Earnings Call: Q2 2017

Sep 8, 2016

Thank you. And Ms. Cameron McLaughlin, you may begin your conference. Thank you. Good afternoon, everyone. Thank you for joining us for RH's Q2 fiscal 2016 Q and 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, and we undertake no obligation to revise or publicly release the results of any revision to these forward looking statements in light of new information or future events. Also during our call today, we may discuss non GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non GAAP financial measures and a reconciliation of these non GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir. Restorationhardware.com. With that, I will turn it over to the operator to take our first question. And our first question comes from Adam Sandler with Deutsche Bank. Yes, good evening everyone. Hope everyone is doing well. I have a couple of questions here. I guess the most some of the more interesting news in the release about the pull forward into the Q2 from the Q3. Just wondering if you could let us know as you look to the Q3, if you think that's going to be felt more in direct or in the retail business? And then sort of sticking with the top line, when we're talking about Water Works, good detail there, 4% to the quarter. Are there seasonality to that business similar to yours? Are they different from yours? And then, I'm not sure you provided any guidance, but as you think about on an annual basis, what do you think Waterworks should contribute to your top line? Sure. Hi, Adam. So first on the this is Karen. On the pull forward, substantially all of that beat that we had in Q2 was a pull forward from Q3. So and that was higher sales, a higher percentage of our sales that is were coming from in stock product versus stuff that was on back order or special order. And then we did have just overall faster shipping than we expected on some of the back order and special order product. So a lot of that was in our outdoor business, direct versus retail split, we don't really look at it that way. It's kind of both and we would expect it to have a similar Yes, really. So in Q3, I wouldn't expect that to have a meaningful impact on retail versus direct split. Okay. And then on Waterworks, they do have some seasonality. They don't have a typical Q4, like a typical retailer because of the trade business and all of the project base that happens in the spring. So we only had 2 months of the quarter in Q2 and we'll have a full Q3. So for them Q3 will be a little bit higher than their Q4, which is a little bit of a flip versus us. We haven't disclosed the specific EPS impact that it's contribute, but it wasn't very meaningful in Q1. It was only about a penny. And it will tick up once we have a full quarter in Q3 and Q4, but it's not going to be a meaningful part of our earnings growth on the year. Great. And just one follow-up, if I may. The 90% in stock on Modern is, I think, ahead of plan. But I know that at least previously you had talked about once things had sort of leveled out, you were potentially looking to expand your assortment in Modern. And I just wanted to confirm the fact that as we go through that process, when you do, that there potentially could be another pullback in stock levels. Is that something that we should consider? Yes. 1, this is Gary. We're not really ahead of our plan. We said we'd be about 90% in stock at this time and we are 90% in stock. So we're right about where we thought we'd be with modern. And as we continue to expand that assortment, I wouldn't anticipate that we would have issues going forward. So depending on customer reaction to new products or not, we may sell out of some faster than others. So whenever you have product growth, you don't exactly know how to forecast those new SKUs. So you could affect in stocks slightly. But now we've got a vast majority of the base of the product in stock, the factories are performing well and the business is performing well. So you don't have anything like we had at the startup of the business launching a 5 44 page book. Excellent. Thank you. I appreciate it. Yes. Your next question comes from Adrienne Yih with Wolfe Research. Good afternoon. Gary, can you talk about the timing of the new product? When will it be at a level that you want it to be as we go into the Q3 and the Q4? And then how much newness? And then Karen, can you talk a little bit about the inventory? The sales to inventory spread obviously improved a lot. What type of inventory? What was the aging of the product that you got out of stock on? And when should we start to see that sort of more in line on a parity basis? Thank you. Maybe can you clarify for me a little bit on the question, there are a couple of questions around of new timing of new product? Yes, you talked about the obviously shifting it with the marketing books, the spring book moving into the fall season. So just wondering when you feel you'll be in the full position the way that you want to be as we go into the fall holiday season? Sure, sure. Okay. So the books are now starting to get in home this week and they will be building through November as we roll out these books. And as far as the couple of things, one, we have some new products hitting the stores that will roll out over that same cadence. And then our in stock should build and we should by mid to late Q4 be fully in stock. Okay. Thank you. Yes. And then on