I'll now turn the call over to Ms. Cameron McLaughlin. Please begin.
Thank you. Good afternoon, everyone. Thank you for joining us for RH's third quarter fiscal 2016 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Karen Boone, Co-President, Chief Financial and Administrative Officer. Prior to this call, we posted a video presentation to our investor relations website, ir.restorationhardware.com, highlighting the company's continued evolution and recent performance. Before we start, I'd 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 and video presentation 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. 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.restorationhardware.com.
With that, I'll turn it over to the operator to take our first question.
Once again, ladies and gentlemen, if you'd like to ask an audio question, you may do so by pressing star then the number 1 on your telephone keypad. Our first question is from the line of Matt Fassler from Goldman Sachs.
Thanks a lot and good afternoon, good evening. My question really relates to underlying demand, as best you can address it. You said in the video that written sales were not quite up to expectations in the third quarter, and certainly that was the case, it sounds like, in November. If you could talk about the cadence of demand and the impact that some discrete items might have had on it, specifically your discussion of the later mailing of the books, and also the weakness that you had in November and perhaps what you've seen in the brief couple of weeks since then.
Sure. Matt, this is Gary. There's really three things we can look at and somewhat quantify today. That is that there's a real softness in November. November got off to a very slow start. We think that was created by some distraction around the election. At least that was our hope early on. As we got past the election, our business was building at a slower rate than we had anticipated. As we dug into looking at some of the implications around that, one of the things that stood out was our books were getting in-home slower in November specifically than we had planned. Beginning in November, we lost about a month of books in the delay. Also impacting the business is really just a poor-performing holiday collection.
We believe some of that, in looking back, is from probably being too aggressive and pulling too much of the holiday content out of the store. Our thesis was we could consolidate holiday in the DC, consolidate the inventory in the DC, move more of the sales to direct, offer free shipping, and we could run the business at a more productive level and at a higher margin. Our thesis, it proved to be incorrect. I think we're just losing too much of the conversion from the store traffic in the stores. One of the things we're considering is next year, layering back in some of the holiday decor and gift items. We won't put the stocking stuffers back in. We think that's just a legacy business that doesn't associate with our business, with our current content. That's really the key things.
For us right now, I think what's difficult is, as we sit here today, how do we think the business will build into January? How do we think the business will build as the books get in? As the impact of our gallery conversions and remodels where we put RH Modern and Design Ateliers, how long is that ramp? In N.Y., when we converted that store and watched RH Modern last year, it took about six to eight weeks to build to the level, RH Modern built to a level where it was doing consistent run rate. It took about that long. We think we've got a build coming from the investment we made in the stores. We've got a build coming from the books in-home and the month later versus where we are. The holiday miss is going to go away.
At the end of this month, the holiday miss, the drag of holiday reduces considerably. You have some holiday markdown sales in the first few weeks that are a little bit of volume, it falls completely off. As we look forward in the next year and we rebuild our base off of next year, off of where we think this will land, the only thing I'd characterize, I think we're being conservative in Q4 today because we just don't have visibility in the builds. It could be a little better, but today, based on where we sit, we thought it was right to take a conservative view based on how we saw the rest of December and January.
When you build and you look forward, you take a look at next year and you build off the base where we think we're going to end, you take a look at the four revenue and earnings drivers next year, as you look forward to 2017, we're going to anniversary the cost related to the launch of RH Modern, which we'd estimated around $20 million. We moved beyond the timing issues related to the launch of RH Membership, expect membership revenues and earnings to increase by about $20 million year-over-year. That's on the P&L affected. We'll pick up about $20 million there, and those fall straight to the bottom line. Those are 100% margin. We'll begin to cycle the efforts to reduce our inventories and rationalize our SKU count.
We expect product margins to rebound meaningfully year-over-year, beginning in the first quarter. The fourth point, which is the one that we'll have to watch as we build through the end of this quarter and into first quarter, we expect revenues to increase based on the fact that we just mailed the books, we'll be up against no Source Book throughout the first three and a half quarters of next year. We'll mail the Modern book in the first quarter. That should provide substantial revenue lift year-over-year. You add to that new stores that are flowing from this year into next year, you add the new stores that we're opening next year. We feel very good about looking at how we see 2017. It's what I mentioned in the video.
