Q3 2019 Earnings Call
Welcome to our age third party they try to 19 acuity called at this time, all participants and everything only by which I can speak, especially station they'll be a question. That's recession to ask a question. During this session you only depressed Taiwan telesales and BCS lines of today's conference is being recorded you acquire any further assistance. Please.
I started Daryl I never like to have declined French over Jewish speaker today Speaker Allison Malkin. Thank you. Please go ahead.
Good afternoon, everyone. Thank you for joining us for our third quarter fiscal 2019 can you update conference call. Joining me today, our Gary Friedman, Chairman and Chief Executive Officer, and Jack Preston Chief Financial Officer.
Before we start I would like to remind you of on legal disclaimer that we will make certain statements today and our 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.
Forward looking statements.
A number of risks and uncertainties that could cause actual results could differ materially. Please refer to our FTC highly as well as our press release issued today for a more detailed description of the risk factors that may affect our result.
Please also note a b when looking statements reflect our opinions only as of the other Tal and we undertake no obligation to revise or publicly release. The result of any revision TV.
Statements in light of new information or future that.
Also during this call we may discuss non-GAAP financial measure, we not gap.
How many be.
Certain items, you will find additional information regarding these non-GAAP financial measure and a reconciliation of these non-GAAP to GAAP measures in todays financial results press release, a live broadcast of this call is also available on the Investor Relations section of our website at <unk>.
They are got RH dotcom.
With that I'll turn the call over to the operator to begin our Q any session operator, we're ready for questions.
Like I did there sometime elect your my everyone in order to ask a question press the part and then number one your telephone keypad. Your first question comes from the lightness Michael last year. Your line is okay.
Good evening. This is my summary, filling in for Mike I'm not sure all thanks, a lot for taking your question.
So if you look at the guidance for the fourth quarter, you, calling for 5% to 6% to school.
Why shouldn't be much higher than this given your cycling down <unk> percentage point decline from December last year due to the stock market volatility and all swaps you house long into the marketplace.
Oh, well, that's what we guided and we're certainly enough.
4.0, you know drag from exiting holiday and Oh.
Some other promotions so.
You can essentially at 4% to our guidance and in essence think about an adjusted revenue growth rate.
Okay. Thank you that's very helpful and I've been as my follow up for arch Guardius copy.
Going on right now with all the new calorie all things you can you quantify concepts being rolled out hospitality and all we also find global expansion.
Oh, you manage sequencing of all that's going on switch to ensure that there are no execution related hiccups so going forward.
<unk>.
[laughter].
Well, we execute the way we've been executing so I.
I just look at our past performance over the last couple of years.
And I think Weve, what beat earnings guidance.
10 quarters in a row so.
We're not worried about it.
Okay. Thank you.
Your next question comes from the Lightening Steven for its your line is open.
Good afternoon.
<unk> I wanted to so I wouldn't start with.
Oh, Orange International right and maybe if you can just comment on your current thinking around a number of international development projects. The business can take on right within a single year I guess I I was sort of assuming I was I would model at the business that you would do one.
But it is that why we would you would you do more than one in Europe . I mean are there any sort of capacity restraints, where people restrictions as we start layering in the potential impact of Hauritz your natural into the model.
Oh, well, we expect to.
Start with one to two a year.
For the first year or two and believe we can ramp it from there but from a capacity constraint point of view or you know, we're not too concerned about it we're.
Opening a in Europe first focus on the UK, ER and and Paris in a few other.
That kind of a joining countries so.
You know, we don't see it is too much more complicated than opening new stores quite frankly, we we run our business is a showroom business you know we don't really.
Stockert stores, we set up or galleries are you know in and you might take orders basically right service customers due to find jobs and take orders.
And yet the fulfillment side of our business we've simplified greatly.
And you know, we don't see much complexity beyond that so.
I think this is like you know 10 years ago opening a you know it international business or 20 years ago opening in international business. There's so much smaller world today, yes, everybody.
Communicate the same way everybody's speaks basically English today, especially throughout Europe , and all the European countries.
And everybody knows our brand there so we don't.
Yeah, we don't see a whole lot of complexity.
You know, it's a just across the water and I you know weren't with it the biggest thing we're figuring out as you know how much of our product needs to kind of be housed in distributed up you know from Europe , how much of it can actually travel across the water from our east Coast do you see.
But there you know that people running businesses similar than ours, a similar to ours. Today, you know every one of our vendors.
Hi shifts to Europe today, I, you know in a big part of our work our business, especially order.
And that yeah that shipped directly into countries from vendors. So there's it's it's not not as complex as you might think.
Thank you and I know just a quick follow up Jack maybe for you right in the release mention 200 basis points of EBIT margin expansion in 2020.
But any any color you can provide on the revenue growth outlook. I mean is it just fair to assume that to expect sort of need to be within the long term guidance range or be it did well.
Correct.
Thank you.
Your next question comes from the line that's Curtis Nagle from Bank of America. Your line is open.
For taking the question first just a quick modeling question just in terms of VR tuner Bips of margin Oxbridge next year, we'll make sure that's a on that not a gross number.
And then I'll follow up with one another quick one so what do you mean, rather Curtis idea. This isn't that number critically we wait what were what we're saying there's it at least 200 basis points of margin expansion next year. That's right. That's a minimum we would hope which achieve yep.
Understood great. Thanks for clarifying that.
And then maybe just a question for you Gary or maybe a little more qualitative I'm just kind of what you have a model I think what are the more interesting things that you guys have done over the past few years is beefing up your.
Collaboration with known designers and artists and kind of bringing them into art your ecosystem, how important I've just been to the growth for the brand do you have people coming in like specifically dashboard.
Like Timothy Olson and kind of how do you see that continuing to develop over the next few years.
Sure sure why I think it's it's one of the things we did when we pivoted the brand in 2009 and 10.
Kind of turned the business.
Upside down or inside out of if you will you know most vertically integrated Branson and ours was that what I call. It inside out more up model, where we had 50 or so designers defining internally in inside the company I and then you know we.
Present that you know externally I.