the inventory, we kind of came in Q2 at the end of Q2 right where we thought we would. We started off the year with a +30 in Q1, we said it would be very similar with a +27. So we thought we would have that as far as making progress with our SKU rationalization and inventory optimization and that's kind of exactly where we landed. By the end of the year, we do expect to have inventory growth right in line with that sales growth, which is really just a modest 1% to 3%. So we do think that by year end, we'll have made progress. Some of that happens through lower receipts and then some of it just happens from making further progress in the inventory efforts we've been talking about. But we feel really good about the complexion of the inventory. We're not really worried about we don't have a lot of high fashion, high things that we're going to go bad, if you will. Okay. And then just a recent question on the Hanjin. Do you have any inventory that might be susceptible to some of these delays? We don't actually contract directly with them. There are some of our carriers who might contract with them, so in through their alliance, but less than 2% of our goods are on their vessels and we've already notified all of those customers, we've reordered the products. So we expect to have very minimal, if any impact to our business because of that bankruptcy. Thank you very much and best of luck. And your next question comes from Matthew Fassler with Goldman Sachs. Thanks a lot and good afternoon, good evening. My first question relates to the buying cycle. You talked about the move to the membership program elongating or extending the bottom cycle the buying cycle. How do you know or how do you think you know that this is actually a prolonging of the buying cycle? Have you seen the people come back and close transactions with longer lead times just in terms of differentiating what would be an extended cycle versus perhaps the customer not coming back at all? Yes, Matt. So as you know, we have kind of 1 full quarter now that the second quarter is our 1st full quarter on membership. And so we're continuing to track these trends and look at it. But it's pretty clear to us looking at it today that the pressure to close your transaction is very different than when it was when we had end of events happening simultaneously by quarter or excuse me, by category, whether it's a lighting event or rug event or an upholstery event or a friends and family event and so on and so forth. So we're seeing fewer transactions at a higher average transaction, which is very good for the business. By the way, long term that should mean that we have fewer deliveries. We have more efficiency through the business and the supply chain. But we're still early on obviously to see if there's fall off negative effects over the long run. The other thing that makes it a little unclear as you're trying to evaluate all the moving parts right now is we're up against the book drop from last year and we have no book drop from last year. So you have a massive shift in customer contact, circulated pages, newness from last year, so on and so forth. So the real key is going to be looking at this in the Q4 and into the Q1 of next year because then we'll have comparable slightly up total circulated pages year on year. And you really see the performance of the business and you'll also see the performance of membership change, right? Like right now, the only marketing that we've had outside of the initial ads we did in the New York Times and a few newspapers is really email marketing and our outdoor book, which has limited circulation. And so the first real marketing of membership will be in these in the fall source books that are going out. So you really need to kind of look at this over the next couple of quarters and see how the consumer is responding to the marketing of membership, to the fact that you've got kind of more apples to apples marketing and circulated pages. Looking at it right now in that kind of the trough of the business with no books against the books last year. You can draw a wrong conclusion. So we've said to ourselves, we've really got to look at this thing through Q4 and Q1 to kind of really make sure we've got it in our sights. I'd say today though, just the early data and looking at the percent of the business that we're doing on membership, looking at the average order of membership, looking at the buying cycles that we can see with the limited data we have, we like what we see today. So my sense is it's going to get better, not worse. That's helpful. And then just a quick follow-up related to that. If you could talk about how your customer is receiving the member program, their understanding of it, perhaps the mix of member driven sales within the total business? Any metrics or qualitative insight you want to give us as to how they're receiving the member effort? Yes. Well, some of the early feedback was people were confused by the gray card. Originally, we called it the gray card was the major marketing effort. And we got feedback from customers and throughout our stores and at our care centers that customers thought it was a credit card offer. So we repositioned that as the RH members program as opposed to the RH Gray Card and tried to eliminate the confusion. And we're making tweaks here and there. But the numbers and the sign ups and the percent of the business we're doing all is