With each passing quarter, we have more certainty, as it relates to how we look at 2017. We have a lot of data now about membership. The only open issue I'd say about membership that we don't know next year, but I think we're conservatively forecasting it, is how we're forecasting renewals. We do know from sign-ups today that a very minimal percentage are opting out saying, "Don't auto-renew me." We believe based on what we've studied in other companies and what we think renewal rates will be, we think we're conservative, and we've got that forecasted in a conservative rate. We have a lot of data now. We feel very good about how membership's rolling through. As we think about 2017, we think we're going to bridge into next year and be very happy with where we land.
I guess a brief follow-up, just to get clarity. Are you getting any comfort from the build that you've seen since business presumably troughed around the election? Is it driving closer to a rate that would be consistent with your long-term growth expectations? Or is it still subdued given the holiday issues and the mailing of the catalog or the timing of the mailing?
It's clearly subdued, and we forecasted it to be subdued from a demand and revenue point of view through the rest of the quarter. My point being is if you take that new base and you build off the base into next year, we feel very good about what next year looks like and the bridge back to business performance that would be more in line with what we'd expect.
Thank you.
Our next question comes from the line of Oliver Chen from Cowen and Company.
Hi, thank you. I had a question regarding the SKU rationalization. Why did you guys pursue it a little more aggressively than you originally expected? Also on the CapEx line, do you have flexibility to continue to kind of tweak that number down in the event that your free cash flow doesn't materialize how you'd like it to? Gary, I think you articulated this, but if you could have done this over the past year, just what would you have highlighted that some differences you would've made? I think also we wanted to know about the Source Book, why was it a little bit later? You had mentioned that it was one month later than planned. Thank you.
Sure. Yeah, let me kind of address those from bottom to top. I'm going to take it backwards. One, why the book's in later than planned. One, we're one of the few people that mail a book our size and our complexity. Some of our books are mailed in bundles. We mail a book, a 600-page book. Our printers don't really have other books of that size besides phone books. Our books still go through like a typical catalog goes through a facility, and our book goes through multiple facilities. There's always a chance that there's going to be some delay in the printer, which we had some delays.
Likewise, when you go through the US Mail postage system with a book of our size, at each of the points that it moves through, whether it's going from the printer to BMC or an SCF, center facility, and then breaks out to a post office, and then the post office ability to handle it and move it, our books can be somewhat imperfect in predicting how they move through all those points and all those steps. We had some delays as we moved through the printers, and we had delays as we moved through the postal network, and those delays were compounded in the postal network. I think what we didn't anticipate is the first time we mailed and had books going in in November And ending in December. The November books is where we missed.
I think we missed because we went into a very crowded time, right? You have all the holiday mailings. The other point is, it was very unusual, we had all the postage that was going through based on the election, right? If you think about early November, a lot of election postage going through the pipeline. That's the feedback and the insights we've been able to give. That's the impact as it relates to the book being later by about, we lost about a month of in-home, about 30 days of in-home. Clearly, we decided to use this year as a kind of a transformational and transition year, and make a lot of moves with the business, from moving from a promotional model to a membership model, which we thought was right for the business long term.
In the first quarter, we were still in the very early days of the launch of RH Modern, we had to figure out how to ramp that business. We decided to reevaluate our supply chain and the way we were moving against our supply chain, and we were ready to put a shovel in the ground to build another DC. We decided not to. One of the ways to avoid that was to reevaluate our inventory, be more aggressive in moving through SKUs that were not long-term, that we didn't think hit the performance hurdles and metrics to be in the assortment. We decided to accelerate that this year, avoid building a distribution center, give ourselves time to reevaluate the network and design the supply chain network in a way that we thought could be more productive and more impactful to capital usage and turns long term.
As far as several other initiatives, we redesigned the entire Source Book. To do that, we delayed that. Also we delayed it to give our vendors more time to catch up on Modern. We remodeled all of our stores, rolled out Design Ateliers and doubled the size of our interior design team. When I look back at many of those things, there's some other things we did too, but those are the big ones. I say to myself, "What would I have done different this year?" The biggest thing, if I had to make a decision over again, I would not have delayed the Source Book. I think that the vendors in Modern recovered and caught up. I don't think that mailing the Source Book would've had the impact, the risk we thought it could've on the vendor base.
The efforts to redesign the Source Book, while I think it looks fresh, new, and very impactful, the lost sales of mailing it 6 to 8 months later cost us significant revenues in earnings. I think that created the biggest risk on the year. That's what I would've done over.
Oliver.
Hey, Karen.
Any follow-ups on that one? I can take the other two.
Karen, I was curious, for investors who are concerned about free cash flow and the outlook there, it would be great to be briefed on your thoughts around that CapEx.
