RH (RH)
NYSE: RH · Real-Time Price · USD
122.00
-7.97 (-6.13%)
May 4, 2026, 12:24 PM EDT - Market open
← View all transcripts
Investor Day 2017
Nov 16, 2017
Well, welcome everyone to our Investor Day here in Palm Beach. We are so grateful that you took time out of your busy calendars. We know it's a busy week for all of you. And I bet there's going to be a few distractions here, but hopefully we're going to have some things to say that will kind of keep your attention and keep you excited. That was a video that you just which was each year we bring our leadership team together about 800, 900 people from across the country and spend a couple of days and connect people to our vision and values and try to ignite the human spirit in the organization and that was our opening video and we thought we'd share it with you today.
We're going to take you through an agenda in a second here, but first I thought I'd introduce the team. This is team RH to my left. This is the key leader to the organization. Some you know, some are more recent to the team, but I'd like to introduce Karen Boone, our Co President, Chief Financial and Administrative Officer to my left. To her left, Eric Chaya, Co President, Chief Creative and Merchandising Officer DeMonte Price, Co President, Chief Operating Service and Values Officer is the longest title in the company.
You can see there from a values point of view, we're a company that's pretty steeped in our values and BP as we call him keeps us all in check and keeps us focused on the right things. Dave Stanchak, who is our Chief Real Estate and Development Officer. Sandra Stank. Sandra and I worked together a long time ago. I'm excited to be working with her again as she's joined us here, is our President of New Business Development.
And Brendan Sotikoff, who probably doesn't need an introduction, he's known for the best burger in America, the best steakhouse in America, the best donut in America, and he's turning out to really be the best partner that we could have ever dreamed of is our President of RH Hospitality. And we're going to take you through an agenda that looks like this. We're going to talk about our view of the retail industry and then kind of put our strategy into that context and hopefully share with you why we believe it will be worth the ride. And then we're going to talk about our new model. We kind of took the car off the racetracks there for a little while.
When you become a public company and we became a public company in 2012. I kind of refer to it as you put yourself out on the racetrack and it's kind of got a cordially cadence to that racetrack and your perspective starts to shift when you're in a public market racetrack. Your view tends to come a little shorter and things tend to move pretty fast. And we came out in 2012 and I think we were pretty good at that public company race for about 3 years. I think we made or beat every quarter in the 1st 3 years.
And then as many companies do, we blew a tire. And when you blow a tire and you're in the public company racetracks, you have to kind of make a decision in that moment. And the decision is do you take the car into the pits and you change the tires and come right back out into the race? Or do you kind of see a blown tire, which in that moment seem unfortunate, can you shift your perspective and maybe see a different opportunity and see an opportunity to come into the pits and build an entirely new vehicle? And that's not an easy decision to make because you're in the pits for longer.
Cars seem like they're lapping you. The fans seem very distressed and don't understand why you're keeping the car in the pits. And you can become pretty unpopular very quickly in the public market for doing anything besides bringing the car right back out into the race. But we believe and we saw a huge opportunity that we could reenter the race and even it seemed like we're farther behind, but see a view where we come back into the race with an entirely new vehicle that was so much so superior to the vehicle we entered the pits in and one that would catapult us forward and not only makeup kind of the laps that we lost, but really have a vehicle that we could ride for a long time that could put its way ahead. And that's how we think about kind of the last 18 months, which and we know, by the way, we're very fortunate to have some of our shareholders here that were kind of with us in the pits because not a lot stay with you when you make the big decisions like this.
And we have some that are in the room today that hung with us and we talked to and shared what our plan was. And I think we're all going to benefit from that. So thank you for those of you that are here, those of you that are listening that couldn't make it. So let me share our view. I'm going to start with this.
P. T. Barnum said, no one ever made a difference being like anyone being like everyone else. Okay. P.
T. Barnum, as you know, started the greatest show on earth, right, and created something new and fabulous in the world that really got everybody's attention and brought people from far and wide to see a spectacular new show, a spectacular new experience. Well, we believe retailers have spent the past 20 years becoming more rather than less like anyone else, okay? As we step back and we look at the last 20 to 25 years in retailing, we see more sameness, not less sameness. And we think that sets up an incredible opportunity to stand out, okay, and be unique.
It's interesting today, if you read the headlines and, man, it's so different than 10 or 20 years ago when we didn't have these devices, right, because we used to sit around and we got our regional or national newspaper and there was a couple of headlines you read a day. Today, I don't know how many headlines we consume just in a morning, right, from publications far and wide all through the world. But it seems that headlines are just dominated with the age of Amazon and the death of the department stores and actually linking those 2. And our view is Amazon is falsely accused. I think it's a convenient association.
I think Amazon is falsely accused. The department stores, the fact is they've been dying of old age and a lack of innovation for 25 years. Okay? You guys follow the industry. Let me put a question out to the group.
Name a significant innovation that a department store at any department store in the last 20 years, a significant innovation. If you just think about the industry, 20 years, 20 years we've been going to department stores. Has anybody took a stab at significantly innovating the department store experience. I remember department stores when I was a young boy going with my mom to the we called the Big E in San Francisco was the Emporium. And it was a magical experience.
And you walked in and under the rotunda was an elevated cafe. And about once a year, she saved up enough money to take us and have a bite to eat there. There was a carnival on the roof. There was a Ferris wheel that people came from far and wide. Going to see Santa in the big Santa at the Big E was incredible.
Going shopping in a department store used to be a magical experience. And I'm not trying to fashion department stores today. What I'm trying to do is put the industry in perspective from our view. Today, we would argue that you could probably take the names off the buildings. And in many cases, if you had to walk in and there wasn't a name, and you had to say, where did I just walk into, you probably couldn't differentiate.
And so we believe this idea of Amazon being accused for the death of many businesses, many businesses have been dying for years. Okay? And it's just convenient to blame Amazon. We kind of live by this quote of Charles Darwin, it's not the strongest of the species that survive nor the most intelligent, okay? It is the one most adaptable to change.
And Robert F. Kennedy said this about change, and it's an important point. Progress is a nice word, but change is its motivator, and change has its enemies. If you step back and you think about that, as we talk about change that change and progress have to be linked. You can't have one without the other.
Okay. It's interesting to talk about progress, right? But for most people, it's difficult to talk about change. It's uncomfortable to talk about change. And a lot of times, there's a perception that you're actually going to make progress without change.
And the degree of change usually is equal to the degree of progress. Little change, little progress. Big change, opportunity for big progress. But change has its enemies. Who are the enemies of change?
It's usually us. All we have to do is look in the mirror. And why is that? We are creatures of habit. Humans are creatures of habit.
If we had a webcam connected to our bedroom, no, I'm not going there. But if we took film for 30 days of our routine when we got up in the morning, okay, what side of the bed we got up from, how many steps we took to the restroom, what hand we picked up the toothbrush in with, what hand we picked up the toothpaste with, what ritual we went through, what were our next several moves. And if we laid that film of 30 days on top of each other, you probably could project it and it might be a little blurry, but it would look the same because that's our DNA. That's our DNA. Yet we also live in a world, right, that is constantly evolving.
And the ability for us to not fall behind requires us to change, but that's uncomfortable. One of the key things Cameron says to me after she has meetings with investors or analysts is like, Gary, they're asking me saying, how can you make me feel comfortable about what you're doing by pointing me to somebody who's already done it? Why would we be interested in doing something somebody's already done? Why would that be innovative? Why would that create big value?
But I understand where it comes from because it comes from a need, right, of predictability. It comes from a comfort level that is hardwired into us as humans, right? But if the public markets really want innovation, the public markets have to be comfortable with change, right? And my sense is, in a lot of businesses, people are afraid to change because they're afraid of the next quarter, right? And look, we understand we're in the public markets.
We understand we're a public company. We understand quarterly earnings are important. But you're going to you should come to expect us to not make decisions for the short term. We're going to keep make decisions for the long term. And over the course of time, Warren Buffett likes to say, time favors the well led and well managed company.
And we believe at our age that that's the important way to frame the perspective of change, especially in the public markets. The other thing we believe is there are those with taste and no scale and those with scale and no taste, right? Those with taste and no scale and those with scale and no taste. And we believe the idea of scaling taste is large and far reaching. And if you want to kind of just check-in on that, right, there's I'll give you a great way to just kind of where could you go and kind of get a quick read.
Go to Zillow, go to Redfin, go to Trulia, go online and pick any neighborhood, any city, any neighborhood and start with the houses and go most expensive, right, to least expensive. Start at the top. Start at the home center, wherever you're looking, dollars 10,000,000 $20,000,000 If we're doing it in Palm Beach, it might be $120,000,000 Start from the top, okay, and start clicking down and say, who has really great taste, okay, which of these homes have beautifully designed architecture and how many have beautiful interior compositions that are really well designed. And I think if you take that simple test, you'd probably start to see what we see and start to understand the market the way we see it because we see a huge market. We get the question all the time, wait a minute, you're playing up here at the high end of the market.
It seems like it's a small market. Isn't that going to limit the opportunity? That same question was asked to Apple about 15 years ago. The same question when Apple had 3% of the computer market and they were making the most expensive computers in the market, but they were making the best computers in the market. And then Apple decided to, 10 years ago, introduce a phone.
That seems like such a good idea today, doesn't it? Doesn't that seem like such a good idea today? Does it seem like so obvious that Apple should have entered the cell phone business? If we step back for a second and just think about the cell phone business, it was dominated, okay, by $49 to $69 phones, okay? It was dominated by Motorola.
It was dominated by Nokia. How many people here have had a Motorola phone? How many people had a Nokia phone? Keep your hands up. So if you had a Motorola, keep your hands up.
If you have Nokia, keep your hands up. It's a pretty dominant number of hands. If you can look back, keep your hands up for a second. How many people still have a Motorola phone? Keep your hands up.
How many people still have a Nokia phone? Keep your hands up. With Steve Jobs, I guess I think about what was that board meeting like, Apple had 3% of the PC market. Microsoft, I think, had 90% of the PC market. And Jobs goes to his board and says, hey, we're going to get into the cell phone business.
And by the way, let me tell you how brilliant it's going to be. We're going to introduce the most expensive phone in the market. It's going to be $600 And the market leaders have phones that are 49 to 69. How did that conversation go, do you think? Can you show I thought it was like, can you show me can you point me to somebody else who's really successful selling $600 phones?
Can you tell me, Steve, why I should feel comfortable that a computer company that is 3% of the market okay, that is struggling for its life, that's almost bankrupt, why should we get into the highly competitive cell phone market? Won't we get killed? What seems so obvious sometimes today, when you really look back at when the idea was formed, it doesn't always look great. Sometimes it can look like a baby, struggling, screaming, say the other things, but it's not obvious that that baby is going to grow up to be somebody or something really important in this world, right? I don't think it would have been obvious to anybody that a computer company that less than 3% of the market decided to get in the cell phone business when the dominant players basically had 98% of the hands went up in this room.
And 10 years later, not a hand went up. 10 years later, not one hand. And the companies don't even exist, right? So, and we come from kind of that spirit. We try to see what others especially if you haven't been sitting with the people, thinking with them for that long, right?
So we think deeply about everything we do. We're not always right initially. And sometimes the ideas might come out looking like a baby that's crying and screaming that needs their diapers changed and it doesn't look really good. And I bet modern looks that way to a lot of people, right? We launched RH Modern because that's what kind of blew that first tire.
But RH Modern, right, with a little care and a little concern, is going to turn out to be one of the most important things that this company has ever done. It's not always obvious. And if someone asks us, can you show us someone else who's rolled out a modern concept at the high end? There isn't anyone. There isn't anyone.
But this idea of taste and scaling taste and creating a market is how we think about the world. When Steve Jobs was asked, what's the biggest difference between Microsoft and how do you know you're heading in the right direction, he paused for a second in the film they found after his death called The Lost Interview. And he looked up and he said this, he said, ultimately, it comes down to taste. It comes down to exposing yourself to the best things that humans have done and incorporating those things into what you do, right? Looking at the best things humans have done incorporating things into what you do and trying to elevate humanity.
We also believe this, we believe it's not about physical versus digital, it's about physical with digital. It is about the seamless integration of a brand across all channels. I'm still dumbfounded when I read articles or reports on companies and the intense focus on what is the sales between retail or direct or web and retail. And I still don't know why anybody cares. I really don't.
I think there's some simplifying assumption that the web must make more money. But I we don't spend one second on that. Not one, not one second. Like have we ever talked about the mix of the business at strategy sessions ever? Have we ever spent 5 seconds talking about like where did the customer shop today?
And I really don't understand why people do. I think there's a ton of capital. We believe there's a ton of capital being wasted, thinking about it, how to shift business from one channel to the other. I mean, I don't know why that would make any more money. And we'll talk more about that.
Here's what else we believe. The web is the most democratic channel. Okay, it is the most democratic channel. Why? It is the most difficult to differentiate.
Do you guys have your PCs or iPads or some device in front of you? Okay. If you pulled up Holly's HomeStore, and by the way, that's a fictitious name, The lawyers made me use a fictitious name. I couldn't use somebody to compare to us, thought we might be sued. No.
But if you pulled up a Holly's HomeStore, fictitious local retailer, Holly's HomeStore here in Palm Beach, single store, 1500 to 2500 Square Feet, has a website, and then you pulled up RH, guess what? Our store looks the same size online, right? The smallest store in the world can look like the biggest store in the world online because our store is the same size, the screen is the same size. The only way that you know the difference between RH and Holly's HomeStore is you have to click about 10000 times. And then you have to keep clicking because their assortment is bigger than that.
So we believe the web is the most democratic channel. Okay? We also believe that the web is not, okay, the web is not the most profitable channel. And I still don't know why anybody believes that. I really don't.
And I read all the reports. And we study this industry. We're obsessed about knowing whatever we can, finding any edge we can. And we study our own business. And I spent 14 years at Williams Sonoma playing the channel game that quite frankly was just moving costs or assets from one channel to another.
And we've debated how we think about it. But most retailers and if you do the work, if you look at most retailers who have increased online sales and it might be all, I'm saying most because there might be someone that I've missed, but most retailers who have increased online sales have decreased operating margins. And I'd put up a big bet with anybody here. We go and looked at 100 retailers and I don't think we'd be wrong. So why are people trying to shift sales online?
Why would a retailer take business from a highly profitable store, okay, and try to spend capital and spend expense to try to move sales to another channel and create a whole new cost structure, not really understand what the true metrics and how to make money there are. And I got Amazon to become $140,000,000,000 but it's not a lot of it's not a lot of operating margin. And everybody is still trying to break down that model. It's like a $140,000,000,000 lost leader surrounded with other businesses. It's a marketplace model.
It's not really like a retail store. Yet, man, there's a lot of time and shift focused on trying to be like Amazon. Yes, we kind of sit there and go, why would we want to be like Amazon? We're doing something completely different. Why would we want to shift sales to this other channel?
The only way the Internet channel looks more profitable in a retail business if they're not allocating their costs correctly, right? If they're actually thinking like for some reason that's incremental and I should not take cost from all these other departments that created the product, created the brand, drove the business and so forth and shifted it over here. We don't understand it. But I think it's going to probably the dots will connect soon. And the simplifying assumption that online is more profitable than retail, I think the truth is going to come out very soon.
But the data tells us this and I think that the other question we put forth is name an online only retail brand, don't name Amazon because Amazon's like this marketplace, it's just like not a retail store, name an online only retail brand that has reached $1,000,000,000 profitably. That's the question really to the group. No, no, not a marketplace, retail brand. So who created a retail brand? Yeah, okay.
It's like, for instance, I love Warby Parker. I've got a lot of their glasses. They had a $1,200,000,000 market cap on $90,000,000 $80,000,000 of sales several years ago. How many people have been waiting for them to come public? And I love Warby.
But I bet that they have to open a lot of retail stores to make the model work. But seriously, we're sitting here kind of like that somebody's got somebody and then somebody's saying like, no, well, now they're not really a retail brand. But if it was really more efficient, like why wouldn't there be a whole bunch of people? Because the graveyard is getting filled up pretty fast. It's getting filled up pretty fast.
You name a lot of people that have already went into the graveyard that everybody thought were going to come out and have this new model. So we believe the web is not the most profitable channel. We also believe this, the physical manifestation of a brand will prove to be more rather than less important, especially for brands not selling commodities. The web is an amazing distribution channel. People as I give these talks and people go Gary Friedman doesn't believe in the Internet.
Almost half our business comes online. It's not that I don't believe it. I believe that there's a lot of simplifying assumptions that are not true. And I think there's a lot of poorly allocated capital in our industry today. And I think it's great for people like Amazon and other marketplaces because it's making everybody a lot easier to compete with.
But we believe the most capital efficient way to scale in a physical world is through a physical manifestation of a brand, and we believe that will prove true. We also believe that we live in a world of complexity and clutter that we're bombarded with information and choices. We are bombarded every day with so much information. How many people just want to it would there might not be that many wants because it becomes like crack, right? You just you want like what the ocean.
I didn't get any new text. I didn't get I don't have the Instagram or Snapchat or all these things that my daughter, 15 year old daughters have. I mean, their minds must be so developed. I don't know how they keep track of everybody, but the information that's coming through, but we're bombarded with information and choices. We live in a world of complexity and clutter, and we believe great brands can be a silver bullet, okay?
Great brands can be a silver bullet, and they can break through the chaos, simplifying our lives by delivering a predictable promise, right, by making it easy for us, not hard for us. We also believe that time is the ultimate luxury, that businesses or brands that don't deliver time value will become less valuable, right? Businesses or brands that don't deliver time value will become less valuable. We also believe that brands with more control will become more valuable. The biggest issue brands face today is the danger embedded in their distribution channels.
Look at brands that are unwinding their business from distribution channels that have changed, right, and don't reflect the experience of that brand. We believe those with control from concept to customer will be rewarded over the long term. We believe in more control than less control as it relates to retail brands. And we think long term, the brands that have more control versus less control will be rewarded. We also believe this, it's not about marketing, it's about truth.