tracking really within a few percent of where we thought it would be. So I'm honestly surprised it's accurate we are, but it was all math, right? And one thing I would say, and because I think people are somewhat confused, a lot of people think like we're eliminating promotions. Well, we are, but we really just created a consistent promotion, right? The membership was to the goal of membership was to eliminate the peaks and valleys in our business, which really create havoc in the operational infrastructure and the vendors trying to supply the goods with these peaks and valleys, ordering the goods correctly. It's really chaotic running a business on what evolved to post 2,008, 2009, a very promotional retail environment. And probably not as difficult if you're in the apparel business, right? But we are in a really logistically difficult business like furniture. It's very costly and it affects execution. So our goal was really to evolve the business to a more consistent model. And so really we kind of went from erratic peak and valley kind of promotional cadence to a consistent promotional cadence called membership, right? So a lot of people have brought up to me over time, well, gosh, the last person that tried this at J. C. Penney decimated the business and it said, well, we're not going off promotion. We're 25% off all the time. You give us $100 but you're getting a bigger promotion than a year ago. So, but the real key here is letting the shift to the book drops is creating, I think, the most unclarity around our business, right? I mean, the books are the major marketing vehicle for our business and shipping the books by 6 months changes a lot. So we've really got to let the books get in here at the end of Q3 into Q4, watch the business and the trends. Then we'll have a second drop, we'll have modern hit in Q1. And when we look at how we think the business will sequentially build and the changes we articulated in the video and in the press release, we like the model we see in 2017 today. Thank you so much. Yes. Thanks, Matt. Your next question comes from Steve Forbes with Guggenheim Securities. Good evening. So Gary, when you think about putting RH Modern and the design of 3As into the legacy galleries, how do you take those efforts and put them into a smaller box size while maximizing the impact to consumer? Is it something I mean do you edit it by taking a very small handful of the best sellers and create a smaller design space in the box? And what should we expect as it relates to the pace of the rollout of these initiatives looking into the fall here? Sure. Yes, good question. It's again, it's kind of a it's basically a math equation, right? It's taking a look at the best selling modern items in collections, right? And we've got pretty good data. We've been doing this a long time that we can extrapolate when we take something that is source book and web only and we put it into our retail stores. We've communicated to you guys that we get a 50% to 100% lift on the item when we show it at retail. So we can extrapolate taking now we have data. The first few stores that we put modern into didn't have the best of modern. It just had our best guess at what we thought would sell with modern into many cases because we ramped up in such a difficult way, it was really all we could get, right? So the first stores, honestly, I'm surprised of the success we had with Modern. It didn't even have the best of Modern. We had no data. Now we've got data on modern. We know what the best sellers are. We know what the best collections are. And we now we just basically do our math that says, okay, we take this from to a tri channel item and we're putting in retail. We know we're getting these lifts. And then we basically just edit we're changing out about a third of the SKUs, right? So we're taking out the lowest performing SKUs that are in the that have been in the retail stores for the last year and a half, the last 18 months, taking those out and replacing those with the best modern SKUs. And our math says that we're going to get a positive arbitrage, right? And so and then when you think about the design ateliers, our typical legacy store has kind of a great room in the middle and that great room has kind of walls all the way around it. Well, in the left and right hand side, there's generally 4 small walls that would have generally repetitive cabinets, right? Because we're very disciplined in how we present the goods. So you have 2 of 1 cabinet, 2 of another cabinet. Those 2 cabinets come off the floor and they get replaced by so they get replaced by design atelier cabinets. So right in the center of the store. The other thing we do is we take out the cash wraps. Our business is almost no cash and carry anymore, right? So that's why the earlier question was says like how much was retail, how much was direct when you think about the pull forward or things like that. We think of our whole business as direct, right? We really just we have showrooms and we have source books and we have a website. Those are places where customers interact, but all our goods are kind of direct orders. Customer places an order and we ship it direct. So we're taking out cash wraps, which are really not needed anymore in our business. None of our new galleries are built with cash wraps. All our business is really done through an iPad. And so we pick up a pad. So we give up 2 cabinets, but we