Yeah, sure.
Strategically, the SKU rationalization was, why were you incrementally more aggressive? Was that an effort just to make sure you were clean? Because it looks like you've been prudent about trying to make sure you're aggressively managing inventories as well.
Yeah. The two questions are definitely tied because they both impact our free cash. So one, our working capital has been something that we're very interested in making sure that those inventories get down. As you guys saw, we ended last year with our Q4 miss with much higher inventories than we wanted. So some of that, the ongoing assortment, we just managed through lower receipts, but there were that critical evaluation of the SKUs, as Gary mentioned, to see what we no longer needed in the assortment. So we've been making great progress in that initiative. As you can see, at the end of Q3, our inventory was at plus two, and that includes the Waterworks, so really great progress with that.
As we're heading into Q4, with some of the slowdown and what we saw in November, whether it was the election or the consumer, whatever the reason, we don't want to be sitting on some of that inventory, and we want to move through it. So we went to, at the beginning of the month or about the 11th, we went to 20% off sale. A lot of the stuff that's on sale is that SKU rat merchandise. And then we also just took a little bit deeper markdowns on some of that, and we're planning to continue to do that through the end of the quarter just to make sure we're clean by year-end and do get through what we wanted to get through.
That has obviously a very positive impact on our cash flow situation as we head into next year if we can continue to make improvements on getting our inventories down. The second piece of that with the capital, you saw that we took our range down. That's really just based on the lower sales and what we're looking at. We're taking a much more critical look at what projects we have on deck, what's in flight, where do we need to be more critical in that spend. I still feel really confident in what we have the ability to affect, both in the real estate and other projects, what's nice to have, what's a need to have, and we'll continue to be diligent in that to make sure we reach and deliver that free cash flow positive goal in 2017.
Okay, thank you. Best regards.
Thanks, Oliver.
Our next question is from the line of Steven Forbes from Guggenheim Securities.
Good evening. Gary, if you can, maybe just taking a step back, given the amount of challenges this year and recent additions to the team, can you just give your thoughts on the organizational capacity of the business, given everything that's going on as we look out into 2017 and beyond here?
Sure. Yeah, I think we have the strongest team we've ever had historically. Let me start at the top. I think the changes we made in creating the Office of the President to break down silos, drive collaboration, drive a cross-functional view of the business as we drive our key strategies and priorities and decision-making through the company, I think it's just beginning to make a very big impact.
I think, when I look back on my career years from now, my sense is I'm going to look back and say, "That was one of the best business decisions I've ever made." The silos that are being broken down and the collaborations that are happening and the way we're now starting to lead and make decisions for the future, I think are just significantly better decisions, more fully informed, and we're going to start seeing impact and benefits from that as we look into next year. That is also trickling down to how we've organized the organization at a level below, right? We created internal chief merchandising officers inside the business. We have three of them. They control cross-functional teams that have merchandising, product development, sourcing, inventory management, where many of those functions were independent.
Again, breaking down those silos, and the leaders we have there, I think are fantastic and we're going to see big impact from the business there. I think the next big piece is really what DeMonty has done in a very short period of time in the supply chain operations call center part of the business. I think the organizations that he's put in place, and the strategies they're developing, the urgency they have, the fresh kind of minds and points of view looking at our supply chain and looking at our product pipeline and how we lead that and how we execute at that level, I think the impact that we're going to see over the next one, two, and three years, I think is going to be huge. Alex has brought in tremendous talent. Tom Kurtz worked with Alex at Amazon.
Tom was the head of global customer service for Nike, and Alex brought him into the company. Dave Neumann, who was at Target and crossed paths, worked with Alex at Target and then, prior to that was at Apple in supply chain and operations and technology, who's joined us at a senior level is terrific. These three guys have worked together, and they understand each other, and I think they have just standard levels that are much higher than we've ever had, and intellect and problem-solving capability that is world-class. I just couldn't be more excited about the team and the changes that DP's Damonte, excuse me that Damonte has made. There's many other changes.
Damonte likes to say he's also our chief values officer, and one of the things, if you're here, you hear him say almost every day is the right people are our greatest asset, and the wrong people are our greatest liability. He's made, I think, 54 changes in that organization. The people he and Alex and team have been bringing in, I think we're going to see RH organization leapfrog over the next one, two, three years. Couldn't be more excited about what's happened in that side of the business. I think just across the organization, I think this is the best team we've ever had. Of course, our results right now, I'm talking about this in the face of kind of a very disappointing outlook as we've just guided it down.