It's not what we say, it's what we do that defines us. We don't have a marketing department in this company. No marketing department. We have a truth group. Why do we have a truth group?
Because marketing is usually about putting lipstick on the pig. It's usually about trying to spin a story and make something look better than it really is. And that's not usually a good allocation of human or financial capital. So we like to say, if our truth isn't relevant, we probably won't be. So how do we become relevant?
And our truth is really our work. Our truth is our product. Our truth is our source books. Our truth is our galleries. Our truth is our online experience.
Our truth is our service. Our truth is the experience that we create for the customers. That's our truth. And that's what we think is the most important aspects of what the world would call marketing. We believe that if we want to be part of the conversation, we have to create the conversation, right?
Our product source books and galleries have led RH to become the most pinned Instagrammed and tweeted brand in our space. Okay. And guess what? We don't have a Pinterest site, and we don't market on Pinterest, and we don't have an Instagram site, And we don't take pictures of ourselves and post them on our site. And we don't tweet, even though it's the preferred communication platform for the President of the United States.
We don't tweet. Yet somehow, we are the most pinned, most Instagrammed and most tweeted brand in our space because the opportunity lies in the world talking about you versus you talking about yourself. The opportunity lies in doing great work and there is a platform for people to talk about your brand. So we don't have a department, a Pinterest department in our company trying to figure out what to do on Pinterest every day. We don't have an Instagram department in our company trying to figure out what to post and what to do.
We don't have our own blog. We don't have our own Facebook group. We did. I found out we did at 1 point years ago. And then I said, seriously, let me see the Facebook page.
And I said, oh, my God. Like, seriously, we have a few people in our company that are trying to make stuff every day and put something on Facebook like someone was going to care. And we don't have anybody in our company tweeting. I mean, I don't think so. I mean, they're probably tweeting, but as a social platform, fine.
But we don't have a Twitter department. Then I like Twitter. I mean, I think it's a great platform for people to communicate. But we think the way to create a conversation to be part of conversation is to create that conversation. You do it through your work.
We also believe this, great brands don't chase customers, customers chase great brands. Great brands don't chase customers, customers chase great brands. Great brands are vision, not customer led. And that doesn't mean we're not customer obsessed. That doesn't mean we don't care deeply about our customers.
But we don't ask them what we should sell. We don't get their opinion on next season's color palette. We don't have focus groups. We've never had one. I just think that sounds so confusing.
It's hard enough to have your own point of view in this world. Invite 100 people that you just gave a $50 gift certificate to and you're sitting on the other side of a one way mirror and you have some stranger called a focus group facilitator asking random questions to people that don't have anything better to do with their time, but show up for $50 with other random strangers and talk to a random stranger about a business that they don't even tell you why they're asking the question. It's not like, hey, we're doing a folks group for RH. We'd like to know. No, they say, hypothetically, if there was a retail company that was going to do this, what would you think?
Bunch of random people that showed up for $50 gift certificate. It makes no sense, right? But somehow people allocate a lot of capital to it. And again, it's not don't interpret that we don't care about customers. We're obsessed about our customers.
But we'll do anything we can to delight a customer. But I just don't know how you get to a decision when you start inviting a whole bunch of people and say like, hey, what should we sell? Like, let's bring in more. Like, we have confusion with 500 people. Let's bring in 5,000.
Maybe that'll make it more clear. Let's get more people. Let's get more customers to tell us what to buy next season, something they've never seen. I just can't see that that's how the iPod came along. I just really don't.
I bet if you got like 5,000,000 people and said, hey, what would you like us to do and how would you like us to deliver music to you? What do you think about like a little white thing with a button in the middle that had 1,000 songs? Why would anybody tell you what they wanted? That's what we get paid for. That's what we do, right?
Yet it's funny to me when businesses or brands go off course, you read a lot about like, wow, they hired a customer insight group. Then they hire 150 people. One of my former places I worked when I grew up, I remember many years after I left, I would read and like they have a customer insight group and they have 150 people developing customer insights. And I had friends that were still merchants there. And they said, like I said, well, Phil, why did you buy that?
I mean, didn't you know that was going to be a massive markdown? They said, well, yes, I didn't really want to buy it. I really wanted to buy this and I wanted to bet on this. But we have this customer insight group and they've got all this data that they come in and say customers want this, not that. So that's what I had to buy.
Like, goofy, right? You ask yourselves like, why is there not a lot of innovation? Wow, that just sounds like good things are going to happen when you have a bunch of strangers show up and opine on what you ought to do. So the iPhone, Tesla, Instagram or Disneyland did not come from a focus group. I'm sure of that.
And Henry Ford said this, right, if I asked my customers what they wanted, they would have told me a faster horse, right? And he believed that deeply. Okay. Now let's talk about our strategy and how it kind of fits into our perspective of the industry. Our journey begins with a question.
And we like asking questions because it makes us think. Who is the home brand for the luxury customer? And we asked ourselves that question, oh gosh, 10, 12 years ago. And it was real clarifying. Because when we asked ourselves that question, nobody had an answer.
And all of us worked in the home industry. When you ask yourself a question like that and you can't get an answer, and you're experts in an industry, you're either way off course, right, or you just found a massive opportunity, a massive opportunity. And when we thought deeply about that, that question started to frame a very big opportunity for us, because we didn't believe there was one. And what we've spent the past decade doing is creating the most comprehensive collection of luxury home furnishings presented in the most inspiring spaces in the world. This is a picture of RH Boston, the Gallery of the Historic Museum of Natural History.
Why do we put the product in beautiful historic buildings? We say we're obsessed with great architecture that we either find it and readapt it or we build it, right? But why do we care about great architecture? Why do we care about great buildings? Because it renders the product more valuable.
It renders the product more valuable. Yesterday, we had our Partner Day. We had 150 of our vendors and designers and partners from all over the world here in the same room. And one of them said, actually, I found a few products like RH at this home store, furniture store down the road. But quite frankly, if it wasn't me, you would have never seen it because they didn't put it in the same context.
They didn't put it in the same context. I couldn't really see it. And the store was a mess, and it rendered the product less valuable. So we obsess about things like this. We obsess about architecture.
Why? Because that's where product lives, right? So if it lives in a more beautiful space, if it lives in a space that renders it more valuable, it will we believe it will connect with the customer and they will pay more. So looking back, how did we get here? We began as a retailer of nostalgic discovery items with a $20,000,000 market cap.
This was my 1st season I arrived. This was the cover of the catalog. It says on there, summer 2001, right? 84 page catalog and an AquaTroll on the cover. Now you ask yourself, what's an AquaTroll?
I thought it was Santa Claus. I did my first walk through at one of our stores and it was late April and there was a yellow sofa on the floor and kind of a pinewood coffee table. And I had the whole merchant team and the inventory team, and I was trying to learn about the business, and we're walking through every SKU and every product, right, every margin, every turn. And then all of a sudden, we got to the middle of the store and there was about 20 of these on a coffee table in front of a yellow couch. And you got to understand, I just put $4,500,000 of my own money into a business that everybody said wasn't going to make it and was going to go bankrupt and it was the dumbest decision I could ever make.
And when I saw that table, I thought they were right. Because I thought there was 20 Santa Clauses on a coffee table in the middle of a gallery at the beginning of May. And I thought, oh my God, we haven't even taken our markdowns. And I already don't have much cash on the balance sheet. This is like do I go back and talk to Howard about getting my job back, right?
Seriously, I mean, it was a I was like I said, I was like I couldn't even get out. Can someone tell me why we have a table full of Santa Clauses at the beginning of May? And they looked at me and said, that's not Santa Claus. And I thought, I'm really dreaming. I'm not here.
I'm not in the storm. I'm having a dream. I'm home with that. I'm dreaming. And I said, excuse me, but listen, I know I'm half Jewish.
I know I'm half Jewish, but I do know Santa Claus, right? And they said, no, no, it's an Aquatrol. And I go, what's that? And they said, well, his head pops up and then he waters the lawn. And I said, so why is that relevant?
And why is that on this coffee table? And they said, because it's funny. And at that point, and this is a true story, I said, from this point forward, funny is not a brand attribute, okay? Funny is not a brand of entry. We don't want to be the store that people wake in the morning wake up in the morning on the weekend and go, hey, honey, we're going to go shopping today.
Let's go to that really funny store called Restoration Hardware because you're going to find really random shit like a Santa Claus whose head pops up and he waters the lawn. But this is how we started. And the reason why I start here, people go, oh, God, some of you maybe have known me for years knows like I bet he's got the AquaTroll catalog because I show it to you. Why? Because if we started here and we transformed to this, okay, a $2,500,000,000 a company with a $20,000,000 market cap on the edge bankruptcy with the cover of the catalog being an aquaTROL, okay, to a $2,500,000,000 luxury design platform with over 3,000 pages of our design and building some of the most inspiring spaces in the retail industry has ever seen, What the hell are we going to do when we do have capital, okay?
And we don't have to obsess how to mark down the AquaTrolls that nobody wants, right? And how to get the customer to believe that they should buy higher end furniture and home furnishings from us when we also sell Aqua Trolls and Bite the Man dog toys and fly swatters and auto bingo. The number one when I got here, the number one unit SKU in the company was auto bingo. Anybody play auto bingo? Yes.
Does somebody doesn't work for us? But it's no, seriously, you know what auto bingo is? It's like a little car. It's about this big and it's got little slide things. And it's for when in the many of you are not as old as me, but back when I was a little kid, you sat in the back of the car in a long drive getting carsick while you're going, oh, there's a stop sign, I got B12, right?
And you played bingo by seeing things while the car was moving. And in about 17 minutes, you're like, can you pull the car over? I'm sick. But we came from that with no capital. That's where we came from.
And we got to here. What are we going to do with the capabilities and the platform we have today? What might we imagine if that's where we started? With no money on the edge of bankruptcy, we had to raise money 3 times in the 1st year to keep the company out of bankruptcy. And I tell people, people don't know this, like I actually kind of sit with the accounts payable department, right, every 2 weeks to have them review the checks that were going to be paid, right, the checks that were going to be paid that pay period, either to our people, our vendors, suppliers, the electric bill, and then show me how much cash we brought in.
And I made them add it up twice and I added it up on my calculator because I had something that I still have today called an asset based loan. And if somebody miscalculated and had a couple checks too much go out and didn't do the math right, the whole company was going to go bankrupt, right? That's how I had to spend my time at the beginning of this journey for about 3 years. That's how close it was to the gallery that you're going to see across the street here be in a 20 story office building because that's what they were going to build. That's what they were going to build.
So what might we do under the conditions we have today? The other thing that's important to know is furniture of this quality has never been made in these quantities. We are building the 1st luxury home furnishings railroad that will be very hard to duplicate. We have a lot of scar tissue trying to figure out how to make furniture this quality in quantities. There was no manufacturing platform for furniture this quality.
There was no supply chain know how, right? So we've had to build this from scratch. We've also built a powerful product platform that attracts and amplifies the best design and manufacturing talent in the world. We had a light bulb go up about it was 8, 9 years ago, right? Light bulb went off.
When Apple created the App Store, right? And they had the iPhone and then they had the App Store. And then I had a friend that was actually working in technology and he was going it was called the CES conference in Las Vegas where all the technology is marketed, big, big conference. He said, you've got to come, come meet me. It's amazing.
You're going to see where things are going. And I wound up going, not that inspiring, really kind of confusing the ugliest boost. I mean, like nobody had taste back then. It was really jobs that clearly an open field on taste and technology. But I think back and I go, there's no Apple product here.
And I'm like, where's Apple? I spent like the first couple hours walking around and I'm looking at all this kind of ugly stuff and I'm listening to pitches on ideas and I go, like, where's the Apple booth? And I go, oh, they're not here. What? This is the biggest show in the world and Apple is not here.
No, no. Like they have Macworld or something like that. And so then I saw that was interesting to me. I was like, wait a minute, Apple is not here And they have Macworld. And they have this really neat, cool phone.
And they have this app platform. And they have the iPod, right? And they're changing the music industry, and they're not here. And then we started to kind of nose around and look at why is Apple not there because they did Macworld. And what happened with Apple, and I think it's a big enabler, and one of the reasons they're where they are today is they built the best platform in the world, and that platform attracts the best developers in the world.
So over the last 5, 10 years, how many people do you think were developing apps for Apple and not BlackBerry? Or for Apple and not Nokia, right? Apple created best platform and the best talent outside and inside developed for Apple. And the light bulb went off for us and it said, we had a design department. We probably had 40, 50 people in the design group.
And we thought like we were kind of what we called kind of an inside out company, a model I refer to as inside out. You design everything inside and then you kind of take it to the market to source it and send them, present it. And it hit me that Apple was an outside in company in some ways, even though they're an inside out company for their platform, right? They have a lot of people developing apps all over the world. Apple has the best access to the best apps.
And then the other thing that hit us was Apple created the iPod and they have all the best music, right? So they had the best platform for music. All the music was going to the best platform. They didn't write music and they didn't create music. So we said, gosh, we've got this design department of about 50 people.
And honestly, if we went to a design review and liked 5% of what that team designed over the course of like the past 6 months, that would have been a great day. It would have been a great day. Like we designed probably 97% of the stuff we didn't even buy. And we thought like and we always feel like we need better people, we need better designers. But the fact is, right, the best people are sometimes doing their own thing.
And they don't live in Corte Madera or San Francisco, they might live in LA, they might live in Amsterdam, they might live in Shanghai. They could live anywhere in the world. And we said, wait a minute, maybe we're thinking about this wrong. Let's flip this upside down and let's be an upside in company. Let's put our focus on building the best platform, right?
And let's try to attract the best designers, right, the best manufacturers, the best artisans in the world to develop products for our platform because we will render their work more valuable, right? And we will give them more leverage. And so we began that journey and we started it in 'nine? Yes, 'nine. We just changed everything.
You kind of needed to after 'eight, right? 'eight and 'nine. If you didn't change much, you probably weren't going to be here. So that was a big epiphany for us. And today, we believe we're just at the tipping point.
There are people now that are coming to our platform that 3 years ago, 4 years ago, someone would have told us they will never design for you. They will never put their product on your platform. But what's happened over the last 4 or 5 years here is we are building the most magnificent physical spaces for the best product in the world. And so those designers, artisans or manufacturers are saying like, do I want my product over here mixed in, not well edited, not well presented in this crappy building that's not inspiring? Or do I want my goods presented on this platform?
And so we're just now, just because we've got enough of these big galleries out there that people are seeing it. There's a woman named Alison Berger, true story. Alison started blowing glass when she was 15. She's a professional glassblower. She's also an architect.
She worked for Frank Gehry. She also is a designer and she's also an artist. And if you met her and you talk to her, she is brilliant, right? And she has been making some of the most spectacular lighting products I'd ever seen in my life. And it was sold in a really exclusive kind of small showroom platform, I think.
I don't want to say the name, but they're I think they do totally their total revenues are somewhere around $100,000,000 and they maybe have like 12 showrooms in the world. And honestly, I would have never contacted Allison because I would have thought she'd maybe turn her nose up at us and felt like, oh, no, I can't sell my $60,000 chandelier that's just so incredible at Restoration Hardware. And I'm having breakfast with my girlfriend, Bella, in LA at La Pawn. And we're sitting there and this woman comes up and I didn't quite notice, like, there's a couple of dogs and comes up and goes, Gary, oh my god, Gary, I've been thinking about you. I want to meet you.
My name is Alison Berger. I'm like, I'm kind of in awe. And she is like, I think what you're doing, the gallery you built in here in LA, what you did with RH Modern here in LA is amazing. And I've been thinking about like, I think I could design incredible product for you. You're right.
I mean, I didn't know what to say. I was so excited. I'm like texting the team, like you won't believe what just happened. Alison Berger approached me at LaPonde and said she's been thinking about us and wants to develop product for our platform. We were embarrassed to ask her because we thought she'd turn us down.
We didn't think we were good enough. That was a kind of a big moment for us, right? A big tipping point because now more and more of the very best people, okay, are working for our platform. And by the way, they're all different, right? And we try to enable them in all kinds of different ways, but they're also all the same.
They care deeply about doing the best work in the world, right? But some have capabilities, some have manufacturing capabilities, some have design capabilities, some have conceptual capabilities. But we say, 1st and foremost, we say we are curators, not designers. We're curators, not designers. We really don't really design anything, right?
We curate. But we don't just curate product. We curate products, people, ideas and inspiration. If we see a great product, the first thing we do is we ask who did that? We're more interested in who did it because if you can find who did it, who's the person that actually swept the details, obsessed over and over again, got the proportions right, got the dimensions right, got the finish right, got all those pieces right, which means usually you're getting knocked down 10 times and you have to get up 11 to kind of get great work done in this world because usually people want to take shortcuts.
They all obsessed about great work And they obsess like we obsess about great work. But they're also so different. They all have different capabilities. And what we try to do is we try to enable their capabilities. And where they're strong, we amplify them.
And when they're not, we try to support them. And we think this platform that we're developing is unlike anything in the world. It's like unlike anything I've ever been associated with. And I think it's a massive, massive advantage for RH and will be for years. And we're just at the tipping point.
We also like to say this level of design was only available behind the iron curtain of the 2 that trade design centers. How many people have been to design centers? A lot of hands. How many people went there by themselves? 3.
How did you get in? You walked in backwards and they thought you were walking out. Now how did
you get in?
So you're in the business. So they let you in. They probably thought you were a spy. But it's here's the interesting thing about the market that we're competing in. It's not only highly fragmented, but it has a lack of accessibility.
Oh, my God, it's such a huge thing. We're competing with people that have a lack of accessibility. If you're not an interior designer, you don't have to resale license, you can't get in, right? Unless you're like Bud or Matt or Brian and somehow you figured out how to work the system. So there's a lack of accessibility.