Hi, and what we did just we really turned out model inside out and we call. It outside in model now, where we realize it and it was really a light bulb that went off I kind of watching Apple and when Apple launched the App store and if you looked at what Apple did everybody went today what was it was the C. C. S. C. C C S.
Conference timber Electronics conference I'll, just say, yeah, yeah, and and a you know Apple is the only we're not going there and Apple did their own conference in seemed to have the best attendance and that.
Hi, its quality designers and developers in technology. We're you know all designing for the Apple platform and Apple focused on building the very best platform to amplify I you know that the work of the very best people in the World and <unk> and that's one of Leipold went off for us where we changed our model, we don't have any designers and turtle.
In the company anymore, and we really haven't what we call it curation platform.
And now instead of our our product and our innovation being limited I you know to 50 people or you know in that in that area inside a company that would have to live in Corte Madera, you know really the the best people in the world can design and collaborate with us and we can amplify their work across the best plot.
Form so our focus is really building the blast that's platform.
Hi, and building the best relationships with the best people and I would say, we're just starting to hit an inflection point, where you know at the highest end of the market people that I think many many would say might have never design for our platform you're going to hear about new names see new people inside our yes insider books on our web site a that are yeah.
That are amongst the very best people in the world and it will help help let's take the brand to it to another level of quality, you know taste and style. So it's.
From our point of view it it's one of our real competitive advantages and Weve I think weve, especially over the last decade have you know our efforts on focusing on building. The best platform you know that physical platform. The a best online platform the best print platform.
Hi, you know that service platform with interior design and you'll hear about other things that we're doing that kind of enhanced our services to really amplify the working very best people I think now that word a lot more visible now that we have more of our larger physical stores.
You know, it's hard not to believe what we're gonna do right. It was different than when we had a lot of small mall stores, yeah, it'd be a big believer to say we were going to take you know the experience and the quality to it entirely different level now I think people see it and believe in it. So we were again as I said, we could have a tipping point, where you have just more and more piece.
People coming onto the platform.
Because we you know we provide the must leverage for anybody in the industry today at the high end to the market.
Okay. That's a that's a different appreciate it thanks very much yep. Thank you Chris.
Your next question comes from the line if all these very Chen from calling any company. Your line is open.
Hi, Gary I'm International a big opportunity what are your thoughts when you think about a market like Germany <unk> first is France and also as you I really think about the supply chain and delivering to the customer the delivery networks, there as well as how you're thinking about.
Supply chain with.
The season, and how those may evolve and in the context of your expansion plans. Thank you.
Sure sure well, Germany, clearly is one of the biggest markets in Europe in France is you know I'd say the much fashionable and Ah, Yes, probably has the most influence on taste and style and maybe a brand cachet and all of Europe . So you know our view and and.
And we believe the UK will be our biggest market and again I think you have just about rivals France, London in.
France for me just to kind of a global view.
And global awareness or you know two very very important city. So we're going to start in the UK I think we're going to do something completely revolutionary and unique to introduce ourselves into Europe , a in a way that I <unk> know retail brand has has done before and we believe its right to follow that with.
Paris, and with France, and make a statement there, especially if it's a center the the fashion World and and Germany is also on our lift when you know I articulated in my letter that we have five to seven locations that we're in negotiations on it pretty close to closing quite a few.
Germany is is right on that list, we're looking to two locations in Germany right now one in France that would be Paris, we have two in the UK and then we're looking at cities.
No other cities in Europe , Brussels, and Madrid, Barcelona other other key cities, where you know you really the right place to kind of starter Brandon.
Yeah positioned the brand from a design perspective, you know also looking at it Milan, because it's the center of UBS taste and style and where the really the biggest home show in the World is a the Salon show in Milan.
So Gary as you do that Youve paid a lot of great attention to your delivery experience here in the U.S.
Do you anticipate that being.
A big piece of the puzzle just to ensure that.
So it's a luxury experience when you touched a consumer at the home and these markets.
Yeah, absolutely well you know one that again the world is getting smaller and smaller every year and Ah Yes Europe .
Europe has more complexity as far as trying to.
Sometimes delivering in some of those cities. The you know the infrastructure is a little more challenging the good news is yeah everybody's home and in Europe has furniture and furniture has been delivered.
He has been being delivered.
For longer than our country spin on on the planet. So its not like it entirely new practice. What it is is it it's new to us and as we've studied it.
You know, we think that it's not going to be too much more difficult then.
Kind of opening a new area in America.
Opening in <unk>.
You know in in Canada, you know the world. The World has just gotten that much smaller so.
The real key is where do you positioned to D.C. you know, what's the most effective way to kind of cross borders I you know how do you manage some of the administration complexity.
But what we feel confident about is the work work we've done over the last three years more than three years now here on really architecting the entirely new operating profit platform and yes, simplifying the business from a distribution network point of view, yeah, and and it kind of.
Architecting, the reverse logistics and supply chain part of our business and focusing on elevating and simplifying the home delivery part of our business. We've just learned so much and feel so confident from an operational perspective, and you know our leaders in the business today or or just kind of real forces I think in the industry.
And I think you know where.
In many ways reconceptualize in the way.
Supply chains are being looked at an executed in at least in our part of the business or the way home deliveries being.
Looked at and executing on our part of the business and you know will bring all that same thinking I have to Europe , we maybe initially a little bit more constrained to just because we won't have all the all the volume and leverage we have but you know our business is going to be pretty concentrated and in certain markets. Just as it is in the U.S.
Today, so a pretty quickly, we'll get scale and leverage and.
The good news is where we're really good today and only getting better right. Dan I think that's reflected in our operating margins and.
We guided to 14 to this year, we're saying we're going to have at least 200 basis points of operating margin expansion last next year. You know that would tell you will be somewhat above 16, 16, two or Bob.
And you know all that is inherent in the work we've done over the last three years and what we've learned and and really now the culture. We've built from a from it kind of it operational service culture that I think is second to none second to none in the industry today, maybe second to none in the world. We don't we don't know yet we haven't spent enough time you know.
Over there, but I'm I'm, just really confident in the team we haven't our ability to execute and continue to innovate and improve.