I think, look, we made some very brave and courageous decisions this year that I think are significantly strategic that many people don't make in our industry. I think that we're going to be right on most of them. I think that the one thing, if I had back, if I could have done it over, if we would've mailed the book in the spring, we'd have probably had $100 million more in revenue this year, and the earnings outlook would've looked a lot better. We thought we had enough room to navigate, and we thought we wanted to get the book redesigned and give our vendors some room. Again, if I had that one to do over again, I would've done that one over.
Based on the data we have today on memberships, based on how RH Modern is building and tracking, based on how our new galleries are performing, based on how F&B has performed in Chicago and our investments to build an F&B organization and put restaurants and wine vaults and coffee bars in five stores next year, the impact we think that'll make to the long-term model of the business.
The remodels of all of our galleries and putting Modern in those stores and putting Design Ateliers and the investments in interior designers, I think are all the right strategic investments. I think the decision to go through an aggressive SKU rationalization and forego building another furniture DC and rethink how we are going to design the supply chain network, and most likely have a strategy that has fewer DCs that requires significantly less working capital and inventory, and is going to improve in stocks and the things we are doing, the investments we are making in the final mile system, in selectively insourcing delivery and trucks, and the tests we have there, I think it is going to make a huge impact on the back end of our business and our customer experience.
I like our team and I like our strategy and as you guys saw earlier in the quarter, I am too an investor.
Thank you, Gary. Maybe as a follow-up, touching on one of the topics you mentioned there pertaining to home delivery and the progress you are making on those initiatives, can you touch on where you are today, both in terms of your customer satisfaction scores with delivery in general? Also, Gary, if you can, where does the company sit today versus where it needs to be as it relates to completing that final mile and completing the transaction itself?
Yeah. I think as you look across our supply chain, there are some areas where we are executing at a B and some areas we are executing at a C level, and we believe we can leapfrog and get everything to an A level. It is going to be kind of a step-by-step as we make these investments. We have got a lot of things that we have got to test. We are moving in the Bay Area DP. We are buying our own trucks or leasing our own trucks. We are insourcing it. We are taking 100% control of the delivery.
Yeah.
We just think there's an enormous opportunity here to reduce returns, reduce exchanges, get deliveries to stick, delight customers at that point. I think I've said it before, the fact that we have outsourced that last piece of the business, and it's really been a compounding outsource, right? There's many markets where we haven't controlled the hub. We're starting to take more control of the hub. We don't control the delivery, right? You have a third-party delivery group who's scheduling drivers. Those drivers are not always consistent. There's an inconsistency in the vehicle. There's an inconsistency in the talent, in the people that are making the deliveries. If you can make a justification at actually going into people's homes with a third party, and in some cases, a third party's a third party, it's a double outsource, compounding outsource situation.
Just because it's slightly cheaper, you should make the same argument and say, "Why don't we staff our galleries with third-party people and stuff like that?" I'm sure we could do it cheaper. That's not the brand we're trying to build. I think we still have some kind of legacy habits and mindset left. If you think about what this brand used to be and the brand we've built today, if you look at the go-forward expression of this brand, and you look at the galleries in Los Angeles, Atlanta, Chicago, any of the new ones we've opened, it's a world-class experience. No one's ever built retail experiences like this. The level of quality of the product, the level of quality of the experience, the level of the quality now that we're taking in the interior design, too. You've got to have a consistent quality level throughout a brand, right?
The great brands don't have different levels of quality at different customer interaction points or touch points. The really great brands, it's a consistent level of quality. I think because we've taken this company and this brand from something very different to where we are, we still have parts of the business that are catching up, right? That's where we're making the investments and where there's a lot of upside. The good news is we're not sitting here thinking that there's not a lot that we can do better. We think there's a ton we can do better here. That's why we're making the changes that we're making and making the bets that we're making.
The other thing I think that I wouldn't let it get lost on anyone, moving from a promotional retail model to a membership model, creating a more consistent, streamlined business, the impact that's going to have on our execution, on our cost structure, on our ability to think strategically and make important decisions for the business as opposed to how most retail companies with promotional cadence, they're week-to-week spending all their time trying to figure out what's the next sale, what's the next promotion, how do you comp this, how do you comp that? You get a much lower level thought process, right? I think what's different about us is we think big. We make big moves. We make big strategic moves. That's how we've gotten to where we are.