And then if you've got in somehow with an interior designer, someone with a resale license or you snuck in like these 3, There's a lack of transparency. Has anybody been to a design showroom and saw a price tag on anything? There's a secret code once you get in, if you can get in, there's like little stickers that have numbers and letters, right? Bud's laughing, he can probably knows the system. So you figured this stuff out.
There's numbers and letters. If you can't, you don't know the price. And then you don't even know what discount that you don't even know there's discount. So if you snuck in and you paid $15,000 for that dining table that they really sell, okay, to the trade at $8,000 you thought you felt really good because you got in and they actually sold you the table and they weren't supposed to until you found out that your friend who's an interior designer paid $8,000 to that table you just paid $15,000 for, right? So there's this whole lack of transparency.
And there's a lack of scale. So we love this market. If you go like, well, it's a small market. No, it's a huge market. The number one phone in the world is the Apple phone.
It's the most expensive phone in the world, not by a little, by a lot, because it's the best. And we believe people have a bias for quality. People will pay more for quality if they can and people will stretch for quality. And so we're obsessed with quality And we will always bet on quality versus price. Okay.
We will never render anything less valuable to take a price down, right, to open up a market because we think that is like opening up an infection, right. So it's opening up a wound to a disease. Once you start going that way, good luck turning it around. But we love this market. It's behind the iron curtain.
It has it's highly fragmented. It has a lack of accessibility. It has a lack of transparency. And there's nobody that has scale. We love this market.
We see so much opportunity here. We've added the most prestigious bath and kitchen brand in the world to our platform, Waterworks. Some people have asked me why, you sell some of this stuff. Waterworks has been doing it for 40 years. They're the best.
They have the best product in the world. And we believe it positions us long term as we think about how we bring these brands together and how they'll amplify each other. It positions us as an authority into the most important rooms of the home, the bath and the kitchen. And long term, you'll hear more about our vision for this business. We've also launched one of the most exciting new concepts in retail, RH Modern.
We believe it's poised to become a $1,000,000,000 plus brand. If you haven't been to LA, this is the picture of our freestanding RH Modern Gallery in Los Angeles. It's a great representation of the product. You'll see a representation in our new big design galleries. You'll see later today, you'll see RH Modern on its own floor.
And we're just getting started here. Like we start big, I got it. Most people start with an 80 page catalog. We started with a 5 45 page source book, right? Make no mistake, we saw an opportunity and we didn't see anybody there.
We said we want to be first, we want to be famous, okay, for the 1st fully integrated, right, modern brand in the world, right, that took all the categories and integrated them beautifully and created the 1st fully integrated modern lifestyle brand in the world. And that's why we move so quickly. And because we move quickly, we had a couple of vendors. They blew a tire. They imploded, cost us $20,000,000 Got it.
Okay. But don't think for a second that RH Modern isn't one of the best things we've ever done. I'd go back and do this again. I'd take the ride as the biggest shareholder in the company from 105 to 25, okay, like have the press make me feel like a fool, right, to do this again, because this is going to prove to be a really big idea. Another important part of our strategy becoming more and more important and something that we're going to obsess and become famous for here is RH Interior Design.
We are building an interior design business that moves the brand beyond creating and selling products to conceptualizing and selling spaces, right, beyond creating and selling products to conceptualizing and selling spaces. Right, this gives Peter, Kelly come. Kelly, where
are you?
Kelly, where are you? Kelly's here. Okay, Kelly, stay there for a second. I'm going to tell the story. I only know some of the highlights that's just happened.
Breaking news at RH. Last week, I said DP called Kelly, their gallery had a $510,000 sale to a customer, right, dollars 510,000 sale to a customer. And maybe Kelly if you can kind of give the highlights. How long did it take and what was this the situation? Just give Kelly and Mike, yeah.
Kelly is our gallery leader of our Tampa gallery.
Yes. So the client actually reached out to us through our interior design through our website. It was a 9,000 square foot home, and they were interested in designing the entire home. It took an entire month from start to finish with my design team here. I have Nicole and Shelly, the gallery designer.
Nicole and Shelly, everybody came. Hi, team. Stand up, stand up. Here, come walk up here. It says there we can see there.
Don't bend there next. Yes, walk up here. Come to the stage. Go ahead. Tell them about how this came together.
I'm actually going to divert to Nicole and Shelly, so they can share that story.
So as Kelly said, the clients contacted the gallery after doing some research on the RH Interior Design website, and we reached back out to them and set up to have their initial consultation in the gallery. And that was approximately a week after we reached out to them via phone. And they brought with them all of their samples for the home and really wanted us to be a part of making sure that they were on the right track for all of their hard finishes and all of their selections. And the process went really, really smoothly. I think Gary's talked today about time value, and this is a perfect project and example of how we were able to deliver that to them, through the design ethos and the design process that we have in place as a company.
Yeah, I think that this is a client that was really special because they lived and breathed this design. So they were very pleasantly surprised to find us and to utilize our service. They told us at the very end of the project that they have done this three times. And so they have all they had always found somebody else, a competitor, had a whole presentation and then walked away very disappointed and called the process painful. They were very thankful for the service that we provided and they are very loyal to us now.
They're extremely excited and we're very I think that we all live and breathe our values and we have a vision and to be able to execute it is very exciting.
Thank you. So $500,000 to $10,000 order came together in 30 days. So you guys went to the home, figured out the whole home, put together the order, worked with the client and $510,000
And growing.
And growing. Still growing. We
have another 15.
You have another 15 coming. Okay. And you might get the 4th home they do.
Yes, they're closing on the property by end of this month.
Yes, they are. And they
commented that they'd like us to be a part of the property.
I really don't know much about this. Kelly got in the call with D. P. Who said, hey, they had a $510,000 sale. I said, hey, get them on the phone.
And we're talking and Kelly said, we're presenting to you. You're coming to TAMP. She said, what? I wasn't. I said, well, can you come to town?
I didn't know the whole team was going to thank you for coming. But the real key is, yes, like I get asked every once in a while. So what do you think about Wayfair? I don't really think Wayfair can pull this off. I don't think Wayfair can pull this off.
I don't think they've got an integrated assortment. I don't think they've got a dramatic presentation. I don't think they have the design talent on their team. I don't think they have the passion. I don't think they have the connection with people that we can make.
I just don't see that happening. And so when you think about this, we're just getting going on interior design, like we're just warming up. We're making big steps. This is going to be a huge part of our business. And already, it's 65% of our business in our retail galleries now.
Interior design, where we have an intimate connection with the customer, we're going in their home. When we go in their home, we see lots of opportunities to help them further, right, to help inspire a whole new opportunity. So, the huge, huge competitive advantage, I know other people have design services or this or that, and they don't have real interior designers, they don't have people that live and breathe it. I think they have kind of part time hobbyist or visual merchants that are being sent in a home to kind of decorate. We're not decorators.
We think about design. We have a really clear design ethos in our company, right? It's all about or starts with a reflection of human design. Right, it's about balance and symmetry and order and proportions. And it's about the golden mean.
And you'll see it when we walk through our galleries, but there's no accidental things that we think about from design. And I tell you like, when we go to this gallery across the street, and I'll take you through a tour and we'll talk about these things, but just study the way things are presented and the order things are presented. And because that what that does, it gives us credibility, right? It gives us credibility to the consumer to come into this amazing space, presented in an amazing way, right? And it renders not only our product, it renders our people and our designers more valuable, right.
So all of this is kind of a huge integrated play, right. It all works together. It's not really independent. And we're going to get better and better and better at this. And you'll see us making more investments to differentiate the brand and deliver thank you time value.
So, well, thank you, team. Let's see. I don't want to have a feedback mechanism. Someone take this. Thank you.
Thanks, Jack. Okay, this is so we do some advertising, right. But it is our truth. It comes from our truth group, not our marketing department, because we don't have one. But this is some of the ads that you've probably been seeing in the key publications and interior design magazines across the country.
And it says just boldly on a spread, it says imagine yourself here, right? And then you turn the page and that's what you see, right? RH interior design, the infinite potential of a blank canvas, the home you hope to create, all you have to do is imagine, right? And then how to contact us and contact our design services. I don't know if this is they saw our gallery first and they saw this ad first, right?
But I think this is a really, really good campaign. And I think it gets across the idea and it demonstrates our work, right? And what how we can transform a home or a room or an outdoor space. Okay. We made the brave move, it has the RH members program, some of you still call it the gray card, it's not the gray card.
What happened with the gray card? They thought it was a credit card. And then we thought they thought we were like a department store trying to give them 15% off to take the credit card. And there was mass confusion and it wasn't good. And Barry and Henry, you guys were right.
They said that I think the 1st week. But so we renamed the gray card to the members program. But we made the brave move from a promotional to a membership model that has enhanced our brand, streamlined our business and dramatically improved the customer service customer experience throughout the company. It's huge. As you know, the transformation of our real estate has the potential to double our retail sales in every market while lifting our direct revenues.
Has anybody ever said that in the history of our industry? Has anybody said, hey, we have a new store concept that will double our retail sales in every market while lifting our direct business. This is a really big idea. It's never been done. And why can we do that?
People go like, how do you build these big galleries and how does the productivity work? How does the model work? There's a lot of pieces to the model. We'll tell you some pieces of it. We don't want to expose all the confidential parts.
But here's the headline. Less than 10% of our assortment is presented in our legacy galleries. Before we take you through the magnificent experience that we've just built across the street, What is it about price 40 yards away is our existing legacy gallery and it's still open. And so we all get a chance because sometimes we don't even get the chance that the gallery is closed. But I'd really like you to have the opportunity to walk over and see this is who we are to the consumer today and then walk 40, 50 yards and they go, this is who we are now and then ask yourself, who does that?
When we're in a meeting in this company and we're trying to think really hard and see what others can't see, you know when we know we're on the right track, where somebody has an idea and then everybody else in the room goes, but who does that? And then usually the dots connect, the light bulbs go off and go, we do, because the idea is that good. And I think the idea, our real estate transformation and these new design galleries are that good. It's that good of an idea. And I think the numbers and the transformation that we're seeing today is just the beginning.
We are planting a flag. We are claiming a market, right? It's not about just year 1 or 2 or 3. It is about what's going to happen in the next 10 years, how this brand is going to be perceived. And it works because we've spent over a decade merchandising our business beyond the four walls of the store.
We were trapped in these legacy real estate galleries that were built for Aqua Trolls and yellow sofas and pine tables and bite them at dog toys. We weren't limited by that real estate. We said we were going to merchandise. We were going to merchandise the business beyond the 4 walls of the store. We were going to size the assortment to the potential of the market versus limiting it to the size of the store.
And we used the catalog and the web and we built the best assortment in our space in the world. But the vast majority of our retail stores are still these little legacy galleries. In our own hometown in San Francisco, Marin County, in the center right next to our headquarters, people go, oh, I've been to your flagship store. And I go, oh, where? And they go in Corte Madera.
That was like store number 5, I think in RH, store number 6, right? And so the consumer doesn't even know in our hometown, or they go, oh, I've been to your flagship store in San Francisco, the one in the design district. It has 4,500 feet of selling. They think it's our flagship store. We are the best kept secret in the world today from a brand point of view.
We really are. I mean, but the key here is to unlock the value of the assortment, have to transform the real estate. So it's a huge opportunity. And I think the numbers are going to be worth more than this long term. I think it's like when Apple got into the phone business, and they realized there was customer acceptance.
Do you know that I think it was just 3 or 4 years ago, they said the Apple phone won't work in China. It won't work in China. They won't pay for it. They can't afford it. It is the number one phone in China.
Markets change when you do extraordinary work. The other thing we'd like to say is it's not about the Internet. Only 12% of retail sales are done online. It is about the lack of imagination in retail. Most retail stores are archaic windowless boxes that lack any sense of humanity.
There's no natural light or fresh air. Plants die in a department store. This has got nothing to do with Saks Fifth Avenue. Should I hope they don't sue us. This is webcast, but I've been showing this for a long time.
It just happens to be a former Saks Fifth Avenue location that if the name wasn't there, it could be mistakenly identified as a bomb shelter, right? And it was torn down in Cherry Creek in Denver and we built this. And many of you were there when we opened it. We did an Investor Day a couple of years ago. But we're building inspiring spaces that blur the lines between residential and retail that are more home than store.
It's an important part of our strategy. It's more home than store. There are spaces that are flooded with natural light and fresh air with garden courtyards and rooftop parks. Here's a picture of RH Seattle, the gallery in University Village. Here's RH Los Angeles, the gallery in Melrose Avenue RH Austin, the gallery in The Domain RH Las Vegas, the gallery in Tivoli Village RH Atlanta, the gallery in the estate in Buckhead and RH Chicago, the gallery at the 3 Arts Club.
And this was an important inflection point for us. So we're going to spend a couple of minutes here. The next logical step for us in this journey was to further blur the lines between home and hospitality by seamlessly integrating, okay, a restaurant, a wine vault and a coffee bar, right? Now, we're not the 1st person people have put a restaurant in a retail store. But if you've seen recent attempts, they're really kind of bolt ons.
They're not seamlessly integrated. It doesn't really have anything to do with the experience. And we think what we're doing here is revolutionary. And it's an experience that cannot be replicated online. It's one that activates all of the senses, Okay.
It activates all of the senses and it drives significant consumer traffic. So we're going to play a little video
We have always tried to blur the lines between residential and retail. The next logical step was how do you blur the lines between home and hospitality. This was a location that we all knew was a long shot. I don't think there's a retailer on the planet that would have considered this location. But we thought, what if we take this old building that's been sitting here mothballed for 20 years and we bring it back to life.
This project is not separate from the traditional history of the 3 arts. It's more a continuation of building a new chapter.
It was a building that was for young women to study the arts, the performing arts, the musical arts and the visual arts. We thought we could bring some of those arts back to life. We could leave the historic stage and we can have musical performances here. We could do an RH contemporary art gallery on the the top floor. And then we thought, and we can bring in the culinary arts.
If you really think about it, and I told you to define a restaurant, you would probably give me all these rules, right? And it's waiters or hosts and bartenders and you order and food comes out of the same set. I didn't want any kind of reference point really.
There's no hostess. There's no reservations. You can come sit down in the courtyard. You can sit down in the library. You can sit down up on the modern floor.
You can sit down up on the roof. Everything you look at, you can buy. And everywhere you sit, you can eat.
I just want it to be almost residential in the field. You could have amazing food at your house every single day. That's what this would be.
We want to be able to attract interior designers and architects here. And so we said, why don't we build a design atelier? It's an incredible design resource from the window treatments to the rugs to the furniture finishes to the fabric finishes, all accessible and it's easy to start to concept and design your home.
Coming to RH now represents something that nobody would have predicted a few years ago.
This isn't really a retail space. This is a space where people come to start to imagine their life, right? Like what does their home look like?
It makes everyone pause when you experience it to consider new things. Think about the way we live, think about the way we eat, Think about the way we want to interact socially. I think that's really what our age is all about is looking for new ways of expressing lifestyle.
It's impossible to relate what this is unless you see it. You can try to describe it, but the greatest success I've had, I just stopped talking and I just invite him in and just say, come on, let's take a walk around and everyone leaves saying the same thing that this is amazing. And it is.
All of these things together from the product to the integration of the hospitality and then the people create something that is truly one of a kind in the world and is truly a field of dreams.
Having been to R. A. Chicago, you really have to stop by. I mean, we've probably been there 20 times. There's so much to learn and so much we've obsessed about and learned about.
And we saw the impact of the integration of hospitality right away. We were really surprised by the numbers in Chicago. They were way ahead of anything we thought it could be. And by the way, we're in the middle of a residential neighborhood. There's not a retailer for 5 blocks.
And every weekend since opening weekend, we've had a line around the corner. I've never seen anything like it. I mean, even when it's snowing, this is a picture that's taken early on. I just got a video a few months back from John, our chef there that took a time lapse video of showing all these people coming around the corner. But name another retail store that has a line every weekend that wraps around the block to be able to get in.
And there's no traffic. I remember the mistake I thought I made, David joined the company. And this was not an easy sell with the board. We wanted to open a retail store in the middle of the residential neighborhood, no one anywhere around and we wanted to open our first restaurant in the middle of it and so on and so forth. And we garnered the board support, but it was a big leap at the time.
The economic model looked good. The financial risk wasn't as great because we were kind of not paying for prime real estate. But I remember, what was the day about 2 weeks before I opened or something? Dave and I are on the 4th floor and they took the paper down from the windows and I'm standing up there with him for about a half hour and I'm looking down at a street that like no one walked by, like for about 30 minutes. I go, Dave, like we've been here talking and in the last 30 minutes nobody's walked by.
I think I jumped the shark. I think I really I've been seeing myself how did I even talk myself into thinking this was a good idea. You ever have those moments when you have an idea and then you go do something and then it seems like a really good idea and then you're sitting there with yourself with that idea later and it's kind of showtime and you're thinking like, what the hell was I thinking? Like I'm thinking like this isn't going to work. And I'm saying to Dave, Dave, I might have like really blown it here.
This could be a disaster. And Dave's new to the company. He's probably thinking, I just came to work for this guy who's having a mental breakdown on the eve of opening a really important store. And Dave said, no, listen, I know people in Chicago, Gary and Dave actually is an investor in a restaurant, restaurant business and knows quite a lot about hospitality. And he says, look, the neighborhood really is going to support this, the people in Chicago are going to support this.
It's really extraordinary. No one's ever done anything like this. And I'm like and I'm still waiting. And then finally I saw someone walking by the street, like we got one in 37 minutes and someone just walked by. And so I mean the fact that it came together and worked, but that is that's all being an entrepreneur, right, is when you have to fight that battle.
But this has turned out that the lessons here and what we've learned in coming back and iterating, but what it led us to is quickly, I thought I was going to put a restaurant everywhere, by the way. Brendan flies out, it's probably we're open about 2 months and like it was clear this was a huge hit. It's going to be a huge hit. And I had had the team rallied in every new store we'd already done, Atlanta, Melrose, this and that, everyone we're going to do. I'm like at the team concepting where we can put a restaurant.