Okay and our last question Gary Waterworks has continued to be another impressive part of the business. What are your thoughts about that operating margin opportunity in terms of enhancing that and the integration pieces that are most important for the next few years.
Yeah, well you know with all the work we've had to do with redesigning and.
Architecting the operating platform.
And Ah you know.
You can enhancing the gallery experience and launching a you know really kind of a revolutionary integrated hospitality platform inside our business and we had we had our hands full and and honestly waterworks has been operating no differently than waterworks operated when we bought them you know there there really hasn't been any integration of.
The business today in any meaningful way that would.
Create any amplification port or leverage in that business. So we now believe it's the right time to focus on water works. We believe it's the right time to begin to integrate that business onto our platform and amplify that business onto our platform.
And you know we look we think it's the best friend in the industry and we think it will render the RH brand more valuable and and we believe waterworks on our platform is no different than.
Any of the great artisans in the world on our platform, we amplify their business and render them more valuable based on the platform. We're building a with it which is really kind of second to none in the industry today.
Thank you best regards.
Thank you.
Your next question comes from the line of Seth Basham fashion from Wedbush.
Thanks, a lot and good afternoon.
My questions around gross margins you guys are supposed to some strong performance in the third quarter and I was hoping to get a little color in the drivers behind that performance.
And you're afraid relative to our guidance not a lot.
Yes, because obviously, we beat last year by not be but we are we increased gross margin if I heard 70 versus last year and versus the midpoint of our guidance is up 140 basis points.
You know few factors there you know I guess relative to expectations, where we are seeing your continued strong this in sort of product margin.
Piece of our business you know we are up as we talked about the operating platform.
And the savings that we're getting.
There that that 15 to 20 million that we've talked about we continue to learn about the full impact of that and I think where we were seeing just to get happily surprised that there continues to be leverage in that in that part of the part of the up but part of the yes, good cost of goods sold.
And then frankly as we've said before you know we gave a number.
And you know.
Yeah, the guidance, we give versus what we have internally obviously, what we have internally is higher I think in this case there was just a bit of conservatism and we did we were proud of the result, we did a great job and and I was just stuff probably again, our internal forecast is generally higher than what we got.
Got it that's helpful color, we'll take that to name into fourth quarter gross margin guidance unchanged at your internal forecasts are higher and the pricing power will persist, which is good news I last question on the topic related to tariffs that you imply that there was little to no impact on the business.
Could you state whether or not you saw us for the full price business units declined or increase for the quarter.
Yeah, we don't give that that level of data, but I'd, just say look you've got to our business is expanding.
At a pretty healthy pace, yeah, our gross margin for expanded substantially.
I think we're the only once in our industry that meaningfully.
Growing operating margin most are trying to kind of hold on it you know or their eroding and I think what what you're seeing is C.
What I'd say the emergence of the our each brand as you know it's a it's a luxury brand that can has the potential to generate luxury margins and I know you. We just have a completely different business models today, we have a different brand today you know the connection we have to the customer the membership model that we have you know the physical.
Environments, we're creating or that are multi dimensional with integrated hospitality.
You know the design services that we offer you know where we have real interior designers doing your home not.
Regional merchant or someone you know that.
Right out of school so.
We just have a completely unique and differentiated brand and platform and its.
Allowing us.
To get better margins as as and as we continue to position. This is as a luxury brand twice that we've clearly the site at 20% operating margins in the company today.
And when I think clearly and say we know we can get there we could probably get there faster than.
Most people believe and you know it's just a question of how we want to invest along the way and you know how we want to kind of keep building and it's not that 20% is.
The target or the endpoint.
We looked at our five year plan, 20% is.
Not that it's not the endpoints.
You know not by any means so I you know if you think about the operating margins that you know many people running at a luxury brands that could be 25% to 30% I and I you know I'm, not saying that that will we'll get to yeah, 30% today, but I would say, 20% is visible and.
And very doable and 25% is likely.
So when you put that together with.
The long term growth algorithm and the brand or being able to play internationally. There's there's no one likes internationally. There's no I mean, we have less competition enerdel internationally than we do in in the United States. You know I think our biggest competitor in the United States to the higher end is probably three or $400 million.
So the the impact we have or the impact we will have and that disruption. We can cause internationally I think its exponential comparatively the U.S., where you where you actually have you know more developed competitor base.
So.
Yeah.
You know.
Tariffs to us or I mean, they're not a big headline inside our company today I mean, it might be a big headline in companies that are.
Kind of trying to squeeze the lemon and hold on and you know.
Maintain operating margins or are not let them slide further and you know that's just not who we are it's not what we're building a this is an entirely new business model that has.
Yep massive potential and tariff tariffs are kind of a short term episodic kind of distraction they're not.
Not anything that we look at strategically I, where we've got lots of flexibility. We can source in many different companies all over the world I think still believe China is a great partner I.
Still have faith that you know trade deal would be worked out but if it doesn't work out with lots of Optionality, there's that yeah.
So you know not not not a big headline when you're thinking about our age.
Wonderful Thanks, a lot good luck.
Yeah. Thank you.
Your next question comes from the line Oliver Wintermantel from Evercore, I guess I'm like okay.
Yeah. Thanks, guys.
Gary you were talking just now about you know operating margins into 2020, 5% range and up from 14 today.
Can you maybe help us understand how you know maybe on a path how to get there was that more on a gross margin line or said really leverage from yesterday line or or does the business after change materially to get there just help us maybe understand that a little bit more how you think good to get there. Thank you.
Yeah. It will it did you get a chance to read the letter yet.
I did yes, okay, well it that gives you a path to 20, you know just basically right there and so I you know if you. If you just take those pieces and you know with some in it some enhancements so.
You know it and then if you kind of just thinking about the business.
The last point I made there every time we.
We trend that you know transform a legacy gallery to eight.
Design Gallery, a and we expect in the first few years to double the business.
That provide leverage across our entire platform, but you know as I pointed out meaningful leverage and occupancy meaningful leverage in advertising and and I know advertising is in SDMA, but I wanted to pointed out because it doesn't mean just to take any market where were you know we might have that $15 million Gallery, and we opened a big gallery and over there.
First few years it gets to 30 million.