pick up a floor pad and we give up 2 dining tables. So net net from a product and a productivity point of view, we really don't lose anything with it as far as product presentation, putting the design ateliers in because we take the cash wrap out. And we're replacing just some cabinets, which are not the highest performing SKUs and we get another full pad of furniture where the cash wrap was, which is a living room pad, which is the most productive pad that we have in the business. And then we get the center of the store now communicates clearly that we're kind of a design business, right? And I think more dominant than any other store of our kind. It's a very dominant. You're going to see a very big change as far as the communication that we're in the design business. And remember, we're if you look at all of our all the other retailers that have moved into kind of design services, right? Almost everybody has free design services today. And it's really kind of commoditizing and I think kind of devaluing the service because the level of service you get is very different depending on who you're interacting with and why I made my comment in my prepared remarks in the video that you get a lot of people that are marketing design services and they're sending a couple of sales people into your home or a consultation with a salesperson or someone who might have minimal decorating experience where we've got we've been now been doing this for several years and never really marketed it. Besides one page in our source book, we haven't been sending emails about it. We haven't really marketed the program. We wanted to get really good at it. Now we've armed our people with tools and training. We have a specific design ethos in our company that everybody is trained on. We now are installing design ateliers and now we're going to really market this program. And you're going to see it visually in our galleries in a very dominant way. So we think that is another meaningful positive move to the business. So we're very excited about it. But that's how it kind of plays out. The pieces come together. And then just as a quick follow-up. Is there yet a plan to roll out Waterworks to the next generation galleries and potentially the legacy galleries themselves? Not anything that we're ready to communicate. We have a lot of ideas here. Waterworks is a tremendous business. They're the best brand of their kind in their category. I don't think anybody's close. And strategy number 1 here is to not screw it up. Sometimes big businesses can kind of goof up really good smaller businesses and we're taking time to kind of spending time really discussing and debating our strategy, how do we evolve and marry the brands together in an appropriate way. We're going to 1st and foremost, our efforts are to really amplify and advocate for the Waterworks brand. I think they're a business that's been undercapitalized for a long time, running without capital. They've got tremendous product. I don't think it's exposed very well in the market. And so we're going to support them in I think we announced San Francisco, one of their new flagship locations opening in San Francisco. If you're in LA, go see their new flagship in LA or in Chicago. They have a tremendous strategy to kind of build their brand. And I think there will always be an independent nature of Waterworks because it's a very different business. It deals to the trade, to architects and contractors. We're much more of a retail facing business. We think there's an opportunity long time, over the long term to have much more exposure and visibility and transparency of that business directly to the consumer. But we want to be careful with it. We don't want to infect the brand at all and have anybody think that we're lowering our quality or the only interest we have is to make that brand better. And then in an intelligent way, integrate these brands and allow us to access to their consumer, which is the highest demographic in the entire industry and to serve our consumer better. So you're going to see this move like a clock, right? It's going to move very slow. We're in no rush here. We feel very lucky that a brand of the Caliber Water Works is now part of the RH family and platform. Thank you, Gary. Yes. Your next question comes from Peter Benedict with Robert W. Baird. Hi, guys. I'll just pivot over to maybe some more macro stuff. I know it's maybe hard to read just given all the things going on in the business. But any update on what's going on in some of those markets you guys have spoken to in the past, Texas, Miami, the Canadian markets or any other regional commentary that you could share? Yes, we have been tracking those and we did see some improvement. So that negative 4 drag that we had talked about for the last few quarters went down to a negative 1. So there was some improvement there. So we're very, I'd say cautiously optimistic about that, kind of planning for something similar as we think about the back half. And we're anniversarying last year, we're coming up against anniversarying a tougher compare. So that's good for our business in the back half. That's great. Was the improvement across all 3 or was any one more impactful than the other? We haven't given a lot of details for each one specifically. Yes. The way to think about it is last year, as Mark said, we articulated, right, we're a drag of 2 points in the first half and