And I remember sitting with Brendan and I'm thinking he's going to be really excited and we go through that meeting. And so I'm like, so what do you think of this one and this will we do? And he goes, no. And I go, no, no. And I'm like, okay.
And I'm thinking, oh, and I turn and we go to the next plan because, yeah, no, I'd never put a restaurant there. I go, really? I'm thinking like, I thought this was really smart and great. We went through 20 plans and I didn't get one yes. Not one, not one yes.
And but we had a couple that got his vote of approval. And that is one you'll see here, this gallery was being built without a restaurant. And we were trying to figure out where we could put it here. And we said, well, we could put it on the roof. And we said, well, we've never put 1 on a roof before, will that work?
And what we said, we can figure out how to make it work. So we delayed the store by a few months, we had to reinforce it with new steel, we had to have be able to have the load and put a restaurant on a roof. So you're going to go up to a restaurant later and dine in a space that was supposed to be decomposed granite and have some hedges and outdoor furniture on it. And now it's a magnificent restaurant. And the other one we did was Toronto at the last second.
And so but going forward now, now that I've learned a lot more about hospitality from Brendan and really admire his discipline and deep thinking about those choices, right. And at the time financially, they would have been good for him. I mean, the initial deal we had together, he could have opened a bunch of restaurants and they might not have been that good for us, but they could have been pretty good for him. But he is a really deep thinker about how a model will work and where it might work and where it won't work. But the majority of our new galleries going forward will include hospitality, including the new galleries this year in Toronto and Palm Beach.
And we've been very thoughtful about where and how. So this is a picture of R. H. Toronto that just opened last month. It's the gallery in Yorkdale.
It's anchoring the new wing of the highest volume mall in Canada. This is the outside entrance and this is actual photograph of the gallery. And then if you come in the inside, we did something really innovative. We had the developer, because they're building a new wing, put 140 foot skylight across the front of our building. So when you're looking at it from the mall and you're looking down the corridor of the mall that we anchor, it looks like we're sitting outside.
The sunlight comes straight through, illuminating this Courtyard restaurant. And what's interesting here, this wasn't supposed to have a restaurant. So this is a store that terraced back like our a couple of our galleries do and have had kind of balconies. And we said, well, what if we rip out the balcony above and we just create a walled in courtyard with the sunlight coming through and we have olive trees and we create a restaurant across the front. And again, not knowing if it was going to work or not.
And we just opened and this is what we know in the 1st 25 days, okay, of operation of the restaurant, the volume is about 10% less than Chicago's 1st 25 days, right? And by the way, we're on a brand new wing in the mall. There's not a store for 100 yards on this new wing. There's us, and they haven't filled it all in yet. We've anchored it, and they're going to fill it all in.
So we were really worried. And by the way, the volume would be the same as Chicago's if we had gotten our license to sell wine out of our barista bar, because we have you'll see we have barista bar. A lot of times our restaurants have a wait time and one of the I think one of the magical things here is we just say, oh, would you like to get a cup of coffee? Would you like a glass of wine? Wander the gallery and we'll text you when it's ready and then they get to discover product.
But Dave, what's the latest, greatest on the
we
think we're going to get it? Yeah. So we think we'll be able to sell wine and then this should be the same productivity as Chicago and we'll have more people wander around with glass of wine in the gallery, So she usually puts them in a good mood. Every once in a while you get one of those, somebody had one too many and they get angry. So next coming up is RH West Palm, the gallery on Okeechobee, which is right across the street.
Here you can see that the dramatic courtyard, rooftop restaurant, wine vault, pantry, coffee bar. This is a little view of the restaurant. It was going to have palm trees until about 8 days ago when we came here, took a look at it, and we realized that the palm tree stocks were a lot wider as they all went up and you blocked all the sight lines. So the best seats in the house in the corner, you couldn't see the fountain, which was not good. So you're now going to see olive trees that just got imported in and installed a couple of nights ago.
So it's going to look a little different than this. And then you're going to see wine vaults that flank it on both sides and you're going to see our pantry and barista bar, which we've now kept evolving the ideas. So the ideas are going to get better and more relevant, more productive. And then this is the gallery in the historic Meat and Packaging District in New York. This we love this location.
It's quickly becoming one of the iconic corners in New York. It's anchored by the entrance to the High Line of the new Whitney Museum. It seamlessly integrates 6 floors of our multiple businesses and hospitality offering. When you come in, we built this beautiful atrium that goes all the way up 5 floors to a beautiful rooftop restaurant in a skylight. I don't think that there is another retail experience like this in New York City that integrates the floors and the businesses so beautifully, and we're very excited about it.
This is as you come up, this is a rooftop restaurant. It will be in the middle of a park. We've got this beautiful sculpted kind of park garden park that's been installed on the rooftop. We think it's going to be the modern day tavern on the Green. We think it's going to be a landmark in New York.
It's going to be that beautiful. And there you have it. Those of you that wanted to say, the shorts in the room is like they delayed New York. There they went, they misstep, they screwed up, they can't execute. Right?
So I said, guys, we have to have the picture here. They don't think that we screwed. New York Week had opened. This is the picture from last week when we were there. Yeah, yeah.
Last week we were there, Dave took the picture and he said, look at this, this is incredible. And I go, hey, give me that picture, because I got to prove to the world that we're not late opening the store. But those of you from New York know they're doing a whole infrastructure project. They're ripping up all the streets, they're putting in all new infrastructure, all new cabling, they're doing all new cobblestone streets. And if you zoom in on that side, sidewalk closed, right?
We didn't buy that sign and hang it up there. We didn't install this and stage this. We're pretty good stagers, okay? But this is why we can't open this fall. And by the way, if it gets a little better, like in late December, January, it's not supposed to be done now until the spring, which could mean the summer.
You're dealing with the city of New York, right? You can't really hurry them up. It doesn't work that way. But it's going to be spectacular when it's done. But we don't want to try to force it either.
You don't get a second chance to make a first impression in the most important city in the world, okay? This is the most important city in the world. We extended our lease in our current gallery in Flatiron, costing us a few $1,000,000 We should have called that out in the P and L too, in the release, because we're going to pay a little bit more rent for a while to keep it open. Unfortunately, we can't charge the city of New York the delayed feed on this rent, but this will be a spectacular gallery when it's done. With only 15 galleries, we are in the early innings of our transformation.
We believe we have the potential for 60 to 70 in North America. We remain confident in our long term goal of 4000000000 to 5000000000 dollars in North American revenues with industry leading operating margins and return on invested capital. We believe long term we can grow the revenues of this company 8% to 12% a year and grow our earnings by 15% to 20% a year, and we believe we can do that for the next 10 years. We think we've got really good line of sight with our retail strategy and the productivity with hospitality now being integrated in these galleries and the expected lift we're going to get from hospitality and many new kind of product concepts and kind of new iterations of the ARG brands that are in the pipeline that we're not going to talk about publicly. We also believe and believe really strongly about this now that the long term opportunity for international expansion is we believe is huge and that RH has the potential to be a global brand.
We are exploring locations to open our first gallery in London. We know the location we want. We looked at a lot of them. It's the only one we want. It's the one we've got to get.
It'll be amazing and introduce the brand in London. Terrific. It's a few years away. Take us a while just to get the real estate deal. But we think we can the brand is highly accepted.
We have customers today that are actually shopping in New York, shopping in Florida, and we don't ship internationally today. They actually get their own container and they're filling up containers and sending it over there. We're doing real money, 1,000,000 of dollars internationally. So we think that there's a huge opportunity to unlock this brand across the different oceans. When you step back and you consider, like 1, we are building a brand with no peer 2, we are creating a customer experience that cannot be replicated online and 3, we have total control of our brand from concept to customer, total control that you realize what we are building is very rare in today's retail landscape.
And we would argue will also prove to be very valuable. So with that, we're going to take a 20 minute break and come back and we're going to talk about our new model and we're going to open it up to Q and A. And Karen is going to take you through a few slides of our new financial model. So it's 4 o'clock. So when we come back about 3:54, let's come back at 4:15.
Okay, great. Thank you, everyone. Okay. One second here. Should have got my ringer on.
Okay. Welcome back. To spend a little bit of time on our new model and this is how our model is evolving. We're doing a lot of things simultaneously to build a new operating platform. And we're architecting entirely new and fully integrated operating platform.
There's a couple of big pieces to it. 1 is a new membership model. 2 is this new kind of operating model and operational model. And 3 is a new real estate model that we'll talk to you about today. Let me first start on the membership model and we'll give you a little bit more insight into this and but not too much because it's still really important that this is a proprietary move.
We made we took a big risk here. It is working and we don't want to give away the secrets. But there's here's what you need to know. There's 2 objectives when we began this move to membership. 1 was to simplify and streamline our business, okay, simplify and streamline what is a chaotic industry and a chaotic business called retail and develop a deeper connection with our customers.
And it's funny because I've got some of the team here, Sandy and Christy and Stavon are all here. They helped give me the courage. When God, what was that date? We need the date. January 4th.
January 4th. We did a walk through at our LA gallery and we went and we're doing a recap at a little cafe called Zinc, right? And we're sitting around and we're talking about this concept and we've been talking about it for a few years of making this move from a promotional model to a membership model and the benefits. And the team looked at me and I think Sandy kicked it off and she says, Gary, we have to do this. We have to do this.
And I said, look, no, no, we're going to do it. And then she goes, no, no, no, no, we have to do this. And the 3 of them are looking at me and she goes, pinky swear. And I swear to God, pinky swear. It's famous in our company now, the pinky swear.
And I said, pinky swear. And all the pinkies went in. And I knew that was it. I knew I mean I would have lost all credibility as a leader if I would have broke that pinky swear. So it's actually it's great having you guys here today to speak to the pinky swear team that helped give me and the leadership team the courage to make this move, which I think is revolutionary.
It's going to be looked back upon in the history of our company as one of the most important things we'd ever done. But the objective is simple and streamline our business and develop a deeper connection with our customers. Those were the 2 objectives. So we believe that membership has eliminated the frantic buying patterns and associated returns, exchanges and canceled orders that are result of a chaotic promotional model. This is the actual graph of 2015 of our business before membership.
Okay, this is how it operated up down, up down, up down, up down, up down, okay. It creates massive chaos on an operating platform. It is really hard to run a business that is doing that and having these wild swings. This is our business after membership, okay. This is 2017 and the trend going forward.
So the new membership model, what does it do? It dramatically simplifies sales forecasting and improves inventory accuracy. Try buying inventory to the blue line and try being right. It creates manufacturing efficiencies and lower costs. Imagine the impact on supply chain.
Imagine the impact on the manufacturing base. When you're always wrong with your inventory bets in this chaotic system, When you have all these different promotions and somebody decides to add another day, extend it by this, have a St. Patrick's Day sale with 17% off or all the crazy things you see in these emails, it's just total chaos. And it moves everything around and makes the business hard to track. And you spend an inordinate amount of your time as a leadership team of a retail company just trying to figure out your business week to week because it's so chaotic.
And it also improves execution and productivity throughout the supply chain and the gallery network. The DP will tell you and the teams will tell you scheduling in our stores, in our galleries, how difficult it was. Like all of a sudden, you have an end of event on a weekend, and all this business happens in 1 or 2 days. And then all of a sudden, no business happens. Very little business happens for the next 2 weeks.
And then all of a sudden you have another big event hiring, training, allocating human capital correctly in a chaotic environment like that. Think about it from a home delivery point of view or distribution center point of view. All of a sudden, all these orders come in, and now you've got to work double shifts and you're trying to process all these orders and hit the timelines. And then all of a sudden, not a lot of orders. And you don't have any work for anyone.
60% of your team is like, I'm sorry, I have no hours for you this week. Right? And then, but please come back 3 weeks from now at the end of the next event. All through is is massively chaos. I think those of you who have never really worked behind the scenes in a retail company, you look at something like our gallery or how you look at retail, something like that looks amazing and so on and so forth.
You go inside, if you were able to really, those of you who haven't, sit inside and work in a promotional in a retail business that's got a promotional cadence, it is massive chaos. You'd never invest in a company if you really knew what it looked like behind the scenes. You think this is like, this is chaos. And it was. And some of us thrive on the chaos, right?
And I don't know why, but we're okay with it, probably because we grew up with it. Most of us didn't necessarily decide I'm going to I mean, I wasn't sitting there when I was 15 years old in high school saying, hey, I'm going to grow up and be a stock boy at the Gap. And I'm going to like work in retail my whole life and work my way all the way up. But you just like some of us just find ourselves, we just got into this business and you get used to the chaos. And sometimes you think like, it's just always like this, right?
We're humans, we get used to it. Like simplifying, removing the chaos from a retail model, I think all of us here that we said and we had the pinky swear and then we said we had a leadership team meeting and we're all sitting in our leadership team room sitting around the table and I go, do we have the courage to do this? Do we have what it takes to do this? Because we are going to have to march through hell for this heavenly cause. We are going to get destroyed.
Our stock will get temporarily destroyed. We're going to get destroyed in the press. People are going to think we're nuts. They're going to think we lost control of the company. And we've got to be able to make sure we are aligned here.
Because we've got thousands of people in this organization that we have to lead through this. And are we prepared to do the work? Are we prepared to lead this organization through this move? And I think we're going to look back and we are going to remember this move for the rest of its lives because the not only just these things about the simplification of the efficiencies, the cost savings, the reallocation of human capital time, the time we have. Like we did a time study, we're spending like 65% of our time trying to forecast and manage and figure out our business from week to week, right?
Now that 65% of the time is back, okay? And we're getting to think deeply about opportunities. We're able to discuss things that we have never had time to get to. We're able to find opportunities that we would have never even noticed were there. So the reallocation of our time, but the human capital in the company and the benefit we'll get off that reallocation of human capital, we think is going to pay off for decades.
We're also developing a steeper connection with our customers. 65% of our retail business is driven by members who use RH Interior Design. Okay. We give free interior design services to members. 65% now of our retail business in our retail galleries is being done through RH Interior Design.
We are getting into people's homes. We are developing connections and relationships like the one you just heard about, okay? And we currently have 380,000 members that drive 95% of our core RH business, right, of our core business. So in that with what's not included is outlet, contract and waterworks, right? Am I missing anything?
Yes, everything else is included. So our core business is being driven. 95% of our business is driven by our members. And our membership fee income is up 37% year to date. So our membership fee income is growing faster than our sales.
So those of you who've been studying retail for years or been an analyst and looked at models like Costco or looked at the developing model over the years at Amazon and so on and so forth knows that if you can crack the code on membership, there's actually accretion, right, to revenues and to profitability in a membership model. And not that our model is going to look like Costco's, right, because Costco drives vast majority of their earnings through their membership, and it's a key part to Amazon. But if you can figure out how to thread this needle, it's actually a really, really good model financially and it will continue to kind of build over the next several years. Let me talk about our new operating model. 3 key areas of focus here, our distribution network redesign, our reverse logistics and outlet redesign and our home delivery.
So our distribution network 16 months ago, exactly 16 months ago, we peaked at 1,100,000 furniture units across 4 furniture DCs, 2 furniture storage DCs that used to be DCs, right. So 2 storage DCs that are 300,000 square feet and the other one is 500,000 square feet. So technically you could have said we kind of almost had 6 furniture DCs, but they were just storing goods for those DCs. And we had 1,000 storage trailers out in the yards that we couldn't fit into the DCs. Okay.
And part of that was caused because we have a business in furniture, and Bud knows this, he's in furniture for a long time. We've high ticket, high average ticket, right, low velocity, right. So high average ticket, low velocity. It's naturally slow turning by the nature of the business when you have high ticket, low velocity. And if there's another complicate to it, it's a SKU dependent business.
Okay. So what I mean by SKU dependency, if someone is buying the bed, first, by the way, they have to figure out what bed they want. They want it with the headboard or no the tall headboard, the shorter headboard, they want the footboard, they want it in king, queen, cow king or queen, they want it in 1 of 4 finishes. And then the course, there's a skew dependency, they're going to get the nightstand, a very high percentage of the time they're getting the nightstand as part of the collection. Now do you want the large nightstand or the small or the medium nightstand?
Do you want the one that's open, drawer or closed? Do you want it in 1 of 4 or 5 finishes? And then of course, you might want that dresser, right? And so you've got to have all these things and all the SKU dependency and you've got to actually have it in the right DC at the right time. And there's a lot of people who talk to you, the consultants will come talk to you about, oh, well, you've got this system that can pick from any DC and it really doesn't matter where the inventory is, inventory is always in the right DC.
Yeah, let's run that cost model Because that was sold to us, right? And we built that system and we started opening furniture DCs. And all of a sudden we were spending, what did we get to on DCDC transfers, Jack, dollars 9,000,000 a year? Yes. Yes.
Okay. Dollars 9,000,000 a year in DC to DC transfers, meaning that that piece of that order is in the West Coast DC and I need it in the East Coast DC. So now I'm transferring that to the East Coast DC. But where's the reorder coming? The reorder is coming to the East Coast DC and I just moved the inventory from the West Coast DC.
So now this boat that's going through the canal and coming up the coast is going to the wrong DC. So then what happens? So now it's in the wrong DC, and I get an order from the West Coast DC, and the system transfers it from the East Coast DC where I just trucked it back to the West Coast DC and now I get an order over here and it's in the wrong DC again, right. That happens all the time in a system like that. And unless you're really disciplined and you're into the details and you really start understanding cost, inventory can implode in a business.
And it could be working capital drain and it just creates so much cost. So 16 months ago, we picked a 1.1 furniture units across 4 furniture DCs, 2 furniture storage DCs and we had 1,000 trailers in the yard that couldn't fit. And I'll tell you this, the furniture was not designed to sit in a storage trailer without air conditioning, okay, in 104 degree heat, which amplifies like an oven inside a container to about 180 degrees, shit cracks, finishes get destroyed and bad things happen when goods are in furniture trailers. 16 months later, we are on track to end the year with 535,000 units of furniture. Okay, what do we have today, 582,000 units of furniture, with plans to close 2 furniture DCs by the end of the year, total of 1,750,000 square feet, and we have eliminated storage trailers, and the 2 furniture storage DCs are almost empty.