We're not mailing anymore source books into that market, we're not doing anything differently from an advertising point of view of that market you know, but we're doubling the volume in the <unk>. The market. So you can do the math on that pretty easily your AD cost falls in half.
You know our occupancy cost leverage in our new galleries, and especially with our need new development model.
Were you know we're able to really.
Kept very little depreciation in the next galleries that we're going to be doing going forward.
And so you know just just right. There you think about and then then you take that that volume and leverage it across the whole corporate SDMA right and.
The entire supply chain.
And and when you look at our business and you look at you know the if they're very healthy percent of our business, we talk about what percent of our businesses, especially order now we don't we don't okay. Well. This let's just say we have a big percentage of our business, especially order right. So that that inventory spins very fast and has a very high return.
You know on it and.
You know you you just kinda do that math all the way through the model as you expand the model and get to.
60 to 70 design galleries in North America.
And then think about the fact that.
Hi around the world, we're starting with the new models not the old model you have to remember at the start with the fact that.
This was a very different company with very different earnings when I took over it was that negative 5% and we kind of got to seven and then we hit a you know we hit the downturn, we had to scratch backup from zero and and yet today much the people.
That her.
Home furnishings businesses have a scale and in North America have operating margins of probably five to honor, 8%, maybe someone has 10% I and go today, we've got 14 going to stick 16 16 too.
Hi, and and so you know it's just.
We're not starting with having that kind of build up you know like we're starting with the new model in these countries.
And we're starting with really really great brand awareness and brand power. So we think we're going to ramp relatively quickly when we go internationally, we're opening internationally with.
All the leverage and.
The real estate development model that we're executing here so.
Yeah. That's that's what kind of gives us a lot of leverage long term and and the growth and in that kind of that corporate overhead.
Is gonna be relatively minimal.
Over the long term I will make investments and we'll keep expanding businesses and things like that but it in some ways you could think about us in a way like a technology company from the perspective of we also runner business in a very project based point of view you know so just as Apple might you know shift a lot of resources to dip.
<unk> being you know from an ipod to an iPhone earn I've had you know we shift internal resources to develop arch Beach House Archie House, you know our age color in something so for those are not kind of new businesses with new infrastructures in the organization you know if it's just really the leverage of the flywheel we've built.
That will provide.
You know provide a lot of gross margin expansion and operating margin expansion.
And then you put that on on this kind of new massively more efficient operating platform. We we built I think people probably underestimate the work we've done over the three and a half years I mean, we basically took that entire leadership team cross functional leadership team for the company you know spend three and a half years reconceptualize him and white boarding and into.
I really new operating platform.
I have never been with a company that ever tried to do that usually the methodology is let's go higher consultant lets higher Mckenzie are.
Insulting urbane or you know take your pick whoever they are yeah, let's bring as a consultant to slip let them interview everybody intercompany and then you know it look at our look at our supply chain look our business and come back with it you know 1000 page report and you know charge you two or $3 million to say. Thank you very much. Good luck. If you want us to help you execute this weekend and to be around.
I did and try to assure you along for another few million Bucks.
And you know usually becomes a plan nobody believes and it's not the plan the organization conceptualized nobody really stopped work long enough got out of their silo functions long enough to really look at the business cross functionally to really build something entirely new and that's what we did you know and and Luckily It was painful it first right we pulled the current at the.
Pits after we blew attire, when we launched RH modern everybody's expecting us to kind of change the tires and come out back into the race and we cited to taking that stand the pits and build an entirely new car or stock when other way down to $25 to share people thought we were not but you know we decided we were going to kind of stop and focus.
And conceptualize an entirely new business platform and we built it not one consultant nobody from the outside everybody from the inside and everybody that knows this business, but everybody is forced to work an entirely different way, we got all the brains and the game, although he goes out with room, we broke down every silo.
Right and you know if it moved we measured it if it didnt, we painted and we we built an entirely new company and I think.
Yeah, well, we'll all see how you know how the results unveil over the next several years and look when our operating margins got to 10, you know a lot of analyst reports said Oh, you know there it.
Operating margin to the highest performer in the industry.
And that person is slid back we don't think 10 operating margin sustainable when we got to 12 same story Oh, We don't think 12 operating margin sustainable now were 14 I'm sure a lot of people don't think 14 sustainable. We just told you we got at least 200 basis points of operating margin expansion in the model for next.
Year as Jack you said, that's probably not our internal forecast.
So correct, it's not sustainable it's only going to get better. So you know.
I think.
Yeah. This is this is a new business a new model you know very differentiated brand with it with entirely new platform and brand proposition and so it it's a.
Yeah, it's going to be fun.
Got it thanks, very much and good luck.
Thank you.
Your next question comes from the minus time music Haiyan from JP Morgan Your line is open.
Hi, Congrats on another strong trends and thanks for taking my question. So I have two quick questions. The first one is.
Do you think a the two distribution centers you have in the U.S. our enough in the medium term to support your skills and the momentum into business, you're seeing especially if you go into Europe and 22 anyone.
Yeah, we we've.
We'll probably start to expand that the footprint.
In the distribution centers.
You know over the next 12 to 18 months or so you know weve, but but you're really talking about kind of space expansion I'm not so much new distribution centers in new markets, We think we're well positioned.
So as we go into Europe , we're still sizing that up you know what percent of the skews should we.
Should we start with for your European expansion, Yeah, just like any other business I. You know you can use kind of the 80 20 rule, maybe ours is 30 70, but.
Directionally the top 30% of our skews drives a 70, 576% of our revenues.
You got to a good portion of those skews that are special order. So they really never hit a DC. They just get cross dock and go to a customer. So I just like we don't necessarily house, 100% of our skews in both distribution centers that would just slow down the turn I mean, you think about what's really different our company.
We step for furniture Dcs at 100 at 100% of the skews.
Right that like made no sense now we have one DC that has 100% and skews and when do you see that has.
Significantly smaller percentage skews and so when we.
When we opened in Europe , I think about it that way, we probably open a distribution center that has maybe a third of the skews and then the you know the other.