a drag of 4 points in the second half. So we're up against the 2 point drag, right? So you would expect it to moderate, because you're up against the drag. So what that tells us is, so if you take last year's 2 points and this year's 1 point, you've got 3 points, which tells you it's 1 point better, right? But the business didn't really come back, so to speak. It just didn't get worse. Does that make sense? Yes. Maybe got one point better. So, but what we like about that is it's not in a continued decline year over year. So as we go into the second half, we're up against a 4 point drag to last year. That could be neutralized year over year, then that provides lift, right? Right. And then Karen, what the latest view on kind of free cash flows, again, a lot of moving parts here, just your latest view on when you think that could evolve in the business? Thank you. Yes, sure. So we kind of stepped off that goal for 2016 on the last call, just given where we took our guidance quite a bit lower. But we still feel very optimistic. It's still a very important goal for us. So I'm not committing to it for 2016, but feel very good about 2017 and beyond, especially with some of the earnings things that we're going to cycle as we head into 2017. Okay, great. Thank you. Your next question comes from Michael Lasser with UBS. Good evening. Thanks a lot for taking my question. How should we think about the spread between brand growth and comp growth in 3Q? Is it going to be wider than the 1,000 basis points that you saw in 2Q? Yes. So, great question and this is one that we want to make sure we're getting some clarity and information on. We do expect that that gap between brand comp and non comp will continue to widen. We have a couple of things going on there. 1, the Waterworks is not going to be part of comp, but we're going to put that into the comp base when we anniversary the acquisition, so 1 year from Q2. So that will have a full quarter in Q3 and Q4 as opposed to just part of the quarter in Q2. We also have additional new stores coming on plus we because we have a 14 month comp period for our new stores, some of the ones from last year won't join into the comp until Q4, even if they're open in Q3. We have the new vintage that's opening with the new stores this fall and the outlets that we're opening won't be in the comp base either. So we will see that widen even further. And that will continue into the Q4? Yes. And then a bigger picture question, and it's going to probably be in couple of parts. But Gary, you mentioned that Gray memberships are trending in line with your expectations. How should we think about overall customer acquisition to the brand? Presumably, you anticipated that you might miss out on some of the marginal customers that come in and buy on promotion and get into the brand. Are you missing out on those customers at the rate that you anticipated? And then with that, how is that going to trend into the holiday season? Again, this may be a separate question because you're going to have a more focused customer who tends to spend more. How do you think about that impacting the Q4 where you are competing for a broader pool of spending with giftable item? Sure. So the way to think about it is the 1st and foremost, you have to get up against the books, right, apples to apples. So the best time for us to answer the first part of that question is probably in the Q1 when we've had a chance to look at the new source books hit and how is the consumer reacting to the marketing of the membership and what does that look like. It's the murkiest time to really look at it right now, right. But I'd say even in the murky times, I feel in the more positive side than the more negative side. So I think I feel very good today based on the fact that we're going through a murky couple of quarters where we don't have a book. As it relates to customers entering the brand and specifically around holiday, I think we've communicated that we are going to pull kind of stocking stuffers and the last of the legacy kind of leftover RH business off the floor. And we're installing these design ateliers. And we're really it's kind of the last little pieces of moving the business to a true design platform and not like a typical retail business. And so I don't see us competing for that customer. We're not might we lose someone buying a couple of towels for holiday gift? Yes, might we lose some throw sales? We might we're going to give away the stocking stuff for sales. We're not going to put all the Christmas lights up in the store. We don't think that renders the brand more valuable, not the brand we're building today. So to build great brands, you've got to decide who you are and who you're not, right? Brands are defined as much by what they don't sell is what they do sell. And so we're going to be very disciplined this year, editing and eliminating the things that we believe render the brand less clear and less valuable. And that's all in our forecast. We've talked about that. They're low margin businesses and they're not businesses we want to be in long term. So and we think we're replacing it with a real statement about design services and having in store design ateliers. And you don't have to get that many design customers to make up for a whole lot of little stocking stuffers or picture frames or other things. So we'll let other people kind of battle out for that turf. That's