Good afternoon. My name is Jesse, and I'll be your conference operator today. At this time, I'd like to welcome everyone to RH's second quarter fiscal 2018 Q&A conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question, please press star, then the number 1 on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. Cammeron McLaughlin, RH Investor Relations, you may begin your conference.
Thank you. Good afternoon, everyone. Thank you for joining us for RH's second quarter fiscal 2018 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, Ryno Blignaut, President, Chief Financial and Administrative Officer, and Karen Boone, former President, Chief Financial and Administrative Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities law, including statements about the outlook for our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results.
Please also note that these forward-looking statements reflect our opinions only as of the date of this call. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during our call today, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the investor relations section of our website at ir.rh.com. With that, I will turn the call over to Gary for some brief opening remarks, and then we'll begin our Q&A session.
Great. Thank you for joining us today. Before we start, I'd like to take a moment and welcome Ryno to his first call with us. We are very excited to have him join team RH. Welcome, Ryno. I would also like to take a moment and thank Karen Boone who is also on the call with us today, for six tremendous years of leadership. We will all miss her bright light, and we are very happy for her and her family in this next chapter. We know she's close and just up the road, but couldn't be more happy for you, Karen. This is the first call we've ever had two financial experts on the call, so this will be a little interesting, but we're all here to answer your questions today. With that, I'll open the call.
Operator, we're ready for our first question.
Thank you. As a reminder, if you'd like to ask a question, please press star one on your telephone keypad in order to queue for a question. Your first question comes from Chuck Grom with Gordon Haskett. Your line is open.
Hi, thanks. Good afternoon. First question is on the revenue miss in the quarter, along with the downward revisions to the third and fourth quarter expectations. Can you discuss how much of that came from internal decisions, particularly the SKU rationalization versus perhaps external factors, the consumer macro, et cetera?
Hi, Chuck. This is Gary. I think as we mentioned in the letter, it's very hard to be precise given the inventory optimizations last year, even harder to be disappointed when you've got gross margins up 800 basis points year-over-year. As we've said, we've got a clear focus in optimizing our business model. This is a year where we're going to manage the business with a bias for earnings versus revenue growth, like any retailer and almost all do. You can always pull levers and promote the business. We could easily put a lot more revenues this quarter, and we could post a lot more revenues in the next two quarters, but it would be at the expense of optimizing earnings. We're in a funny time from my point of view.
I've told the team here, I said, "Look, if you look at our industry, we've got a lot of people with declining operating margins, but they post a couple of points in incremental revenues, and everybody thinks that's great news." That's not what we're focused on right now. Our focus this year on optimizing this new operating platform and this new operating model. When we pivot back to growth next year, we've got the best business, the best brand, and the best operating platform in the industry. That's what we're doing. You have decisions day to day, week to week in this business, and our decisions are going to be made with a bias for earnings versus revenue growth. If people are unhappy with the fact that we took earnings up 14% and took revenues down 2%, honestly, that's their problem.
Our focus is to optimize this business this year and to position ourselves for the long term.
Okay, great. Makes sense. Then just to pivot towards next year, when you think about all the moving parts that you're going to have going on in the business as you pivot back towards growth, in order to bridge to that mid-teen goal that you guys brought forward a year today, how should we think about the most appropriate revenue run rate for 2019?
Yeah. Everything's still the same. Our long-term targets, as we stated, is 8%-12% revenue growth with earnings growth substantially better than that. Obviously, we think in the short term, it's going to be substantially better than our long-term targets from an earnings point of view. You're going to see us aggressively pivot back to revenue growth next year. We've been holding back a lot of ideas. We decided to make that decision, and look, I couldn't be more happy. You've got a company that has went through a massive transformation, right? Created an entirely new business model here. Our results are massively better than we or anybody else anticipated. We came into this year and our first outlook was for 9%-10% operating margins, and everybody thought we were crazy.
Now we've raised the numbers for a third time, the numbers are pointing in the 11%-12% range. So we've made a big step forward and the step to the mid-teens is a very short one away. There's more upside in this model than we anticipated. It's coming faster than we anticipated. I wouldn't be surprised if our long-term outlook becomes an even more robust long-term outlook. We just want to get a couple more quarters under our belt, it's going to be very clear what this looks like. This is going to be a model that throws off 50%-70% more earnings than anybody else in our industry when we're done.