Two thirds gets shipped from from Europe , and you know so that's why I'd say, it's not it's complex as you might think right yeah, and we're not housing the goods, where you know in retail stores were not replenishing retail stores, you know, we set up our galleries and there it's like setting up a beautiful.
Home or hotel lobby right like nothing really moves you know once in a while we get a customer that wants to lay on top of the bet. You know we've got to kind of fluff up [laughter] inside the gallery, but you know our business is not you know its look I think back in my days at the gap and I was restocking shells and back rooms, and having a.
Floor sets because all of a sudden whatever collection blew out you have empty racks and now you've got to try to move the whole store around and you're trying to stay in stock and all these styles sizes colors, so and so forth. We don't do any of that so much simpler business on many levels artist part of our businesses.
He is actually delivering the stuff to the customers' homes, which we believe weve leap frog from where we weren't probably leave for much of the rest of the industry.
But it's not it's not it's complex is I think people think it is for US we kind of look at it looked okay, we're going across the pond and we're opening in London.
You know then we'll open in Paris, then, we'll open beautiful galleries and.
Again, we just kind of got to set them up once right nothing moves.
Nobody steels anything nobody walks out with the bad nobody moves a bad or sofa, you know, although all the mirrors in light staying the same place.
What we do as we show up and we service the customer and.
You know provide an outstanding experience and then on the back end. We you know we have to execute and get the goods in the customers home.
And for the bigger part of our business would just furniture again.
You're talking about probably the top third of our skews that we have to focus on you know not the entire assortment and then add to that you've got to a meaningful percentage of that.
You know.
I mean less than half more than a quarter that special order right. So.
It's a different kind of model.
Got it that's that's helpful and my second question is how should we be thinking about the tax rate next year.
So Tammy you know, we havent, obviously guided to that level yet.
We've provided a few for this year you know the update to the up to our guidance. It's actually we did the priority was to 21%. We clearly beat that this this quarter given the stock option activity.
I think getting were.
No specific guidance I'll tell you internally, we're using 20%.
You know it could be better than that to be honest I think that.
It's a function of the stock price right. So we've got a lot of people holding options at relatively low prices and so stock continues to perform I'm sure people are going to exercise options and self stock I mean, weve pretty widely distributed option plan within the company.
And that's Ah you know, where that's where it really what drives it. So it's our as our stock has performed as a stock as you know went from 50 to 100 100, 150 150 to 200.
You know it more activity in our stock option plan and that drives lower tax rate.
Exactly so yeah, it's probably part I think about it simply if our stock stays as this level continues to go higher we're going to probably have a high activity in our option plan, if our stock dropped $50 it'll probably slowed down will pay more tax it's not too much more complicated and back.
Got it that's super helpful. Thank you.
Your next question comes from the line if Brad Thomas from Keybanc Capital. Your line is open.
Great. Thank you good afternoon.
Hey, Gary I was hoping you could talk a little bit more about the guest house as we look ahead to its opening and in 2020, and if you could tell us a bit more about what you hope that experience to be like for gosh sand.
Maybe how it may fit into the long term business model. Thanks.
No not a lot to report yet we wanted to let you know we're obviously open it this year.
Well, we'll do a more fulsome explanation, but I'd start with the fact that everything we do its intended to to render the orange brand more valuable right and physician is positioned our ages.
Kind of thought leader.
Tastemakers in place makers inside our industry and that's with the guest house is designed to do we believe we can.
We have reconceptualize entirely new market will create an entirely new market for travelers seek eating privacy and luxury.
In security in many ways. So you think about privacy privacy today is something everybody's given away with social media and it a with the internet for the most part is taken away and it's what people talk about most as being at risk is our privacy. So hard to find privacy today, you know hard to.
But nobody's got too many people are selling privacy today, so we're creating a concept built around privacy and luxury.
A lot of people have asked me.
Because it hit that real estate press right and that's the way we had to start talking about it a little bit because we signed a lease and and knowing that public document that talks about our age building a hotel concepts that people ask me I hear you opened in hotel in New York and I say now and then they say Oh, I mean, a boutique hotel and I say no and then and then they.
Okay. What are you doing if they will create into guesthouse and.
Try to Reconceptualize hospitality and do something no one is ever done.
And then and then they say Oh so.
I got it is going to be a showroom for your for your product and I say now what we have a 90000 square for children 20 steps the way why would we do that in fact, it's not gonna have any of our product and that usually what twist everybody's head around a bit because it's it's it's too.
Expected right and if you do something that.
People expect and consumers expect you'll never surprise and delight them. So we're doing something that I think.
Nobody can imagine.
I think it's going to elevate our brand it's can be amongst one of the best things we've ever done and one of the most innovative things done in hospitality in years. So.
We're very excited about it in the first one is in New York the second one.
I've broken the letter is in Aspen.
Our two epicenters for you know taste design and wealth.
And you know, it's where the wealthy and fluent visiting vacation you know Aspen is one of those global up centers.
And I think you know this will again be another thing we do that creates a global conversation that continues to elevate the ARPU trend is as we.
Attempt to climb to luxury mountain I tell our team internally here that.
And if you think about almost every I think every luxury brand in the world today, all the best luxury brands, where there are Mays. Louis Vuitton Chanel I you know you name it on a non Christian Dior and.
All the others. They were all born at the top of the luxury mountain right. They started there and we obviously didnt and we're one of the few that is trying to make the climb.
To the top the luxury mountain and.
The people at the top of electric mountain quite frankly.
Don't really want you to make that climb you know them. They don't really invite you to their party.
You know you're not from the neighborhood you don't have the background.
And to make that climb, which I don't know brand that has from from the level. We started that to make that climb up the luxury mountain you have to do things that create a forced reconsideration right you have to do things that force people to respect to you that force people to tip their hat.
Right and I believe that's the kind of work we've done a you know throughout our entire journey step by step we've taken another client another rung up that luxury mountain, we've only done things set of rendered our brand more valuable even if they were painful like taking the car into the pit and going from a pro.
Emotional model to a membership model and changing.
Changing her brand is perceived door.
Opening really inspiring spaces and galleries when you know the world were shrinking in closing stores, we're opening the most inspiring architectural.
Environments in the history of retail.