not really the turf we want to dominate, right? Like you can buy that stuff anywhere. It's hard to be really distinctive and unique. And so we're going to kind of get really good at the few things we want to own and be great at. And hence the discussion around Waterworks, right? And I mean Waterworks is one of the best brands in the entire trade industry. It's really the only the really recognizable brand of its kind, right? When you go behind the iron curtain and that gets us into the serious bath business, the serious kitchen business, the surfaces business with tile and stone, wood floors, kitchen cabinets, so on and so forth. So we're evolving away from a retail business. All our legacy stores that are sitting there in the mall where you're seduced into saying, gosh, I've got this real estate and the malls have all these people for 5, 6 weeks. Shouldn't we sell stuff to the random people walking by? Well, yes, maybe we had to do that to survive historically. That's not what we have to do anymore. And that's not our strategic direction. So all those closed doors will close. It would look ridiculous to if you've seen our Chicago gallery or Melrose gallery or any gallery to have stocking stuffers and tchotchkes and giftables and Christmas lights and stuff that you can buy at Target for God's sake, most of these place, hard to differentiate that stuff. So that's not who we want to be. And we're giving up some of that business. It's in our plan. And no different than don't want to have the same kind of promotional cadence as everybody else. That's not what our business looks like. If you go to the highest end of our business to the trade, that business is interior design facing business. Obviously, some consumers get into those showrooms with their interior designers, but that business is done on promotion. Designers get 25% to 40% off the business. That's why we can't be like a luxury brand like Hermes that has no promotions, right? Because at the highest end of luxury apparel, there's no promotions. At the highest end of luxury furniture, it's 100% on promotion. So we're now 100% on promotion. We're aligning ourselves with the highest end of the business. We've made it a membership model. We think that was the right way to thread this needle. No one's ever done this before. So I appreciate all the concern and trepidations and skepticism. I mean, we have the same feeling, right? But we think that the decisions we're making this year for the business, while it's pressuring short term earnings and results, If you never make these decisions, you never actualize the potential of the business or brand. And so we're making some tough decisions that are painful on the short term. And again, our math and our bridges say, we really look we really like what the other side looks like right now. Unless we make something there's some very bad assumption and calculation that we're going to mail all these new books and nothing happens, right. And that's never happened in my 30 years in the industry. So I think our data says that the outlook looks pretty good despite the fact that we're going to give up some customers that are not as high a value, right. If I could sneak one more in, how have you thought about your further push into design services impacting your relationship with the trade with interior designers? And if you could frame how much of the business has been done through that constituency in the past, so we can get an understanding of what the impact might be? Yes. We're not going to release those numbers, right, because that just creates a blueprint for our competitors, right? And so but I'll tell you that initially some of the anecdotal feedback was when we went to the gray card in the membership program and we went with a full time kind of promotional positioning, right, for the buy into the membership and you get 25% off. That was we got a certain level of feedback, anecdotal feedback from our teams and some of the trade designers they're working at working with. The data and the performance of that group, right, would indicate it's not an issue. Now I don't know if that means over time it becomes an issue. We were thinking, do we need to provide more incentive for that group? Do we need to provide another different level of service for that group? But I think our business is the value equation of RH is very disruptive. The product assortment of RH is very disruptive. No one has our product assortment. No one has product quality made in quantities. No one has our real estate positioning. No one has our source book circulation. No one has the traffic on a website that we have. And now no one is going to have the design services that we offer. And our design services are designed to also support interior designers and trade clients, right? So we act as a design office for them, right? They can come in with us and our interior designers work as their design assistance and we manage their whole project and we manage all their orders. And so we're a huge value to that constituency, right? Because they're generally entrepreneurs, small businesses, they've got a lot of back end support. If they're placing orders from 12 different showrooms and they've got to manage all those orders individually and lead times and issues and late orders and deliveries and 12 different deliveries and all the logistical costs and then all the administrative costs and managing