We're at the very early stages of doing a real estate transformation that the world's never seen. We've already augmented that with hospitality in a manner that the world's never seen. We've just introduced RH Modern with a 500-page book, which is a meaningful business, and opened a brand new store. We are taking interior design services to a level that the industry has never seen. I think it's because we have the ability to think strategically to see big moves. We wanted to get out of the rat race of this crazy promotional cadence, having the same emails that everybody has. How many companies over the last two months have mailed you a friends and family sale, a private sale message, only for you sale? You name it, right? It's a mess out there. I think, look, does the mess work to a degree?
Sure it does. Is there a better way? We absolutely think so. We said early on at the beginning of this year, this leadership team stood together and we said, "Do we have the courage it takes to march into hell for a heavenly cause?" We created a strategy and a view, and our members said, "Yeah, it was going to be a difficult year, but when we get on the other side of this new model is going to be long-term, significantly more productive. We're going to spend our time in a much more strategic way. We're going to operate a different kind of company." Look, like I said to the team, it's really hot right now, right? We're still in the middle of hell. We're a few steps away from the other side.
I think you're going to see, when we get to the other side, the next five to 10 years, I wouldn't want to be competing against us.
Thank you.
Our next question is from the line of Adam Sindler from Deutsche Bank.
Yes. Hi, good evening, everyone. I was hoping to ask maybe a couple of bigger picture questions here. I think on the call, maybe four or five times, you've talked about transitional year, 54 changes that DeMonty Price made, big strategic moves, the bars and the interior design. You're looking back at 2014 and maybe even 2013, there's a lot of redesign to the full line galleries. Clearly all those things are exceptionally important, right? They're being flowed through to the new model. At what point do you think it would be sort of prudent to maybe try and lock in some sort of strategy just to not have pieces moving around so much? Because as you become a bigger organization, those changes are magnified. Would be the first sort of bigger picture. Second bigger picture, on the SKU rationalization.
I was under the impression that the whole sort of reason of having a very broad line was to have a very long tail to the product life, such that a new product is not to simply replace product, but to actually introduce newness. Sort of balance that against $0.40-$0.45 of inventory reduction charges.
Well, one, we do have a wide and dominant assortment, and we'll have a wide and dominant assortment. At the high end of the luxury end, I think we have no peer, right? The question we get a lot is, "Who are your competitors, right, nationally?" I think the fact that nobody can really name very many of them is because we have an assortment that really doesn't exist in the marketplace anywhere else in our dominance in depth and breadth. That doesn't mean that you shouldn't go through a SKU rash. That doesn't mean after five, six years We had four straight years of comparable brand growth that was over 25%, right? You go through high growth years, and there's going to be some inefficiencies everywhere in your organization.
We're trying to deal with those inefficiencies, whether it's in the supply chain, whether it's in the assortment, whether it's in what we think was a promotional cadence to the business that wasn't right for the brand long term, whether it's what the store size is and whether it's I don't know. You say, like, "Geez, when do you stop and lock in a strategy?" The investor deck that we present hasn't really changed. It's the same slides, right? Who is a home brand for the luxury customer, right? That question frames our opportunity. RH is building the most dominant assortment at the high end. We're building a supply chain that offers tremendous value and is completely disruptive.
Our real estate, the biggest value-driving priorities in the company, which we've been saying for multiple years here, is the transformation of real estate and the continued expansion of our product offer. The launch of RH Teen last year, the launch of RH Modern last year, the launch of RH Hospitality. Nobody knows how to drive traffic in retail. If you saw the video, that's what it looks like every Saturday and Sunday. Find another store that has a line around the block. If investors' expectation is that we had to stop innovating, I think you're betting on the wrong people here because we're not going to stop. Look, I think it's Simon Sinek that said, "There's nothing efficient about innovation." Did we pack a lot of innovation into this year? We did.
Did we decide to use this year in a transformative, transitional way to do a lot of things? We did. We told you that. Did we think that the numbers were going to be hard to predict? We did. Were they more hard to predict than we thought? They were. Does it mean that there's anything systemically broken here? I think if you watch our videos and listen to what we're saying, we're telling you there's not. You can choose to believe us or not, that's your choice. I'm also CEO that bought a lot of stock in this last quarter. I didn't just do it for optics. 95% of my net worth is in this company. Yeah, we feel really good about what we're doing. Is every year going to look like this year? Of course not.