And Oh or are integrating hospitality indoor galleries, the way, we have ER and the guest house will be no different I you know it will be a magnificent statement of our brand. It will we believe it will create a global conversation and set a new standard and not only that what happens when you do work like this.
Is it challengers your organization.
In a way that kind of just executing the same thing everyday doesn't right. It forces you to think differently. It forces you to reach higher.
And and that's why by the way we started to New York lot of people said like Gosh, why don't you and your first guest house somewhere where everybody is not going to pay that much attention, where you can make mistakes, where you know the critics won't be so harsh and yeah, we more operate.
From the Frank Sinatra models, hopefully that if you can make it there you can make it anywhere and that's why it's important to start New York is starting to city like that and it brings out your best work. It brings out your best thinking and I think what you'll see when we open the guest houses here is something that's entirely new entirely unexpected and I just told you entirely.
Me too much.
[laughter] well I appreciate it Gary and looking forward to change when it opened.
I was hoping you could ask a quick follow up on on color and if you could just give a sense of how big you think the scope of that.
New category, maybe next year and and if you think you need to make changes of significance in the store to highlight that product in the store next year.
I guess not well I think if you.
Hey, you know our brand is a lot of times.
Picked on for not having much color people, usually say Oh, you know our age doesn't like color Gary Friedman doesn't like color. It's not that we don't like color. Just so happens that the vast majority of the market is colorless why is it color like because humans are generally colorless right were shades of light to dark the world is generally colorless.
Except for some green you know that the ocean is actually color English.
Section of the Sky and so what do we most comfortable with neutrals.
Is there a market for color there is how big is it it's not that big.
If it was that it significantly bigger significantly smaller than clothing.
And I learned that the hard way back in my pottery barn days. When you know I think I could change that the fashion color pallets and all they didn't create a hell of a lot of markdowns.
And so.
We think color will be additive to the brand at today Nobody is waking up in the morning, saying I want.
Once some color colorful furnishings, and saying I'm going to RH like zero right, where we're basically a neutral based brand.
Is there you know is our market is or possibly another 15% to 20% of kind of opening up the aperture of our brand I think so I think it could be up to 20% I think it'll take several years to get there.
And we have to do this in a in a really smart way yet, but we don't want to do is is confuse the branded unfocused brand. So we're doing it in in a in a very RH way, it's very architectural if it's very.
Disciplined.
Very structural and its approach, it's very intentional in its approach and it done in a way that maybe one or two interior designers in the history of the world have executed color. You know that's who we have study one primarily who who is really influenced by the way I see the world and from an interior duct design point of view more than any but.
He also in that new she got Hempel, who is an interior designer that was really the the godmother to the boutique hotel trends you know everybody kind of gives in schrager credit actually an example was before in Schrager cheetahs launched in in London with the Blake's hotels.
And you know if you look at December work and she uses color. It's been a very architectural very disciplined way. We've studied her work. We studied one other person is work honestly I don't think anything that too many people do color very well. So we have to do color as well as we do neutrals, we have to do it within the point of view of our brand a and we have to do it in a way said it.
Elevates the our each brand in renders the Orange brand more valuable we can't let it on focus as we can't let it kinda distract from the core business. We have to you if the beautifully integrated and and it has to amplify what we do so I'm not easy we've been working on it for five years have.
Well you know we thought we are going to kind of.
Get it done last couple of years and it just hasn't got there yet we think we're very close.
And we'll be ready next year, but it's like anything else we do.
Right I mean, everything we've done is kind of a test right and we learn it you can have all the ideas in your head that that you want but.
You know you don't really know anything until you do something right and so we tend to learn by doing we spent a lot of lot of time deeply thinking about anything we do.
And you know we try to conceptualize it we try to kind of move our vision translator vision from a you know from vision to a strategy and figure out then how we can bring that strategy to life.
I'm, but but honestly until you do it you don't really know that much in so no different than our each beach house or a ski house. They launched is relatively small test.
You source books that are 100, I think there about 120 140 pages.
Very different than how we launched modern wants with 545 pages that didn't go so well be fields, maybe a little bit too much complexity.
But you know looking back we look we're glad we did a cautious $20 million to keep customers happy we.
Kind of botch, some of the execution, but but it's a huge business for us today.
But if you look at be Ciesinski House, a you know we tested them very small.
We're learning a lot we know what's working what's not working we you know we will expand the assortments optimize the mailings optimized web presentation and begin to two then test and moved some of the best collections into our retail galleries that will be the same thing with color. You know, it's why we try to integrate color into that are each core book into the.
Interiors book I at least five times and.
Probably 30 days before mailing the book, we just yanked it because it was on focusing the brand and so we decided to capitalize it in its own book and we'll call. It our age color and it will you know kind of give its own part of the website or something website integrated to our portal of the world of our age, which you'll hear more about that later.
Well, we'll be working on and introducing later this year.
But what presented in a way that people will know we're in the business will be in the business in a very distinctive way.
But yeah, we'll test it will learn we'll we'll do some things right, we'll do some things wrong I, but we we get we get smart really quick here at once we get data once we get real feedback.
So and then and then then our then we accelerate the learning curve and we start to accelerate the business.
So we're hopeful we think we think we're going to do color better than anybody else on the planet, except for maybe initially temple and one unnamed.
Interior designer.
But but oh, we're hopeful but I don't think it'll start real fast.
I think there's just nobody waking up in the morning thinking about us for color. So what little it'll take it'll take a couple of years to kind of habit be known and habit grow and no no differently with modern today, if anybody is thinking about modern home furnishings or furniture, I think everybody's thinking about us.
So it's color will will ramp in you know will it will build a bigger impression in people's minds, and we'll be able to integrate it into our galleries in a really beautiful way, we've got a lot of concepts and things we've been thinking about and how we'll do that so.
Super excited about it but it's not going to change everything the first year.
Very helpful. Thank you so much Gary.
Yep.
Your next question comes from the line is accelerating from Wells Fargo. Your line is open.
Hi, This is actually David Lance on for snacks, Thanks for taking my questions.
So on the on the evolution of the real estate strategy I was curious to see how you think about the opportunity as it stands today and in particular, whether you see an opportunity in some of the smaller domestic markets like.
