worried..

Thanks for the color. I appreciate it..

Thank you..

Your next question is from Oliver Wintermantel from Evercore ISI. Your line is open..

Hi, this is [indiscernible] for Oliver. Just couple of quick ones, Gary. Any update on tariff sourcing efforts, conversation with vendors? And for Jack, if you could just delve into the tax rate guidance that you changed for the year? Thank you..

Yes. It's kind of what I would have said, I think that, look, there's certain things that are episodic and there are distractions. But they're not kind of necessarily strategic, right? Like, there's implications of some strategic sourcing shifts that are going to happen with tariffs.

But tariffs are more of a distraction and they shouldn't take our focus off the big rocks and what we're doing and where we're going. The tariffs are a little rock. It's kind of distractive. Somebody dropped a little rock in our head, and oh, here comes another one, there's another little tariff.

And I mean, it's like, you got to kind of it's like having apples falling on your head. And thinking, well, I'm standing under a tree, but you can't see the orchard, right? You got to get up and look at the bigger picture. And so, look, there's long-term, where does it all shake out? The numbers say, the U.S.

needs China and China needs the U.S.? To what degree does China need the U.S. and what degree does the U.S. need China? The numbers would tell you that China needs the U.S. more than the U.S. needs China.

Therefore, if you’ve read the art of the deal and understand what's in the mindset of a guy that wrote that book and how he negotiates whether you like that he negotiates in public and on Twitter, not just kind of relevant, you get understand, like when you have leverage, you should use leverage, if you're negotiating. The U.S.

has leverage with China. China's uncomfortable. U.S. is uncomfortable. Read the letter I wrote in our recent source book, leaders have to be comfortable making others uncomfortable, because you're leading people to places they've never seen, getting outcomes that have – that has had never been achieved before.

And I think that's – where we're going through from a tariff point of view is very important to U.S. long-term, strategically. I'm perfectly comfortable being uncomfortable about tariffs, because I think it can be really good for our country long-term. Balancing trade with China is a really good thing.

And people that don't understand that don't understand math and economics and world power. So, I'm okay. Is that a distraction? Do I have to worry about like, Oh, shit, I was going to do a convert and Trump tweeted about more tariffs and our stock went 12 points in one day, and we called up a convert or something like that. Yes, got it.

It's inconvenient. It's a distraction. It's not strategic. Strategic is – the strategic nature of it is as it relates to the United States and our country's economy long-term. And so, how it's relating to our business, specifically? Nothing different than what we report.

I mean, we actually put out press releases when these things happen and tell you like, look, I mean, has anybody seen a difference in our business or our performance or our profitability, since all these tariffs have been launched? No. So, we keep telling you don't – it's not an issue. It's not a problem, no different than the U.S.

needs China and China needs the U.S. I like to say to our partners and the people that produce our products they go, look, yes, we should be linked together and completely integrated. We're shopkeepers without factories and you’re manufacturers without stores.

We're not really good in isolation, either one of us, right? We have to be integrated and we have to have deep partnerships and relationships, and that's what we have. So, we have really good partnerships and relationships all over the world and in China.

And when you are playing for the long-term and you’ve got deep long relationships and you have real partners. You don’t abandon your partner in times of trouble, right? That's not when you flee. So, we're not just like, hey, okay like, let's just uproot and leave China. We've got great partners in China. We have great manufacturing partners.

We have great relationships in China. We're great – getting great product out of China, great quality out of China. And so how do we get through difficult times? We work together as partners. We do the math. We figure out how to create a really good outcome and we get through it. And that's what we've done.

And, yes, we've moved a little production, where probably the only places we've moved production is where we – the relationship wasn't as good and the quality wasn't as good, or the long-term investment wasn't going to make sense.

But we're not that – I think, I said in a [indiscernible] I said, like the companies that are going to, like in a complex business like ours were quality and manufacturing capability is so key.

You're going to uproot and just try to take things to other countries and ramp up production, get ready for the chaos and the complexity and chaos and problems that comes with that. I'd rather deal with the math and some of the changes and we'll all get through this. It's not – we're not going to have an embargo on China.