So we'll be talking about plans for those soon. And our business is growing. And here's the funny thing. We don't have currently, we don't have a head of supply chain. We hired someone, I put them in a video, they didn't fit.
And they haven't been here in the last 10 months. And so this team, working together as a collaborative group, looking at the whole picture said, we're going to build a fully integrated operating platform. We're not going to build it in silos. And so we place so we don't want to play whack a mole like most organizations do. This team thinks this is really important.
They do that. And that creates efficiency here and it creates something wrong here and then you go try to fix that and you focus in that silo and something goes wrong here. So we've worked together and we're re architecting all these processes and we're thinking about it all the way through the organization, right, and what will it impact. And somehow, this team, without an experienced head of supply chain at the top, I think has figured out revolutionary ways to run this business, because we're not victims of history, and we're thinking deeply about it. And 16 months later, we've completely changed the fundamental platform that we're going to run the biggest part of our business on.
We also avoided the construction of a planned 1,500,000 square foot new furniture DC in Savannah that would have opened this year. And our 5 year plan had a DC how often? Every 18 to 24 months, we had a new 1,500,000 square foot DC coming. That's what the model has. So our plan now is to run the business with 2 coastal distribution centers.
We expect and know in stocks will improve and inventory turns will significantly increase. You can just kind of do that math, right? You go back to here and you go, used to have 1,100,000 furniture units, now you're going to have 535 and your sales went up, they didn't go
down.
So expect in stocks to improve and inventory turns to significantly increase. We have total projected annual expense savings of $15,000,000 that we've called out separately. We have other savings that are woven through this in many areas. We have total projected inventory savings of approximately $400,000,000 versus our previous long term plan. So if you looked at the long term plan we had 16 months ago and said, what does inventory look like over the next 3 to 4 years?
And now you look at where we are and where inventory is going to be, we're going to take $400,000,000 of unproductive capital out of the system, right? And that's one of the reasons why we reallocated that capital we were getting and knew we were going to get back into our undervalued stock because we think we thought that would be a great reallocation of capital for our shareholders. So let's talk about the reverse logistics and outlet business redesign. We are now liquidating 90% of our returns in market, eliminating the need to transport product back to our distribution centers. How long are we into this now, guys?
What 3, 4 months into this now? Yeah, yeah, about 3, 4 months into this. And we're moving very quickly. We used to return let me give you a scenario. Say we would have sold had an order in Denver, we would have shipped that furniture from Patterson that's just outside San Francisco, cross the Rockies to Denver, right?
If there is a return and it's got cross stock deck at our HDL provider who delivered it into the home, there was a return, our HDL provider would pick up the goods in the home, bring it back to the HDL, we'd hold it in the HDL And by the way, you don't even want to think about what happens to furniture once it gets out of a box. Okay. Once furniture comes out of a box, you better get it delivered without many touches because it never gets better. Okay. Furniture never gets better when it's traveling through a supply chain once you take it out of a box.
So it's now moving out of a box back to an HCL. It's getting stacked up in an HCL. It's waiting for a truck. It's now getting touched again and put on another truck, right? Now it's shipped all the way back to Patterson just out of San Francisco.
Now we've got another team taking it off another truck. And now we're taking it and we're sorting it. And now we're sorting to see what's 1st quality, what's 2nd quality and what's 3rd quality, which is basically just written off, right? 2nd quality goes to the outlets. And we had somewhere in between 10% 20% that might have went back to 1st quality.
So we would medicate, we would repackage it, 10% to 20% of it, and it would go back into first quality. I guarantee you, you did not want to be the customer that placed the order and had that product that traveled that distance, that got touched that many times, that got medicked, put back in a box and got shipped again. We don't know the data on this, and we're changing the process very quickly. We just weren't measuring this. But I got to believe that that was marked first quality that got shipped back to Denver or it got shipped to somewhere else to Seattle that that probably came back to, right?
There's probably another move there. But we had a whole team, we had medics, we were reconditioning it. And then by the way, we were holding the inventory in the distribution center, waiting to deliver it to an outlet. And so then, the second quality stuff that didn't go into 1st quality, which the biggest part of it was that, it then got put away and then it got touched again, and then it got loaded onto another truck and then it traveled to outlet and it got touched again, unloaded, put in an outlet store. Not a pretty process, right?
Not a pretty process and nowhere near cost effective. Made no sense. So what are we doing now? Take the same scenario, products in Denver gets picked up by the HDL, gets taken to an outlet directly in market, right? And we now have 90% of the business and we're moving quickly here.
I mean, just in a few months, we went from 0 to 90. Yes, a month ago, it was at 70. And we'll get it to 100 quickly. We're repositioning outlets and we're realigning the system. So the goods don't get touched.
They'll be in better quality and they'll go right to an outlet and we'll sell them in higher margins because they didn't get screwed up along the way. So we expect our test and measurements here that we expect will result in cost savings and margin enhancement of approximately $15,000,000 to $20,000,000 annually. From my point of view, that's a very conservative number. So let's talk about home delivery a little bit. Our evaluation of the home delivery network has led us to several conclusions.
One, the current provider networks, the current third party provider networks that we use are not designed to deliver a luxury customer experience. Most are low cost commodity models. When we started reviewing this, we had part of the team was deep set in the old culture, right? Nobody likes to be wrong. Nobody likes to be in a meeting and have the work you're doing be challenged and critiqued.
And all of a sudden, it might get exposed to say like, wow, this is really dumb, right? So people generally try to defend history. And we know that and we understand this happens. It's human nature. But I remember one of the meetings and we're in and there's this kind of defensive push because it just didn't make sense like, wait a minute, so we are paying a 3rd party provider to broker a delivery who's paying a 3rd party or you might call them a 4th party trucker to then go deliver our furniture.
So we've got 2 markups and then we're paying another 3rd party to pay all those people, right? So it's really convoluted and you realize it's just the way it's been built in this country. And why? Because nobody's really built a furniture distribution network. I mean, most furniture companies have been regional, right?
So they've worked in that regionally and they've been family run businesses and stuff and they've been regional. Very few people have tried to scale this. And so it's been mostly scaled through 3rd parties. I think a couple of people who have gone more nationally have done it and done a pretty good job, but nobody really at the high end, right? There's no standards at the high end of the business at the luxury level for the customer.
And so we're at this meeting and part of the team was saying, hey, we like some of these providers are fantastic and this is that. And I said, great, I'm sure they're really good people. I'm not sure we're architected correctly. And I said, so tell me, take that one you're talking about right now, who did they deliver for? Team didn't exactly know.
I said, well, somebody's got to know. Who else did they deliver for? It's not just us. Who else did they deliver for? I said, pull up their website.
We pulled up their website. Who did they deliver for? They delivered for Ashley Furniture. Okay. Really good company.
Price points significantly lower than ours, customer expectations significantly lower than ours. They deliver who else was on that list? Yes, the dump. Anybody heard of the dump? How many times have we sued the dump for knocking us off?
Twice. We've sued the dump twice, right? Because all of a sudden they have big flashings on their website or in their storage signs that say like the restoration hardware Maxwell sofa for half price. It's not the Maxwell sofa. It's not the same leather.
It's not anything. It's a rip off. And they actually take our photos from our websites and then they put them on their website and they use them in their marketing and they run ads. So we sued the dump twice. And if you saw the dump and I thought this is true.
I said, can we pull up anybody been to the dump? Nobody in our in that meeting had been to the dump. I said, well, pull up their website. Let's take a look at the dump's website. And let's pull up our website and let's just do a little comparison.
If you saw the dump's website, you'd realize we should never be our product should not be delivered by people who are delivering product for the dump. They're delivering for Dorothy's furniture store, they were delivering, yeah. Jerome. Yeah, like just a whole bunch of random people that were in nowhere near the customer experience or quality level that we were at. And so really, we have a lot of work to do here.
And what was great, and by the way, the stuff I'm saying is public. And yesterday, we had most of our home delivery providers and third party leaders were all here. And I said, look, we got to have an honest conversation here. Do you want to be in the quality business? And I don't mind if you want to deliver for the other people, but not with the same people, not the same warehouses, not the same trucks.
So if you want to partner with us and you want to create a luxury experience and build a network, a delivery network for our customer, let's have the conversation because and by the way, let's have a conversation about cost, because I can't it's not right for me to say like I'm going to pay the same as the dump or Ashley and then but I'm going to have expectations that are here. So let's talk about how much it costs, let's talk about what's the service we want to have and how do we architect it backwards because I know returns are going to go down, customer satisfaction is going to go up, revenues are going to go up, right. Margins are going to go up all through, cancels go, every metric will go up if we deliver better service. And by the way, we're going into homes with strangers who don't work for our company, who don't know our values, and we don't have control over. So we have tested now in the Bay Area, the Bay Area market and in sourced our own home delivery.
We have what 10 trucks?
10 trucks, 5.
I should have the pictures trucks, sexiest trucks you've ever seen. Seriously, charcoal, metallic. Some of the supply chain team complained, Ares team took 3 months to approve the gray, right? And they folklore now says it took 2 years to approve the color gray. It wasn't 2 years, like it was 2 months, but we had to get the color gray, right?
We're going to buy these trucks, we're going to make an investment, it's going to be our brand. What's the logo on the truck going to say, we have beautiful RH logo on the truck and it's got a graphic that's beautiful with pace on the side. It says, there are pieces that furnish a home and those that define it. Right? By the way, a good part of our furniture was being delivered by some guy that rented a Ryder truck that week, it was delivering our furniture, hiring a partner to it's like it's so far away, the odds of it being great are not high.
But the opportunity is way beyond high. It is huge. We believe it's going to be a huge unlock. And let me tell you what some of the early the testing, so here's the other thing that our scale creates the opportunity to in source and or build exclusive partnerships. We have the scale.
Nobody has our scale at the high end today. Nobody. We're the only ones that can do this. Our current test in the Bay Area, while still early, indicates there's significant opportunity. Here's what the numbers look like.
An independent survey sent to our customers serviced by our own in sourced operation received a 93% satisfaction score versus our outsourced providers with a score of 62. That is a big gap. It's a huge gap. And we're just getting started. So we're not that great.
I mean, like, we're just figuring this thing out. Our in sourced operation scored 100% when asked if you would request or recommend our delivery drivers or service versus our outsourced providers with a score of 77, a huge gap, a huge opportunity, right. And you look at this and you say, even though we only got a 93 satisfaction score, so something went wrong 7 percent of the time, right? But here's the good thing. These are our people.
We hired them. We trained them. We're addressing them. They live and breathe our values. I'll tell you, you work in DP's operation.
He's the Chief Values Officer of the company, you know the values. You have values meetings every morning in DP's organization. You have values calls every week in the organization. And my sense is, even though we screwed up 7% of the time, because our people cared, and they reflected our values, the customer still would request or recommend them. And that's a big deal when you screw up, because it means that you can save that business and you can save that customer.
We believe it's a massive, massive opportunity here. So let's talk about our new real estate model. And by the way, in each of these areas, when we open up in the Q and A, you have plenty of time to ask questions to the team. They're all here. They'll answer any of your questions.
They thought it was more efficient to have me go through this presentation than having us get up and down. We practice getting up and down and going back and forth, and it was kind of a little odd and inefficient. So let's talk about the new real estate model because Dave is going to make a massive, massive impact to the return on invested capital and the capital structure of the company with this new strategy he's putting in place. We're transitioning from a lease to a development model through a sale leaseback structure that will reduce our capital requirements and increase ROIC. So let's give you some points here.
1, we had 2 key learnings from our Chicago design gallery. We're successful in creating a standalone retail destination, very important point, and the addition of an integrated hospitality experience creates a more immersive customer experience that drives traffic. We have retained, Dave has brought on, Eastill Secured. They are the premier real estate investment banking group. Will identify capital partners, arrange sale leaseback transactions for us.
And it is a whole new way of doing real estate. And basically what it does is it cuts out the landlord and it takes a big chunk of the landlord profit out and we're kind of going to vertically integrate the real estate process. We believe the vast majority of new galleries will require little if any upfront capital from RH. Not this year yet, because the deals in the pipeline, when Dave will we first start being affected?
2018, 2019 will be.
2018, 2019, yes. So we have deals in 2018 that are development deals that are using our capital, right? And we'll get that capital out. And so we'll create we'll get our capital out, but there'll be a timing issue where we put our capital up to develop and then we get our capital up. We think we can actually East Hills creating a structure and a model where for slightly higher cost on a cap rate on a building, maybe 20 or 30 basis points over a period that we can actually have the investment group fund the capital.
So we think we can get to, in many cases, 0 capital model. But we believe long term, the vast majority of the galleries will require little, if any, upfront capital from RH. And you say like, hey, Gary, why are you comfortable talking about this? You're not comfortable about talking about some of the things in membership, some of the things here, there and you're talking about this public and people earning. Our competitors can't do this, right?
You have to be able to sell on multiple floors. You have to be able to optimize a real estate pad. You have to be able to be a standalone location if you need to. Okay. The ability for us to take historic buildings and transform them, the ability for us to take a piece of property in the middle of Okeechobee that was going to be a 20 story office tower, right where the competitors can't do that.
They're mostly one level retailers. They don't know how to retail multiple floors. They can't make the economic model work and they don't have our volumes to make it work. I can say other things that they don't have, but that would be nice. The key benefits of a development model, opportunity to buy and develop unique retail locations, ability to structure sale leaseback with significantly lower rents, the ability to eliminate percentage rent, okay, and expensive triple net charges and pass throughs, and the ability to minimize depreciation and amortization on our balance sheet, right, all really good things, all really good things.
So let's talk about one that's in motion. And this is one that Dave already had in motion that will that we're using some of our capital, but it will actually transition over at some point during the development stage and will become fully in the new model. But this is a freestanding pad site at Southdale Mall. And what's interesting about the Southdale Mall is owned by Simon Properties. When Dave said, I think I can get David Simon to sell me the best corner of South Dale Mall, the hard corner of where, Dave?
69th in France.
69th in France, and sell me that property. Anybody knows David Simon? David Simon doesn't sell a lot of properties. He buys a lot of properties. And if he's going to sell properties, you're probably not going to get a great deal.
Okay. And so but Dave knew David and set a relationship with him a long time. And Dave believed that we could render David's mall more valuable. And this would be more valuable to David Simon than having a Shake Shack or having a restaurant out of the corner or something else that they might be using as prime property for. So this is what we're going to be building there.
This is location. So here you can see the streets that come around. Which one is that? So one is
The north south is France and the east west is 69.
It's 69. This is the hard corner. You can see the red is our development site right here. And this is Southdale Shopping Center. And we're building it with a garden of grass.
Imagine something like you're going to see across the street here. It'll help you see it once we do the tour. And so in the development and lease model comparison, we'll show a couple of slides. In the development model sale leaseback, we've invested $33,000,000 to own the land and the gallery. We've already purchased the land for 2,500,000 days.
Yes. Right. And they're doing about what $500,000 of work on it? Infrastructure work. Infrastructure work.
So we'll invest our performance says we're going to invest $33,000,000 to own the land and develop the gallery. It'll have a restaurant and all the amenities you're going to see across the street. We believe we'll sell the property for 33,000,000 dollars and a leaseback property for $1,800,000 annually and that would be significantly lower rent structure and 0 capital structure versus what our previous alternatives would have been. So in a lease model, we would have no ownership of the land in gallery. We'd invest $15,000,000 of our capital in gallery leasehold improvements.
We would have somewhere around $1,000,000 of depreciation a year or maybe a little bit more in the early years because you have some time depreciation rules. And then we've leased the property for about $1,800,000 plus have $400,000 of percentage rent in the model, right? So it kind of looks like this if you look at the comparison. The RH development model has a net zero capital investment and no percentage rent generating $25,000,000 of incremental cash flow versus the lease model over a 15 year term. So you see here sales in both models $30,000,000 And by the way, in this case, we are in the center right across the street in the Dyna Mall.
And we had a deal that I did that was signed that I thought was a great deal that looked like the old model. Right? And I thought I was really doing great. And then this new guy joins the company who we all call the most interesting man in the world. He's really like the Dos Equis guys, the coolest guy in the company.
And structures a deal that made my deal look so bad, right, that we had to go figure out how to break up the deal across the way where we still have a store today. And we were to break it up again and the deal comparisons looked about like this. Dave's deal was $25,000,000 of cash and earnings better than my deal. Dave's deal is a net zero capital deal. My deal was $15,000,000 of capital upfront.
Like it's not even the same world, it's not even the same model when you project this out long term and you think about what the capital structure of the company will look like using this new model. Anyway, so in closing, before I open it up to the Q and A, I would say this, it's not about Amazon. With all due respect, They are an amazing company and amazing what they do. It's not about big data, with all due respect. We love data.
We love numbers here. We're assessed about numbers, Right, Han is our Chief Merchandising Officer shaking her head saying like, yes, he really likes data. If you were in meetings with us, we really love data and love the numbers. But what we believe it's about, what we believe the future of retail is about imagination, right? We think that's the secret weapon.
Albert Einstein, who's said to be one of the smartest people who've ever lived in our planet with one of the highest IQs said this, imagination is more important than knowledge. And we believe it's about imagining a new and revolutionary membership model. It's about imagining a new and dramatically more efficient operating model, a new and significantly more accretive real estate strategy and a new and inspiring way to live. And in these dismal days of brick and mortar retailing, where every week and every day you're seeing some article that's saying how many retail stores are closing and how they're shuttering and they keep showing pictures of the Sears, like, oh, that's new news, like a Sears store that doesn't look very good, that looks empty, that's not doing any business, that looks like it's going to close, like let's just plop that on Yahoo! News one more time.