Columbus, or Minneapolis, and relative to this to the sales lifts that you've seen in some of the larger markets are you have.
[noise].
So well.
I mean, we're about to see opened in Minneapolis are opening Columbus next week. So what's what are your specific question David.
I guess, just just more clarity around kind of some of the lift and like what you've been seeing in some of the smaller domestic markets in comparison to some of the larger markets. Yeah. The lift basically the same you know the big the biggest differences. If do we are don't we have hospitality integrated hospitality integrated into into the.
Gallery gives us a greater lift not just from the hospitality business, but the traffic the hospitality business drives.
So we've been really really consistent you know plus or minus 10% or so.
We haven't really had any any surprises per se.
Whether it's small market as small as I guess small so we've done as Kansas City, when Leawood I guess.
And the biggest is big need New York, New Yorkers really two step right New York with it.
Legacy Gallery that we expanded.
For years before or something like that to a what I call kind of a design gallery, we tripled the size of New York in its in its previous location in the Flatiron went from one Florida three floors and then we.
Then we more than doubled the size in New York again.
And so you know the map has been very consistent you know it's within a band as you might expect and and sometimes it's a little different just on how.
You know how the business is actually growing.
That year right. So if you.
Yes, it looked at a gallery that was converting in a year, where the business might have been growing at 15% that gallery.
Lifted bigger because you're at the grit business grew at 5% that gallery, you know that that number also influenced the lift right. So depends on what we're doing with the assortment strategy with the marketing strategy, so and so forth around the business, but but we've got enough of now we're we're very consistent.
Three predictable.
And then what's what's very different than other people in white hasn't worked for other people must most people.
You know they've taken a 5000 square foot assortment they put it into it 20000 square foot flagship.
Manhattan, or Los Angeles, or San Francisco name any city and it's still performs like a 5000 square foot assortment right you might get a little bit more sales, but yeah. What we have today is it's very different we have probably a.
200000 square foot assortment.
And less I think today, it's less than 5% of the assortment is in our legacy galleries right. Yeah. You can only go in and probably see 5% to 8% of the assortment today in a typical gallery. So when we go from showing.
5% of the assortment to 30% of the assortment.
We know that map and we know what that lift is and so in each of these markets. We look at you know not only how big of a Galleria is really but also you know how are we presented units each category. How many collections each category do we have how many living living room presentations dining room bedroom bathroom we.
We understand the mapping the productivity instead these these prototypes.
Are designed very scientifically very mathematically.
And we have a lot of data so.
And and because we've we now have a real proven concept in a high productivity concept it can.
That can perform on multiple levels right multiple floors, most retailers can't and they can use rooftop space and garden space with our outdoor furniture business.
You know, we're really very desirable to developers.
And so and you know were proven and now were more desirable we have hospitality, that's really valuable to developer 'cause it drives traffic into their development.
And we don't just to have any hospitality with many markets. So we're going into probably the most beautiful restaurant in the market and and one of the most productive restaurants in the market. If you look at our hours were not really open some of the peak hours for dinner, we closed relatively early.
And we don't have a bar so when you look at our productivity and you take the alcohol component away from it you look at our hours of operation, we were probably as productive as almost anybody out there and I think it's because we're building beautiful environments, we have an amazing hospitality and we have really high quality consistent.
Culinary experience and food so.
You know that just it's only going to make the gallery performance better going forward as we expand the.
The offer with beach, how ski house in color.
We're not going to do zero with any of those [laughter]. So they're all going to be incremental right and they don't even have to be in the gallery to be incremental to the gallery right because our galleries can sell beyond the four walls and store so.
Hi, we feel more confident than ever about the real estate strategy and.
And it really does matter with again, whether it would are kind of our lowest volume markets about $10 million right. So.
Our lowest volume stores, we're probably about as productive as many of our competitors highest volume stores. So.
You know.
Many people would like to have a 10 or 12 million dollar gallery.
Stuart you know, we look at those are kind of or lower volume ones, but when you know 10 million dollar store will turn into you know go for like tend to 17 to 18 in year, one and then to 19 or 20 or too.
Keep growing but we tend to on average by year three doubled the business, if we have hospitality and.
You know, it's less than that if we if we don't have hospitality.
Great. Thanks, so much for the color and just one follow up for me on outlets sales are continuing to expand curious if you talk about any additional drivers beyond the DC liquidation in the extent you think the eldest sales could be cannibalizing your your full price business.
No. We don't we don't believe it's a cannibalize the full price business Weve. The outlet business is basically always been a return business right. So it's mostly you know a return.
Slightly second quality product, sometimes it gets some new some new product if weve you know if we have long inventory. We're we're just continuing things, but really what we've done over the last several years is just reduce inventory and the company right I think versus our five year plan from three years ago. We the company has.
About $500 million less inventory if you would it if we were turning the business at the same rate. We were in 2016 I think today, we'd have about 500 million dollar inventory rights. If you can think about it is like for like company, we took $500 million of inventory at cost out of the system right. That's how much more efficient we are the companies.
It is significantly bigger on $500 million less inventory.
So we use the outlets to kind of help us liquidate that inventory right and drive down that inventory.
And so it's as we think about it going forward, we actually think that you know it's funny, you're asking because we're just going meeting stay for yesterday in here thinking about okay, now where do we go from here you know what does the outlet business look like for our age as we go forward.
And you know not that we want to.
Bill that big Big second quality brand or do anything to kind of.
Render the arch Brant less valuable, but we yeah we.
We've never really kind of looked at it in a real innovative way we've made its massively more efficient.
Next year, it will be massively more profitable just because we're not going to be driving so much.
Revenue at low price through it but we now have some some new kind of thoughts new vision systems and ideas for you know that channel that where we could probably even drive some incremental long term incremental revenues next year, it'll it'll probably be a revenue drag, but long term incremental revenues and incremental profitability. It's just it's never be.
Unused.
For anything besides liquidating.
Turns and damages.
Okay, great. Thanks, again for all the color.
Yep.
And your next question comes from the line this Bobby Griffin from Raymond James Your line.