Great. Then just my last question is, you talked about accelerating the pace of the new design galleries in 2019. I'm curious if you've sized up the opportunity long term both here in the U.S. and international in terms of the total number that you think you could do over the next, say, three to five years. Thank you.
Well, we said we're going to accelerate the growth because of the development of the prototype, you'll really start seeing it in the out years, right? Because as we do these deals, as we start to ramp up our pace. 2019, I think from a new store month point of view will be something like 18, then you'll start to see it ramp beyond that. One of the points we put in the letter was, we talked about the fact that we're developing a secondary market gallery at 10,000-18,000 sq ft. If our predictions are right and that test works, it will open a significant amount of more market. I think that the real thing we look at long term, as we think about this company is we clearly see a $4 billion-$5 billion opportunity, maybe greater in North America.
If you stand back and you look at the distribution of wealth globally, the distribution of wealth in America, you've got what? About one-third of the billionaires live in America. I think it's 15%-20%, whichever report you look at, percent of the millionaires live in the United States. If you looked at somebody's business like LVMH, right, who's got a collection of luxury brands, a very large business that is well distributed globally. 25% of their business is in North America. As we've been focused more on the global opportunity, we think the opportunity for RH is very big and it gave us the confidence to put out an initial number of $7 billion and $10 billion.
That number's, from my point of view, very conservative, as we look about the long-term runway and long-term sustainable growth on what we believe will be the best operating model in the industry that will be super efficient from a capital point of view. We like where we're going, nothing's changed.
Okay, great. Thank you. Karen, congrats on your retirement.
Thanks.
Your next question comes from Steven Forbes with Guggenheim Securities. Your line is open.
Good afternoon. I wanted to start with the new product development, right? You mentioned RH Beach House and RH Color within the release. Can you touch on how you plan on introducing these new categories to your customer? Is it catalog only, will be in future galleries? Then I wanted you to touch on Waterworks, right? You think about where we are relative to the acquisition a couple of years ago. Can you discuss whether there's a larger integration effort around this brand on the horizon here?
Sure. Well, you'll see us in 2019 launch both RH Beach House and RH Color. The way to think about those is. Well, one, let me answer your question specifically. As we do when we launch all new businesses, they'll be launched with a source book. They'll be launched with a lot of identification on the website, and possibly an adjunct website that's integrated, if you will, and as well as some of the product in the stores, we'll do some testing. I think if you think about the opportunity there. The wealthy and affluent customers generally have more than one home. All the data says that the second homes have twice as many bedrooms as the first homes, which has a huge opportunity to sell in those markets, whether it's beach house, whether it's ski house.
Thinking about targeting second homes and presenting goods and presenting collections that are specifically focused on those homes and presenting ideas that clearly give people ideas how to furnish their second homes. We're very excited about that. We've been working on it for several years. RH Color, if you think about RH, we're kind of famous for neutrals. There's a reason for that. That's by far the largest percentage of the market. There is a good percentage of the market that is a color-driven market. For us, over the last decade, we wanted to have a real point of view. We wanted to stand for something. We wanted to dominate something. Also, sometimes it's hard to integrate color. It's got to be done with real thought and real focus. Over the last several years, we've been developing this strategy and this concept.
We feel very good about it. We think we're going to come to the market with a very exciting assortment, color-focused, fabric-focused, that will be presented unlike anything else in the marketplace, that will make a big impact. I think it could open up another 25% for the brand and can be a very important part of the brand long term. You'll see us come after that aggressively. We think it'll amplify the brand and open up the aperture for the brand. You'll see that be introduced with its own standalone source book, and integrated into the website. You'll see an impact, if not all galleries, select galleries to start with.
Then just a quick follow-up on the reverse logistics network. Can you just touch on where we are? Obviously, gross margin here is benefiting from a variety of different factors, but where are you specifically as it relates to the outlets, the build-out of the outlets, and capturing that benefit associated with the reverse logistics?
Sure. The way I think about the three big pieces here, you've got the redesign of the distribution center network redesign. I'd say we're 80%-90%. We've got a couple of more moves that you'll hear about later this year as we optimize the distribution center network over the next kind of 12 months. As you think about the outlet and reverse logistics redesign, I'd say we're probably two-thirds into that. The real key is how do you One, we've changed a lot of the process in reverse logistics. We stopped sending product back to distribution centers. We have them coming back to the local home delivery centers and then going to outlets. Our outlet architecture does not adequately mirror our revenue architecture in the U.S. We're building that out and trying to get to how do you get to equilibrium?