all the paperwork and following up all of the orders. We do that all in a centralized place with an offer that nobody has, right? We're like taking a big swath of a design center and a lot of showrooms and putting them into one business in a cohesive organized way with a service experience that doesn't exist at the high end of the industry. And again, like we're not perfect today by no means. We kind of look at it like we're just now in the very early stages of kind of who we're going to become. And that's why I refer to the point of moving beyond just creating and selling product to conceptualizing and selling spaces, right? And thinking about the business more as a design platform, more selling a whole room, a whole home. I think a lot of you saw the video that went out, right? The house I did. And I did that house to show what can RH do with a total home, top to bottom. And I think you're going to continue to see our business evolve in a very dynamic way and become more unique and more differentiated. And we're not going to be a business that's going to be out there slugging it out with Amazon or anybody else that goes online that has just a kind of a mass market approach to a category. It's a very different business. Cool. Thank you so much. Yes. Your next question is from Oliver Wintermantel with Evercore ISI. Hi, good evening. I had just two clarification questions. The first one is the shift of the book drop into the 3rd Q4. So all is equal, if the pages are and I think you mentioned that they're comparable, should there be an additional SG and A pressure in the back half? And looking at your guidance for the Q3 and the full year, it looks like it might be roughly around 150 basis point SG and A deleverage in the Q3. But is that the right way to think about it? And if that is, could you maybe tell us how much of a help that was to SG and A in the first half? Sure. So it actually is not going to be a drag on SG and A. The biggest thing in Q3 that we're coming up against or I guess that we have that we didn't have in Q2 and we won't have in Q4 that's unique to Q3 is some of the investments that we're making in our product in the floors. So we have a big new floor set, the installation of the design ateliers, the cost of getting all that product, all the people involved in that effort, the new stores that are opening. So 3 of the 4 new stores are going to be in Q3, so all those preopening costs, that's the biggest drag on Q3. The advertising, because last year we had the spring books and then we also had modern, we will actually get some benefit in the second half from advertising. Got it. Thank you. And then the other one was the guidance for the full year, when you said you adjusted EPS $1.60 to $1.80 but then you have like these three items about customer recommendation, membership deferral and then the inventory SKU rationalization that gets you to a pro form a of $250,000,000 to $280,000,000 So and then in your in the video, you mentioned that you cycled all the headwinds in 2017 and operating margin should be up and sales expanding. So if I look at the consensus numbers of about $2.32 next year, so I just want to make sure that I understand where you base it off of that adjusted number of the pro form a numbers? Thank you. Yes. So we're really wanting to stay away from guiding 2017 at this part. At this point, what we were trying to do is just show that some of these costs that we've had this year, we don't expect to be ongoing and continuing parts of our business. So the cost related to the RH Modern and all the production issues that we had in the customer accommodations, the SKU rationalization and then this kind of one time deferral because once we anniversary the launch of the RH members program, we'll be on a normal and more consistent as we collect the revenue. Even though it will be deferred, there'll be revenue from prior periods getting recognized. So we won't have kind of the ramp up to where we will have all of the kind of more consistent cycle booking that revenue. We were really just trying to say that, hey, there's a lot of kind of more one time temporal things that aren't going to repeat into next year. We're not necessarily trying to set guidance for 2017. Okay. Thanks very much. Your next question comes from Matt McClintock with Barclays. Hi, yes. Good afternoon, everyone. Gary, you just said that you're not trying to be Amazon, but you just brought over Alex from Amazon to help with the supply chain. Can you maybe walk us through some of his priorities, his initial priorities for the supply chain? It seems like there's a lot of puts and takes going on in that area of the business. Thanks. Yes. We think we have tremendous opportunity to match the customer experience that we deliver on the front end of our business to the customer experience we deliver on the back end of our business. And I think we've kind of taken leapfrog steps and moves on the front end. If you look at the difference between one of our old galleries and one of our new design galleries, it's not even close, right? It's not evolutionary, it's revolutionary. And if you look at the quality of our people and how they've evolved in our galleries over the past several years, I think under the de Monte Price's leadership, massive change. I mean the design organization we've put in place, the leadership team that's in place, I put our store teams, gallery teams