But in these perceived dismal and dark days of brick and mortar retailing, it's about imagining a new and revolutionary retail experience. So I'd ask you to imagine this with me for a minute. Imagine a retail store where you valet your car in front of a 12 foot high wall of water inspired by the famous fountain in New York's Paley Park, where you admire a 70 by 100 foot installation by the world renowned contemporary artist, Retina, where you wander through 10,000 square feet of tropical gardens featuring artistic compositions of outdoor furniture, where you navigate 3 floors of interior installations and imagine the home of your dreams with an interior design professional, where you favor your favorite coffee drink and a pastry from a barista bar, where you enjoy a glass of Rose in a dramatic wine vault, Were you dine under heritage olive trees beneath a soaring glass atrium while listening to the sound of trickling fountains and taking in the sunset in a rooftop restaurant? Now try to imagine that online. And again, the point here is like it's not that I don't like online.
I just really believe that we're physical creatures and we need inspiring physical experiences, right, to really activate all of our senses to get the most and best and productive use of our time, right? We're about igniting the human spirit, right? We're about connecting with people in a unique way. And that's what we spend a lot of time imagining. It's no different than P.
T. Barnum imagining the greatest show on earth, right? And truly understanding that you can never make a difference by being like everyone else. And with that, I'd have you watch this clip.
And I have your attention. You're all dismissed. Bankrupt. Better luck with your next job. This is not the life I promised you.
Not even close. Girls, I think I've had an idea.
PT Barnum
at your service. I'm putting together a show, And I need a star.
Every one of
us is special,
and nobody is like anyone else.
That's the point of my show. Bernie, Showtime. No one ever made a difference by being like everyone else.
I can't just run off and join the circus.
Why not? I mean, you clearly have a flair for show business.
For show business? Mhmm. I've never heard of it.
Because I just invented
it. We were inspired watching that film clip and it reflects a lot about how we think. And we believe we have to create something really special if we want people to come spend time with us and spend money with us. And we believe that retail is missing that theater, is missing that show. So now let's get ready to tour the greatest store on earth, RH West Palm right after our Q and A session.
And before that, I want to turn it over to Karen because there's a couple of kind of looming big questions we've been hearing about and we thought let's just kind of address those head on. Okay? Take it away.
Okay. So we're going to do a Q and A with everyone, but I have a few slides that we're going to cover that are going to address probably 1 or 2 of the biggest questions that people have had about us for some time, our balance sheet, we'll spend some time on that and then the bridge we're calling it, so the bridge to our 2018 operating margin. So to start, I wanted to start by saying that I've been here 5.5 years since I've joined RH and I've never been more confident in our business and in our balance sheet. We've had a lot of ups and downs. We've had a lot of changes.
But I think as Gary mentioned the time that we have had as a leadership team to spend post membership on the business and the kinds of things that we're uncovering really make our business model, it's at a place where it hasn't been in the 5 years. Even though we had years of 25% growth, I think underneath, there was a lot of just mess and noise. And I think we're really getting to a place where we're building long term sustainable growth that's going to be executed well up and down the P and L and through the supply chain in the stores and the call centers everywhere. So just wanted to start with saying that. Our business outlook and strong cash flow are giving us tremendous flexibility in how we think about the converts, our debt balances and our overall just general liquidity.
So we started by putting a debt summary up here. A lot of you guys know this, but you can see that we right now have about $1,100,000 of debt outstanding, very attractive low cost of capital of 1.35%. That's because of those converts which are at 0%. We're going to spend a little bit of time just making sure that everyone understands the convert. That will go down to about $1,000,000,000 even by the end of the fiscal year with more free cash flow generation and you can see the improvement in those debt ratios just since we kind of had our peak in Q2 to Q4 at the end of this year.
So when we think about the options, what are the options that we have as it relates to the converge? That's kind of the key question I get a lot of times and Cameron gets and has been kind of something that's been on everyone's mind. Let's talk about the options. Cash is king, so we'll start with cash and that would be our preferred approach because it avoids dilution. And what kind of options do we have?
We've kind of talked about what the cash flow we've had over the last year, but some of that was inventory driven. Is that sustainable? We have now told you that we actually do expect cash to be or inventory to be a source of cash next year, clearly not to the same level and extent we had in 2017, but it is going to be another good guide for cash. We've put up here nothing new that we haven't told you that $240,000,000 that was in our press release yesterday and then some illustrative these aren't don't hold me to these exactly, but this is directional for how we might think about the first half of twenty nineteen and the second half of 2019 and then that first half into 2020. So the converts come due in June of 2019 June of 2020.
Based on this, we have the ability to pay down with our cash that we're going to generate and our existing liquidity sources, our ABL and such that we already have in the balance sheet and have availability on to pay down both of these converts. Now these are at 0, so might we use that to pay down ABL which is higher interest, of course. But this is one scenario. What are the other options as it relates to the convert? Well, we as a leadership team I would say spend a lot of time thinking about financing, really talking to our banking partners, understanding the capital markets, when we could access the capital markets, I'd say that I put Aerie next to any creative person in the country on knowing different debt sources and structures and converts, because we do spend a lot of time talking about it.
We could go out right now and I don't know that we could get a 0, but we could absolutely get a very, very low coupon convert that effectively would push out the other ones. We would take that cash, pay down the ABL, which is that 3 ish percent and other high cost debt and we'd have a lot of options in the future. Of course, we could go institutional term loan, that interest rate obviously is not as attractive, but that's another option available to us. So I guess the point I want to make is just that we're not concerned about these. We think that we could pay them off in cash, we could refinance, we could add other debt.
We think that the strength of our business, kind of improved credit ratings, the current our stock is still volatile which is a key condition for our convert. We have a lot of options with respect to this debt. I'm going to put this up here and then just kind of talk through what the converts are. We get a lot of people who misunderstand the shares and the dilution component. So I'll just kind of talk through the June 2019 one just as an example.
We do plan to settle the converts in cash, but I'm going to talk about what these are. So the maturity, I'll just talk on the left hand column. The $350,000,000 June 2019 converts have a coupon of 0%. So we are actually not paying any cash interest. There is interest, which I lovingly refer to as fake non cash interest that is imputed for GAAP purposes and it is on the balance sheet and that is basically giving a value to the conversion premium.
So people were willing to invest in our company and give us money at 0% thinking and believing that our stock would be over that $116 price back when we issued it several years ago.
Just to be clear, that's not cash interest statement. Right. We just need to It's a cash interest statement.
We thank Barry Sternlicht all the time for really explaining this to us years years ago.
Yes. Thank you, Barry Sternlicht. He'll be at the party on Saturday night.
So there's 4 scenarios at maturity. So next June of 2019 in a year and however many months that is from now. If the stock price is below 116, dollars we will pay $350,000,000 in cash. We have no choice if it's below that $116,000,000 conversion price. If it is at $116,000,000 we have the choice.
It is at our option. We can either pay $350,000,000 in cash or this $3,000,000 shares, those are the base shares underlying the convert. So we can have $3,000,000 of shares issued and have that dilution or we can come out of pocket with $350,000,000 in cash. The third scenario is at maturity, the stock is between $116 and this upper strike, which is $172 That was the bond hedge that we bought at that time and paid cash for to push up the strike price and the point at which we would have no true dilution because even though the bondholders if the stock is at $150 the bondholders are happy, they bet right that they said we think the stock is going to be above $116 pay us in shares for that. We will absolutely issue shares and we have contracts with the bank who will deliver us similar amount of shares such that we'll have no dilution.
So that's the 3rd scenario. We still have the choice for the $3,000,000 whether we pay it in cash or settle and give 3,000,000 shares. But above $116,000,000 up to $172,000,000 we're basically covered. Then over $172,000,000 we're on the hook for those shares. So there's an IR table on our website that shows the amount of basically dilution that you'd have from the different conversion prices.
As an example, this specific convert at $200 I just wrote it down, it's 400,000 shares. You can go to the table on our IR site and understand what that dilution looks like for both different both the 2019 notes and the 2020 notes and see what the conversion dilution is at those respective prices. So I just wanted to make sure that that's really clear. So that's at maturity is what's really going to happen. So what happens to EPS before then?
No one's been asking us that question because the stock price hasn't been near the $1.16 If your intent is to settle in cash, you don't have dilution because you're never going to issue those shares. And our intent at this time is to settle in cash. So once the stock goes above $1.16 because we also have shares that we're going to deliver, we actually have contracts to deliver those shares. We won't have any actual dilution. We won't have any dilution on our EPS.
For GAAP purposes, there is a small amount of dilution. The only time we're going to have dilution for these shares is over $1.72 in our EPS. So this is I just thought I'd address that because people are asking right now like what happens in Q1 if your stock is at $120,000,000 are you all then going to have 3,000,000 shares coming into your dilutive EPS calc? And the answer is no. Okay.
So I'll move on and we'll take questions on this afterwards if anyone has them. The other point I just wanted to address is built to suit leases because a lot of people think built to suit leases are debt and they are not debt. A built to suit lease I mean a lease is basically us saying, hey landlord, we want to use your space, we'll pay you money and they take our money. Whether it's an operating lease or capital lease or built to suit lease is really just about the specific terms, but a built to suit lease is not an operating lease. It is not a capital lease, so it doesn't show up as debt and it's not even really a hybrid of the 2.
Many of our leases are required both to suit accounting, because we're taking on some of the construction risk is the main thing that usually trips it up. And if they're required accounting treatment under GAAP, it's not like we have a choice, it's not like we're out there trying to choose to do this. It's something that we have to do and our auditors require that we do. So it requires a growth up of the balance sheet for landlord assets. So in the case of Simon or landlords, they put their land.
The land might be worth $10,000,000 that's going on our balance sheet. It's going up in property and equipment and it's going down in a build to suit liability. It has nothing to do with that. It's never going to turn into a payment. It's never going to turn into depreciation.
It's never going to impact the P and L and it's never going to impact the cash flow, meaning cash will never come out of our pocket for that. So you'll see and it's very easy to just build it all over the place in the footnotes that you see a growth up of amounts in property and equipment, the built into assets and the amount in the liability is its own line. But it really has nothing to do with it's just a growth up of the balance sheet. There is a landscaping issue that happens where some of our rent is down in interest. And we disclose that.
So if you wanted to take that and say, hey, their margins might be worse by 20 basis points when I'm looking at their peers or whatever the number is these days, because you have some rent that's included down in interest. Absolutely fair. We put that
all over the 10
Q and 10 ks, so you can actually see what that amount is and do that calculation in case you want to compare it to our peers. The last thing I'll leave you with is this is all going to go away. Lease accounting guidance is changing. It's been on the list of rules for the FASB and NSESS for years years and it's happening in 2019. So once this happens, everyone's going to have new rules, everything's going to look different, everything's going to look the same and we think build to suit leases as we know them now will go away.
My main point here is it is not dead. Okay. So on the bridge, we provided a 2018 preliminary outlook yesterday. I'm not going to read all these because it was all in the press release, But you can see our revenue, our adjusted operating margins, our income, cash flow CapEx, we've given that all for you now. The bridge to 2018 operating margin, we wanted to put up here and show kind of where it's coming from, from a margin versus SG and A perspective.
And it is about 2 thirds, 1 third gross margin versus SG and A. And where is that gross margin going to come from? Mostly product margin. And that is things like outlet, things like not a lot of the savings that we've been talking about from the reverse logistics, that transportation and DC occupancy savings, that's in margin too. And then all of the labor savings from some of those initiatives are actually in SG and A.
So this is just kind of a high level bridge of where we're going to get that. And then I'm going to spend just 2 minutes quickly talking about the Q3. This isn't intended to replace our Q3 conference call. We're going to have that the quarter still it's early for us in the close process, so I don't have all the details and data that I normally would. But we wanted to just make sure we call that a few items.
Total revenue growth of 8%. We had a 6% comp. That 8% was negatively impacted by we think it was about a point from the hurricanes and we have market data and we know which stores were closed and we know which ones didn't have any sales during those periods. So that was about a point. Gross margin is going to be at the high end of our guidance range.
It was 4 60 basis points better than last year and this is all preliminary technically I should say. SG and A we did have a beat, it was driven by compensation and a lot of that's because of some of these initiatives and having lower comp in the DCs and galleries and kind of efficiencies in our model that we've been talking about. Interest, I did want to point out, we retired as you guys all know the $100,000,000 of second lien debt. There is a debt extinguishment charge, it's like an extraordinary item under GAAP. That's its own line item on the P and L.
That calculation was a little bit different than we thought. So we did have a benefit of $0.05 versus our guidance. And I wanted to call that out because $0.05 of that is just an interest beat from it being in this debt extinguishment charge versus just in the interest line in our P and L. And then taxes, we did have an effective rate of 32%. That's very different than kind of our typical 39% we might have.
The thing that's driving that is there was a new accounting standard update related to stock comp and taxes. If you had stock based compensation awards and an option was exercised and you see employee got a greater benefit than you were expensing that used to go to deferred taxes, it now hits your tax rate because our stock price has been doing well and employees have been exercising their options and they've been getting a lot of value. That's a great thing for us from a tax perspective. It's a true cash savings for us for tax and we expect that to continue in Q4 and Q and A items.
Yes, I think, Seth, these are the 2 big questions we've been hearing. I think you want to stay up there for a little bit, Seth. And I want to let's take your questions and make sure we're just answering all the questions around these 2 big topics. Yes, go ahead, Brock, you want to start?
So, do you want
to take the mic over the other questions?
There we go. Cool, thanks guys. So I have a couple of questions, actually I have 1 in 3 parts. And it's about how you sell stuff. And the first point is, how do you actually sell your product?
I know that's a stupid question, but it's always been like you have a leather sale, you have a flooring sale, you have a lighting sale, you this, that. So A, how do you sell it? B, how do people buy it? Do they say, okay, I'm buying a new house, I have to furnish it. This month, I'll buy a light.
This I'll buy a carpet next month and I'll buy a leather couch that following month. So I guess one is a cost thing and one is a revenue thing as far as how that could be optimized. And then lastly, at least I think based on my own experience and probably not the higher echelon of stuff I bought, but I think you pay once, you buy a bedroom set, you pay X for shipping. If something is available over a 3 week time period, I guess if it's available 6 weeks later, a different part, I might get that too and I might get another piece if 12 weeks later. And it's a balancing act as to how many times you have to pay on your end in order to get my furniture over to me in a timeline that's acceptable.
I don't know if
that makes sense or if I have my facts right, but it seems like there you have revenue opportunity, you have a cost opportunity and you have work capital opportunity. Would you address that?
I think I'll address just I don't know if you're asking about just revenue recognition, but a customer comes in and in the past they might have waited to buy their lighting on the lighting sale and they would have bought their couch on the poultry sale or something. But now anymore with membership, that's one of the things that has been a great benefit. As they're coming in, most people are spending a lot of money when they're redoing their home or they're remodeling or they've moved. So they're coming in and they want to buy a bunch of stuff. If you think about that order that we talked about, dollars 500,000 that's a big order for a full house.
Unless they said like, I want it all right now, when they search for stuff that was in stock, I'm sure they had some special order business, meaning it was custom and it's going to be made for them. We don't recognize revenue. So we'll we call it demand, written orders. That's kind of a common industry term. We'll have that whole $500,000 But if there's 3 chairs that were being custom made and it's going to take 8 weeks to get them, we're not going to there could be multiple and it kind of depends what the customer wants.
They could stage them and all get them together. But the furniture is not all going to be ready at the same time. We will have multiple delivery charges if they want it as quickly as they can. And we won't record revenue until it hits the customer's home. I might not be exact.
I don't know if someone else wants to.
Talking to this mic. There you go. You're wise in the mic.
I think I screwed it
up. Okay.
So if it gets to where it has to be or where you want it all to be on the final mile, what kind of gross margin? This could be pie in the sky. It could be maybe what you think realistically it might be, but how much are we talking here? Is this 100 basis points? Is it 500 basis points?
We have more work to do to quantify that. Okay. Yes, it's going to be a meaningful number. Yes, it could be a meaningful number. We're just getting into it, right.
We need to get a couple of more test markets. We need to line things up. We need to track the data and really understand what the data tells us where the opportunity is. And then we'll invest more aggressively around the biggest opportunities.
But to Gary's point with once the furniture is out of the box, good thing happens there's low returns and exchanges and all those things. So having a better customer experience, having lower returns and exchanges, all those things are just a lot of
Yes, it's going to be a big number. But I don't want to go out there and try to quantify it.
Hi, guys. So you guys put a slide up there that showed I believe a little over $700,000,000 of free cash flow.
Yes, go back to that slide.
Through 2020, first half of twenty twenty. Obviously as you guys said you could use that to pay down debt given that you could roll up the converts, given that you could refinance the debt at lower rates. What are some other things that you could potentially do with that cash or think about doing with that cash as it represents a pretty significant amount of your market cap still?
Sure. I mean at this point I do think we want to make sure that the debt levels are in check. So I do think we will be focused on paying down and having more general liquidity. That said, if we right now, we have these deals on the real estate. If we can do more of those ourselves and capture more of the value, that's absolutely something we would do.
There's a lot of places we can invest just in the business. I don't know if you're asking about acquisitions or buybacks or
Yes, let me jump on in this. I think we said 2017 was about execution architecture and cash, right. And we wanted to execute our new business model. We wanted to architect entirely new operating platform and we wanted to optimize cash flow by drive cash flow by optimizing inventory, reducing inventory and capital spending. And I think we're at the very early stage.
I think you're going to hear us say 2018 is about execution, architecture and cash. We just made a significant bet for the size of our company. We created a capital stack that has that's probably one of those favorable capital stacks. Private equity guys are sitting there going, how did you guys figure this out? We bought back $1,000,000,000 for our company at a net cost of debt of 1.3%.
That's a huge bet. We don't take that lightly. We have all our eyes focused, right on all the data, all the metrics and we are in first from just a capital structure point of view in risk elimination mode, right. And we believe we have a really good asymmetrical risk profile on this bet that I mean, look, where's the stock today? Higher.