How do you handle and dispose of returns and damages in the most cost-efficient, margin-efficient way, handle it the fewest times, move it the least amount of times, and optimize the margin and turn the goods in the most efficient way? I'd say we're two-thirds, call it 60% through that. Over the next, I'd say, two years, we will finish that out and get to equilibrium. There's still optimization to go there, and margin enhancement. The biggest opportunity is margin enhancement, inventory reduction, turn improvement. When you think of the home delivery customer experience reconceptualization, we're at the very beginning there with our test in the Bay Area. I'd say we couldn't be more excited about the early results, and from 2 levels. One, from a just a customer delight point of view.
I used to only get letters about us kind of somehow goofing up a delivery. Now I'm getting letters and pictures from customers about how excited they are about the experience. It's a complete transformation. We're beginning to measure the data. We like what we're seeing early on with reductions of returns, increase of stick rates, reductions of exchanges, and so on and so forth, being able to service the customer and, one, make sure it's perfect when they get it. If for some reason there's something wrong, to be able to dispatch a medic in minutes, not weeks, to a customer's home to resolve an issue. We think it's long term. It could be the most valuable thing we've done long term from a revenue enhancement, cost reduction, returns and exchange reduction, improved stick rates, so on and so forth.
The biggest thing we do. It'll be a multi-year project. I think it's going to three to five years to tackle the entire country. We'll perfect it. We'll then go to another market. We'll learn. We'll perfect it, and I would imagine as we get better and we learn more, we'll probably go faster. Right now, it's not about making it a little better. It's about a massive leapfrog beyond what anybody else does.
Thank you.
Your next question comes from Geoff Small with Citi. Your line is open.
Hi, Gary, Ryno, and Karen. Thank you for taking my questions. I just wanted to also touch on the gross margin, which obviously came in meaningfully better than you had planned. I was hoping you could break out the 800 basis points of improvement between the full price selling, the lower outlet revenue, and the supply chain changes. Just also curious how the back half gross margin opportunity breaks down between those factors.
Well, again, it's no different than we articulated in the letter, right? It's really coming from better full-price selling, improvements in the supply chain. It's significantly on the product margin side. You're seeing massive improvements there. As we look at the back half, obviously, we start to cycle some of the margin improvement as we come around in the quarters. We think we still get meaningful product margin improvement, and we will see continued supply chain improvement. Obviously, we had enough confidence in the numbers, so we took the numbers up in the second half and believe that there's meaningful upside as we look ahead and, again, even more meaningful upside as we look into next year.
Thank you, Gary. That's helpful. On the topic of the acceleration in sales growth targeted for next year, can you help us understand what you're looking for in terms of comparable brand revenue growth and also the level of contribution from the new initiatives across the gallery openings, the expansion of hospitality, and the extension of the RH brand?
Let's start with the brand extensions and the product extensions. We're very efficient, I think, at introducing new products and expanding the brand. Because we do it the way we do through a source book and online, we don't take big inventory risks initially, so we get very good return on investment as long as we're more right than less right from a product point of view, from a customer acceptance perspective. We should expect a really good flow-through. At least that's what we've always had on any of these businesses. That's how we think about that piece of it. Opening the new galleries is highly accretive. You're talking about a meaningful revenue pickup on a modest, generally, rent increase and so on and so forth.
The return on investment and the profitability returns on the new galleries is very accretive right from the get-go. Hospitality will continue to be less and less of a drag on our P&L. We had to initially build the team and the leadership team and the corporate structure of hospitality to be able to begin to open multiple units. That reaches scale somewhere around $50 million-$70 million in hospitality sales is when we start to have corporate SG&A on hospitality, more in the targeted range where the deleverage goes away. We will hit that number sometime next year and begin to leverage hospitality. We expect hospitality by the fourth quarter will be clearly profitable all in, right? The business at a four-wall level today is very profitable.
We just have to get enough scale to offset the initial investment, and that begins to happen in the fourth quarter. We've got a very profitable business in hospitality at the four-wall level. We've been fine-tuning it. The other thing I'd say, you've got to be careful when you think about something like hospitality that's a brand enhancer, that drives traffic, and you have to look at it in an integrated way. How do we really think about it? We've always thought of this business in an integrated way. What are the other contributions we drive? Clearly, we drive substantial traffic. We drive three to four times more traffic into a gallery, in a gallery that has hospitality than a gallery that doesn't have hospitality. Our numbers show that we get an X lift.