Have the last five years looked like this year? No. Is there going to be change and innovation every year? Of course, there is. Unless you want us to be like a lot of other retail If you walk a retail mall, I don't think most people know that at a retail shopping center, retail mall is like a graveyard for short-lived ideas. Does anybody know what percent of retailers live out the 10 or 12 years of their lease? It's a very low percentage. How many retailers make it two lease terms? Right. Go walk a mall. It's only the ones that innovate that are still here.
Okay. Thank you, I appreciate that. Just sort of secondly, in the video, talked about the doubling of revenues from the mall-based stores to the full-line stores. I know you said more than 2 times, just in the past, for clarity, it's been closer to 2 to 4 times. I just wanted to make sure that 2 to 4 times is still the right sort of outlook to use.
The way to think about it, when we used the Denver model, back then we had a smaller assortment. We weren't impacted by RH Modern or RH Teen yet, or a lot of SKU growth. As we did all our real estate deals during that period when we presented that, we had lower base volumes. Our expectation was to get a 2 to 4x, and at that point, somewhere around a 3x we thought was about the right number. Our average store volumes since that point have grown from $8 million to $12 million in an average gallery. All our numbers that we thought for every market, if you looked at our business from then, every market that we said we can go from here to there, the number there is still correct. It's just on a bigger base.
It may start at a 2x, it may start at 2.5x. Also, I'd say with the layering on of RH Hospitality, that's incremental, and the extra business that RH Hospitality drives to the gallery, at least based on our first test, gives us some expansion. I think what we're saying is we have at least a 2x lift to the retail sales in every market off a bigger base now.
All right, that was perfect. Thank you, I appreciate it.
Yep.
Our next question comes from the line of Peter Benedict from Baird.
Yeah. Hey, guys. Thanks. Just a clarification. On the fourth quarter, it looks like the implied CBR down high teens, maybe. The top-line acceleration you're thinking for next year, I know, Karen, you said up kind of each quarter. Does that mean CBR you think will be up, like, in the first quarter, or is it just kind of total revenue is up and then CBR catches up later in the year?
Yeah, I think we're at this point talking about total revenue. We are not-
We're not giving quarterly guidance
guidance yet on comps.
Yeah.
I will say that some of the things that are non-comp right now that are making a pretty wide delta between total revenue and the brand comp, things like Waterworks, things like membership revenue.
New stores
New stores. New stores, there'll always be a number there. Some of the other things are going to go back into the comp base. We plan to put membership revenue in as soon as it anniversaries the launch. In May of next year is when we'll anniversary the launch, or actually the acquisition, I should say, of Waterworks. Those are some of the big drivers that are pushing that delta further than normal. That'll shrink down middle of next year.
Okay, that's helpful. Thanks. On the membership program, it looks like at least over the last couple of quarters, so when you've had it for a full quarter, so 2Q, 3Q, you've been signing up maybe 7,000 to 8,000 members a week. At least that's been the pace. Is that the level we should be thinking about going forward in the fourth quarter? How are you thinking about the pace of sign-ups from here?
Yeah, it's ranged between anywhere from 5,000 to 8,000 a week, depending on the week and depending on what's going on with our volume. I don't think that's going to change too much. It's generally pretty consistent with sales. As we said, 90% of our volume's coming from members, we don't expect that percentage to change. It should just track with sales.
Okay. Just the last question around that, to the degree that you've been able to track it or look at it, can you comment on how the member has behaved kind of before you had the member program to the degree you had details about how they were spending with you and then what their shopping habit has been since? I recognize it's not a long period of time, but any early thoughts on that?
The only thing I think we've commented on is the average order is slightly bigger and the time to transact is longer. Without the promotional kind of urgency dates that drove someone to, "Oh, I better purchase this now," they're working through their interior design cycle, and it's taking longer to close an order.
What we're really tracking or anxious to track is, as Gary mentioned, the renewals and then the repeat buying because buying furniture is sometimes an event and what happens, does this create loyalty or what happens with those things? We continue to monitor those. We're still in the first year of the program, so not ready to really speak to any of those yet.
Okay, fair enough. Thank you.
Our next question is from the line od
Good afternoon. This is Bobby filling in for Budd. I appreciate you guys taking my questions. I just had two quick clarification questions. One on the RH Modern rollout and the traditional galleries. Can you give us an update on how many that furniture's been rolled out in, and when do you expect that rollout to be complete?
Sure. That effort got completed at the latter part of Q3. At the end of October, all of the legacy galleries, save about a handful who are transitioning to big stores next year, got the modern product and got Design Ateliers.