Higher. Yes. I mean, so it's $105,000,000,000 We bought $1,000,000,000 of our company at $49 a share, dollars 49.66 what was the final price? Dollars 49.66 Okay. So we've already made $1,000,000,000 on this bet, right?
So we've already made over $1,000,000,000 on this bet in form a. We think the opportunity here is huge. If we execute, we sure don't want to go backwards on this. And we don't we're not going to take our eye off the ball here until we're completely clear, right? And that doesn't mean that we're missing any other opportunity, right.
But we don't need to kind of take on any other risk. If somebody said, hey, are you going to go out and buy a business or buy a company today? No, right. 2017 is the year of execution, architecture and cash. 2018 will be the year of execution, architecture and cash.
And when we really understand our business model, our membership model, as we architect this new operating platform, we will really understand what we've got here. We have something that in the early stages of this transformation looks really good. Okay, step back for a second and ask yourself, if we gave you 9% to 10% operating margins, do you think 10% s are high? Would you give that number, Right? No, but no, let's just be transparent here.
I don't want to play games. Like, no, seriously, like managing quarterly numbers and it's like, let's just be transparent, right? The model looks really good. And we're in the early stages of architecting the model. I've never been so excited about the inner workings and the opportunity of a retail model in my career.
Like, are we spending a lot of time in this model? Like, how granular are we getting on the moving parts of this business? Every part. We are putting all the intellect, right, all the curiosity, all the discipline, all the imagination, all the creative horsepower in this company into building a model that nobody's ever seen. I think we're going to extract more costs.
We're going to have better execution. We're going to have just leapfrog customer experience when we're done here. And everybody will talk about our model that we've architected, the operational model that we've architected with as much passion and respect as they talk about the galleries that we're building today or the products that we're building today. I think they'll also look back and say, boy, these things these people think deeply about capital. Like, wow, we thought they were crazy to buy $1,000,000,000 of our stock back based on the debt structure of the company.
I think we're going to look pretty smart, But we're going to make sure we don't screw it up. Okay. I'm the biggest shareholder of the company. I have the most to gain and I have the most to lose here. This is like 97% of my net worth.
This is not a casual investment. We have our weekly leadership review meeting. What are the headlines? The headlines never change. Execution and all the things that deal with execution, okay, architecture and all the pieces that deal with architecture and cash, right?
And that's what we're focused on. So if all of us in the cash gets better, are we going to go do any I just don't see us do anything that's there's no upside right now creating risk in this company. There is so much upside focusing and executing, so much upside. So and if someone asked me today, how am I thinking about the business right now? I would trade sales for profits right now.
I would trade a point or 2 of sales, right, for a couple of points of operating margin, if I see it, because I can always go back and get those sales. But if I don't get those operating margin points right now, right, well, we are deep into this, the guts of this business. If we don't architect this right now, if we lose focus, we look over here and we chase that bright shiny object, this is going to we won't be able to go back and rebuild it because the engine will be going and it is as hard when you take the car into the pit and you start taking you got to do it now. We've got to make this as great as we can right now and we've got to eliminate the debt risk in this company, right. Look, we know we're at the end.
We think we're late stages of an economic cycle. We know there's a level of risk we're taking on because of the economic cycle. But I don't know how to predict that. And I think we're in a kind of a different economic age. We have more companies that are worth $500,000,000,000 in the world today than in any time in history.
There's significantly more value created in the markets today than in any other time. We're in a new economic time. So like, look, the 7 to 9 year move or 10 year move that says we're going to go down and the economics are going to hit some kind of recession. I mean at some point we will, but it might look different this time. And by the way, we believe based on our internal data and how we think about the business and our interpretation of the new tax bill, the Republican tax bill that's out there, we think that's really good for our business and it's really good for our cash flow.
Okay. That bill gets passed in some form, current form. And by the way, we were happy to hear Home Depot say, they don't think there's a big economic hit if the tax deduction on mortgages go from $1,000,000 to $500,000 right? And we believe that too, our data is not as good as theirs. We're not as big of a company as they are.
We're probably not as good at analyzing those things. But we spend a lot of time in this stuff. We've spent a lot of time thinking about the capital markets, about the trends, about the economic environment. But our sense is that this new tax bill probably gives us another couple of year run. So if that goes through, we're feeling pretty good.
We're feeling it's the cash flow model here will be better, right? If our tax rate falls by half or 30% or 40%, our cash flow is going to get better. We think that the investment that's going to be caused by the tax bill in the economy is going to maybe it doesn't take the economy up, but we're not anticipating that. We're anticipating kind of just kind of keep on going, right? If it just kind of keeps on going, we're going to all these metrics will be some form of really good.
But we also know like, look, new data might come in, new data comes in every hour, every day. If it looks different, I mean, we know today we're pretty savvy capital market people. And the reason we are is we experienced to go private and we experienced to go public. We've had very smart people like Barry Sternlicht on our board, who really educated us and thought about capital markets. You don't learn this stuff growing up at the Gap, right, when you're a stock boy going through the ranks.
But we've learned a lot. And I think we think very differently about the capital markets and how to finance the company. And some people say like why did you take on the 9.5% debt? Why did you do the 2nd lien term loan? Like it's all math.
Our business is math. It's imagination and it's math. Those are the 2 most important pieces of the business. We borrowed $100,000,000 We structured a deal to take the loan out early at a cost of $7,500,000 We knew exactly what day we would start paying was a $26,000 a day of incremental interest. Yes, right.
We knew exactly what day we're going to be paying $26,000 a day of incremental interest above $7,500,000 And on that day we took out the $100,000,000 debt. And you say, wait a minute, you spent $7,500,000 for the debt. How many months did we have the debt or days do we have the debt? 3.5 months. So we paid $7,500,000 for 3.5 months of $100,000,000 but let's do the math.
So let's do the math of the same 3.5000000 3 months. We bought $100,000,000 of our stock at an average of $49 stocks at $105 today. So we made $115,000,000 right, minus 7.5. So we minus 7.5. So we netted $107,000,000 That seems like a good outcome.
We understand that math. We also know today, if we wanted to do a convert tomorrow, we know factually, we can do a convert tomorrow probably somewhere between 50 basis points and 100 basis points, right? So could we do a convert tomorrow for let's just make up a number. I'm not saying we're going to do this, but I want you to know how we think. That is important for you to know the DNA of this company and how we think.
If we have today total debt $482,000,000 where are we?
Yes.
Yes. Okay. So we have total debt of $482,000,000 So if we did it convert tomorrow, what's our average interest on the $482,000,000 was 3 point something? 3.2, okay. So if we did a $500,000,000 convert tomorrow, took out $482,000,000 of debt and we paid 50 basis points to that coupon, we're going to have a positive arbitrage of 2 70 basis points on $482,000,000 of debt.
Okay. And so you take the debt expected debt pay down $482,000,000 over a period of time, what would our debt pay down be? We'll get back to you with the exact number, but we won't know those numbers. We do this math. So we know initially it looks like a $14,000,000 arbitrage.
Okay. So is that interesting? Sure, that's interesting. We think about doing that? Sure, we think about doing that.
Why aren't you doing that? We feel really good about our business trends. We think our stock is going to go higher. We think we can do another convert at a higher price. We know that we have to pay 50 to 100 basis points because the stock borrow is tight.
It's optimal conditions to do a convert today. The stock borrow is tight because we have 47 percent of the stock outstanding short. We think as we continue to perform, we're going to run shorts out of the business and the stock borrow is going to loosen up and we think we can do another 0 convert. Yes. Hi.
We can't see who's got the mic.
Yes. So just a couple of quick questions.
Hi. Hi.
On the longer term sales and operating profit growth, can you sort of just give us a rank order of the biggest buckets, obviously supply chain, one of them on the margins. But what are a couple other how would that all fit together in terms of that 15% to 20% over time? Then the other thing is just on the membership growth. Any sense for what that's been on sort of a cash revenue basis? How that's been trending year over year as we've moved through 2017?
Yes. I think on the margin, when you think about the long term profit margin growth of business, probably give us let us completely finalize our plans for next year and tighten everything up. And we'll come out in the new year and provide I think greater degree of visibility into how we think the model is and where we think the model is going. It's clear, it's very clear to us today, it doesn't stop at 10.
And I would just add that real estate continues to be a single giant value creation opportunity for us as we take these smaller legacy stores into what you're about to go see as an example across the street. The sales volume, especially with the new kind of deals that Dave's getting done. However, we felt about real estate opportunity 6 months ago, it feels a lot better even today. So that's another big one obviously beyond supply chain. And then membership.
Yes, the 37% is cash without the accounting. If you did it just on an accounting basis because of the deferral last year, you'd be like 200% growth. But just cash for cash, that's the 37% growth.
We have a question right here.
Hi, good evening everyone.
So I want to take
a step back maybe a little bit bigger picture. You've been talking about the $4,000,000,000 to $5,000,000,000 in longer term revenues for a long time now. But a lot of the things we talked about tonight and things you just talked about recently, leapfrogging customer experience, better execution, things like that. And then even more bigger, the membership model and the Telias, how much of that was actually contemplated in the original guidance? Because it seems like having a $510,000 sale under the old model would have been nearly impossible with certain things going on sale at certain times, friends and family certain times a year, maybe that person is not ready to buy then.
Clearly that's your guidance and I understand that. But as we want to sit here and think about it ourselves, what was actually contemplated in that initial guidance that you gave now several years ago?
Getting to $4,000,000,000 to $5,000,000,000 Yes.
And then even in respect to that, next year guidance $2,600,000,000 only 15 galleries open now, dollars 5,000,000,000 with 50 more galleries open.
Right.
So I mean just the biggest value creators, right, the biggest bucket were the continued product expansion, right, and the real estate transformation. Those two pieces, if you just we just did the math, we easily got to $4,000,000,000 to $5,000,000,000 We do that same math today. We clear line of sight to $4,000,000,000 to $5,000,000,000 We have a document that has every single the great thing about our model and it's Carlos Alberni is the co CEO with me and he will be here. Is Carlos here? Carlos going to be here for dinner.
Yeah, this is right now. He's super excited. I tried to get him here earlier. I would have him on stage with us. But Carlos had a really good way frame this because this is what's amazing about this is we have a you have a test, we have a test in every market.
With almost every one of these markets that we have an implied new gallery, we have a gallery. And we have data that says when we go from this square footage to this square footage, when we go from this much outdoor presentation to this much outdoor presentation, we go from this much bedroom to this much bedroom, here's what the lift will be, right? And we've got that calculated out for every single market. And then we've got the few markets where we don't have a gallery, right, calculated out. And I think we're going to be pretty accurate, right?
So that right there is the fundamental piece that gets you to $4,000,000,000 to $5,000,000,000 And then you've got some other product category growth. We there's kind of ways that we can kind of frame the business as you've seen us do in the past. And we'll probably bring back big style, small spaces and objects of curiosity and some things where big style, small spaces, we thought we could be more productive by kind of moving it back into the core book. And as we've done it, I think you don't see it as a customer. We're not optimizing people that have smaller homes or apartments and things like I love RH's style, but I feel this big furniture, right?
And so whether it's bringing back big style small spaces in its form as a source book, What else there we did?
Possibly leather.
Yes, yes. RH leather, we did a leather book, but objects of curiosity, we just bought it wrong. We got over inventoried and then we're like, oh, shit, it's going to take us too long. And that was when we had all these promotions and 25% growth. So inventory accuracy on buying back then really, really difficult with our goods.
So it's really a different company today and way more predictable and way more clear. And we got off that crazy racetrack. We had comparable store sales of plus 25% I think for 4 straight years. I don't even know if anybody's ever done that in retail before. And to do that like you're focused on it, right?
We came out in the racetrack. We were a high growth company. We kept growing. We did it really well. It's not sustainable.
I'd never try to do that again. Like if I had to do if I had to play this movie, Ken, I would have came out and grown the business at 12% to 15%. And we were just that type of stuff. That's okay. We learn and we're less smart enough, right?
And
yes.
I've got
2 questions if
you could. Can you go back to the line that you showed of the volatility historically of your sales, which was very lumpy and you explained that elegantly in terms of sales on leather, sales on this, sales on that, and that drove the business. I would have thought the line underneath wouldn't be as volatile, which I get, but it was almost flat, which I find hard to believe because furniture sales are still episodic, right? If it rains in New York where I'm from, you're not shopping on Saturday or Sunday.
So I would
still think I would see some volatility as evidenced even by the team before who talked about the $500,000 sale. There still should be some volatility, it should be muted. But how are you controlling that? Are you controlling the delivery times?
So if somebody orders, it just
it makes no it sounds intuitive to me that it would flat line.
Well, it's not completely flat. It still moves. Yeah, like 500 dollars like if we're doing roughly $40,000,000 or $50,000,000 a week, right, a $500,000 sales is going to move the business a little bit like right point. It's not making the business go up 30%. Right.
So I mean, our business is really consistent. We now we used to be a big furniture business in December. In the industry, it's the worst month for furniture because on vacation in December. We created an abnormal business in December and an abnormal smaller business in January by pull forward. So Christmas takes a little bit of a dip because people aren't buying furniture and then it comes right back in January.
So it's just So is the
foot traffic less volatile
or could you connecting I know,
because you're connecting with your customers and their loyalty, you're driving sales however it may be in a less volatile manner.
Yes, yes. No, this is just we're not really a foot traffic business, right. I mean we get we know because of the restaurants we can get an incremental people like if we just we all step back and think about it, right and get like how often do you go to a furniture store? Not very often, right. Our business is really an event business is driven by people that buy new homes, that are remodeling a home and that are redecorating a home, right.
And then we get a layer of business that is people coming in seeing a new chandelier, people getting the source book seeing something that we drive desire and drive need and so on and so forth. They come into a gallery, they go into Chicago with a friend and they have dinner and they're sitting there and they would have never gone to a furniture store. And so now they're in a furniture store and they see this amazing bedroom and they're like, honey, let's redo our bedroom, right? But our business is not really a foot traffic business. And that's why we can pursue the real estate model we can.
I mean, no one's walking by just like walking down the mall and like, oh, there's a couch, let me buy a couch. This is not like it just doesn't happen, right? And that's why we're re architecting a lot of ways business. It's just it may not be intuitive because maybe you've never worked in the furniture industry, right? It's super intuitive.
Jason Camp, where are you, Jason? Yes. Yes. I mean Jason Camp was President of Bassett, like it's of like that, isn't it, unless you're doing crazy promotions. I mean there's no furniture business in December really, so it goes in the last few weeks, it goes like that.
But we're all learning like, okay, I used to sell jeans and T shirts, right? And then I sell cookware, right? And then some really smart merchant at Pottery Barn while I was there and Williams Son was there and named Hillary Billings said, let's like put a soap on the cover of the Pottery Barn catalog. When we used to sell Pottery Barn was like 60% of business was tabletop, you know, and then we had accessories. And she put a white slip covered sofa, you know, shabby chic kind of thing on the cover of Pottery Barn and it was the best selling item in the company.
2nd question if I can. On the delivery business, when do you think you'll do 100% delivery and what do you think that will cost you? I know it's going to be materially better. I know it's going to result in better savings, less breakage and all other stuff, but you're basically taking what was historically a variable cost, which was an outsourced cost, which wasn't and turning into a fixed cost, which so I just want to understand what that fixed cost will be 2 to 3 years out from now once you've fully brought that in house?
Well, 1, I don't know if we will fully bring it in house. I don't know what percent might be partnerships. All I know is that we're going to create a luxury customer delivery experience. It may be a hybrid. Right now we're testing, okay.
We're testing in house in the Bay Area market. We'll be testing in another market soon. We are working we just had all of our 3rd party providers here yesterday. We're setting our expectations. We're going to sit down and conceptualize and put strategies together to build a luxury customer experience.
And what percent will be in sourced versus outsourced, I don't know yet. And I don't I mean, we're just going to do what's smart for the business, right? And we're going to do what creates great customer experiences, which gets customers to buy more and be more loyal to the brand and we're going to do things that's right for the operating model of the business. So we're not going to sit here today and say like in 3 years, we're going to be 100 percent in source and we don't know what the capital is or it's going to cost, it's going to deleverage the company 200 basis points or if that would not be a really smart thing. So we're just going to do smart things for the business.
We think directionally we're identifying today there's a huge opportunity. We know the metrics when we execute when we don't execute a delivery well, there's massive cost. You have to send another truck, you have to pick up the goods, you got to sell the goods, send it a markdown, you've got all kinds of costs when you don't stick furniture. So yes, we'll let you know as we know more. Tim, we have a question right here.
Thanks a lot. Two quick ones. The first relates to inventory. So you're obviously pretty early on in your journey of changing the model around your turns are kind of 2.7, your prior peak is 2.6. Where do you think you can take inventory in the business if you think longer term about supply chain and what the opportunities are?
Can you get above 3 times over time?
Yes. It's a funny question because you guys look at inventory externally reported with occupancy and all that stuff and we don't really look at it that way. We'll get inventory against inventory turns, right, just pure inventory turns.
On the external basis based on what we know we're going to end this year and where we're heading next year, I would say yes, that's achievable.
Yes, that's very achievable. But on an existing inventory to an inventory basis, I showed you a slide that said we had 1,100,000 units of furniture and a slide that says we're going to end with 535,000 units of furniture. And then you can probably do that Matt.
There you go. Second question on the membership numbers, huge number that you shared with us. What are you seeing in terms of new member growth versus retention or or people as you're now a number of months cycling membership. What are you seeing in terms of people coming back? Are they coming back proactively?
Are they kind of falling into it? And to what degree does renewal you find relate to actually doing more business with you?
Yes. We really like what's happening right now. We like the metrics as far as renewals. We like the metrics as far as new numbers. And we are just learning where we can allocate more resources to make those metrics look better, right?