For every dollar of hospitality we drive, we get X in growth on the retail side. We've got really good metrics around that, and it's very consistent. Obviously, I'm not going to say what that is. We don't need to give anybody a blueprint of what to expect. When you look at it in an integrated fashion and the incremental revenues it drives, it's massively accretive to our business model. You would do it every time you could. The key here is executing really well. We always say inside our company that anything we do has to render everything else that we do more rather than less valuable. That's especially true for hospitality. Hospitality has to render the core RH brand more rather than less valuable. The only way it would render it less valuable is if we had poor quality and poor execution. Right?
The experience has to be stellar. The quality of the food has to be stellar. We believe that's what we're delivering today, and we're being very thoughtful and focused about building quality into the DNA of this experience, and then being able to ramp from there. Big test for us will be RH New York. That will by far be our highest volume restaurant in the company. We think it's a spectacular setting. I think it's the most beautiful rooftop in all of New York, if not all of the world. It's got views of downtown and Freedom Tower, and it's going to be incredible. I think it could be the hardest table to get in the entire city.
It puts a lot of pressure and a lot of focus on us to execute at the same quality levels that we have in all of our other hospitality experiences. That's what we're committed to. We know with each one of these, we're learning a lot. We know there's big tests, new learnings. I just couldn't be more proud of Brendan Sodikoff and his team. Not a lot of people can scale this quality of a hospitality experience the way they have. We're just going to be really focused, really thoughtful. The good news is the financial model now is unveiling itself. It looks way better than we thought, and it's now a real investable business.
Thank you, Gary. It's very helpful. Best of luck in the third quarter. Karen, best of luck in retirement.
Thanks.
No time off.
I'm going to take a break.
Yeah. I'm much too young to retire forever.
Your next question comes from Daniel Hofkin with William Blair. Your line is open.
Good afternoon. Just a quick question, I guess, when you talk about potential acceleration a little bit in the second half, is that relative to the 8% kind of underlying comp that you reported in the quarter or is that total revenues? Just how are you thinking about that? That's my first question.
Yeah, that's total revenue.
Total revenue.
Yeah.
Okay. Then in terms of longer-term store targets, can you update us on your thoughts there domestically and what that split might look like between the two main types of new galleries you're talking about?
We said last time that we believe probably two-thirds or so of the forward galleries will be the new prototype. Which is, when I say the new prototype, it's really our best thinking of the past 5 years. Everything we've learned from category, space allocations, flow, the different experiences in store, the hospitality experience, and how we think about rooftops and gardens for outdoor furniture. We think we've really got a super well-designed and efficient model. It's going to be no less spectacular than anything you've seen us build. It's just going to be way more efficient from a build point of view and from a productivity point of view. You'll see those start to ramp, and those will be kind of the dominant part of our rollout, and they're just more predictable from a time and cost perspective.
The capital efficiency of those new format stores, I think, will be the best of anything we've done. In addition to that, we'll continue to have what are referred to as bespoke galleries in the major markets, N.Y. being one of them. That obviously is opening here this week. Galleries like San Francisco or if you look at past tense Chicago, et cetera. Galleries that are really tailored to a market, that really optimize a market and then optimize the brand presence in the market. What they communicate about the brand regarding design leadership our respect for great architecture. We say we're obsessed with great architecture in this company. We either find it and readapt it or rebuild it. These kind of iconic locations, I think, communicate something about our brand that makes it very hard for others to emulate.
We've got what are called indigenous bespoke galleries that are really targeted to kind of the key second-home markets where the wealthy and affluent visit and vacation. Places like The Hamptons, where we have a gallery today, and we may do something more spectacular long term in The Hamptons, but very successful in The Hamptons. Built something that's very indigenous to Yountville. It's an integration of food, wine, art, and design. You see food and wine becoming more dominant even than design, because that's the valley and that's the language to speak there. I think it's the number 1 tourist attraction right behind Disneyland in the state of California, but it's the number 1 attraction for the wealthy and affluent customers. More people travel to the Napa Valley than almost anywhere.