Okay. All that's complete. For the lift, though, the lift is where you're referring that it's coming at a slower pace, or it's just six to eight weeks like you kind of saw in New York with the modern lift?
That's what we think. We think it'll take six to eight weeks to kind of ramp up. The other thing is we would expect in the first quarter of next year to get another lift when we mail the modern book. Right? We will mail the second mailing of modern in the first quarter of next year. The stores will be set with modern. A lot of the current customer base will get exposure to modern, and that will start to lift. We'd expect another lift when the book drops in the first quarter.
Okay. Also, Gary, you've talked about a lot of the changes that have gone through the business over this year and last year, and I understand you're always going to be innovating, and I do agree that's the way to stay ahead in a changing retail environment. When you look at kind of the size of change that we had to undertake this year, especially with the new product offerings, what's a more normalized cadence that you would look to kind of refresh a book or reshoot the book on the core product line? Is it once every 24 months or is it once every 36 that we should think about when we think about kind of a much more longer-term strategy picture?
You mean what's the lifespan of a product in our business? Is that what you're asking?
Yeah. That's what I'm trying to get to. Has that changed drastically?
Yeah. No, the way to think about it, a lifespan of a product in our business is on the low end, if we really miss, it's one year to two years. There's a good majority of our business that the lifespan is 7-20 years. Right? Some of our best sellers have been in the assortment for a very long time. If you look at our assortment, the core part of it is still here. We've been expanding the assortment. Where we just went through some significant SKU rationalizations where we expanded the assortment in places that the productivity didn't warrant, whether it was sizes, it might've been finishes, things like that, or a few collections. It's not so much that collections are going away. It's within the collections, how do we optimize the offering.
Where we thought maybe an additional size or additional finish and color might have been more incremental than we thought, and it wound up being just sales transfer, right? That's where the majority of the SKU rationalization is happening, and where we're being the most aggressive.
Okay. I appreciate the color. Best of luck in the fourth quarter and going into next fiscal year.
Okay. Thank you.
Our next question is from the line of Oliver Wintermantel from Evercore ISI.
Yeah, good evening. I had a clarification question regarding the one-time cost in 2016. If I got all the numbers right, I think it's now about $0.70-$0.75, and it was $0.90-$1.00. Maybe that's for Karen. Can you maybe walk us through what's different and what bucket has changed? Thank you.
Sure. It's actually $0.95 to $1.00 still. It was $0.90-$0.94. We're just kind of providing clarity, the buckets have changed a little bit. The customer accommodations related to the RH Modern production delays, that stayed exactly the same at $0.30. The SKU rationalization has increased a bit as we talked about going a little bit more aggressive and having higher penetration of those sales during this time period. That's now at a $0.40-$0.45 range. The last one is the Grey Card or RH Membership deferral is about $0.25 now. That's how you get to that $0.95 to $1.00.
Got it. Thank you. That's helpful. Just quickly on RH Modern in-stock levels, are we back to 100% or maybe some details there, please?
Yeah. You never get to 100%. We're running at about 90% right now in stock on Modern.
We're fully recovered. The vendors have caught up.
Yeah.
We feel really good about that everything's kind of back to where it was.
Yeah. 90% is a good number in our industry.
Right. Just the question was if with the vendors if that was all sorted out from the issues that we had at the beginning of the year.
Yeah, we're all caught up at every vendor.
Great. Thanks very much.
Thank you.
Our next question comes from the line of Michael Lasser from UBS.
Hi, this is actually Atul Maheshwari filling in for Michael Lasser. Thanks a lot for taking our questions. My first question relates to your Grey Card membership. You mentioned in the video that your Grey Card members account for 90% of your core sales. Assuming 80% of your 3Q sales are core and dividing that by a total number of members, we're getting a $1,500 spend per member. Is that the right way to think about it?
We don't comment on average order. Yeah.
Can you say the number again?
We can't really guide you to think about something that we don't guide. Yeah.
I didn't actually hear the number.
I said $1,500 spend per member.
Yeah. We don't comment on average order, or how to think about it.
Okay. That's fair. Looking into next year, you're modeling a pretty significant acceleration in your comps. What's going to drive that acceleration? Is it going to be more member sign-ups or simply more spend per member?
Well, the biggest things are having books. This year is very depressed. As Gary's been talking about, we haven't had a Source Book, that would be more of a comp driver. Certainly in the new stores it's going to have an impact, but certainly that's a comp driver.