Like what we're just we're learning. Like for instance, in one of the biggest leakages of membership renewals, Those people when they sign up, they have a choice of saying, hey, renew me or don't renew me. And we have a very high percentage that are on automatic renew. But the biggest problem with automatic renew is you've got all this cybersecurity and credit card data breaches and so on and so forth. People are getting new credit card numbers at a higher rate than any ever in history.
And I think it's got to be wreaking havoc on a lot of models like this. It's interesting, I am a member of the Soho House and the Soho House would charge my card for my $2,700 membership on my credit card. I just got a thing a few months ago that said that now to renew, I have to give them my checking account or bank account number and they're no longer taking credit cards. And the dots connected for me at best. This is because more members are falling out and then they're having spent expense trying to find the members, trying to get people to sign back up and so on and so forth.
So we're just learning a lot about this stuff. But the biggest leakage is that you go to hit the credit card and automatic renew and it doesn't work because they either lost their card or there's a credit card breach or like we all get these things now. It's like, hey, was this a real bill? I mean, so there's lots of opportunities like that for us. I mean, we think the numbers will get better based on what we know today, but we like all the metrics.
We really feel good about the membership model.
We
have a question over here.
Gary, thanks very much for the discussion of the capital structure. That was really helpful. I was wondering if you could dig into the 2018 bridge a little bit, help us understand conviction in delivering particularly that exceptional margin expansion next year? What gives you that conviction? Help us see the vision?
Yes, we feel tons of conviction about the numbers that we gave you, right. And a big part of it is really clear. We know how much inventory we move through outlets through warehouse sales and we tried to burn down inventory and we know what the margin is going to look like. And so far, our math is more right than wrong, right? I mean, in the last couple of quarters, we've been more right than wrong.
And I mean, the cost savings that we're going to get are real. We're closing 2 DCs, right. That's real money. We're not taking all the goods back all the way to the DCs. All the transportation costs are going to come out.
We're not handling all the second quality goods and handling it. How many touches we eliminated? I think 6 touches, something like that. And we're taking it straight to an outlet. So the goods in the outlet are going to be higher quality.
They're going to be fresher goods. And we're going to have matching parts. We actually take sectionals. Okay. We'd have a sectional sofa that got returned.
And we go all the way back to a DC. Well, a sectional is a bunch of SKUs. It's a right arm, it's a left arm, it's a middle section, it's a chest piece and you buy the pieces and you come together. The return on the sectional, you get a leather sectional return. It might have been a scratch in leather, might have been something perfectly good piece of product that people would pay real money for, goes back to a DC, gets checked back in as individual SKUs and then gets was getting distributed out to the outlet stores as individual SKUs.
So we'd have like a right arm with nothing else. And we had a middle thing was set and so the outlets were full of all these like oddball SKUs. That's not going to happen anymore, right. So now it's like gets picked up as a sectional, it gets taken to the outlet as a sectional and it doesn't go back to a DC and get held and checked in as individual SKUs. I see some men's room.
I'm going to let you guys take the questions for a second. I'll be right back. Yes.
And I think that we do have kind of known labor savings and known rent savings and known we've been doing the transportation reversing since July. So that's what's giving us some of the confidence with that here. Now it's not going to be 100% of that $15,000,000 to $20,000,000 because we're getting some of that this year.
Question on your far left.
How are you doing? Thank you. I was wondering if you could talk about the $240,000,000 free cash flow next year and just some of the building blocks to get to that. Obviously, already pointed out inventory, but anything else you could add along those lines?
Yes. I mean, the 3 biggest pieces are just that higher sales, higher earnings flow through the inventory. And then we gave the new capital number. We've been running it, call it, dollars 130,000,000 of capital and to knock that down to that $65,000,000 $75,000,000 range is pretty meaningful as well. Those are really big three pieces.
Take a question up here.
Hi. So I guess a couple of questions on real estate. One, with the larger format stores, is there as they begin to mature, have you seen any significant difference in performance between the units? Is there
No, other than like what I would say like Houston when there's a hurricane, like when there's something going on with that market, but no, I think that when there's something geographical going on in the area, obviously that's impacting that entire market, but nothing that's saying like at the 3 year mark, it stagnates and something happens. No. And we've had quite a few years now with some of these being in place. So we feel really good that they will continue to comp positive and that even in the market, the online market around it is performing well also.
And then second question I had just with respect to Modern. You guys again highlighted as a very powerful potential powerful brand. As we think about the evolution of Modern, you have a store out in Southern California and LA. Will it be a stand there will be other standalone Modern stores that will be more incorporated within the larger format galleries? And then to what extent now as you watch those sales, are they incremental or potentially cannibalizing sales of other products and with non Modern type products?
Yes, sure. So, 1st on the real estate, at this point, other than maybe, I don't know, I'd never say never on like a Miami, I would say it's going to be a floor in the current galleries. That's our current thinking. One of the reasons we did it in LA is we already had the full line design gallery. It wasn't big enough to put modern and then we had a really advantaged real estate option with that modern location.
So it was a perfect place to test. So that market, especially because it does lend itself to modern, you could probably replicate that in Miami and some of the other really urban areas. But for the most part, it will be a floor and it will kind of the size of that floor and the size of the space dedicated to modern will be really based on kind of the market and kind of what the architecture in that market is. And then secondly, I'd say the reason why Gary is so positive and we feel so strongly about modern is it has been much more incremental than even we had thought in the beginning. It's truly just, if your house and your architecture is modern or not.
It really does determine and there's more and more modern architecture that's leading people to get that kind of furniture. So I think we do believe that it's absolutely going to be a $1,000,000,000 brand and it's been highly incremental to our other sales that we've had in the past.
Our modern gallery in LA is about half a mile from our full line design gallery on Melrose and we're pleased with both results of both galleries.
Yes, it was kind of telling when that opened, we thought, hey, we're going to see a dip on this other one and they both kind of rose with the tide.
Another question right here.
Over here.
Regarding the supply chain redesign, can you just expand on how much confidence you have in the ability of the brand to consistently delight its customer, maybe as we kind of think about what happened back in 2016? And given that you just had the Vendor Day, right, touch on how the relationship with your vendors has evolved to make sure the availability and timeline expectations will be met?
Sure. So that's kind of 2 things. When we talk about supply chain redesign, we're really talking about delivery. The vendor piece, meaning like where we get the furniture from and supply is kind of a totally separate issue. I'd say we're working even deeper and more collaboratively with our vendors than ever.
And we've talked about before the fact that the top 25 vendors are 80% of our volume. So especially those top guys, we're working with them all the time. Are they going to every once in a while flip up? Maybe. But I think what happened with modern will never happen again based on all the things that led up to that with the bigger book and it was kind of products that we didn't have the same kind of experience with the manufacturing processes.
So I'm not really concerned that that kind of a mishap will happen again. Will there be things where we just don't know it's going to be a best seller and it takes long and we have back orders that's going to happen all the time. And then I think with the home delivery experience, it's people are delivering our furniture. So I think right now we know that it's not where it needs to be. Will it ever be perfect?
No. Can we make a lot of investments to train and hire better people and pay them better and have better SOPs and processes in place to make sure that they know what great looks like, absolutely. And I think we can get we can go from here to here, will we ever get to like here, who knows if it will ever be perfect, there is always going to be someone who is not happy I'm sure.
And then as a follow-up, so you talked to Gary talked about kind of the 2 trade design centers, the opportunity for RH interior to kind of disrupt that. So can you help us better understand talent acquisition right within the company and who you know the quality of the interior designers you're putting forth to drive disruption?
Yes, I'll probably turn that over to DP because he's at the heart of that effort. Yes, absolutely.
Yes, it's been a mission of ours to ensure that we attract the best talent that is out there. So we don't have a model where we take a sales associate, put them through a 2 or 3 week training program and then call them an interior designer. They have to have domain expertise. So that means they have to have background in interior design, they have to understand interior design. Many of them are interior designers in previous size that have then come to work for us.
So we spend a lot of time vetting the talent and ensuring that we have the right talent before we make the decision to hire. As you can see from the designers that came up and had a conversation with you, they're not fresh out of school designers. They're designers that understand design and have worked in design before. You're welcome.
Hi. I had a follow-up question on real estate. Does the new real estate model to the development deals change the way the number of stores you're opening a year? And then with hospitality, are you looking at where you place the stores in the markets in a different way? It seems from the commentary that perhaps locations that you chose a couple of years ago if they had had hospitality would have been different today?
Dave, you want to take the number of deals question? Sure, sure.
I think we've gone up we said we're going to be at about 3 to 5 galleries per year and we're highly confident in that and that won't be a problem. The hospitality I think has given us the question was asked to me before, how does that change things? And quite frankly, it Chicago has proved out that we are a traffic generator on our own to go into a residential neighborhood like the Gold Coast and really be in our element with our customers and to be able to bring them there and keep them with us, it gives us tremendous flexibility. So before we might maybe have legacy stores are in malls and you're kind of locked into the mall footprint. Today, like the entire field is open to Today, like the entire field is open to us and we're able to get into great places like the Gold Coast.
The other nice thing about our model is we're a gallery model. So we don't have loading docks. We don't really have a situation where to bring trucks in and have a cash and carry business. So it allows us to be really close to our customers in these really inspiring spaces.
Couple of questions on the outlets.
How many are there now? How many will there be?
You're doing them in store in market clearance that says that you should have probably more outlets going forward?
Yes. Right now we have about 28 or 29. I'll have to look exactly and I'd say we'll have I think one more by the end of the fiscal year. By next year we'll open 2 or 3 more doors and you're absolutely right that they're not all perfectly situated for the reverse model to be kind of shorter distance, lower transportation costs. So over time, we had opened several pop ups.
Those might reposition a little bit and is the right number 35 or 40, we'll kind of figure that out. It depends how close we can get them in between the home delivery centers to minimize reverse logistic costs.
And have you figured a size out that you want for those?
So far the 15 to 20 size has been well for us, but it depends on the size of the market. If it's a smaller market, we don't want to have it have it, it might be a smaller outlet. Yes. My sense is we're
going to test a lot of things. We're going to test smaller outlet stores closer to our full price stores. Yes, we want to take closer instead of customer having let's take the Bay Area. We have a highly productive store in Corte Madera near our corporate office. Closest outlet is Vacaville.
It's a day trip for people to get up there and give back, right? And today, when we say think about time value, you might have a really good customer that can afford to do their living room and their master bedroom, but they've got 3 more bedrooms in their house and they want a deal. And so they want to go look at your outlet. Now you're telling them you have to take a day trip, drive to Vacaville and you don't even know what's in the store. You're not going to know when you're there.
And then if it's not a good trip, you're going to drive all the way back. Our sense is have if I take this market for example, take that market for example, it's probably better to have an outlet in San Rafael or in Nevada and they're 15 minutes away, 20 minutes away and you're going to turn the inventory faster. They're going to look at it more times. You're not doing a big day trip. We think there's a lot of opportunities there.
So we'll keep fiddling with this and evolving it as we go. But we think we see a lot of opportunity in the outlet model and in the reverse logistics business.
And just one question on the convertibles, Karen. That you can settle if you're going to settle them in cash, isn't there a strict restrictive corridor of when you can settle them in cash? Isn't it like 90 days before the due date or is there or can you do you have an option as to when you can settle those in cash?
We can always settle them in cash.
So you can declare them at any time? We
have to deliver shares if it's over and my banker friends are in the back we have a resident. Well, yes, they're non call. Yes, so we have to wait until it gets closer to maturity. Right.
I thought there was like a 90 day period, right. There's a non call provision,
but there's nothing that would force us to sell it in shares.
Okay.
The base that is above that $116,000,000 in my example, we do have to deliver shares below it's our election.
Thank you. We have another question right here.
Hi. Just a couple of quick questions I'm curious about. I assume with the hospitality that the stores the galleries that have the restaurants that they're ramping at a higher sales level because you have higher traffic, maybe you can validate that for me, I'm not sure. Also I'm wondering about your promotional strategy, how set is it in stone, you have your clearance, the members get a higher rate of discount on the clearance, there's some textile promotions that go on now and then. How is that evolving?
Is that set in stone? And just lastly, Gary, you said something interesting about the New York store that that construction could go on and on. I mean, I live in New York. I know what you mean. But will that store open in the Q1?
Or do you anticipate that it will ramp at a Yes.
1st or early Q2. I think based on what we know today of the street schedule and when it will all be paved and when all the is come
down, yes. And the restaurant will open at the same time? Yes. Okay. And should we think maybe because of that construction that that store won't ramp at the historical rate that a major flagship would?
If the
district is still ripped up, we'll probably set lower expectations for it in the 1st few months. Yes, I mean just for instance, we just opened in Toronto, we're at the end cap of a new wing of the mall. It's 100 yards before a store. They haven't filled it in yet. So our plans are for that store to ramp slower as yes, yes.
But our plans are our plans would just be logical based on a neighborhood, based on a development, based on construction and so on and so forth as that relates. And then your question about the restaurants, we've only had one open for 2 years and we just opened Toronto 30 something days ago. 4
weeks ago.
4 weeks ago. 4 weeks ago. And West Palm is not open yet, right. So we have a test of 1 and we have a second test for 30 days and we're still learning. I mean we anticipate because the numbers were so good in Chicago that they'll be I want to say the numbers, not just the numbers, but the restaurants.
I feel very confident that what we're going to put together from a food experience business. Under Brendan's leadership, I think we're at least in the first two so far, it looks really good. And if you haven't had our food, I think you get to try some tonight. I think you'll enjoy it. The thing that we still have to learn about is what's the translation and the incremental opportunity right from the traffic that translates into higher revenue sales because we really look at this as an integrated model not a standalone restaurant model, right.
Like so we built the model in Chicago to say, look, we know what the store would be doing, right? Just our 2x or 2 to 5 2.55xx, whatever the 1st year is modeled at. And we're pretty accurate at that. And we added the restaurant and it looked to have a significantly higher lift, right. And so we need a few more under our belt to know what is the predictable lift.
So and we're pretty conservative in our estimates and what we're estimating right now. So I'd say my sense would be there's more upside than downside. As you think about how we think about the business going forward, as you think about like 3, 4, 5, 6, 7, 8 restaurants coming online over the next 18 months?
The time check is 6.20. I don't know if we want to do 1 or 2. We'll be obviously walking around within the gallery. I don't know how many more we want to take before we have breakfast for the tour.
Yes. We take a couple of questions. Yes. We can't say anything, guys. So we're blind.
We have a couple more hands up.
Okay. Let's give it to you 2 more. Something I don't think
you touched on here today was marketing and source books. I was hoping you could just talk about the evolution of the books, how that may change going forward and what role we might see digital play in marketing in the years ahead?
I mean, Erika, you want to comment on maybe that?
The evolution of the source books, we continue to always be really critical of our work and see what's working, what's not. Just to give you an example, the fall source book that recently got in home, we made considerable updates from last year's book. As Gary mentioned previously that last year we felt like we skewed the aesthetic and the style perhaps a little too contemporary. We also perhaps walked away from some of our key sellers and key franchise businesses. And so just really looking at that this year's book, we really leaned into those businesses and we also brought back a more classic updated look.
And so we're always looking to update and evolve the source book strategy.
Yes. And I think the other thing I'd add to that is what Harry brought up and we talked about a little earlier, as you may see more specialty books come back out, you might see big style small spaces reappear, you might or might not. We're working through those ideas. You might see objects of curiosity reappear. You might we test a lot of things all the time.
We're constantly testing and measuring and monitoring. And the good thing about the catalog source of model, it's a pretty low risk test, it's a pretty low capital test. We can buy small enough inventory, put it in a single DC mail books to select segments of our file and see our response rates. And if they're doing well, we can grow them. I think what would have us back off on some of those things is we were doing it during the wild growth years and we just come by the inventory accurately.
And so it was just made the test have a higher risk profile. Another question on your right side.
Just two quick ones for Karen on SG and A. I think when I look at your SG and A over the past just the past two quarters, it's been up kind of 12%, 15% -ish. But on a per square foot basis, it actually declined pretty meaningfully. So maybe just talk a bit on what's going on there? And secondly, now that you have source put back in, I think in maybe one of the previous 10 ks sort of disclosed as a $30,000,000 benefit on timing, how does your SG and A look moving forward now that source is sort of up and running again?
Could you repeat the second question?
So on source, I think when you took when that wasn't happening, there was a 30,000,000 ish benefit that you disclosed in your K. I'm not sure that's exactly what source is, but now that it's back in, is there does it change the run rate of SG and A moving forward?
So I think maybe you are referring to the timing of the source book?
Yes.
Okay. So that's a great question because we do have what our source book strategy is, every year does have a meaningful impact on our SG and A. They impact sales, course. But last year, when we didn't have a book in the spring, we had a lot of leverage. Our sales were impacted, but we had the lower SG and A because of those books.
And then in the fall, they came in home later. So this year, when we had the book, we both had the modern book earlier in the spring and then we had the books landing in the fall. There is some deleverage on the SG and A line in general this year versus last year. We're not yet speaking to specifics on SG and A for next year as it relates to source books just because the timing number, depth of the mailing, etcetera, is not 100% known. But that is a lever and something that does impact SG and A.
With respect to the last few quarters, some of the savings, I think people tend to say, oh, it's transportation and it's occupancy related to some of these initiatives in the DCs, but there's a people element to all of those. So we have had compensation savings in the DCs just from the trend everything that gets transported also gets handled and then having some of the people costs come out of as we close these DCs that's something that will impact next year as well.
No more hands. Okay. So let's go take a look at this. What we believe is the greatest
It's raining.
It's raining
a bit.
Yes. Yes. So those are the previous ones
you've done?
Yes. Well, so is it raining right there right now, Cam? It's still raining.
There's a farmers market.
There is. Okay. Well, let's not go through the little gallery if there's a farmer's market over there. So we have umbrellas for everyone. Yes.
Depending on how let's all meet in the main lobby. Let's go up to the main lobby. Let's get the umbrellas. Let's assess the range and then we'll kind of detail the plans from there.