Places like Aspen and other places like that, you'll see us focus on those. Again, really, we have great returns in those markets, but we have exceptional brand building with the wealthy and affluent customers. We're working on the secondary market stores. We look at some of these secondary markets, beyond the kind of 60-70 we initially have targeted. As we study those and get closer to those, we see a lot of opportunity, and we see those markets kind of dominated by regional or small local players that we think we can be very disruptive. You just want to size to the potential of the markets appropriately, you have the right capital investment, and make sure you have the right returns. That's what we're working on next. If successful, that could open up the market for us.
I don't want to say exactly how many yet. We'll see how well they do. Obviously, international will be the next big step and could be really the next big idea for the brand. I think our brand internationally will be even more disruptive than it is in the U.S. because you've got significantly less competition.
Great. Thanks, Gary. Appreciate the color. Best of luck, everyone.
Your next question comes from Michael Lasser with UBS. Your line is open.
Good evening. Thanks a lot for taking my question. Gary, you mentioned in the letter that revenues were a little short of expectations. If you broke that down between members and spend per member, how did each one of those components compare to what you expected? Did you recruit fewer new members than you thought, or did each one of those members spend less than you thought?
When you've got this kind of massive margin difference, it's not in those finite details, right? I've been doing this for 40 years. I've never had gross margins increase 800 basis points in a quarter. I've never had gross margins increase, I think, 500 basis points in a quarter. I don't know if there's anybody in our industry that's ever forecasted sales with 800 basis points of margin improvement and a focus on optimizing earnings, right? I wouldn't get lost in the details here.
I kind of stay motored up and say, "Look, what is this model looking like?" Just stand back for a minute and you look at our revenue growth and say. The only person I think in our industry that grew revenues faster than us this quarter, despite the fact we have by far the best earnings, are the people that don't make any money. Okay, got it. There's some big market caps out there on businesses that are not profitable. We've got a funny market today, and it's no different than when we decided to make the move to membership. I said, "Look, we have to be willing to march into hell for a heavenly cause," right? If we want to get to a better place. No different than this quarter. Humans are creatures of habit, right?
We're all retailers, we have this habit and this twitch that says, "Oh, revenues. Revenues are a little softer than we thought. We can do this. We can do that. We can do that." We're not going to do anything. We're going to optimize earnings. We're going to make decisions with a bias for earnings, and we're going to fine-tune this model. This may be the only chance in my life that I get to do this. By the way, this may be the only team that has ever done this. I've never been at a retailer that is focused like this on optimizing a model. No different than the move to membership and the value unlocked that membership created. The long-term value creation of creating a leapfrog model pivoting back to growth, pulling growth levers.
Not moving back into promotions, we could've easily drove a lot more revenues. We beat earnings by plenty. I think we just look so different on every level, what we're doing. Whether it's the move to membership, whether it's building the galleries we're building when other people are shrinking stores. On and on and on and on. Look, I told the team, I didn't really care what the stock did today. I said, "Look, our stock could go up 20 bucks, it could go down 20 bucks." Our revenues are lower than guidance. We took revenues down 2%. We took earnings up 15%. I'll take that trade any day. It may not be what the external world expected. It was better than we expected. Slightly different on the revenues, only because we're trying to sit here and forecast revenues with 800 basis points of margin expansion.
As the model goes in, then we adjust it. As we learn, we're adjusting it, but we're adjusting it and we're taking earnings up.
I would add, too, that make no mistake that we're super happy with membership.
Yeah.
That has been a game changer for the company.
Game changer. Membership revenues are up.
Yeah, membership should grow generally with sales. The math is such that you are always going to become a member. I would add that as Interior Design services have taken off, these new galleries and average order values increase, you would not expect that $100 with a much bigger order size. Overall, membership, we could not be more pleased with how it is performing and what it has done for our business.
Yeah. I feel like we are going to look back here, people are going to look back here and realize what we are doing and that what we are doing right now, while somewhat unconventional for our industry, is going to prove to be, I think, transformational for our industry and transformational for our business and brand long term. This is just another quarter and another step in our journey. The biggest news that is going to happen this week is our brand is going to arguably open the most innovative retail store in the world in the most important city in the world. I do not even know when the last time that was done. I guess if I look back, it was probably 35 years ago, 32 years ago when Ralph Lauren opened the Rhinelander Mansion on Madison Avenue, I think that changed everything for their brand.
I think when people see what we have just done in New York City and the echo that is going to create around the world and how that is going to elevate our brand, I think it is going to make a huge difference. Something that you cannot do with digital advertising, something you cannot do with anything that anybody else is trying to do or how they are trying to market their brand. I tell everybody, "You really want to see where we are going? Come show up this week in New York.