Yes, good afternoon, and thanks for taking my questions. Just one quick clarification first is the 20% operating margin target inclusive of the international expansion or is that just for the North American business.
Well, there's some international expansion you know if I can say, we'll we'll we'll launch international and 21 or 22. So yes, you go forward I mean international.
We will be part of that.
So.
I I don't really kind of separate them out as we model it.
Okay I guess the other would have to do you Gary do you expect the international margin profile to be similar to what we're used to seeing here in the U.S. business I guess, the other way to ask about me clear Yeah. We do we do yeah. It was as we've modeled it out there'll be a little bit of startup cost die.
We opened at a DC again, but we're not going to open a giant DC. So we'll see some investments will have some minor overhead.
You know some boots on the ground internationally in.
They'll probably be some.
Slightly higher Preopening cost cuts will initially we won't be able to leverage the local teams will send more people over but again once we once we get a gallery up and running you know, it's pretty self sustaining a pretty quickly I. So.
Initially if we're if we're right on the volume foot, what's interesting here, Bobby and for the rest of people on that on the call that we probably even talked about.
You know when if you think about going into the UK.
Right the UK is.
What does that population 61 million or something like that.
California as the population 40 million, yes, 68 million to 40 million significantly more people in the UK very high demographic you look at California, we have lots of galleries brick and and yet we're gonna open in the UK with initially one and then we'll have to.
But you're going to have it be like think about New York.
If we just opened one gallery in New York, and we didn't have anything in New Jersey, which we've got to multiple stores. We didn't have Connecticut, we didnt have Westport, we didnt have Philadelphia, we didn't have anything that's.
In that geographical region, or just take that kind of almost that the entire east coast or the entire west Coast me.
That's great Britain is bigger than you know it got 40, 50% more people in California.
California with a lot of stores.
We were doing about 450 million in California, today, 450 million in California, and and we only have one market with the Big Gallery, and that's Los Angeles right. We don't have Orange County, we don't have San Diego, We don't have San Francisco, We don't have northern California in Marine County, We don't have Silicon Valley, we don't have.
Bay Walnut Creek area.
I mean, California once we once we transitioned to galleries will probably be a 700 million dollar market for US right. So will you notes.
Overtime double the retail business and we'll get a lift in direct.
So if you think about starting in the UK you know I look at it and get what what does that potential then a billion dollar market, what if I had a potential billion dollars marketing open to just one big store in L.A.
It it's going to be a giant store and the direct business is going to be huge.
Right.
You know so we think because of the.
The size of the market and the fact, we're opening with these really dramatic retail experiences with as you know within assortment that is.
Really disruptive.
That you know, where we're going to ramp very quickly and and get get really good leverage in the international growth you know, it's not it would be one thing if we were opening little galleries right. It's so it's very different that is what they were going in opening 7000 square, but stores opening in lending with a 7000 square foot store or in the less.
The greater London area with like four or five 7000 square foot stores and you know opening in these other markets with these little stores, and then having to come back and redo them.
Yeah, Yeah, I mean, we were opening these massive markets and where it opened with incredible brand statement and with an incredible assortment. So.
You know I think I think we're going to do really really well and then all the math on our internal models, even at our conservative side.
You know a return on invested capital in our operating margins earnings look really really good so.
We don't see this is being a you know any kind of real drag to the business site I know for some businesses, they rollout and internationally, they're not really making money or they've got to drag or if they go to wait five years to make money that that's <unk>.
You know I hate to say anything is impossible, but call. This.
Close to one Pos we'd have to have such as swing in a Miss you know like in these markets and I, just don't think thats going to happen not not based on the work we've done.
What we know about our brand today, how much we export to those markets today et cetera.
Okay I appreciate the detail very exciting look forward to seeing seeing one of those stores once they're up and running on secondly for me I I just wanted to go back to the comments about product margins can you maybe just help me get a better understand you're hoping to get a better understand the fundamental drivers driving better product margins and then within those drive.
There's the sustainability of that is there a concern that at some point if its price it consumer becomes you get too pricey for your core customer or is some of the drivers difference your volume, becoming a bigger part working with you know more fewer designers the doing more business with each one of those designers just help me frame the product margin discussion better.
Well, you know our product keeps evolving right and we keep kind of climbing the luxury mountain the quality get better. The you know with better quality, you know prices get higher but while the prices get higher there's still massively disruptive inside the marketplace.
Let's start with RH modern the average price of furniture and arch modern when we launched with.
30% to 50% higher than our core business.
Right, so and it's wildly successful, but it also had higher quality, we used it as a platform to kind of take another step up from a quality point of view.
And so.
You know I didn't know if you look we'll get the value of amaze globally, which is like.
$80 billion or something like some.
You know market value.
Theres a lot of people that want really high quality product and I think if you just study American business over the last whatever period, you want to 10, 2030, 40 50 years people trade up people will pay for better quality. They just won't pay more for the same quality.
They'll pay for better quality, so whats evolved in our business is the quality has gotten better the design has gotten better that taste has gotten better the scarcity is gotten higher the desirability has gotten gotten higher gotten better.
We were just a more desirable brand today, we are at more admired brand today, we have higher quality product today, we have better design. Good product today, we have better it's presented in more aspirationally spaces today.
We've got that we've got an aspirationally hospitality concept that drives thousands of people into our galleries that are now seen that really you know high quality high taste.
You know inspiring it presented inspiring spaces you know so it yeah in many ways, we're creating a new market.
Right and when Youre, creating a new market.
You've got a lot of leeway with.
What should the price fee.
I mean, I don't know you hold up a burke and bag against every other bag in the world.
Is it cost too much.
Is it too expensive or is it the most desirable bag in the world.
That's the way to think about it.
I appreciate it best of luck in the fourth quarter and happy holidays to everybody there it or not all happy holidays, Bob I think.
Thank you very much and that there no further questions at this time over to selling person needs to be continue.
Okay, well great. Thank you everyone for your time I, we wish all of you happy holidays, we look forward to hopefully seeing some of you I at our Columbus opening next week.
And it and if not we'll see you in the new year. Thank you so much.
Okay.
This concludes todays conference call. Thank you all for participating you may now disconnect.