Yeah. Think about the books as not just the books marketing the current assortment, but the books have newness, there's new collections that also drives sales lift, right?
Okay. Thank you very much.
Sure.
Our next question is line of Matt McClintock from Barclays.
Hi. Yeah. Good afternoon, everyone. Two questions. The first one is, Gary, I understand that the books are what potentially is going to be driving a comp acceleration, can you speak to the historical correlation between your sales and your business and the stock market, particularly as we may be looking at one of the biggest corporate tax rate cuts in history?
Yeah. Don't take this year, right? Everything is moving. Books are moving, promotional membership. Historically, in a more normalized year, the two biggest correlations in our business is the high-end housing market, not the housing market. Right? If you look at the broad housing market right now, the numbers look good. If you look at the housing market at houses $1 million and over, it's down about 5 points against the rest of the market, it doesn't look very good. We think there is a headwind in high-end housing. That doesn't really get reported broadly, right? A lot of times people get mixed up because we're an outlier in where we compete in the market, I think people miss that.
The other one is, as you're saying, is the performance of the stock market has historically, our business has tracked with that as another indicator. Those are two of the most important things we look at.
Okay. Helpful. Just secondly, I know that modern is building, can you potentially talk to any variances in the acceptance of the aesthetic across the country that you're seeing?
Yeah. We'll know a lot more as we get a couple of months, as we get into the kind of the third month of the set. I look at it and I go, "Okay, we've kind of got November, December, January." January, February, we'll have a much better sense for how modern's performing and where it's performing. The initial books that we mailed, we targeted a lot of the mailing into markets that we thought would have better response to modern. The first time we mailed the book, we did targeted mailings into N.Y., Miami, San Francisco, L.A., Chicago, kind of key markets that were more urban-based and we thought were more progressive markets. As we mail the second mailing, now that we've got a representation of modern, we will support those markets more from a marketing point of view.
I think we'll get a much better read than our first mailing, from a market acceptance point of view. Our expectation, it's not going to respond democratically across the country. Not many of our products do. For example, one of our, by far, one of our best-selling bedroom collections in the company is mediocre in Los Angeles. Right. There are different aesthetic differences in the markets, and that's why we only gave about a third of the square footage to Modern. Our sense is that we will put it out there, we will get reads, and based on the market reads, we'll flex up Modern in local markets based on acceptance and based where we think we have a positive arbitrage, and we will flex it down if we don't have acceptance. Still more to learn. Very early stages of Modern.
Great. Thanks for that color, Gary.
Yep.
Our final question comes to line of Jessica Mace from Instinet.
Hi. Thank you. My question is on your outlet strategy. You mentioned the opening of some temporary locations, which I assume is related to the SKU rationalization, any other thoughts you could give us on how you view the role of outlet stores going forward?
Yeah. Outlet for us is really just a liquidation channel. First and foremost for what we call second-quality nick and dent type items that come back from a return or an exchange. If something gets damaged in transit, it goes to the outlet. We did open up a number of temporary outlet locations to get us through the inventory, SKU rationalization and inventory efforts, just to make sure we could get rid of the occupancy and avoid occupancy. A lot of the locations, 8 of the 12 that we're going to open this year are temporary, anywhere from 12 to 24 months, and we'll be out of those. You'll see some closures next year as those cycle and meet their 12 or 18-month timeframe.
Understood. Thanks. My second question, you mentioned some of the headwinds facing the luxury consumer, and you mentioned some relative softness at the high end of the housing market. Have you seen that change as you-- I know there's moving pieces in your business that are affecting the beginning of the fourth quarter, but anything you can call out as how that's progressed? Thank you.
The high end of the housing market has gotten slower, and that's got more of a headwind that we're cycling. If you look at the index against luxury brands, the numbers are still slow, but they're historically better year-over-year, right? You're going up against the biggest difficulties. I think it's going to be interesting as we come up against January, right? January of last year, obviously, everyone knows was the big drag down in the markets. We haven't factored in much upside based on that because we just factor our business as a run rate. That's the best we could tell today on those two data points. Looks like the housing market at the high end is a little slower, and it looks like there's starting to be some recovery with the luxury apparel players.
I would now like to turn the call back to Gary Friedman for any closing remarks.
Yeah. Well, thank you, everyone. We want to wish everyone a very happy holiday and look forward to talking to you in the near future, and excited about 2017. As we look forward, we think it's going to be an excellent year. Thank you so much.
Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation, and you may now disconnect.