As you transform into this newer model, is there a point at which you expect the top line will become more predictable? The ability to predict the top line will become easier? Are there levers that you would push to grow membership on some of the more mature galleries that have been opened?
Of course, it's going to be more predictable. That's the whole point. If I asked everybody on this call, name retailers that have improved their gross margins by 500 basis points or more in a quarter, I don't think anybody's even got one they can put on the list, let alone name somebody who's improved margins by 800 basis points in a quarter. We're going through a different time. It's not about the nits and gnats in the sales forecasting. It's about, are we developing a leapfrog operating model and platform that will put us in a position to dominate and win long term? That's the key here. Don't get lost in the details. You're going to miss the forest here. The key here is what does this business look like? What does this model look like?
What is this value of the company going to be over the next several years? We think the value's going to be significantly higher because of the work we're doing. We've got a stock that's massively volatile today. For everybody that's looking at it from a short-term point of view, that's not the game we're playing. We're playing a long-term game, and we're playing to win long term.
Thank you so much.
We run this company like we owned 100% of it. Right?
Understood. Thank you so much, and good luck.
Thank you.
Your next question comes from Curtis Nagle with Bank of America Merrill Lynch. Your line is open.
Good evening. Thanks for taking the question. I'm just wondering if you could just quickly go into the free cash flow guidance. You're maintaining $260, or it's over $260. It looks like the first half came in maybe a little light. Just hoping you guys could maybe flesh out how you think the rest of the year is going to play out. Do you still think that inventory will be a source of funds?
Yeah. Sure. 260 is still our number, and again, I would point out it is better than 260. Inventory, we're still tracking at 450 to 475, so we do expect it to still be a source for us this year. Obviously not as big as last year, but it's still tracking in line, and our forecast had always called for more of that to come in the second half versus the first half, as we work through going from four DCs to two DCs and some of the receipts of getting the inventory received in the right place. We've continued to make progress in making sure with our SKUs that we don't have every SKU in both DCs. Some of the lower velocity SKUs are now only in one DC, and some of that, again, was affected through receipts versus sales.
Yeah. I would say, Curtis, neither earnings nor cash flow is below our expectations, neither one of them. The only one is the top line is a bit below our expectations.
Got it. Okay. That makes sense. Just a quick follow-up. I guess, what are we expecting for the outlet business? I think you added another four stores. How did it perform? How did sales perform for the quarter, and where do you think you're going to end up by year-end in terms of total top line?
Yeah. The outlet business is evolving as we're trying to kind of design the network and reach equilibrium, right? Equilibrium without a lot of transportation costs, right? It's a completely new model that we're designing and building. Get the model all fine-tuned, get all the outlet stores in all the right markets, and optimize that business. We think we've got continued margin enhancement opportunities, cost reduction opportunities in transportation, in the outlet business.
We do have in the press release, you can see that we do disclose the dollar amount of outlet revenue was about $38 million this quarter, and that was down from $51 million last year at this time. That's going to continue to be a smaller number than last year into Q3 and Q4 as well. We'll be below last year's overall outlet level. Again, as we grow the business and put the outlets in the right location, we're not expecting that to be a big growth driver long term. It's really just the way we dispose of our reverse logistic inventory.
Okay, understood. Thank you very much.
Your next question comes from Matt Fassler with Goldman Sachs. Your line is open.
Hi, this is Stella originally on for Matt. Could you talk more about your real estate strategy, specifically how you're thinking about your exposure to the mall, and at what point can or will RH be largely out of the mall?
Yeah, that's not necessarily the goal. I think it all depends. I think you have to ask yourself which mall, right? There's some really productive shopping centers in the world. Ones that the best developers are investing into and are no different than we are creating next generation shopping destinations for consumers. We have no headline says that we don't want to be in the mall. I think, most of the press that talks about a lot of the decline in sales is about the secondary, tertiary malls in the U.S. that are losing Sears, losing JCPenney, losing whatever anchors. All the dying retailers that are a big part of the decline and the decay. There's a lot of developing centers that are really fantastic and will continue to be fantastic, if not even stronger long term. Let's start there.