Don't underestimate what Trump might do and what moves he might make from a negotiating point of view. And it's – I think he's master negotiator and – but don't like, I don’t see – we think we're going to have like the embargo Cuban Missile Crisis thing happen here. There's not going to be an embargo in all the ships.

It's got to get through some negotiation. And I think it's going to work out for both countries really well. And we're going to get back a little of what we've given up long-term and – or it’s going to – I wouldn't want to be in China's position and have the cards China has versus the cards the U.S. has in this negotiation.

When you have leveraged, it's just a matter of time. So – but we've been able to get through it. We're not really worried about it. And if it really escalates for a short period of time and panics everybody in a short period of time, it's going to be a distraction. But we'll look back a few years from now.

Yes, that was that big of a deal and I think the outcome will be good for our country..

Got it. Thanks, guys..

So, John, as it relates to taxes, I think the – one of the drivers of changing tax rate is the exercise of an employee stock options and the vesting of restricted stock units. And so, depending on that activity and the share price and the amount that our employees exercise, there's a certain benefit that flows through to us.

And a benefit changes can change quarter-to-quarter last year, in particular, we saw some distinct variability in that. We had a tax rate last year of 16.8% effective and in Q2, it was 4.4%.

So, I guess, we talked about in a couple of quarters ago as we were preparing our outlook for this year and there's just the noise of that low tax rate versus what the activity and trying to project that employee activity, quarter-by-quarter that just, it doesn't help in terms of comparisons and looking at your earnings growth year-over-year.

Now, so we address that by picking a normalized tax rate, and we picked in a quarter or two quarters ago, 26%, which is effectively our statutory tax rate in essence are marginal one. The problem with that, though, is that economically, we do.

There is this activity, and I think there some of that activity in 2018 was pronounced, but what we continue to get this benefit. And this year….

It's a real benefit..

…the real benefit, real cash benefit, which – so, this year, our outlook for the tax rate is 21%. And in terms of EPS, if you think about that just in terms of our guidance, that math is $0.67, and that's the material amount of earnings power that was being understated by our choice of 26%.

So, we're just – we just want to make sure that investors and you have the most accurate view of what the earnings power of the business is. And so, we're going with the 21%, normal – normalized tax rate for all four quarters. And that, again, I think that just takes a little of the confusion out with the variability that we were seeing last year..

Yes. I mean, if you just take a simple multiple, I mean, I, which are multiple now about 15 or so, if you take our multiple intake 15 times $0.67, it's $10 a share.

Why would we present the numbers to be worse for our shareholders? We're – all we're trying to do is to create comparability that makes sense to evaluate the health and growth of the business. We don't want to understate it. We don't want to overstate it. But the tax rule has changed. You've got some of these activities happening.

And so, we're just trying to create the best comparison for ourselves, for our investors and for our shareholders, that's all..

There are no further questions. So, I'd like to turn the call back over to Gary for any closing remarks..

Great. Well, thank you, everyone. I want to thank our people and our partners all around the world who have just worked so hard and passionately bringing our vision to life and generating these really extraordinary results, like I couldn't be more proud, and we just ended the quarter with operating margins of 14.9%.

I don't know who the next closest competitor in our space is, maybe the [L2] people want to do a ranking on that. But we've got really one of the best models in our industry and we're just warming up. I think we've got the best people in the world, best team in the world, not just inside this company, but outside this company.

Our partners around the world are incredible that we work with. We're proud to work through problems with them, whether it's in Europe, or whether today it's in China. We're about partnerships and we're about passion and vision.

And I can tell you, we've never had a greater are a greater view of the future and a more inspiring vision in the future and we're going to passionately pursue that vision. And I think we're going to build one of the most innovative and inspired and inspiring brands the world has ever seen.

So, thank you for being a part of the journey and wanting to be interested in our story, we'd like – we like talking about it. So, we'll talk to you next quarter. Thank you..

This concludes today's conference call. Thank you, everyone, for joining. You may now disconnect..