up against anybody in retail. Quality to people, culture, passion, belief in our vision and in our strategy and our brand. I don't think we've had the same evolution on the supply chain side of the business. And if you look at the disconnect that I talk about today is we in many markets we have an HDL whether that HDL is in sourced or outsourced meaning that we have our people kind of running the home delivery kind of hub. We basically are shipping goods to home delivery hub. In some cases, we control that hub, some cases we don't. But we're handing off the goods to delivery teams and truckers that are not our people and they're not our trucks. And it's you may get a truck that has a restoration hardware logo on it. You may get a truck that has a Penske logo on it. You may get a Ryder truck. Your truck may be driving with Pottery Barn goods or other people's goods. And they're not our people. They're quite frankly and it doesn't mean that they all have to be our people. But I think we've just because of the nature I think of most supply chain cultures come at things from a low cost point of view. And it's and I think we've got to look at our business from a high touch, high service point of view. We're going into people's homes, right? If it was okay to go into people's homes with people that had no connection to our culture, right, that we're being contracted out daily. So there's no continuity at all. You would argue then why shouldn't we do that in our galleries? Why should in Melrose Avenue or in Chicago or any of our galleries? Why wouldn't we just put contract labor in there too, like it would be cheaper. I'd argue that our results would be much lower. And I believe that our customer satisfaction levels are missed opportunities and building on sales, our return rates, our failed deliveries, our exchanges are on and on and on. The back end of this business is so costly. And I've always said for years, it says, been in the furniture business, it's an ugly baby, but it's ours, right? And so you got to love it, you got to care for it. But it is a tough business. And I think we've now elevated this brand. We've elevated the product. We have an average ticket that is significantly higher than our competitors, right? We should be getting massively more leverage, but we're not. And we're not because we're not executing well. We have multiple failed deliveries. We have multiple return issues. We have and we have a strong view that if we invest and take the level of delivery to to the level that matches the brand that we're going to see these metrics get massively better and we should get real leverage. But today, if you really looked at the supply chain cost and the architecture of it, I think it's architected for an old business. It's architected for the old resto. It's architected for like a Pottery Barn Todd business or a much lower end business. And that's not our galleries are different, our people are different, our time services are different. Our home delivery needs to be different and it needs to be high quality and high touch. And I think if you look at reviews on our company online, you talk to each other, you guys are customers. If I took what's the number one complaint about RH, it's that final mile, it's that final delivery, we screwed up. It wasn't the same quality that you expected. And I think it's the last piece of the puzzle to solve here. And I'll tell you that, DeMonte is just our Co President, Chief Operating, Service and Values Officer, is just setting a whole new level of standards for the organization. He's made multiple changes throughout the organization at many senior levels and bringing in a quality of leadership that we haven't had before. And so I've just never felt more passionate and enthusiastic about what can happen operationally in this company. So I could go on and on and on here, I won't. But I'd say, I think it's the next 1, 2 3 years. I think it's we're just talking last night with DP, we call it the Monti. And I think it's going to take about 3 years to make it perfect, right? Like and his standards are perfect, so he didn't know anything but that. But I will tell you 6 to 12 months from now, you're going to see massive change. For example, last week, what last week we had 3,000 home deliveries. 5,000. 5,000 home deliveries, excuse me. And how many were do we have resto employees on the trucks? We are on 1500. Yes. So 1500 Resto associates accompanied deliveries last week of 5,000 deliveries. We've never done that before. Customers are sitting there just massively delighted and surprised. We're actually getting design jobs because we're going into customers' homes. We're not making customers interface with strangers and delivery guys. They're interfacing with a quality of person that they'd interface in their stores. And so it's you see us make transformational changes here. And I think that we're going to bring the level of execution and quality and service up to a level that's in alignment of the brand that we built. Thanks a lot for that. Operator, do we have another question? Are you there, operator? Your phone is still live? Jennifer, are you there, operator? We're getting close to the end of our call time anyway. So if anyone can hear us now, I think we're going to wrap up the call now. And thank you guys for your time. We'll talk to you next quarter. Great. Thank you. Thank you, everyone. Talk to you soon.