I say that we look at every market and try to say, what's the optimal location in the market for the brand today and long term? Where you're making long-term real estate decisions, it's not just where it's at, but where do you think things are going. When we made the decision to do the deal in the N.Y. in the Meatpacking District, it was five years ago, right? Now the project's gotten approved, developed, built, delayed because of the streets under construction. I think we're pretty good at figuring out where things are going. Now you've got the Whitney Museum that's opened right across the street from us now. Our hope was always to anchor the Meatpacking with a luxury business because there wasn't really any luxury in the Meatpacking.
We thought with the Whitney coming in, we can anchor this other corner of the Meatpacking that, Gansevoort Street, where we're going to have our first guest house at 55 Gan. We could tilt the street and create a luxury destination. Hermes took the corner across the street from us. Loro Piana took the other corner. Pastis is reopening across the street from our guest house. I think what you're going to find is the Meatpacking is going to be one of the great retail destinations and traffic destinations in New York City for years to come. They're all different. If you look at Chicago, we made a bet in really the most affluent neighborhood in all of Chicago. We're right in the middle of the Gold Coast in a historic building. We believe the Gold Coast is a good long-term bet, a great long-term bet.
If there's an opportunity to do a bespoke location that speaks to the brand, that's great. We will not do that if it means compromising revenues and earnings because we don't want to be in a mall. I think people that are too black and white and linear with decisions like, "Oh, I'll never open a retail store." Or, "Oh, we'll never go into a mall." It's going to miss opportunities. You've got to keep your mind open. You've got to really do the math on all these things. You got to understand where the investments are going to be made and where things are going. That's why I respond almost to anything when somebody says, "Oh, I'll never open a retail store." Oh, this. Oh, I'll never open a mall. That kind of thinking is going to miss a lot of opportunities.
I think you got to leave your mind open and just try to be as smart as you can and maintain maximum optionality and make the best call for your business. I mean abandoning malls, good luck to the retailers that want to take that strategy. There's going to be a lot of great shopping experiences coming.
That's really helpful. Thank you.
Your next question comes from Peter Benedict with Baird. Your line is open.
Hey, guys. Congrats, Karen, and welcome, Ryno. First question, I'm curious, Gary, around the supply chain to support the new concept launches. How much of that is piggybacking or leveraging existing vendor partnerships and relationships, and how much of that is striking up with new folks? That's my first question.
Really, 100% is existing relationships.
Okay, great. That's good to hear. Circling back to the member conversation, you guys ended last year with a little over 400,000 members. You were adding net around 25,000 a quarter. I think that was the pace last year. Is it safe to assume that pace has continued, or when should we expect a leveling off of that? I'm just trying to understand maybe where you're sitting right now in terms of member count.
Yeah. Actually, you should expect an acceleration of that pace. You've got the dynamic again, if you think about the SKU rationalization, right? The SKU rationalization brought down retail, brought down average orders, accelerated individual transactions, and it would accelerate something like membership, right? Now we're anniversarying that, you've got membership growth slowing, although it was still positive. Now you should expect, as we cycle around, membership growth will grow faster. It'll accelerate.
Okay. That's helpful. Thank you. Last one, just the tax rate that's assumed in the second half adjusted earnings guidance, what should we be thinking there? Thank you.
We're using 26%. We're not assuming any benefits from stock options exercises in that number for the second half.
Okay. That's all.
Which is also the main driver of the 4% in the first half in this quarter.
Yep. Okay. All right, great. That's all for me. Thank you.
Thank you.
The last question we have time for today comes from Brian Nagel with Oppenheimer. Your line is open.
Hi, good afternoon. Gary, you've spent a lot of time on this call and in the letters talking about the prioritization of profit over revenue and the strategy behind that, the effects on the results here. Just wondering, could you maybe articulate a little more within that strategy, specific product decisions, marketing decisions that have been made? As we're thinking about that, is it more of this transition period where you find that balance and then going forward, it'll be less of a trade-off because the business will actually be operating under that philosophy?
Correct. Specifically, we've held back. Remember, we came out and said 2017 is about execution, architecture, and cash, right? We said we wanted to execute our new membership model, architect a new operating platform, and optimize cash by increasing revenues and earnings and decreasing inventory capital spend. That was 2017. We said, as we got through that, based on that focus, we are able to begin to see opportunities that we just couldn't see before. We said, "We're not done here. We need more time to focus." When we came to 2018, we said 2018 will be about a continued focus on execution, architecture, and cash. By doing that, in 2017, we said we weren't going to launch any new businesses or brand extensions outside of RH Hospitality. In 2018, we had things planned to launch.
We said, "Look, we need more time. We want to focus more here because we think the long-term opportunity of building a massively differentiated model and more efficient model is once in a lifetime." Once you get back on the tracks running, it's hard to do the work we're doing. You need all the brains in the game. You need a complete collaborative, cross-functional effort, and it takes the time and attention of every leader at the top of the organization to lead the organization through the kind of massive change we're leading the organization through. It takes an inordinate amount of focus and discipline. We said 2018 will be a continued focus on execution, architecture, and cash. The businesses that we were going to launch in 2018, we held back. We focused for another year.
That's a tough trade-off because we're in a business where a lot of people just get overly focused on the top line and never focused on the bottom line, and they just never build a great model. This'll be the last, I'm sure it's the last retail business I ever lead or build. I've always said since I was a stock boy at The Gap, I grew up in the retail business, I used to get these stupid memos from headquarters telling us to do this and do that. I used to think about all these knuckleheads in corporate, like, don't they know what inefficiencies they're driving? Don't they understand the business? They're wasting this money or doing this and not optimizing things.
I always said, one day if I grow up and get to run a retail company, I'm going to try to make it great and try to make it super efficient and stop the dumb things. I've got a shot to do that. This is it. That's what I'm committed to do as the leader of RH and with this team is aligned and focused on doing it. We couldn't be happier with what we've learned. We couldn't be more ecstatic about what we're accomplishing. Once again, because we're unique and we follow our own path, we're hard to understand. We're just trying to be super clear to you guys. You can read all the letters in the last two years. It's laid out. In 2017, focus on execution in cash.
2018, a continued focus on execution, architecture, and cash, that we have managed the business with a bias for earnings versus revenue growth, that we will hold back the launch of new businesses and category extensions and so on and so forth. That's what we're doing. We could've launched RH Color and RH Beach House this year. We could be doing a lot of other things, but we wouldn't be able to get to the business model. We're in an industry today where most retail business models' operating margins are declining, not growing. They're declining. You've got people going from the 10% range to the 8% range. You got some people, and I don't have to name names, but they've gone from 15% to 4%.
You've got allocation of capital in trying to grow sales online, and all people are doing is shift new sales from retail to direct and creating a higher cost model. I think it's all because people are running around working real hard on all the wrong things. They're not disciplined, they're not focused, they're trying to win and get a pat on the back quarter to quarter. We're not doing that. Okay? We might be one of few retailers in the industry that truly have a real long-term view here. That's how we're leading the business. It reflects leadership in the business. Look, I'm by far the largest shareholder in the company if you take all of my options and incentives, right? I've got a big stake in the long term, not in the short term.
Our leadership team, it's the same incentive and motivation. We want to do great work that we're going to be proud of, great work that we're going to be inspired by, great work that is going to inspire others in this world to try to do great work with their lives. It's a different game. It's not a quarter-to-quarter game. By the way, even though we're playing a game, we have the best earnings growth in our group, I don't know if anybody really has much more of a better revenue growth. Maybe somebody's got a percent better or something like that. Not with the earnings. Generally, with flatter declining operating margins. The investors who want to reward those people are probably just short-term investors. They're probably moving money around.
We've had the same long-term investors for many years here, including the people that are inside the company. That's how we're making the decisions, I think our long-term shareholders are going to be greatly rewarded.
Thank you for all the color. I appreciate it. Good luck.
Sure. Thank you.
I would now like to turn the call back over to Gary Friedman for closing remarks.
Great. Thank you everyone. Again, I want to welcome Ryno. I want to give Karen a big ovation and send off goodbye. She's been a great partner of mine for 6 years, thank you for everything, Karen. I just want to say to our entire team, all of our people, all of our partners, all of our shareholders that are on this call, the work we're about to unveil in the most important city in the world, I think will make everyone proud. For those of you that aren't here, I hope you get here soon because this new gallery, even though I've been involved in every detail for 5 years, it's just taken my breath away. I think it is truly the most innovative and most inspiring new piece of retail work this world has ever seen in the most important city in the world.
I couldn't be more proud of the work we're doing. I can't wait till everyone sees it. Those of you that are in New York City, come by and say hi. We'll be here all week. We've got a lot going on. The official opening to the public is on Friday. We'll be here all day. Yeah, come say hi. Thank you, everyone. I appreciate your time and interest.
Ladies and gentlemen, this does conclude today's conference call. We thank you greatly for your participation. You may now disconnect.